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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From to

Commission File Number: 001-07260

 

 

Nortel Networks Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Canada   98-0535482

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

5945 Airport Road, Suite 360

Mississauga, Ontario, Canada

  L4V 1R9
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number Including Area Code (905) 863-7000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of November 8, 2010.

498,206,366 shares of common stock without nominal or par value

 

 

 


Table of Contents

 

TABLE OF CONTENTS

 

          PAGE  
   PART I   
   FINANCIAL INFORMATION   

ITEM 1.

  

Condensed Consolidated Financial Statements (unaudited)

     1   

ITEM 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     62   

ITEM 4.

  

Controls and Procedures

     121   
   PART II   
   OTHER INFORMATION   

ITEM 1.

  

Legal Proceedings

     122   

ITEM 1A.

  

Risk Factors

     123   

ITEM 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     124   

ITEM 6.

  

Exhibits

     124   

SIGNATURES

     125   

All dollar amounts in this document are in United States Dollars unless otherwise stated.

NORTEL, NORTEL (Logo), NORTEL NETWORKS, the Globemark, and NT are trademarks of Nortel Networks.

MOODY’S is a trademark of Moody’s Investors Service, Inc.

All other trademarks are the property of their respective owners.


Table of Contents

 

PART 1

FINANCIAL INFORMATION

 

ITEM 1. Condensed Consolidated Financial Statements (unaudited)

NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Condensed Consolidated Statements of Operations (unaudited)

(Millions of U.S. Dollars, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009         2010     2009  

Revenues:

        

Products

   $ 72      $ 865      $ 478      $ 2,582   

Services

     13        77        114        223   
                                

Total revenues

     85        942        592        2,805   
                                

Cost of revenues:

        

Products

     81        484        452        1,476   

Services

     7        24        40        75   
                                

Total cost of revenues

     88        508        492        1,551   
                                

Gross profit

     (3     434        100        1,254   

Selling, general and administrative expense

     108        141        409        494   

Research and development expense

     3        173        106        574   

Amortization of intangible assets

     —          (1     —          (2

Loss (gain) on sales of businesses and sales and impairments of assets

     —          15        3        (1

Other operating expense (income) — net (note 6)

     (94     44        (250     41   
                                

Operating earnings (loss)

     (20     62        (168     148   

Other income (expense) — net (note 6)

     (18     57        14        17   

Interest expense (contractual interest expense for the three and nine months ended September 30, 2010 was $81 and $237, respectively (2009 — $79 and $236, respectively))

        

Long-term debt

     (77     (75     (227     (224

Other

     —          —          —          (1
                                

Earnings (loss) from continuing operations before reorganization items, income taxes and equity in net loss of associated companies and Equity Investees

     (115     44        (381     (60

Reorganization items — net (note 5)

     (529     (224     (1,420     (290
                                

Loss from continuing operations before income taxes, and equity in net loss of associated companies and Equity Investees

     (644     (180     (1,801     (350

Income tax benefit (expense)

     4        (8     37        (21
                                

Loss from continuing operations before equity in net loss of associated companies and Equity Investees

     (640     (188     (1,764     (371

Equity in net earnings (loss) of associated companies — net of tax

     —          (2     (1     (3

Equity in net loss of Equity Investees (note 22)

     —          (159     (50     (448
                                

Net loss from continuing operations

     (640     (349     (1,815     (822

Net earnings (loss) from discontinued operations — net of tax (note 4)

     (5     (157     28        (451
                                

Net loss

     (645     (506     (1,787     (1,273

Income attributable to noncontrolling interests

     (4     (2     (11     (16
                                

Net loss attributable to Nortel Networks Corporation

   $ (649   $ (508   $ (1,798   $ (1,289
                                

Basic and diluted loss per common share — continuing operations

   $ (1.29   $ (0.70   $ (3.66   $ (1.68
                                

Total and diluted basic loss per common share

   $ (1.30   $ (1.02   $ (3.60   $ (2.58
                                

The accompanying notes are an integral part of these condensed consolidated financial statements

 

1


Table of Contents

 

NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Condensed Consolidated Balance Sheets (unaudited)

(Millions of U.S. Dollars, except share amounts)

 

     September 30,
2010
    December 31,
2009
 
ASSETS     

Current assets

    

Cash and cash equivalents

   $ 1,686      $ 1,998   

Short-term investments

     —          18   

Restricted cash and cash equivalents

     177        92   

Accounts receivable — net

     193        625   

Inventories — net

     29        183   

Deferred income taxes — net

     —          24   

Other current assets

     272        348   

Assets held for sale (note 8)

     269        272   

Assets of discontinued operations (note 4)

     18        148   
                

Total current assets

     2,644        3,708   

Restricted cash

     3,062        1,928   

Investments

     —          117   

Plant and equipment — net

     132        688   

Goodwill

     —          9   

Intangible assets — net

     —          51   

Deferred income taxes — net

     —          10   

Other assets

     112        177   
                

Total assets

   $ 5,950      $ 6,688   
                
LIABILITIES AND SHAREHOLDERS’ DEFICIT     

Current liabilities

    

Trade and other accounts payable

   $ 155      $ 294   

Payroll and benefit-related liabilities

     85        128   

Contractual liabilities

     82        93   

Restructuring liabilities (notes 10 and 11)

     6        4   

Other accrued liabilities (note 6)

     145        660   

Liabilities held for sale (note 8)

     9        205   

Liabilities of discontinued operations (note 4)

     29        53   
                

Total current liabilities

     511        1,437   

Long-term liabilities

    

Long-term debt

     —          41   

Investment in net liabilities of Equity Investees (note 22)

     —          534   

Deferred income taxes — net

     —          7   

Other liabilities (note 6)

     50        226   
                

Total long-term liabilities

     50        808   

Liabilities subject to compromise (note 20)

     9,317        7,358   

Liabilities subject to compromise of discontinued operations

     117        129   
                

Total liabilities

     9,995        9,732   
                

Guarantees, commitments, contingencies and subsequent events (notes 2, 14, 16, 23 and 24)

    
SHAREHOLDERS’ DEFICIT     

Common shares, without par value — Authorized shares: unlimited; Issued and outstanding shares: 498,206,366 as of September 30, 2010 and December 31, 2009 respectively

     35,604        35,604   

Additional paid-in capital

     3,597        3,623   

Accumulated deficit

     (43,675     (41,876

Accumulated other comprehensive loss

     (189     (1,124
                

Total Nortel Networks Corporation shareholders’ deficit

     (4,663     (3,773

Noncontrolling interests

     618        729   
                

Total shareholders’ deficit

     (4,045     (3,044
                

Total liabilities and shareholders’ deficit

   $ 5,950      $ 6,688   
                

The accompanying notes are an integral part of these condensed consolidated financial statements

 

2


Table of Contents

 

NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Condensed Consolidated Statements of Cash Flows (unaudited)

(Millions of U.S. Dollars)

 

     Nine Months Ended
September 30,
 
         2010             2009      

Cash flows from (used in) operating activities

    

Net loss attributable to Nortel Networks Corporation

   $ (1,798   $ (1,289

Net (earnings) loss from discontinued operations — net of tax

     (28     451   

Adjustments to reconcile net loss from continuing operations to net cash from (used in) operating activities, net of effects from acquisitions and divestitures of businesses:

    

Amortization and depreciation

     51        139   

Non-cash portion of cost reduction activities

     —          18   

Equity in net loss of associated companies — net of tax

     1        3   

Equity in net loss of Equity Investees (note 22)

     50        448   

Share-based compensation expense

     —          73   

Deferred income taxes

     (6     8   

Pension and other accruals

     83        153   

Gain on sales of businesses and impairments of assets — net

     2        1   

Income attributable to noncontrolling interests — net of tax

     11        16   

Reorganization items — non cash

     1,279        265   

Other — net

     424        (479

Change in operating assets and liabilities (note 6)

     129        418   
                

Net cash from (used in) operating activities — continuing operations

     198        225   

Net cash from (used in) operating activities — discontinued operations

     (377     (4
                

Net cash from (used in) operating activities

     (179     221   
                

Cash flows from (used in) investing activities

    

Expenditures for plant and equipment

     (8     (26

Proceeds on disposals of plant and equipment

     —          87   

Change in restricted cash and cash equivalents

     (1,221     (82

Decrease in short and long-term investments

     24        40   

Acquisitions of investments and businesses — net of cash acquired

     (3     (1

Proceeds from the sales of investments and businesses and assets — net

     987        6   
                

Net cash from (used in) investing activities — continuing operations

     (221     24   

Net cash from (used in) investing activities — discontinued operations

     203        7   
                

Net cash from (used in) investing activities

     (18     31   
                

Cash flows from (used in) financing activities

    

Dividends paid, including paid by subsidiaries to noncontrolling interests

     (19     (6

Decrease in notes payable

     —          (41

Repayments of capital leases

     (4     (7
                

Net cash from (used in) financing activities — continuing operations

     (23     (54

Net cash from (used in) financing activities — discontinued operations

     (77     (29
                

Net cash from (used in) financing activities

     (100     (83
                

Effect of foreign exchange rate changes on cash and cash equivalents

     11        51   

Reduction of cash and cash equivalents of deconsolidated subsidiaries

     (26     —     
                

Net cash from (used in) continuing operations

     (61     246   

Net cash from (used in) discontinued operations

     (251     (26
                

Net increase (decrease) in cash and cash equivalents

     (312     220   

Cash and cash equivalents at beginning of the period

     1,998        2,397   

Less cash and cash equivalents of Equity Investees

     —          (761
                

Adjusted cash and cash equivalents at beginning of the period

     1,998        1,636   

Cash and cash equivalents at end of the period

     1,686        1,856   

Less cash and cash equivalents of discontinued operations at end of the period

     —          (346
                

Cash and cash equivalents of continuing operations at end of the period

   $ 1,686      $ 1,510   
                

The accompanying notes are an integral part of these condensed consolidated financial statements

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited)

1. Basis of presentation

All monetary amounts in these notes to the condensed consolidated financial statements are in millions, except per share amounts, and in United States (“U.S.”) Dollars unless otherwise stated.

Nortel Networks Corporation

Prior to Nortel’s significant business divestitures (see note 2), Nortel Networks Corporation (“Nortel” or “NNC”) was a global supplier of end-to-end networking products and solutions serving both service providers and enterprise customers. Nortel’s technologies spanned access and core networks and support multimedia and business-critical applications. Nortel’s networking solutions consisted of hardware, software and services. Nortel designed, developed, engineered, marketed, sold, licensed, installed, serviced and supported these networking solutions worldwide. As further discussed in note 2, Nortel is currently focused on the remaining work under the Creditor Protection Proceedings (as defined in note 2), including the sale of the remaining businesses, providing transitional services to the purchasers of Nortel’s businesses and ongoing restructuring matters.

Nortel Networks Limited (“NNL”) is Nortel’s principal direct operating subsidiary and its results are consolidated into Nortel’s results. Nortel holds all of NNL’s outstanding common shares but none of its outstanding preferred shares. NNL’s preferred shares are reported in noncontrolling interests in the condensed consolidated balance sheets.

Basis of Presentation and Going Concern Issues

The unaudited condensed consolidated financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) and do not include all the information and notes required in the preparation of annual consolidated financial statements. The accounting policies used in the preparation of the unaudited condensed consolidated financial statements are the same as those described in Nortel’s audited consolidated financial statements prepared in accordance with U.S. GAAP for the year ended December 31, 2009. The condensed consolidated balance sheet as of December 31, 2009 is derived from the December 31, 2009 audited consolidated financial statements. Although Nortel is headquartered in Canada, the unaudited condensed consolidated financial statements are expressed in U.S. Dollars as the greater part of Nortel’s financial results and net assets are denominated in U.S. Dollars.

Nortel makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Estimates are used when accounting for items and matters such as revenue recognition and accruals for losses on contracts, allowances for uncollectible accounts receivable, inventory provisions, product warranties, estimated useful lives of intangible assets and plant and equipment, asset valuations, impairment assessments, employee benefits including pensions, taxes and related valuation allowances and provisions, restructuring and other provisions, contingencies and pre-petition liabilities.

Nortel believes all adjustments necessary for a fair statement of the results for the periods presented have been made and all such adjustments were of a normal recurring nature unless otherwise disclosed. The financial results for the three and nine months ended September 30, 2010 are not necessarily indicative of financial results for the full year or for any other quarter. The unaudited condensed consolidated financial statements should be read in conjunction with Nortel’s Annual Report on Form 10-K for the year ended December 31, 2009 filed with the U.S. Securities and Exchange Commission (“SEC”) and Canadian securities regulatory authorities (“2009 Annual Report”) and this Quarterly Report on Form 10-Q for the quarter ended September 30, 2010.

 

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Table of Contents

NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

As further described in note 2, beginning on the Petition Date, Nortel and certain of its subsidiaries in Canada, the U.S., and in certain Europe, the Middle East and Africa (“EMEA”) countries filed for creditor protection under the relevant jurisdictions of Canada, the U.S., the United Kingdom (“U.K.”) and subsequently commenced separate proceedings in Israel, followed by secondary proceedings in France. The unaudited condensed consolidated financial statements do not purport to reflect or provide for the consequences of the Creditor Protection Proceedings. In particular, such unaudited condensed consolidated financial statements do not purport to show: (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (b) as to pre-petition liabilities, all amounts that may be allowed for claims or contingencies, or the status and priority thereof, or the amounts at which they may ultimately be settled; (c) as to shareholders’ accounts, the effect of any changes that may be made in Nortel’s capitalization; (d) as to operations, the effect of any future changes that may be made in Nortel’s business; or (e) as to divestiture proceeds held in escrow by NNL, the final allocation of these proceeds as between various Nortel legal entities, including entities that are not consolidated in these condensed consolidated financial statements, which will ultimately be determined either by joint agreement or through a dispute resolution proceeding (see note 2).

The ongoing Creditor Protection Proceedings and completed and any future divestitures of Nortel’s businesses and assets raise substantial doubt as to whether Nortel will be able to continue as a going concern. While the Debtors (as defined in note 2) have filed for and been granted creditor protection, the unaudited condensed consolidated financial statements continue to be prepared using the going concern basis, which assumes that Nortel will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. During the Creditor Protection Proceedings, and until the completion of any further proposed divestitures or a decision to cease operations in certain countries is made, the businesses of the Debtors continue to operate under the jurisdictions and orders of the applicable courts and in accordance with applicable legislation. Nortel has continued to operate its remaining businesses by renewing and seeking to grow its business with existing customers, competing for new customers, continuing research and development (“R&D”) investments in product portfolios until the related businesses or assets are sold, and ensuring the ongoing supply of goods and services through the supply chain in an effort to maintain or improve customer service and loyalty levels. However, it is not possible to predict the outcome of the Creditor Protection Proceedings and, as such, the realization of assets and discharge of liabilities are each subject to significant uncertainty. If the going concern basis is not appropriate, adjustments will be necessary to the carrying amounts and/or classification of Nortel’s assets and liabilities. Further, a court-approved plan in connection with the Creditor Protection Proceedings could materially change the carrying amounts and classifications reported in the unaudited condensed consolidated financial statements. Nortel will continue to evaluate its remaining consolidated subsidiaries for the appropriateness of the accounting applied to these investments as the Creditor Protection Proceedings progress.

Comparative Figures

Certain of Nortel’s subsidiaries in EMEA, Nortel Networks UK Ltd. (“NNUK”), Nortel Networks S.A. (“NNSA”) and Nortel Networks (Ireland) Limited (collectively, “EMEA Subsidiaries”) and their subsidiaries (collectively, the “Equity Investees”), had been accounted for under the equity method from January 14, 2009 (“Petition Date”) until May 31, 2010 at which date Nortel concluded that it no longer exercised significant influence over the operating and financial policies of the EMEA Subsidiaries due to the significance of the completed dispositions, the ongoing role and decision making authority of the U.K. Administrators, and as Nortel is not committed to provide further support to the Equity Investees. Commencing June 1, 2010, Nortel accounts for its investments in the EMEA Subsidiaries as an investment by the cost method. As a result, the financial position and results of operations of the Equity Investees are not reflected in these consolidated results after May 31, 2010. In the context of the Creditor Protection Proceedings, Nortel continues to evaluate the method of accounting for all of its subsidiaries.

 

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Table of Contents

NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Certain 2009 figures in the unaudited condensed consolidated financial statements have been reclassified to conform to Nortel’s current presentation. Certain 2009 results have been recast to reflect discontinued operations. See note 4.

Liquidation of Subsidiaries

With the completed sales of substantially all of Nortel’s businesses, Nortel is focused on maximizing proceeds and cash flows with respect to remaining assets. This includes the winding up of Nortel’s remaining operations and subsidiaries globally, which may involve orderly wind-ups as well as commencement of liquidation proceedings, as the circumstances warrant.

Events may impact when, and if, an entity is deemed to be in liquidation including local statutory requirements and court approvals. As such approvals and events occur, Nortel will evaluate whether a change in basis of accounting is appropriate, and in all such cases, Nortel will assess the carrying values of those entities’ assets when it appears likely entities will be approved for liquidation. Generally, Nortel expects that an entity deemed to be in liquidation will result in a loss of control, deconsolidation of the entity, and accounting for the entity prospectively on a cost investment basis. Nortel recorded nil and a loss of $74 for the three and nine months ended September 30, 2010, respectively, related to the liquidation of 7 entities, which are included in reorganization items. Subsequent to September 30, 2010, events have occurred resulting in certain additional entities being placed in liquidation or pending approval to be liquidated.

Recent accounting pronouncements

 

  (i) In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13, “Multiple-Deliverable Revenue Arrangements”, (“ASU 2009-13”). ASU 2009-13 addresses the accounting for multiple-deliverable arrangements and requires that the overall arrangement consideration be allocated to each deliverable in a revenue arrangement based on an estimated selling price when vendor specific objective evidence or third-party evidence of fair value is not available. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated to all deliverables using the relative selling price method. This will result in more revenue arrangements being separated into separate units of accounting. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010. Companies can elect to apply this guidance (1) prospectively to new or materially modified arrangements after the effective date or (2) retrospectively for all periods presented. Nortel is currently assessing the impact of adoption of ASU 2009-13 and does not currently plan to early adopt.

 

  (ii) In October 2009, the FASB issued ASU No. 2009-14, “Certain Revenue Arrangements That Include Software Elements”, (“ASU 2009-14”). ASU 2009-14 changes the accounting model for revenue arrangements that include both tangible products and software elements. Tangible products containing both software and non-software components that function together to deliver the product’s essential functionality will no longer be within the scope of Accounting Standards Codification (“ASC”) 985-605 “Software Revenue Recognition” (“ASC 985-605”). The entire product (including the software and non-software deliverables) will therefore be accounted for under accounting literature found in ASC 605. ASU 2009-14 is effective for fiscal years beginning on or after June 15, 2010. Companies can elect to apply this guidance (1) prospectively to new or materially modified arrangements after the effective date or (2) retrospectively for all periods presented. Nortel is currently assessing the impact of adoption of ASU 2009-14 and does not currently plan to early adopt.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

2. Creditor protection proceedings

On January 14, 2009, after extensive consideration of all other alternatives, with the unanimous authorization of the Nortel board of directors after thorough consultation with advisors, certain Nortel entities, including NNC and NNL, initiated creditor protection proceedings in multiple jurisdictions under the respective restructuring regimes of Canada, the U.S., the U.K., and subsequently in Israel and France.

On June 19, 2009, Nortel announced that it was advancing in discussions with external parties to sell its businesses. To date, Nortel has completed divestitures of substantially all of our businesses including: (i) the sale of substantially all of its Code Division Multiple Access (“CDMA”) business and Long Term Evolution (“LTE”) Access assets to Telefonaktiebolaget LM Ericsson (“Ericsson”); (ii) the sale of substantially all of the assets of its Enterprise Solutions (“ES”) business globally, including the shares of Nortel Government Solutions Incorporated (“NGS”) and DiamondWare, Ltd., to Avaya Inc. (“Avaya”); (iii) the sale of the assets of its Wireless Networks (“WN”) business associated with the development of Next Generation Packet Core network components (“Packet Core Assets”) to Hitachi, Ltd. (“Hitachi”); (iv) the sale of certain portions of its Layer 4-7 data portfolio to Radware Ltd. (“Radware”); (v) the sale of substantially all of the assets of its Optical Networking and Carrier Ethernet businesses to Ciena Corp. (“Ciena”); (vi) the sale of substantially all of the assets of its Global System for Mobile communications (GSM)/GSM for Railways (“GSM-R”) business to Ericsson and Kapsch CarrierCom AG (“Kapsch”); (vii) the sale of substantially all of the assets of its Carrier VoIP and Application Solutions (“CVAS”) business to GENBAND Inc. (now known as GENBAND U.S. LLC (“GENBAND”)); and (viii) the sale of NNL’s 50% plus 1 share interest in LG-Nortel Co. Ltd. (“LGN”), its Korean joint venture with LG Electronics, Inc. (“LGE”), to Ericsson. In addition, Nortel has completed a court-approved bidding process and has received court approvals in the U.S. and Canada for the planned divestiture of substantially all of the assets of its global Multi Service Switch (MSS) business to Ericsson.

Since June 2009, approximately $3,150 in net proceeds have been generated through the completed sales of businesses. Substantially all proceeds received in connection with the completed sales of businesses and assets are being held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined.

While numerous milestones have been met, significant work remains under the Creditor Protection Proceedings. A Nortel business services group (“NBS”) was established in 2009 to provide global transitional services to purchasers of Nortel’s businesses, in fulfillment of contractual obligations under transition services agreements (“TSAs”) entered into in connection with the sales of Nortel’s businesses and assets. These services include maintenance of customer and network service levels during the integration process, and providing expertise and infrastructure in finance, supply chain management, information technology (IT), research and development (R&D), human resources and real estate necessary for the orderly and successful transition of businesses to purchasers over a period of up to 24 months from the closing of the sales. NBS is also focused on maximizing the recovery of Nortel’s remaining accounts receivable, inventory and real estate assets, independent of the TSAs.

A core corporate group (“Corporate Group”) was also established in 2009 and continues to be focused on a number of key actions, including the sale of remaining businesses and assets as well as exploring strategic alternatives to maximize the value of Nortel’s intellectual property. The Corporate Group is also responsible for ongoing restructuring matters, including the creditor claims process, planning toward conclusion of the Creditor Protection Proceedings and any distributions to creditors. The Corporate Group also continues to provide administrative and management support to Nortel’s affiliates around the world while completing the orderly wind down of the remaining operations.

 

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With the sale of substantially all of our businesses, the interdependency between the debtor estates is expected to continue to diminish, and thus the estates have started to prepare for the separation of various corporate functions to allow each estate to become standalone. An extensive analysis is underway to segregate most of these functions such that the Canadian Debtors and the U.S. Debtors can operate independent of one another.

Nortel is seeking expressions of interest from potential buyers and partners regarding options that could maximize the value of its intellectual property portfolio. No decision has been made as to how to realize this value, whether through sale, licensing, some combination of the two or other alternatives. The solicitation process is being conducted in a manner similar to the court-approved sales of its significant businesses and is expected to take several months.

CCAA Proceedings

On January 14, 2009 (“Petition Date”), Nortel, NNL and certain other Canadian subsidiaries (“Canadian Debtors”) obtained an initial order (“Initial Order”) from the Ontario Superior Court of Justice (“Canadian Court”) for creditor protection for 30 days, pursuant to the provisions of the Companies’ Creditors Arrangement Act (“CCAA”), which has since been extended to February 28, 2011 and is subject to further extension by the Canadian Court (“CCAA Proceedings”). There is no guarantee that the Canadian Debtors will be able to obtain court orders or approvals with respect to motions the Canadian Debtors may file from time to time to extend further the applicable stays of actions and proceedings against them. Pursuant to the Initial Order, the Canadian Debtors received approval to continue to undertake various actions in the normal course in order to maintain stable and continuing operations during the CCAA Proceedings.

As a consequence of the CCAA Proceedings, generally, all actions to enforce or otherwise effect payment or repayment of liabilities of any Canadian Debtor arising prior to the Petition Date and substantially all pending claims and litigation against the Canadian Debtors and their officers and directors have been stayed until February 28, 2011, or such later date as may be ordered by the Canadian Court. In addition, the CCAA Proceedings have been recognized by the United States Bankruptcy Court for the District of Delaware (“U.S. Court”) as “foreign proceedings” pursuant to the provisions of Chapter 15 of the U.S. Bankruptcy Code, giving effect in the U.S. to the stay granted by the Canadian Court. A cross-border court-to-court protocol (as amended) has also been approved by the U.S. Court and the Canadian Court. This protocol provides the U.S. Court and the Canadian Court with a framework for the coordination of the administration of the Chapter 11 Proceedings (as defined below) and the CCAA Proceedings on matters of concern to both courts.

Chapter 11 Proceedings

Also on the Petition Date, Nortel Networks Inc. (“NNI”), Nortel Networks Capital Corporation (“NNCC”) and certain other of Nortel’s U.S. subsidiaries (“U.S. Debtors”), other than Nortel Networks (CALA) Inc. (“NNCI”), filed voluntary petitions under Chapter 11 with the U.S. Court (“Chapter 11 Proceedings”). The U.S. Debtors received approval from the U.S. Court for a number of motions enabling them to continue to operate their businesses generally in the ordinary course. Among other things, the U.S. Debtors received approval to continue paying employee wages and certain benefits in the ordinary course; to generally continue their cash management system, including approval of the NNI Loan Agreement between NNI as lender and NNL as borrower with an initial advance to NNL of $75, to support NNL’s ongoing working capital and general corporate funding requirements; and to continue honoring customer obligations and paying suppliers for goods and services received on or after the Petition Date. On July 14, 2009, NNCI, a U.S. based subsidiary that operates

 

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in the CALA region, also filed a voluntary petition for relief under Chapter 11 in the U.S. Court and thereby became one of the U.S. Debtors subject to the Chapter 11 Proceedings, although the petition date for NNCI is July 14, 2009. On July 17, 2009, the U.S. Court entered an order of joint administration that provided for the joint administration, for procedural purposes only, of NNCI’s case with the pre-existing cases of the other U.S. Debtors.

On June 21, 2010, the U.S. Debtors filed a motion seeking to terminate certain U.S. retiree and long-term disability benefits effective as of August 31, 2010. The U.S. Debtors filed a notice of withdrawal of this motion with the U.S. Bankruptcy Court on July 16, 2010. It is possible that the U.S. Debtors will seek modification or termination of some or all of these benefits at a later time.

On July 12, 2010, the U.S. Debtors filed their proposed plan of reorganization (the “Plan”) under Chapter 11 with the U.S. Court. Pursuant to the Plan, each U.S. Debtor will either be reorganized to the extent the U.S. Debtors determine it is necessary or beneficial to do so for the purpose of fulfilling its obligations under the asset sale agreements and TSAs, selling or otherwise disposing of its assets and fulfilling its obligations under the Plan, or will be liquidated. The U.S. Debtors filed a proposed disclosure statement for the Plan with the U.S. Court on September 3, 2010. The effectiveness of the Plan and the U.S. Debtors’ exit of the Chapter 11 Proceedings is subject to several conditions, including U.S. Court approval of the disclosure statement, as amended, obtaining the requisite number of votes in favor of the Plan from the solicited creditors of each U.S. Debtor, confirmation of the Plan by order of the U.S. Court and the satisfaction of other conditions precedent.

As a consequence of the commencement of the Chapter 11 Proceedings, generally, all actions to enforce or otherwise effect payment or repayment of liabilities of any U.S. Debtor preceding the Petition Date and substantially all pending claims and litigation against the U.S. Debtors have been automatically stayed for the pendency of the Chapter 11 Proceedings (absent any court order lifting the stay). In addition, the U.S. Debtors applied for and obtained an order in the Canadian Court recognizing the Chapter 11 Proceedings in the U.S. as “foreign proceedings” in Canada and giving effect, in Canada, to the automatic stay under the U.S. Bankruptcy Code.

Administration Proceedings

Also on the Petition Date, certain of Nortel’s EMEA subsidiaries (“EMEA Debtors”) made consequential filings and each obtained an administration order from the High Court of England and Wales (“English Court”) under the Insolvency Act 1986 (“U.K. Administration Proceedings”). The filings were made by the EMEA Debtors under the provisions of the European Union’s Council Regulation (“EC”) No 1346/2000 on Insolvency Proceedings (“EC Regulation”) and on the basis that each EMEA Debtor’s center of main interests was in England. The U.K. Administration Proceedings currently extend to January 13, 2012, subject to further extension. Under the terms of the orders, joint administrators were appointed with respect to the EMEA Debtor in Ireland and for the other EMEA Debtors (collectively, “U.K. Administrators”) to manage each of the EMEA Debtors’ affairs, business and property under the jurisdiction of the English Court and in accordance with the applicable provisions of the Insolvency Act 1986. The Insolvency Act 1986 provides for a moratorium during which creditors may not, without leave of the English Court or consent of the U.K. Administrators, wind up the company, enforce security, or commence or progress legal proceedings. All of Nortel’s operating EMEA subsidiaries except those in the following countries are included in the U.K. Administration Proceedings: Nigeria, Russia, Ukraine, Israel, Norway, Switzerland, South Africa and Turkey.

 

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The U.K. Administration Proceedings have been recognized by the U.S. Court as “foreign main proceedings” pursuant to the provisions of Chapter 15 of the U.S. Bankruptcy Code, giving effect in the U.S. to the moratorium provided by the Insolvency Act 1986.

Certain of Nortel’s Israeli subsidiaries (“Israeli Debtors”) commenced separate creditor protection proceedings in Israel (“Israeli Administration Proceedings”). On January 19, 2009, an Israeli court (“Israeli Court”) appointed administrators over the Israeli Debtors (“Israeli Administrators”). The orders of the Israeli Court provide for a “stay of proceedings” in respect of the Israeli Debtors whose creditors are prevented from taking steps against the companies or their assets and which, subject to further orders of the Israeli Court, remains in effect during the Israeli Administration Proceedings. On May 28, 2009, at the request of the U.K. Administrators of NNSA, the Commercial Court of Versailles, France (“French Court”) ordered the commencement of secondary proceedings in respect of NNSA (“French Secondary Proceedings”). The French Secondary Proceedings consist of liquidation proceedings during which NNSA is no longer authorized to continue its business operations.

The current Canadian Debtors, U.S. Debtors, EMEA Debtors and Israeli Debtors are together referred to as the “Debtors”; the CCAA Proceedings, the Chapter 11 Proceedings, the U.K. Administration Proceeding, the Israeli Administration Proceedings and the French Secondary Proceedings are together referred to as the “Creditor Protection Proceedings”.

Significant Business Divestitures — Year to Date 2010 Developments

Optical Networking and Carrier Ethernet Businesses

On March 19, 2010, NNC announced that it, NNL, and certain of its subsidiaries, including NNI and NNUK, had completed the sale of substantially all of the assets of its Optical Networking and Carrier Ethernet businesses to Ciena and that Ciena had elected, as permitted by the terms of the sale, to replace the $239 principal amount of convertible notes with cash consideration of $244, and thus pay an all cash purchase price of approximately $774. The purchase price was decreased at closing for a working capital adjustment of approximately $62. The purchase price has been finalized and the sales proceeds were subject to a further working capital downward adjustment of $19 in the second quarter of 2010. In conjunction with the sale of our Ottawa Carling Campus, Nortel is required to exercise its early termination rights on the facility lease with Ciena and will be required to pay Ciena $33.5 at closing. See discussion below on Sale of Ottawa Carling Campus for further information. The related Optical Networking and Carrier Ethernet businesses’ financial results of operations have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP. Nortel recognized a gain on disposal of $535 in the nine months ended September 30, 2010.

GSM/GSM-R Business

On March 31, 2010, NNC announced that it had completed the sale of substantially all of the assets of its global GSM/GSM-R business to Ericsson and Kapsch for aggregate proceeds of $103. The purchase price with respect to the sale to Ericsson has been finalized and the sales proceeds were subject to a working capital downward adjustment of $6. The purchase price with respect to the sale to Kapsch is also subject to a further working capital adjustment pending finalization between the parties. The related GSM/GSM-R business financial results of operations have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S.GAAP. Nortel recognized a gain on disposal of $114 in the nine months ended September 30, 2010.

 

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CVAS Business

On May 28, 2010, Nortel announced that it had completed the sale of substantially all of its assets of the CVAS business globally to GENBAND for a purchase price of $282, subject to balance sheet and other adjustments currently estimated at approximately $100, resulting in net proceeds of approximately $182. The balance sheet adjustments are pending finalization between the parties. The related financial results of operations of the CVAS business have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP. Nortel recognized a gain on disposal of $191 in the nine months ended September 30, 2010.

LGN Joint Venture

On June 29, 2010, Nortel announced it had completed the sale of its 50% plus 1 share interest in LGN to Ericsson for $242 in cash, subject to certain purchase price adjustments. The purchase price has now been finalized. The related financial results of operations of LGN have been classified as discontinued operations retrospectively (see note 4) beginning in the second quarter of 2010 as they met the definition of a component of an entity as required under U.S. GAAP. Nortel recognized a gain on disposal of $53 in the nine months ended September 30, 2010.

MSS Business

On August 27, 2010, Nortel announced that it, NNL, and certain of Nortel’s other subsidiaries, including NNI and NNUK, had entered into a “stalking horse” asset sale agreement with PSP Holding LLC, a special purpose entity to be fully funded at closing by Marlin Equity Partners (“Marlin”) and Samnite Technologies Inc., a communications technology company based in Ottawa, for the planned sale of substantially all of its North American, CALA and Asian MSS business, and an asset sale agreement with Marlin for the sale of substantially all of the assets of the EMEA portion of its MSS business for a purchase price of $39 in cash. On September 24, 2010, Nortel concluded a successful auction. Ericsson emerged as the successful bidder, for the sale of substantially all assets of the MSS business globally, for a purchase price of $65 in cash. The agreements are subject to certain working capital and other purchase price adjustments. The agreements also include the planned sale of the associated Data Packet Network and Shasta Services Edge router groups. They also include certain intellectual property related to the MSS business. The sale was approved by the U.S. and Canadian courts on September 30, 2010. The sale is subject to approvals by certain court appointed administrators in EMEA, as well as regulatory approvals and other customary closing conditions. In some EMEA jurisdictions, this transaction is also subject to compliance with information and consultation obligations with employee representatives prior to finalization of the terms of the sale. The parties are targeting to close the sale early in the first quarter of 2011.

The related MSS business assets and liabilities were classified as held for sale beginning in the third quarter of 2010. Nortel determined that the fair value less estimated costs to sell exceeded the carrying value of the MSS business assets and liabilities and therefore no impairment was recorded on the reclassification of these assets as held for sale. The related financial results of operations of the MSS business have not been classified as discontinued operations as they were not deemed to have met the definition of a component of an entity as required under U.S. GAAP.

Purchase Price Adjustments

With respect to the divestitures discussed above, Nortel’s sale agreements generally provide for post-closing adjustments to the stated purchase price based on the actual value of certain assets and liabilities as of the closing date relative to an estimate of those amounts at closing. Adjustments may be made for, among other things:

 

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(i) changes in net working capital; (ii) changes in amounts to be paid in respect of transferred employees, including such items as accrued compensation and vacation days, retirement benefits and severance amounts; and (iii) changes in amounts related to assets being transferred outside the United States, including purchase price reductions for assets in EMEA that are unable to be transferred due to further creditor protection proceedings and fixed purchase price reductions for assets transferred in China and India. In addition, some asset sale agreements include additional purchase price adjustments that depend on variations between estimated and actual inventory, net debt, standard margin and deferred profits of the businesses sold. None of these adjustments have materially changed, or are expected to materially change, the purchase price associated with the divestitures discussed above (other than as described above). Nortel has finalized the purchase price with respect to the sale of its CDMA business and LTE assets, Optical Networking and Carrier Ethernet businesses, GSM business sold to Ericsson, and NNL’s interest in LGN. In addition, purchase price adjustments in relation to transactions solely involving the Equity Investees that occurred subsequent to May 31, 2010 have not been reflected in these financial statements.

Transition Services Agreement

Nortel entered into TSAs in connection with certain of the completed divestitures discussed above and is contractually obligated under such TSAs to provide transition services to certain purchasers of its businesses and assets.

In connection with the sale of substantially all of its CDMA business and LTE Access assets in 2009, Nortel entered into a TSA with Ericsson pursuant to which Nortel agreed to provide certain transition services for a period of up to 24 months after closing of the transaction.

In connection with the sale of substantially all of its ES business in 2009, Nortel entered into a TSA with Avaya pursuant to which it agreed to provide certain transition services for a period of up to 18 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction.

In connection with the sale of substantially all of its Optical Networking and Carrier Ethernet businesses, Nortel entered into a TSA with Ciena pursuant to which Nortel agreed to provide certain transition services for a period of up to 24 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction.

In connection with the sale of substantially all of its GSM/GSM-R business, Nortel entered into a TSA with Ericsson pursuant to which Nortel agreed to provide certain transition services for a period of up to 18 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction and a TSA with Kapsch pursuant to which Nortel agreed to provide certain transition services for a period of up to 12 months after closing of the transaction.

In connection with the sale of substantially all of its CVAS business, Nortel entered into a TSA with GENBAND pursuant to which Nortel agreed to provide certain transition services for a period of up to 18 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction.

In connection with the planned sale of substantially all of our MSS business, subject to completion of the divestiture, at closing, we expect to enter into a TSA with Ericsson pursuant to which we would agree to provide certain transition services commencing at the closing of the transaction and continuing through no later than June 30, 2011.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

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Sale of Ottawa Carling Campus

On October 19, 2010, Nortel announced that as part of our focus on maximizing value for our stakeholders, NNL and NNTC entered into a sale agreement with Public Works and Government Services Canada (PWGSC) for the sale of its Ottawa Carling Campus, for a cash purchase price of CAD$208. The sale, targeted to close at end of year, is subject to customary closing conditions as well as approval of certain governmental authorities. The Canadian Court approved the sale on November 8, 2010.

The sale agreement provides for Nortel to continue to occupy parts of the Ottawa Carling Campus for varying periods of time to facilitate its continuing work on its global restructuring including work under the TSA with the various buyers of its sold businesses. All other existing leases will be assumed by PWGSC, including leases with buyers of its sold businesses. With respect to the lease with Ciena, the purchaser of the Optical Networking and Carrier Ethernet business, Nortel was directed by PWGSC under the sale agreement to exercise, on closing, its early termination rights under the lease, shortening the lease from 10 years to 5 years. This will result, pursuant to the lease with Ciena, in the repayment to Ciena of $33.5 from the escrowed sale proceeds from the business sale.

The sale agreement further provides that at closing title will be delivered free and clear of all encumbrances, including the Ottawa Charge in favor of NNI with respect to the NNI Loan Agreement, under which $75 million plus accrued interest is outstanding and is due on December 31, 2010. NNL intends to repay this outstanding amount with the proceeds from the sale of the Ottawa Carling Campus.

Further Divestitures

The Creditor Protection Proceedings may result in additional sales or divestitures; however, Nortel can provide no assurance it will be able to complete any further sale or divestiture on acceptable terms or at all. On February 18, 2009, the U.S. Court approved procedures for the sale or abandonment by the U.S. Debtors of assets with a de minimis value. The Canadian Debtors can generally take similar actions with the approval of the Canadian Monitor. In France, the French Administrator and French Liquidator have the ability to deal with assets of de minimis value in a similar way under statute. There is no formal concept of “abandonment of assets with a de minimis value” in the U.K. Administration Proceedings, although the U.K. Administrators will ordinarily not take any steps to deal with assets where there is no benefit to creditors in them doing so. As Nortel continues to advance in discussions to sell its other businesses, it will consult with the Canadian Monitor, the U.K. Administrators, the U.S. Principal Officer, the U.S. Creditors’ Committee, the Bondholder Group and other stakeholders as appropriate (including the French Administrator, the French Liquidator and the Israeli Administrators as necessary), and any proposed divestiture may be subject to the approval of affected stakeholders and the relevant courts. There can be no assurance that any further proposed sale or divestiture will be developed, confirmed or approved, where required, by any of the relevant courts or affected stakeholders.

Divestiture Proceeds Received

As of September 30, 2010, of the approximately $3,150 in net proceeds generated through the completed sales of businesses, proceeds of approximately $3,134 had been received. These divestiture proceeds include the following approximate amounts:

 

  (a) $1,070 from the sale of substantially all of Nortel’s CDMA business and LTE Access assets;

 

  (b) $18 from the sale of Nortel’s Layer 4-7 data portfolio;

 

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  (c) $10 from the sale of Nortel’s Packet Core Assets;

 

  (d) $924 from the sale of substantially all of the assets of Nortel’s ES business, including the shares of DiamondWare, Ltd. and NGS;

 

  (e) $631 from the sale of substantially all of the assets of Nortel’s Optical Networking and Carrier Ethernet businesses;

 

  (f) $67 from the sale of Nortel’s North American GSM business;

 

  (g) $21 from the sale of Nortel’s GSM business outside of North America (excluding its GSM business in CALA) and its global GSM-R business;

 

  (h) $155 from the sale of substantially all of the assets of Nortel’s CVAS business;

 

  (i) $234 from the sale of Nortel’s 50% plus 1 share interest in LGN; and

 

  (j) $4 from the sale of various Nortel business assets.

Of the $3,134 in proceeds received from divestitures as of September 30, 2010, $2,828 is being held in escrow and an additional $234, reflecting proceeds from the sale of LGN, is included in restricted cash which is currently reported in NNL solely for financial reporting purposes. The ultimate determination of the final allocation of proceeds held in escrow among the various Nortel legal entities, including entities that are not consolidated in the condensed consolidated financial statements, has not yet occurred and may be materially different from the NNC classification and related amounts shown in these financial statements. The Interim Funding and Settlement Agreement (“IFSA”) and the escrow agreements for sales divestiture proceeds entered into by NNL, NNI and other Nortel legal entities provide for the processes for determining the final allocation of divestiture proceeds among such entities, either through joint agreement or, failing such agreement, other dispute resolution proceeding. Adjustments to the NNL classification and any related amounts arising from the ultimate allocation will be recognized when finalized. The NNL classification and related amounts shown in these financial statements are not determinative of, and have not been accepted by any debtor estate, any party in interest in the Creditor Protection Proceedings or any court overseeing such proceedings, for purposes of deciding the final allocation of divestiture proceeds.

Over the past several months, the Canadian Debtors, Canadian Monitor, U.S. Debtors, EMEA Debtors, U.K. Administrators, U.S. Creditors’ Committee, Bondholder Group and certain other interested parties (Mediation Parties) have held discussions in an attempt to agree to allocation of the sale proceeds now held in escrow and to reach resolution of all inter-estate matters. As a result of these efforts, the Mediation Parties have agreed that the proceeds allocation process, as well as the process for settling certain inter-estate claims, would be aided by the appointment of a neutral mediator to review the positions and viewpoints of the various Mediation Parties. A confidential, non-binding mediation has been scheduled during the period from November 11 to 16, 2010. No assurances can be given over the outcome of the mediation process.

As of September 30, 2010, a further $140 in the aggregate was expected to be received in connection with the divestitures of substantially all of Nortel’s CDMA business and LTE Access assets, ES business, including the shares of DiamondWare, Ltd. and NGS, the assets of Nortel’s Optical Networking and Carrier Ethernet businesses, substantially all of the assets of Nortel’s global GSM/GSM-R and CVAS businesses, subject to the satisfaction of various conditions including performance under the TSAs. As the conditions are satisfied, amounts receivable will be recognized as additional gains on sales. Such amounts, when received, will also be held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined. Subsequent to September 30, 2010, Nortel’s escrow agent has received nil of the $140.

 

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Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Business Operations

During the Creditor Protection Proceedings, and until the completion of any further proposed divestitures or a decision to cease operations in certain countries is made, the remaining businesses and operations of the Debtors continue to operate under the jurisdictions and orders of the applicable courts and in accordance with applicable legislation while Nortel continues to focus on the sale of remaining businesses and assets. Nortel has continued to engage with its existing customer base in an effort to maintain delivery of products and services, minimize interruptions as a result of the Creditor Protection Proceedings and Nortel’s divestiture efforts and resolve any interruptions in a timely manner. At the beginning of the proceedings, Nortel established a senior procurement team, along with appropriate advisors, to address supplier issues and concerns as they arose to ensure ongoing supply of goods and services and minimize any disruption in its global supply chain. This procedure continues to function effectively and any supply chain issues are being dealt with on a timely basis.

Since the Petition Date, Nortel has periodically entered into agreements with other suppliers, including contract manufacturers, to address issues and concerns as they arise in order to ensure ongoing supply of goods and services and minimize any disruption in its global supply chain. In certain circumstances, some of these agreements include advance deposit or escrow obligations, or purchase commitments in order to mitigate the risk associated with supplying Nortel during the pendency of the Creditor Protection Proceedings.

Contracts

Under the U.S. Bankruptcy Code, the U.S. Debtors may assume, assume and assign, or reject certain executory contracts including unexpired leases, subject to the approval of the U.S. Court and certain other conditions. Pursuant to the Initial Order of the Canadian Court, the Canadian Debtors are permitted to repudiate any arrangement or agreement, including real property leases. Any reference to any such agreements or instruments and to termination rights or a quantification of Nortel’s obligations under any such agreements or instruments is qualified by any overriding rejection, repudiation or other rights the Debtors may have as a result of or in connection with the Creditor Protection Proceedings. The administration orders granted by the English Court do not give any similar unilateral rights to the U.K. Administrators. The U.K. Administrators and, in the case of NNSA, the French Administrator and the French Liquidator decide in each case whether an EMEA Debtor should continue to perform under an existing contract on the basis of whether it is in the interests of that administration to do so. Claims may arise as a result of a Debtor rejecting, repudiating or no longer continuing to perform under any contract or arrangement, which claims would usually be unsecured. Since the Petition Date, the Debtors have assumed and rejected or repudiated various contracts, including real property leases and commercial agreements. The Debtors will continue to review other contracts throughout the Creditor Protection Proceedings.

Creditor Protection Proceeding Claims

On August 4, 2009, the U.S. Court approved a claims process in the U.S. for claims that arose prior to the Petition Date. Pursuant to this claims process, proofs of claim, except in relation to NNCI, had to be received by the U.S. Claims Agent, Epiq Bankruptcy Solutions, LLC (“Epiq”) by September 30, 2009 (subject to certain exceptions as provided in the order establishing the claims bar date). On December 2, 2009, the U.S. Court approved January 25, 2010 as the deadline for receipt by Epiq of proofs of claim against NNCI (subject to certain exceptions as provided in the order establishing the claims bar date).

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

On July 30, 2009, Nortel announced that the Canadian Court approved a claims process in Canada in connection with the CCAA Proceedings. Pursuant to this claims process, subject to certain exceptions, proofs of claim for claims arising prior to the Petition Date had to be received by the Canadian Monitor by no later than September 30, 2009. This claims bar date does not apply to certain claims, including inter-company claims as between the Canadian Debtors or as between any of the Canadian Debtors and their direct or indirect subsidiaries and affiliates (other than joint ventures), compensation claims by current or former employees or directors of any of the Canadian Debtors, and claims of current or former directors or officers for indemnification and/or contribution, for which claims notification deadlines have yet to be set by the Canadian Court. Proofs of claim for claims arising on or after the Petition Date as a result of the restructuring, termination, repudiation or disclaimer of any lease, contract or other agreement or obligation had to, or must be, received by the Canadian Monitor by the later of September 30, 2009 or 30 days after a proof of claim package has been sent by the Canadian Monitor to the person in respect of such claim. On September 16, 2010, the Canadian Court approved a methodology for the review and determination of claims filed against the Canadian Debtors. Also on September 16, 2010, the Canadian Court and U.S. Court approved a cross-border claims protocol to address the level of cooperation and consultation on issues between the Canadian Debtors and the U.S. Debtors with respect to overlapping and same-creditor’s claims between the two debtor estates. The U.K. Administrators commenced an informal creditor claim submission and evaluation process in July 2010. Creditors will also have the opportunity to take part in a formal claims admission and proving process in accordance with English insolvency law provisions in due course.

In relation to NNSA, claims had to be submitted to the French Administrator and the French Liquidator no later than August 12, 2009 with respect to French creditors and October 12, 2009 with respect to foreign creditors. In relation to the Israeli Debtors, the Israeli Court determined that claims had to be submitted to the Israeli Administrators by no later than July 26, 2009. Other than as set forth above with respect to NNSA, no outside bar date for the submission of claims has been established in connection with U.K. Administration Proceedings.

The unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2010 generally do not include the outcome of any current or future claims relating to the Creditor Protection Proceedings. Certain claims filed may have priority over those of the Debtors’ unsecured creditors. The Debtors are reviewing all claims filed and have commenced the claims reconciliation process. Differences between claim amounts determined by the Debtors and claim amounts filed by creditors will be investigated and resolved pursuant to a claims resolution process approved by the relevant court or, if necessary, the relevant court will make a final determination as to the amount, nature and validity of claims. Certain claims that have been filed may be duplicative (particularly given the multiple jurisdictions involved in the Creditor Protection Proceedings), based on contingencies that have not occurred, or may be otherwise overstated, and would therefore be subject to revision or disallowance. The settlement of claims cannot be finalized until the relevant creditors and courts approve a plan. In light of the number of creditors of the Debtors, the claims resolution process may take considerable time to complete. See note 20 for additional information about claims.

Interim and Final Funding and Settlement Agreements

Historically, Nortel has deployed its cash through a variety of intercompany borrowing and transfer pricing arrangements to allow it to operate on a global basis and to allocate profits, losses and certain costs among the corporate group. In particular, the Canadian Debtors have continued to allocate profits, losses and certain costs, among the corporate group through transfer pricing agreement payments (“TPA Payments”). Other than one $30 payment made by NNI to NNL in respect of amounts that Nortel believes are owed in connection with the

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

transfer pricing agreement, TPA Payments had been suspended since the Petition Date. However, the Canadian Debtors and the U.S. Debtors, with the support of the U.S. Creditors’ Committee and the Bondholder Group, as well as the EMEA Debtors (other than NNSA), entered into an IFSA dated June 9, 2009 under which NNI paid $157 to NNL, in four installments during the period ended September 30, 2009 in full and final settlement of TPA Payments for the period from the Petition Date to September 30, 2009. Similarly, except for two shortfall payments totaling $20, the IFSA provides for a full and final settlement of any and all TPA Payments owing between certain entities and the U.S. and Canada for the period from the Petition Date through December 31, 2009. A portion of this funding may be repayable by NNL to NNI in certain circumstances. The IFSA was approved by the U.S. Court and Canadian Court on June 29, 2009 and on June 23, 2009, the English Court confirmed that the U.K. Administrators were at liberty to enter into the IFSA on behalf of each of the EMEA Debtors (except for NNSA which was authorized to enter into the IFSA by the French Court on July 7, 2009). NNSA acceded to the IFSA on September 11, 2009.

On December 23, 2009, Nortel announced it, NNL, NNI, and certain other Canadian Debtors and U.S. Debtors entered into a Final Canadian Funding and Settlement Agreement (“FCFSA”). The FCFSA provides, among other things, for the settlement of certain intercompany claims, including in respect of amounts determined to be owed by NNL to NNI under Nortel’s transfer pricing arrangements for the years 2001 through 2005. As part of the settlement, NNL has agreed to the establishment of a pre-filing claim in favor of NNI in the CCAA Proceedings in the net amount of approximately $2,063 (“FCFSA Claim”), which claim will not be subject to any offset. The FCFSA also provides that NNI will pay to NNL approximately $190, which has been received, over the course of 2010, which amount includes the contribution of NNI and certain U.S. affiliates towards certain estimated costs to be incurred by NNL, on their behalf, for the duration of the Creditor Protection Proceedings. The FCFSA also provides for the allocation of certain other anticipated costs to be incurred by the parties, including those relating to the divestiture of Nortel’s various businesses.

On January 21, 2010, Nortel obtained approvals from the Canadian Court and the U.S. Court of the FCFSA and the creation and allowance of the FCFSA Claim. In addition, Nortel obtained various other approvals from the Canadian Court and U.S. Court including authorization for NNL and NNI to enter into advance pricing agreements with the U.S. and Canadian tax authorities to resolve certain transfer pricing issues, on a retrospective basis, for the taxable years 2001 through 2005.

In addition, in consideration of a settlement payment of $37.5, the United States Internal Revenue Service (“IRS”) released all of its claims against NNI and other members of NNI’s consolidated tax group for the years 1998 through 2008. As a result of this settlement, the IRS stipulated that its claim against NNI filed in the Chapter 11 Proceedings in the amount of approximately $3,000 was reduced to the $37.5 settlement payment. This settlement was a condition of the FCFSA and was approved by the U.S. Court on January 21, 2010. NNI made the settlement payment to the IRS on February 22, 2010.

APAC Debt Restructuring Agreement

As a consequence of the Creditor Protection Proceedings, certain amounts of intercompany payables to certain Nortel subsidiaries (“APAC Agreement Subsidiaries”) in the Asia Pacific (“APAC”) region as of the Petition Date became impaired. To enable the APAC Agreement Subsidiaries to continue their respective business operations and to facilitate any potential divestitures, the Debtors have entered into an Asia Restructuring Agreement (“APAC Agreement”). Under the APAC Agreement, the APAC Agreement Subsidiaries have paid a portion of certain of the APAC Agreement Subsidiaries’ net intercompany debt outstanding as of the Petition Date (“Pre-Petition Intercompany Debt”) to the Canadian Debtors, the U.S. Debtors

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

and the EMEA Debtors (including NNSA). A further portion of the Pre-Petition Intercompany Debt will be repayable from time to time only to the extent of such APAC Agreement Subsidiary’s net cash balance at the relevant time, and subject to certain reserves and provisions. All required court approvals with respect to the APAC Agreement have been obtained in the U.S. and Canada; however, implementation of the APAC Agreement for certain parties in other jurisdictions remains subject to receipt of outstanding regulatory approvals.

Other Contracts and Debt Instruments

Nortel’s filings under Chapter 11 and the CCAA constituted events of default or otherwise triggered repayment obligations under the instruments governing substantially all of the indebtedness issued or guaranteed by NNC, NNL, NNI and NNCC. In addition, Nortel may not be in compliance with certain other covenants under indentures, the EDC Support Facility and other debt or lease instruments, and the obligations under those agreements may have been accelerated. Nortel believes that any efforts to enforce such payment obligations against the U.S. Debtors are stayed as a result of the Chapter 11 Proceedings. Although the CCAA does not provide an automatic stay, the Canadian Court has granted a stay to the Canadian Debtors that currently extends to February 28, 2011. Pursuant to the U.K. Administration Proceedings, a moratorium has commenced during which creditors may not, without leave of the English Court or consent of the U.K. Administrators, enforce security, or commence or progress legal proceedings. The Israeli Administration Proceedings also provide for a stay which remains in effect during the pendency of such proceedings.

The Creditor Protection Proceedings may have also constituted events of default under other contracts and leases of the Debtors. In addition, the Debtors may not be in compliance with various covenants under other contracts and leases. Depending on the jurisdiction, actions taken by counterparties or lessors based on such events of default and other breaches may be unenforceable as a result of the Creditor Protection Proceedings.

In addition, the Creditor Protection Proceedings may have caused, directly or indirectly, defaults or events of default under the debt instruments and/or contracts and leases of certain of Nortel’s non-Debtor entities. These events of default (or defaults that become events of default) could give counterparties the right to accelerate the maturity of this debt or terminate such contracts or leases.

Directors’ and Officers’ Compensation and Indemnification

The Canadian Court in the CCAA Proceedings has approved a charge against the property of the Canadian Debtors, to an aggregate amount not exceeding CAD$45, to indemnify directors and officers of the Canadian Debtors for claims that may be made against them relating to failure of the Canadian Debtors to comply with certain statutory payment and remittance obligations.

In addition, in conjunction with the Creditor Protection Proceedings, NNC established a directors’ and officers’ trust (“D&O Trust”) in the amount of approximately CAD$12. The purpose of the D&O Trust is to provide a trust fund for the payment of liability claims (including defense costs) that may be asserted against individuals who serve as directors and officers of NNC, or as directors and officers of other entities at NNC’s request (such as subsidiaries and joint venture entities), by reason of that association with NNC or other entity, to the extent that such claims are not paid or satisfied out of insurance maintained by NNC and NNC is unable to indemnify the individual.

Certain Nortel entities have not filed for bankruptcy protection (“Cascade Subsidiaries”). Under the laws of various jurisdictions in which the Cascade Subsidiaries operate, the directors, officers and agents of the Cascade

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

Subsidiaries may be subject to personal liability. In order to protect individuals serving as directors on the boards of the Cascade Subsidiaries and to facilitate participation by the Cascade Subsidiaries in Nortel’s sales of businesses and assets, NNL and NNI have contributed to a trust (“Trust”), which will indemnify individuals serving as directors on the boards and as officers or agents of the Cascade Subsidiaries and their successors, if any, for any claims resulting from their service as a director, officer or agent of a Cascade Subsidiary, subject to limited exceptions. The Trust was approved by the Canadian Court and the U.S. Court on March 31, 2010.

Workforce Reductions; Employee Compensation Program Changes

Nortel has taken and expects to take further, ongoing workforce and other cost reduction actions as it works through the Creditor Protection Proceedings. On the Petition Date, Nortel employed approximately 30,300 employees globally. Through the sales of Nortel’s businesses and cost reduction activities, including the 5,000 net reductions announced on February 25, 2009, Nortel has reduced the workforce to approximately 2,000 employees as of September 30, 2010. Given the Creditor Protection Proceedings, Nortel has discontinued all remaining activities under its previously announced restructuring plans as of the Petition Date. For further information, see the “Post-Petition Date Cost Reduction Activities” note 11 of these condensed consolidated interim financial statements.

Nortel continued the Nortel Networks Limited Annual Incentive Plan (“Incentive Plan”) in 2010 for all eligible employees. The Incentive Plan permits quarterly award determinations and payouts for the business units and semi-annual award determinations and payouts for the Corporate Group and NBS.

Where required, Nortel has obtained court approvals for retention and incentive compensation plans for certain key eligible employees deemed essential to the business during the Creditor Protection Proceedings.

On March 4, 2010, Nortel obtained U.S. Court approval and on March 8, 2010 Nortel obtained Canadian Court approval for the Nortel Special Incentive Plan (“Special Incentive Plan”), which is designed to retain personnel at all levels of Corporate Group and NBS critical to complete Nortel’s remaining work. The Special Incentive Plan was developed in consultation with independent expert advisors taking into account the availability of more stable and competitive employment opportunities available to these employees elsewhere. The Special Incentive Plan was supported by the Canadian Monitor, U.S. Creditors’ Committee and the Bondholders Group. Representative Counsel to former Canadian employees was also advised of the Special Incentive Plan prior to its approval by the Canadian Court and U.S. Court.

Settlement Agreement with Former and Disabled Canadian Employee Representatives

On February 8, 2010, the Canadian Debtors reached an agreement on certain employment related matters regarding former Canadian Nortel employees, including Nortel’s Canadian registered pension plans and benefits for Canadian pensioners and Nortel employees on long term disability (“LTD”). Nortel entered into a settlement agreement with court-appointed representatives of its former Canadian employees, pensioners and LTD beneficiaries, Representative Counsel, the Canadian Auto Workers’ union and the Canadian Monitor (“Settlement Agreement”). The Settlement Agreement, as amended, was approved by the Canadian Court on March 31, 2010.

The Settlement Agreement provided that Nortel would continue to administer the Nortel Networks Negotiated Pension Plan and the Nortel Networks Limited Managerial and Non-Negotiated Pension Plan (“Canadian Pension Plans”) until September 30, 2010, at which time these Canadian Pension Plans were transitioned, in accordance with the Ontario Pension Benefits Act, to Morneau Sobeco, a new administrator

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

appointed by the Office of the Superintendent of Financial Services. Nortel, as well as the Canadian Monitor, took all reasonable steps to complete the transfer of the administration of the Canadian Pension Plans to the new administrator. Nortel continued to fund these Canadian Pension Plans consistent with the current service and special payments Nortel had been making during the course of the CCAA Proceedings through March 31, 2010, and thereafter continued to make current service payments until September 30, 2010.

For the remainder of 2010, Nortel will continue to pay medical and dental benefits to Nortel pensioners and survivors and Nortel LTD beneficiaries in accordance with the current benefit plan terms and conditions. Life insurance benefits will continue unchanged until December 31, 2010 and will continue to be funded consistent with 2009 funding. Further, Nortel will pay income benefits to the LTD beneficiaries and to those receiving survivor income benefits and survivor transition benefits through December 31, 2010. The employment of the LTD beneficiaries will terminate on December 31, 2010. The parties have agreed to work toward a court-approved distribution, in 2010, of the assets of Nortel’s Health and Welfare Trust, the vehicle through which Nortel generally has historically funded these benefits, with the exception of the income benefits described above, which Nortel will pay directly. The Canadian Court approved the Canadian Monitor’s motion regarding a proposed allocation methodology with respect to the funds held in the Health and Welfare Trust for distribution to beneficiaries of the trust.

The Settlement Agreement also provides that Nortel will establish a fund of CAD$4.2 for termination payments of up to CAD$0.003 per employee to be made to eligible terminated employees as an advance against their claims under the CCAA Proceedings.

A charge in the maximum amount of CAD$57 against the Canadian Debtors’ assets has been established as security in support of the payments to be made by Nortel under the Settlement Agreement, which amount will be reduced by the amount of payments made. The Settlement Agreement also sets out the relative priority for claims to be made in respect of the deficiency in the Canadian Pension Plans and Nortel’s Health and Welfare Trust. Under the Settlement Agreement, these claims will rank as ordinary unsecured claims in the CCAA Proceedings.

A group of 39 LTD beneficiaries sought leave to appeal the Canadian Court’s approval of the Settlement Agreement to the Ontario Court of Appeal. The leave motion was denied and the motion was dismissed by the Ontario Court of Appeal on May 31, 2010.

See note 13 for further information on Nortel’s pension and employee benefits plans.

Condensed Combined Debtors Financial Statements

The financial statements contained within this note have been prepared in accordance with the guidance of FASB ASC 852 — Reorganizations (“ASC 852”) and represent the condensed combined financial statements of the Canadian Debtors and U.S. Debtors that are included in the condensed consolidated financial statements as at September 30, 2010 and December 31, 2009 and for the three and nine months ended September 30, 2010 and 2009. The condensed combined statements of operations exclude the Canadian Debtors’ and U.S. Debtors’ interests in the results of operations of non-Debtor subsidiaries.

Intercompany Transactions

Intercompany transactions and balances with Nortel’s consolidated non-Debtor subsidiaries and affiliates have not been eliminated in the Canadian Debtors’ and U.S. Debtors’ financial statements.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Contractual Interest Expense on Outstanding Long-Term Debt

During the three and nine months ended September 30, 2010, Nortel has continued to accrue for interest expense of $77 and $223, respectively (three and nine months ended September 30, 2009 — $71 and $211, respectively), in its normal course of operations related to debt issued by NNC and NNL in Canada until Nortel obtains a claims determination order that adjudicates the claims. However, in accordance with ASC 852, interest expense in the U.S. incurred post-Petition Date is not recognized and, as a result interest payable on debt issued by the U.S. Debtors, including NNI, has not been accrued. During the pendency of the Creditor Protection Proceedings Nortel generally has not and does not expect to make payments to satisfy any of the interest obligations of the Debtors.

Foreign Currency Denominated Liabilities

ASC 852 requires pre-petition liabilities of the Canadian Debtors and U.S. Debtors that are subject to compromise to be reported at the claim amounts expected to be allowed, even if they may be settled for lesser amounts. For foreign currency denominated liabilities, the CCAA requires allowable claims to be denominated at the exchange rate in effect as of the Petition Date unless otherwise provided for in a court-approved plan. The claims process approved by the Canadian Court provides that foreign currency denominated claims must be calculated by the Canadian Monitor in Canadian dollars using a January 13, 2009 exchange rate. However, the claims process order specifically recognizes the ability of the Canadian Debtors to utilize a different exchange rate in any proposed plan. Therefore, given the impact that fixing exchange rates may have on the amounts ultimately settled, in Canada, foreign currency denominated balances, including Nortel’s U.S. dollar denominated debt, will not be accounted for using the Petition Date exchange rate but rather will continue to be accounted for in accordance with FASB ASC 830 “Foreign Currency Matters (“ASC 830”). To date, the Canadian Debtors have not developed any plan or proposed an alternative exchange rate and any plan would be subject to creditor approval prior to the Canadian Court’s approval. Foreign currency denominated pre-petition liabilities of the U.S. Debtors have generally been fixed at the exchange rate in effect on the Petition Date in accordance with local laws.

Cash Restrictions

As a result of the Creditor Protection Proceedings, cash and cash equivalents are generally available to fund operations in particular jurisdictions, but generally are not available to be freely transferred between jurisdictions, regions, or outside joint ventures, other than for normal course intercompany trade and pursuant to specific agreements approved by the U.S. Court and/or Canadian Court, as applicable.

Certain proceeds from the divestiture sales, as discussed in note 2, are being held in escrow by NNL until the jurisdictions can determine the proceeds allocations and are not available to fund operations.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

CONDENSED COMBINED STATEMENT OF OPERATIONS (unaudited)

(Millions of U.S. Dollars)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009         2010     2009  

Product revenues:

        

Third party

   $ 27      $ 747      $ 310      $ 2,010   

Non-Debtor subsidiaries

     3        40        33        239   

Inter-Debtor

     —          (1     —          (1

Service revenues (Third party)

     5        103        111        283   
                                

Total revenues

     35        889        454        2,531   

Product cost of revenues:

        

Third party

     45        375        320        1,023   

Non-Debtor subsidiaries

     4        54        35        224   

Inter-Debtor

     —          —          —          —     

Service cost of revenues (Third party)

     1        53        45        156   
                                

Total cost of revenues

     50        482        400        1,403   
                                

Gross profit

     (15     407        54        1,128   
                                

Selling, general and administrative expense

     96        2        356        434   

Research and development expense

     3        179        110        579   

Other charges

     (1     43        —          39   

Loss on sales of businesses and assets and impairment of assets

     —          13        28        2   

Other operating expense (income) — net

     (89     —          (224     (1
                                

Operating earnings (loss)

     (24     170        (216     75   

Other income (expense) — net

     (23     94        74        (12

Interest income

     —          —          12        —     

Interest expense

        

Long-term debt

     (77     (73     (225     (218

Other

     —          —          —          (1
                                

Earnings (loss) from continuing operations before reorganization items, income taxes and equity in net loss of debtor companies

     (124     191        (355     (156

Reorganization items — net

     (545     (253     (1,025     (872
                                

Loss from continuing operations before income taxes and equity in net loss of debtor companies

     (669     (62     (1,380     (1,028

Income tax benefit (expense)

     5        (1     35        (7
                                

Loss from continuing operations before equity in net loss of debtor companies

     (664     (63     (1,345     (1,035

Equity in net loss of associated companies — net of tax

     —          (113     (72     (502
                                

Net loss from continuing operations attributable to Debtors, including noncontrolling interests

     (664     (176     (1,417     (1,537

Net earnings (loss) from discontinued operations — net of tax

     (1     (145     31        (358
                                

Net loss attributable to Debtors including noncontrolling interests

     (665     (321     (1,386     (1,895

Income attributable to noncontrolling interests

     (3     (2     (7     (8
                                

Net loss attributable to Debtors

   $ (668   $ (323   $ (1,393   $ (1,903
                                

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

CONDENSED COMBINED BALANCE SHEET (unaudited)

(Millions of U.S. Dollars)

 

     September 30, 2010     December 31, 2009  
ASSETS     

Current assets

    

Cash and cash equivalents

   $ 1,087      $ 1,132   

Short-term investments

     —          18   

Restricted cash and cash equivalents

     94        80   

Accounts receivable — net:

    

Third parties

     28        224   

Non-Debtor subsidiaries

     464        570   

Debtor subsidiaries

     —          —     

Inventories — net

     17        68   

Other current assets

     198        258   

Assets held for sale

     265        234   

Assets of discontinued operations

     14        120   
                

Total current assets

     2,167        2,704   

Restricted cash

     3,062        1,928   

Investments

     —          24   

Investments in non-Debtors / Debtor subsidiaries

     390        311   

Plant and equipment — net

     100        566   

Other assets

     112        155   
                

Total assets

   $ 5,831      $ 5,688   
                
LIABILITIES AND SHAREHOLDERS’ DEFICIT     

Current liabilities

    

Trade and other accounts payable

   $ 35      $ 99   

Trade and other accounts payable to non-Debtor subsidiaries

     141        198   

Payroll and benefit-related liabilities

     67        97   

Contractual liabilities

     3        4   

Restructuring liabilities

     5        3   

Other accrued liabilities

     92        331   

Liabilities held for sale

     5        178   

Liabilities of discontinued operations

     24        43   
                

Total current liabilities

     372        953   

Long-term liabilities

    

Other liabilities

     32        62   
                

Total long-term liabilities

     32        62   

Liabilities subject to compromise

     9,929        9,015   

Liabilities subject to compromise of discontinued operations

     118        129   
                

Total liabilities

     10,451        10,159   
                
SHAREHOLDERS’ DEFICIT     

Total shareholders’ deficit of Debtors

     (5,174     (5,018

Noncontrolling interests in Debtors

     554        547   
                

Total shareholders’ deficit

     (4,620     (4,471
                

Total liabilities and shareholders’ deficit

   $ 5,831      $ 5,688   
                

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

CONDENSED COMBINED STATEMENT OF CASH FLOWS (unaudited)

(Millions of U.S. Dollars)

 

    Nine Months Ended
September 30, 2010
    Nine Months Ended
September 30, 2009
 

Cash flows from (used in) operating activities

   

Net loss

  $ (1,393   $ (1,903

Net (earnings) loss from discontinued operations

    (31     358   

Adjustments to reconcile net loss from continuing operations to net cash from (used in) operating activities:

   

Reorganization items — net

    885        865   

Other adjustments (a)

    722        637   
               

Net cash from (used in) operating activities — continuing operations

    183        (43

Net cash from (used in) operating activities — discontinued operations

    (275     2   
               

Net cash from (used in) operating activities

    (92     (41
               

Cash flows from (used in) investing activities

   

Expenditures for plant and equipment

    (8     (18

Proceeds on disposal of plant and equipment

    —          86   

Change in restricted cash and cash equivalents

    (1,151     (79

Decrease in short and long-term investments

    24        40   

Acquisitions of investments and businesses — net

    —          1   

Proceeds from the sales of investments and businesses — net

    900        44   
               

Net cash from (used in) investing activities — continuing operations

    (235     74   

Net cash from (used in) investing activities — discontinued operations

    275        (2
               

Net cash from (used in) investing activities

    40        72   
               

Cash flows from (used in) financing activities

   

Repayments of capital lease obligations

    (4     (6
               

Net cash from (used in) financing activities — continuing operations

    (4     (6

Net cash from (used in) financing activities — discontinued operations

    —          —     
               

Net cash from (used in) financing activities

    (4     (6
               

Effect of foreign exchange rate changes on cash and cash equivalents

    11        15   
               

Net cash from (used in) continuing operations

    (45     40   

Net cash from (used in) discontinued operations

    —          —     
               

Net increase (decrease) in cash and cash equivalents

    (45     (40

Cash and cash equivalents at beginning of the period

    1,132        918   
               

Cash and cash equivalents at end of the period

    1,087        958   

Less cash and cash equivalents of discontinued operations at end of the period

    —          —     
               

Cash and cash equivalents of continuing operations at end of the period

  $ 1,087      $ 958   
               

 

(a) The operating section of the condensed combined statement of cash flows has been presented on a summarized basis and, as a result, Other adjustments represent all adjustments to reconcile net loss to net cash from (used in) operating activities, with the exception of Reorganization items — net.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

3. Accounting changes

(a) Accounting for Transfers of Financial Assets

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets” (“SFAS 166”). SFAS 166 revises FASB ASC 860 “Transfers and Servicing” (“ASC 860”). The revised ASC 860 will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. SFAS 166 is effective for interim and annual reporting periods beginning after November 15, 2009 and will be applied prospectively. Nortel adopted the provisions of SFAS 166 on January 1, 2010. The adoption of SFAS 166 did not have a material impact on Nortel’s results of operations and financial condition.

(b) Amendments to FASB Interpretation No. 46(R)

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.46(R)” (“SFAS 167”). SFAS 167 revises guidance relevant to variable interest entities within FASB ASC 810 “Consolidation” (“ASC 810”), and changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impacts the other entity’s economic performance. Revised ASC 810 is effective for interim and annual periods beginning after November 15, 2009 and will be applied prospectively. Nortel adopted the provisions of revised ASC 810 on January 1, 2010. The adoption of ASC 810 did not have a material impact on Nortel’s results of operations and financial condition.

(c) Improving Disclosure about Fair Value Measurements

In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosure about Fair Value Measurements” (“ASU 2010-06”). ASU 2010-06 clarifies existing disclosures for (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used and requires new disclosures for the activity in Level 3 fair value measurements, and (3) the transfers between Levels 1, 2, and the reason for those transfers. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosure about the activity in level 3 fair value measurements which is effective for interim and annual periods beginning after December 15, 2010. Nortel adopted the provisions of ASU 2010-06 on January 1, 2010. The adoption of ASU 2010-06 did not have a material impact on Nortel’s results of operations and financial condition.

4. Discontinued Operations

ES

On December 18, 2009 Nortel completed the sale of substantially all of the assets of the ES business globally as well as the shares of NGS and DiamondWare, Ltd. to Avaya for $908 in cash, with an additional pool of $15 reserved by Avaya for an employee retention program, subject to certain purchase price adjustments and withholding taxes. As a result of the sale, Nortel recognized a gain of $756 in the fourth quarter of 2009.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

The following table summarizes certain financial information of the ES business, which includes DiamondWare, Ltd. and NGS for the periods presented:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010     2009             2010     2009      

Operations

        

Total revenues

   $ —        $ 353      $ 11      $ 1,064   
                                

Loss from discontinued operations before income taxes

   $ (3   $ (164   $ (12   $ (488

Income tax benefit (expense)

     —          —          —          —     

Income attributable to noncontrolling interests

     —          —          —          —     
                                

Net loss from discontinued operations — net of taxes

   $ (3   $ (164   $ (12   $ (488
                                

Disposal

        

Loss on disposal before income taxes

   $ (2   $ —        $ (2   $ —     

Income tax benefit (expense)

     —          —          —          —     
                                

Loss on disposal, net of taxes

   $ (2   $ —        $ (2   $ —     
                                

Net loss from discontinued operations, net of taxes

   $ (5   $ (164   $ (14   $ (488
                                

The ES operating results for the three and nine months ended September 30, 2010 and 2009 exclude the ES business results of the Equity Investees. The net loss from discontinued operations for the nine months ended September 30, 2009 includes a goodwill impairment loss of $48.

Certain assets and liabilities related to the ES business were not transferred to Avaya and continue to be classified as assets and liabilities of discontinued operations. These assets and liabilities are expected to be reduced as the Creditor Protection Proceedings progress. The remaining assets and liabilities related to the operations of the ES business for the periods presented are as follows:

 

     September 30, 2010      December 31, 2009  

Assets

     

Accounts receivable — net

   $ 5       $ 103   

Inventories — net

     6         10   

Other current assets

     7         31   

Plant and equipment — net

     —           4   
                 

Assets of discontinued operations

   $ 18       $ 148   
                 

Liabilities

     

Trade and other accounts payable

   $ 10       $ 9   

Employee related liabilities

     1         13   

Other current liabilities

     18         31   
                 

Liabilities of discontinued operations

   $ 29       $ 53   
                 

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

LGN

On June 29, 2010, Nortel completed the sale of NNL’s 50% plus 1 share interest in LGN to Ericsson for $242 in cash, subject to certain purchase price adjustments and taxes. As a result of the sale, Nortel has recognized a gain of $53 during the nine months ended September 30, 2010. The following table summarizes certain financial information of the LGN business for the presented periods:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010      2009             2010     2009      

Operations

         

Total revenues

   $ —         $ 102      $ 210      $ 489   
                                 

Earnings (loss) from discontinued operations before income taxes

   $ —         $ 9      $ (17   $ 80   

Income tax benefit (expense)

     —           (2     2        (26

Equity in net earnings (loss) of associated companies — net of tax

     —           1        —          2   

Income attributable to noncontrolling interests

     —           (1     4        (19
                                 

Net earnings (loss) from discontinued operations before disposal — net of taxes

   $ —         $ 7      $ (11   $ 37   
                                 

Disposal

         

Gain (loss) on disposal before income taxes

   $ —         $ —        $ 84      $ —     

Income tax benefit (expense)

     —           —          (31     —     
                                 

Gain on disposal, net of taxes

   $ —         $ —        $ 53      $ —     
                                 

Net earnings (loss) from discontinued operations — net of taxes

   $ —         $ 7      $ 42      $ 37   
                                 

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

5. Reorganization Items — net

Reorganization items represent the net direct and incremental charges related to the Creditor Protection Proceedings such as revenues, expenses such as professional fees directly related to the Creditor Protection Proceedings, realized gains and losses, and provisions for losses resulting from the reorganization and restructuring of the business. Reorganization items for the three and nine months ended September 30, 2010 and 2009 consisted of the following:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010     2009             2010     2009      

Professional fees (a)

   $ (47   $ (33   $ (127   $ (86

Interest income (b)

     3        3        10        13   

Lease repudiation (c)

     —          34        (3     57   

Employee incentive plans (d)

     (10     (4     (31     (21

Penalties (e)

     —          —          —          (14

Pension, post-retirement and post-employment plans (f)

     (451     (215     (445     (215

Settlements (g)

     —          —          (2     —     

Loss on deconsolidation (h)

     —          —          (74     —     

Gain (loss) on divestitures (i)

     (25     —          840        —     

Loss on sale or impairment of stranded assets (j)

     (4     —          (142     —     

NNUK pension guarantee (k)

     —          —          (634     —     

EMEA deconsolidation adjustment (l)

     —          —          (763     —     

Other (m)

     5        (9     (49     (24
                                

Total reorganization items — net

   $ (529   $ (224   $ (1,420   $ (290
                                

 

(a) Includes financial, legal, real estate and valuation services directly associated with the Creditor Protection Proceedings.
(b) Reflects interest earned due to the preservation of cash as a result of the Creditor Protection Proceedings.
(c) Nortel has rejected a number of leases, resulting in the recognition of non-cash gains and losses. Nortel may reject additional leases or other contracts in the future, which may result in recognition of material gains and losses.
(d) Relates to retention and incentive plans for certain key eligible employees deemed essential during the Creditor Protection Proceedings.
(e) Relates to liquidated damages on early termination of contracts.
(f) Includes amounts related to the Settlement Agreement. See note 13.
(g) Includes net payments pursuant to settlement agreements since the Petition Date, and in some instances the extinguishment of net pre-petition liabilities. See note 20 for further information on settlements.
(h) Relates to deconsolidation of certain entities in connection with the Creditor Protection Proceedings.
(i) Relates to the gains and losses on various divestitures. See note 2.
(j) Includes sale and impairments on certain long-lived assets. See note 8.
(k) Relates to the NNUK pension guarantees. See note 14.
(l) Relates to the change due to the deconsolidation of the Equity Investees and the application of the cost method of accounting. See notes 1, 18 and 22 for further information.
(m) Includes other miscellaneous items directly related to the Creditor Protection Proceedings, such as loss on disposal of certain assets, and foreign exchange.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Nortel received $759 relating to reorganization items in the nine months ended September 30, 2010, attributable to $897 received for various divestitures and $3 for interest income, partially offset by $125 paid for professional fees and $16 paid for employee incentive plans.

Nortel paid $67 relating to reorganization items in the nine months ended September 30, 2009, attributable to $66 paid for professional fees, and $11 paid for Key Executive Incentive/Key Employee Retention Plans, partially offset by $10 received in interest income.

6. Condensed consolidated financial statement details

The following tables provide details of selected items presented in the condensed consolidated statements of operations and cash flows for three and nine months ended September 30, 2010 and 2009, and the condensed consolidated balance sheets as of September 30, 2010 and December 31, 2009.

Condensed consolidated statements of operations

Other operating expense (income) — net:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Royalty license income — net

   $ (3   $ (5   $ (9   $ (8

Litigation charges (recovery) — net

     —          1        (3     1   

Billings under transition services agreements

     (93     —          (242     —     

Other — net

     2        48        4        48   
                                

Other operating expense (income) — net

   $ (94   $ 44      $ (250   $ 41   
                                

Other income (expense) — net:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009         2010     2009  

Rental income

     21        —          50        —     

Gain (loss) on sale and impairment of investments

   $ (1   $ (3   $ 7      $ (4

Currency exchange gain (loss) — net

     (44     61        (44     29   

Other — net

     6        (1     1        (8
                                

Other income (expense) — net

   $ (18   $ 57      $ 14      $ 17   
                                

Condensed consolidated balance sheets

Cash and cash equivalents:

Included in cash, with a corresponding accounts payable, at September 30, 2010 and December 31, 2009 is $5 and $24, respectively, collected by Nortel on behalf of purchasers related to transferred receivables as part of the various divestitures. These amounts will be remitted to the purchasers in the short term.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Restricted cash:

Restricted cash includes, in part, $72 and nil as of September 30, 2010 and December 31, 2009, respectively, related to assets held in an employee benefit trust in Canada, and restricted as to their use in operations by Nortel. The employee benefit trust investments of $73 were classified as a long-term investment at December 31, 2009 and reclassified to restricted cash as of June 30, 2010 due to the sale and reinvestment of the proceeds into cash equivalents.

Accounts receivable — net:

 

     September 30,
2010
    December 31,
2009
 

Trade receivables

   $ 197      $ 593   

Notes receivable

     —          3   

Contracts in process

     4        45   
                
     201        641   

Less: provisions for doubtful accounts

     (8     (16
                

Accounts receivable — net

   $ 193      $ 625   
                

Inventories — net:

 

     September 30,
2010
    December 31,
2009
 

Raw materials

   $ 14      $ 53   

Work in process

     2        2   

Finished goods

     73        157   

Deferred costs

     9        144   
                
     98        356   

Less: provision for inventories

     (69     (129
                

Inventories and long-term deferred costs — net

     29        227   

Less: long-term deferred costs (a)

     —          (44
                

Inventories — net

   $ 29      $ 183   
                

 

(a) Long-term portion of deferred costs is included in other assets.

At September 30, 2010 and December 31, 2009, inventories included approximately $52 and $78, respectively, of gross inventory on consignment.

Other current assets:

 

     September 30,
2010
     December 31,
2009
 

Prepaid expenses

   $ 27       $ 54   

Income taxes recoverable

     39         30   

Current investments

     23         10   

Other

     183         254   
                 

Other current assets

   $ 272       $ 348   
                 

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Plant and equipment — net:

 

     September 30,
2010
    December 31,
2009
 

Cost:

    

Buildings

   $ 99      $ 686   

Machinery and equipment

     366        752   

Assets under capital lease

     73        153   

Sale lease-back assets

     9        49   
                
     547        1,640   
                

Less accumulated depreciation:

    

Buildings

     (64     (262

Machinery and equipment

     (292     (586

Assets under capital lease

     (52     (93

Sale lease-back assets

     (7     (11
                
     (415     (952
                

Plant and equipment — net

   $ 132      $ 688   
                

Intangible assets — net:

 

     September 30,
2010
     December 31,
2009
 

Cost

   $ —         $ 103   

Less: accumulated amortization

     —           (52
                 

Intangible assets — net

   $ —         $ 51   
                 

Other assets:

 

     September 30,
2010
     December 31,
2009
 

Long-term deferred costs

   $ —         $ 44   

Long-term inventories

     —           6   

Debt issuance costs

     40         49   

Financial assets

     50         49   

Other

     22         29   
                 

Other assets

   $ 112       $ 177   
                 

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Other accrued liabilities:

 

     September 30,
2010
     December 31,
2009
 

Outsourcing and selling, general and administrative related provisions

   $ 49       $ 67   

Customer deposits

     9         6   

Product-related provisions

     —           22   

Warranty provisions (note 14)

     2         58   

Deferred revenue

     13         138   

Advance billings in excess of revenues recognized to date on contracts (a)

     8         76   

Miscellaneous taxes

     3         8   

Income taxes payable

     29         41   

Deferred income taxes

     —           14   

Tax uncertainties (note 12)

     —           83   

Other

     32         147   
                 

Other accrued liabilities

   $ 145       $ 660   
                 

 

(a) Includes amounts that may be recognized beyond one year due to the duration of certain contracts.

Other liabilities:

 

     September 30,
2010
     December 31,
2009
 

Pension benefit liabilities

   $ —         $ 6   

Post-employment and post-retirement benefit liabilities

     7         8   

Restructuring liabilities (notes 10 and 11)

     3         4   

Deferred revenue

     —           71   

Tax uncertainties (note 12)

     17         89   

Other long-term provisions

     23         48   
                 

Other liabilities

   $ 50       $ 226   
                 

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Condensed consolidated statements of cash flows

Change in operating assets and liabilities — net:

 

     Nine Months Ended September 30,  
         2010             2009      

Accounts receivable — net

   $ 281      $ 319   

Inventories — net

     36        86   

Deferred costs

     20        74   

Income taxes

     (73     (7

Accounts payable

     (59     64   

Payroll, accrued and contractual liabilities

     44        142   

Deferred revenue

     3        (28

Advance billings in excess of revenues recognized to date on contracts

     (77     (110

Restructuring liabilities

     (19     (32

Other

     (27     (90
                

Change in operating assets and liabilities (a)

   $ 129      $ 418   
                

 

(a) The changes in liability amounts noted above include obligations that are subject to compromise.

Interest and taxes paid

 

     Nine Months Ended September 30,  
         2010             2009      

Cash interest paid

   $ 5      $ 14   

Cash taxes paid

   $ 45      $ 17   

Net payment (receipt) for reorganization items (note 5)

   $ (759   $ 67   

7. Goodwill

In the nine months ended September 30, 2009, Nortel recorded $48 of impairment loss related to the NGS reporting unit prior to its reclassification to discontinued operations.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

8. Assets and liabilities held for sale

The following table sets forth assets and liabilities classified as held for sale at September 30, 2010:

 

     Plant and
Equipment —
net
     Multi Service Switch
Business
     Total  

Assets

        

Accounts receivable — net

   $ —         $ 1       $ 1   

Inventories — net

     —           13         13   

Plant and equipment — net

     250         2         252   

Other current assets

     —           3         3   
                          

Assets held for sale

   $ 250       $ 19       $ 269   
                          

Liabilities

        

Employee-related liabilities

   $ —         $ 1       $ 1   

Other current liabilities

   $ —         $ 8       $ 8   
                          

Liabilities held for sale

   $ —         $ 9       $ 9   
                          

As discussed in note 2, during the third quarter of 2010, Nortel concluded a successful auction whereby Ericsson acquired substantially all assets of the MSS business globally, for a purchase price of $65 in cash. The sale was approved by the U.S. and Canadian courts on September 30, 2010. The sale is subject to approvals by certain court appointed administrators in EMEA, as well as regulatory approvals and other customary closing conditions. As a result, the related MSS assets and liabilities have been classified as held for sale as of September 30, 2010. Nortel determined that the fair value less estimated costs to sell exceeded the carrying value of the MSS assets and liabilities therefore no impairment was recorded on the reclassification of these assets to held for sale.

Certain long-lived assets have been classified as held for sale as a result of reaching the appropriate stage in the sale process. During the three and nine months ended September 30, 2010, Nortel recorded impairment (recoveries) and charges of ($18) and $120, respectively, as a result of its evaluation of whether the fair value less costs to sell for these assets was less than their respective carrying values.

9. Segment information

Segment descriptions

In the first quarter of 2010, Nortel completed the sale of substantially all of the Optical Networking and Carrier Ethernet businesses to Ciena, which were included in the MEN segment, and the sale of substantially all of the GSM/GSM-R business to Ericsson and Kapsch, which was included in the WN segment. In the second quarter of 2010, Nortel completed the sale of substantially all of the CVAS business to GENBAND, which was included in our CVAS segment, and the sale of NNL’s interest in LGN to Ericsson. As noted above, Nortel entered into sale agreements with Ericsson for the planned sale of substantially all the assets of the MSS business. These assets and liabilities have been classified as assets held for sale.

As of September 30, 2010, Nortel’s three reportable segments were WN, CVAS and MEN:

 

   

The WN segment provides wireline and wireless networks and related services that help service providers and cable operators supply mobile voice, data and multimedia communications services for

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

individuals and enterprises using cellular telephones, personal digital assistants, laptops, soft-clients, and other wireless computing and communications devices. As of September 30, 2010, WN includes the residual CDMA and GSM businesses.

 

   

The CVAS segment offers circuit- and packet-based voice switching products that provide local, toll, long distance and international gateway capabilities for local and long distance telephone companies, wireless service providers, cable operators and other service providers. As of September 30, 2010, CVAS includes the residual CVAS business.

 

   

The MEN segment offers solutions designed to deliver carrier-grade Ethernet transport capabilities focused on meeting customer needs for higher performance and lower cost, with a portfolio that includes Optical Networking, Carrier Ethernet switching, and MSS products and related services. As of September 30, 2010, MEN includes the residual Optical Networking and Carrier Ethernet solutions businesses and the MSS business.

Comparative periods have been recast to conform to the current segment presentation.

Other miscellaneous and temporary business activities and corporate functions do not meet the criteria to be disclosed separately as reportable segments and have been reported in “Other”. Costs associated with shared services, such as general corporate functions, that are managed on a common basis are allocated to Nortel’s reportable segments based on usage determined generally by headcount. A portion of other general and miscellaneous corporate costs and expenses are allocated based on a fixed charge established annually. Costs not allocated to the reportable segments include employee share-based compensation, differences between actual and budgeted employee benefit costs, interest attributable to Nortel’s long-term debt and other non-operational activities, and are included in “Other”.

In the first quarter of 2010, Nortel’s then Chief Restructuring Officer (“CRO”) (effective March 21, 2010 and for the remainder of the first quarter of 2010, the CRO’s title was changed to Special Advisor) and the President of NBS were both identified as Chief Operating Decision Makers in assessing the performance of and allocating resources to Nortel’s operating segments. The CRO was responsible for the remaining businesses and the President of NBS was responsible for the contracts included in operating segments that did not transfer to the purchasers of the divested businesses. As a result of the departure of the CRO, the Chief Strategy Officer and Business Unit President became the Chief Operating Decision Maker (“CODM”) in the second quarter of 2010 responsible for the remaining businesses, while the President of NBS continues to be the CODM responsible for the contracts included in operating segments that did not transfer, as noted above. In the third quarter of 2010, the primary financial measure used by the Chief Strategy Officer and the President of NBS was Management Operating Margin (“Management OM”). Management OM is not a recognized measure under U.S. GAAP. It is a measure defined as total revenues, less total cost of revenues, SG&A and R&D expense relating to both our consolidated entities and the Equity Investees. Management OM percentage is a non-U.S. GAAP measure defined as Management OM divided by revenue. Beginning in the third quarter of 2010, the financial information for our reportable segments presented, including Management OM, no longer includes the results of the Equity Investees for any period, which is consistent with how Nortel manages its remaining businesses following the sale of substantially all of its businesses.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Segments

The following tables set forth information by segment:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2010     2009     2010     2009  

Segment revenues

       

WN

  $ 31      $ 601      $ 191      $ 1,781   

CVAS

    4        151        166        381   

MEN

    48        190        233        643   
                               

Total reportable segments

    83        942        590        2,805   

Other

    2        —          2        —     
                               

Total segment revenues

    85        942        592        2,805   

Management OM

       

WN

  $ 16      $ 187      $ 83      $ 453   

CVAS

    (4     14        (52     (19

MEN

    5        (22     (28     (39
                               

Total reportable segments

    17        179        3        395   

Other

    (131     (59     (418     (209
                               

Total Management OM

    (114     120        (415     186   

Amortization of intangible assets

    —          (1     —          (2

Loss (gain) on sales of businesses and sales and impairments of assets

    —          15        3        (1

Other operating expense (income) — net

    (94     44        (250     41   
                               

Operating earnings (loss)

    (20     62        (168     148   

Other income (expense) — net

    (18     57        14        17   

Interest expense

    (77     (75     (227     (225

Reorganization items — net

    (529     (224     (1,420     (290

Income tax benefit (expense)

    4        (8     37        (21

Equity in net gain (loss) of associated companies — net of tax

    —          (2     (1     (3

Equity in net loss of Equity Investees

    —          (159     (50     (448
                               

Net loss from continuing operations

  $ (640   $ (349   $ (1,815   $ (822
                               

Nortel had no customer that generated more than 10% of total consolidated revenues for the three months ended September 30, 2010. Nortel had one customer, AT&T, which generated revenues of approximately 10% of total consolidated revenues for the nine months ended September 30, 2010. For the three and nine months ended September 30, 2009, Nortel had one customer, Verizon, that generated revenues of approximately 25% and 23%, respectively, of total consolidated revenues. Although these revenues were generated primarily within the WN segment, they were also from Nortel’s other reportable segments.

10. Pre-Petition Date cost reduction plans

As a result of the Creditor Protection Proceedings, Nortel ceased taking any further actions under the previously announced workforce and cost reduction plans as of January 14, 2009. Any revisions to actions taken

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

up to that date under previously announced workforce and cost reduction plans will continue to be accounted for under such plans, and will be classified in cost of revenues, SG&A, and R&D as applicable. Any remaining actions under these plans were accounted for under the workforce reduction plan announced on February 25, 2009 (see note 11). Nortel’s contractual obligations are subject to re-evaluation in connection with the Creditor Protection Proceedings and, as a result, expected cash outlays disclosed below relating to contract settlement and lease costs are subject to change. As well, Nortel is not following its pre-Petition Date practices with respect to the payment of severance in jurisdictions under the Creditor Protection Proceedings.

During the nine months ended September 30, 2010, changes to the provision were as follows:

 

     November 2008
Restructuring
Plan
    2008
Restructuring
plan
    2007
Restructuring
plan
    2004 and 2001
Restructuring
Plan
    Total  

Workforce Reduction

          

Provision balance as of December 31, 2009

   $ 27      $ 18      $ 10      $ —        $ 55   

Revisions to prior accruals

     (3     (2     —          —          (5
                                        

Provision balance as of September 30, 2010

   $ 24      $ 16      $ 10      $ —        $ 50   
                                        

Contract Settlement and lease costs

          

Provision balance as of December 31, 2009

   $ —        $ 4      $ 7      $ 17      $ 28   

Current period charges

     —          —          —          1        1   

Revisions to prior accruals

     —          —          (1     —          (1

Current period utilization

     —          —          (1     (1     (2
                                        

Provision balance as of September 30, 2010

   $ —        $ 4      $ 5      $ 17      $ 26   
                                        

Total provision balance as of September 30, 2010 (a)

   $ 24      $ 20      $ 15      $ 17      $ 76   
                                        

 

(a) As of September 30, 2010 and December 31, 2009, the short-term provision balances were $2 and $2, respectively, and the long-term provision balances were $2 and $4, respectively, and the liabilities subject to compromise balances were $72 and $76, respectively.

During the three and nine months ended September 30, 2010 and 2009 the charge (recovery) by profit and loss category was as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010              2009             2010             2009      

Cost of revenues

   $ —         $ —        $ (1   $ (7

Selling, general and administrative

     —           (4     (3     (14

Research and development

     —           —          (1     (3

Reorganization items — lease repudiation

     —           (51     —          (83

Other

     —           2        —          (23
                                 

Total charge (recovery) before discontinued operations

     —           (53     (5     (130

Discontinued operations

     —           —          (2     —     
                                 

Total charge

   $ —         $ (53   $ (7   $ (130
                                 

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

The following table sets forth the charge (recovery) before discontinued operations incurred for each of Nortel’s cost reduction plans by segment during the three and nine months ended September 30, 2010 and 2009:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010              2009             2010             2009      

WN

   $ —         $ (32   $ (5   $ (81

CVAS

     —           (9     —          (25

MEN

     —           (12     —          (24
                                 

Total charges

   $ —         $ (53   $ (5   $ (130
                                 

A significant portion of Nortel’s provisions for workforce reductions and contract settlement and lease costs is associated with shared services. These costs have been allocated to the segments in the table above, based generally on headcount, SG&A allocations and revenue streams. Previously, Nortel allocated these costs only based on headcount and revenue streams. Charges related to these plans prior to 2009 were recorded in special charges and were not included in the calculation of Management OM, while any revisions to provisions after this date will be recorded in operations and are included in the calculation of Management OM.

11. Post-Petition Date cost reduction activities

In connection with the Creditor Protection Proceedings, Nortel has commenced certain workforce and other cost reduction activities and will undertake further workforce and cost reduction activities during this process. The actions related to these activities are expected to occur as they are identified. The following current estimated charges are based upon accruals made in accordance with U.S. GAAP. The current estimated total charges to earnings and cash outlays are subject to change as a result of Nortel’s ongoing review of applicable law. In addition, the current estimated total charges to earnings and cash outlays do not reflect all potential claims or contingency amounts that may be allowed under the Creditor Protection Proceedings and thus are also subject to change.

Workforce Reduction Activities

On February 25, 2009, Nortel announced a workforce reduction plan to reduce its global workforce by approximately 5,000 net positions which, upon completion, was expected to result in total charges to earnings of approximately $270 with expected total cash outlays of approximately $160 and the balance classified as a liability subject to compromise. Included in these amounts are actions related to the Equity Investees (see note 22). On a consolidated basis, absent amounts related to the Equity Investees, the plan was expected to result in total charges to earnings of approximately $168 with expected and total cash outlays of approximately $77 with the balance classified as a liability subject to compromise.

Subsequent to the February 25, 2009 announcement, as Nortel continued to progress through the Creditor Protection Proceedings additional workforce reductions were deemed necessary to achieve the broader cost reduction initiative. On a consolidated basis, absent amounts related to Equity Investees, the incremental workforce reductions were expected to result in charges to earnings and cash outlays of $176 and $89, respectively, with the balance being classified as subject to compromise.

On a consolidated basis, excluding amounts related to the Equity Investees, Nortel completed all 2009 announced workforce reductions discussed above resulting in a net workforce reduction of 4,625 with charges to earnings and cash outlays of approximately $117 and $38, respectively, with the balance being classified as subject to compromise.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Three and nine months ended September 30, 2010

In addition to the concluded 2009 workforce reduction plans discussed above, Nortel has continued workforce reduction initiatives during 2010. For the three and nine months ended September 30, 2010, approximately $6 and $37, respectively, of the total charges relating to the net workforce reduction of 100 and 1,130 positions, respectively, were incurred. For the three and nine months ended September 30, 2010, Nortel incurred workforce reduction recovery of nil and $2, respectively and charges of $3 and $65, respectively, for discontinued operations. As Nortel continues to progress through the Creditor Protection Proceedings, Nortel expects to incur charges and cash outlays related to workforce and other cost reduction strategies. Nortel will continue to report future charges and cash outlays under the broader strategy of the post petition cost reduction plan.

During the nine months ended September 30, 2010 changes to the provision balances were as follows:

 

Provision balance as of December 31, 2009

   $ 70   

Other charges

     42   

Revisions to prior accruals

     (5

Cash drawdowns

     (12

Foreign exchange and other adjustments

     1   
        

Provision balance as of September 30, 2010 (a)

   $ 96   
        

 

(a) As of September 30, 2010, $94 was included in liabilities subject to compromise, the short-term provision balance was $2, and the long-term provision balance was nil.

During the three and nine months ended September 30, 2010 and 2009 workforce reduction charges were as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Cost of revenues

   $ 1       $ 5       $ 12       $ 25   

SG&A

     4         14         17         38   

R&D

     1         2         8         13   
                                   

Total workforce reduction charge

   $ 6       $ 21       $ 37       $ 76   
                                   

The following table sets forth charges incurred for workforce reductions by segment during the three and nine months ended September 30, 2010 and 2009:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

WN

   $ 3       $ 12       $ 6       $ 51   

CVAS

     2         6         23         16   

MEN

     1         3         8         9   
                                   

Total charges

   $ 6       $ 21       $ 37       $ 76   
                                   

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Other Cost Reduction Activities

During the three and nine months ended September 30, 2010, Nortel’s real estate related cost reduction activities resulted in charges of $2 and $8, respectively, which were recorded against SG&A and reorganization items. During the three and nine months ended September 30, 2010, Nortel recorded plant and equipment write downs of nil and $11, respectively, against SG&A and reorganization items, and additional charges of nil and $13, respectively, against reorganization items for lease repudiations and other contract settlements. As of September 30, 2010, Nortel’s real estate and other cost reduction liabilities were approximately $31, of which $29 is classified as subject to compromise.

12. Income taxes

During the nine months ended September 30, 2010, Nortel recorded a tax recovery of $37 on loss from continuing operations before income taxes and equity in net loss of associated companies and Equity Investees of $1,801. The tax recovery of $37 is largely comprised of $10 of income taxes on current year profits in various jurisdictions offset by decreases in uncertain tax positions and other taxes of $9 and the reversal of previously accrued income taxes and interest of $38.

During the nine months ended September 30, 2009, Nortel recorded a tax expense of $21 on loss from continuing operations before income taxes and equity in net loss of associated companies of $350. The tax expense of $21 was largely comprised of $13 of income taxes in profitable jurisdictions primarily in Asia and the provision of $24 of income taxes due to adjustments relating to transfer pricing and uncertain tax positions. This was offset by the true-up of prior year estimates of $15 and a benefit of $1 from various tax credits and R&D related incentives. Previously included in continuing operations, Nortel reallocated to discontinued operations tax expense of $7 relating to the accrual of the deferred tax liability associated with NNL’s investment in LGN.

As of September 30, 2010, Nortel’s net deferred tax assets were $nil. In June 2009, Nortel concluded that the sale of Nortel’s remaining businesses was the best path forward and divestiture activities are described in note 2. Nortel has entered into TSA with certain of the buyers of these businesses and, as described in note 2, is in the process of selling its remaining businesses and assets. Certain of these dispositions have been considered positive evidence in the determination of future income available to support the realization of the remaining net deferred tax assets. Although these additional dispositions are estimated to generate gains, due to the significant uncertainty concerning the forecasted income for 2010 and beyond, the uncertainty concerning the estimated final proceeds allocation by jurisdiction and Nortel’s limited ability to control the ultimate closing of any remaining transactions, this positive evidence does not outweigh the significant negative evidence that exists and therefore, Nortel continues to conclude that as at September 30, 2010 a full valuation allowance continues to be necessary against Nortel’s deferred tax assets in all jurisdictions.

At December 31, 2009, Nortel’s net deferred tax asset was $13, which included a net deferred tax asset of $20 in Korea, offset by a deferred tax liability of $7 associated with NNL’s investment in LGN. As at September 30, 2010, the net deferred tax assets decreased from $13 to $nil, mainly due to the sale of the Company’s interest in the LGN joint venture.

In accordance with ASC 740, Nortel recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. For purposes of intraperiod allocation, Nortel includes all changes in reserves relating to historical periods for uncertain tax positions in continuing operations.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Nortel had approximately $1,871 and $953 of total gross unrecognized tax benefits as of December 31, 2009 and September 30, 2010, respectively. As of September 30, 2010, of the total gross unrecognized tax benefits in its consolidated entities, $15 represented the amount of unrecognized tax benefits that would favorably affect the effective income tax rate in future periods, if recognized. The net decrease of $918 since December 31, 2009 resulted from $813 from the resolution and settlement of the 2001 through 2005 Advance Pricing Arrangements (“APA”) between Canada and the U.S, $37.5 from the settlement payment made to the IRS on February 22, 2010, $22, $8 and $6 from the deconsolidation of its Brazil entity, its Colombia entity and the LGN joint venture, respectively and by a decrease of $43 from adjustments to prior year uncertain tax positions, mainly attributable to the finalization of amended tax returns and filing positions in Canada. This was offset by an increase of $12 from changes to the measurement of existing uncertain tax positions for changes to foreign exchange rates and other measurement criteria.

Nortel recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the nine months ended September 30, 2010, Nortel recognized approximately $1 related to interest, penalties and foreign exchange losses, which was offset by a decrease of $56, $13 and $2 for the deconsolidation of its Brazil entity, its Colombia entity and the LGN joint venture, respectively. Nortel had accrued approximately $9 and $79 for the payment of interest and penalties as of September 30, 2010 and December 31, 2009, respectively.

Nortel believes it is reasonably possible that $200 of its gross unrecognized tax benefit will decrease during the twelve months ending September 30, 2011 with such amounts attributable to possible decreases from the potential settlement of audit exposures of $197 in Canada and $3 in various jurisdictions.

Nortel is subject to tax examinations in all major taxing jurisdictions in which it continues to operate and Nortel regularly assesses the status and the potential for adverse outcomes to determine the adequacy of the provision for income and other taxes. Other than the U.S., Nortel’s 2000 through 2009 tax years remain open in most of these jurisdictions primarily as a result of ongoing negotiations regarding APAs affecting these periods and ongoing audit activity. Specifically, the tax authorities in Canada are close to completing an audit in respect of non-refundable investment tax credits claimed by NNL in its 2002 tax year. It is expected that this audit will result in a substantial denial of NNL’s non-refundable investment tax credit claim and NNL has reduced its investment tax credit balance and related valuation allowance to reflect the more likely than not audit outcome. We are in the process of assessing the anticipated 2002 audit and the impact on future non-refundable investment tax credits. NNL has not decreased its 2003 to 2008 investment tax credit deferred tax balances as a result of the 2002 tax audit. However, since these investment tax credits are not refundable, can only be applied against taxes payable and these deferred tax balances have a full valuation allowance, any potential audit adjustments are not expected to result in any charge to tax expense. Nortel believes that it has adequately provided for other tax adjustments that are more likely than not to be realized as a result of these ongoing examinations.

Nortel had previously entered into APAs with the U.S. and Canadian taxation authorities in connection with its intercompany transfer pricing and cost sharing arrangements between Canada and the U.S. These arrangements expired in 1999 and 2000. In 2002, Nortel filed APA requests with the taxation authorities in the U.S., Canada and the U.K. that applied to the 2001 through 2005 taxation years (“2001-2005 APA”). In February 2010, Nortel and the U.S. and Canadian taxing authorities settled and executed the 2001-2005 APA resulting in a reallocation of losses from NNI to NNL in the amount of $2,000. The agreement between the tax authorities makes no mention of an appropriate transfer pricing method for the 2001-2005 APA. Nortel continues to apply the transfer pricing methodology proposed in the 2001-2005 APA requests to the other parties subject to the transfer pricing methodology in preparing its tax returns and its accounts for its 2001 to 2005 taxation years. The other parties are the U.K., France, Ireland and Australia.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Although Nortel continues to apply the transfer pricing methodology that was requested in the previously withdrawn 2007-2010 APA to the 2006 through to the 2008 taxation years, the ultimate outcome is uncertain and the ultimate reallocation of losses cannot be determined at this time. Other than in the U.S., there could be a further material shift in historical earnings between the above mentioned parties. If these matters are resolved unfavorably, they could have a material effect on Nortel’s consolidated financial position, results of operations and/or cash flows.

Nortel has not provided for foreign withholding taxes or deferred income tax liabilities for temporary differences related to the undistributed earnings of foreign subsidiaries since Nortel does not currently expect to repatriate earnings that would create any material tax consequences. It is not practical to reasonably estimate the amount of additional deferred income tax liabilities or foreign withholding taxes that may be payable should these earnings be distributed in the future.

During the second quarter of 2010, NNL completed the process of amending a number of previously filed Canadian tax returns to reflect adjustments relating to various restatements of its financial statements and the 2001-2005 APA settlement described above. As a result of completing the filing these amended tax returns, NNL has released income tax liabilities in the amount of $28, mainly relating to previously accrued interest and other tax exposures that are no longer estimated to be payable due to the finalization of filing positions in the restated Canadian tax returns.

13. Employee benefit plans

Plan Description

Nortel maintains various retirement programs covering substantially all of its employees, consisting of defined benefit, defined contribution and investment plans.

Nortel has defined contribution plans available to substantially all of its North American employees. Additionally, Nortel has traditional defined benefit plans that are closed to new entrants. See below regarding the PBGC termination of the U.S. Retirement Income Plan on September 8, 2009. See note 2 regarding the transfer of administration of the Canadian Pension Plans on September 30, 2010. Although these plans represent Nortel’s major retirement plans, Nortel also has smaller pension plan arrangements in other countries.

Nortel also provides other benefits, including post-retirement benefits and post-employment benefits. Employees previously enrolled in the capital accumulation and retirement programs offering post-retirement benefits are eligible for company sponsored post-retirement health care and/or death benefits, depending on age and/or years of service. See note 2 regarding the termination of the Canadian post-retirement benefits on December 31, 2010.

Nortel’s policy is to fund registered defined benefit pension benefits based on accepted actuarial methods as permitted by regulatory authorities. Other post-retirement and post-employment benefits are funded as claims are incurred. The funded amounts reflect actuarial assumptions regarding compensation, interest and other projections. See note 2 regarding changes to the funding of Canadian registered defined benefit pension plans, post-retirement and post-employment benefits. Pension and other post-retirement benefit costs reflected in the consolidated statements of operations are based on the projected benefit method of valuation.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

PBGC termination of the U.S. Retirement Income Plan

On July 17, 2009, the PBGC provided a notice to NNI that the PBGC had determined under the Employee Retirement Income Securities Act of 1974 (“ERISA”) that: (i) the Nortel Networks Retirement Income Plan (the “Retirement Income Plan”), a defined benefit pension plan sponsored by NNI, will be unable to pay benefits when due; (ii) under Section 4042(c) of ERISA, the Retirement Income Plan must be terminated in order to protect the interests of participants and to avoid any unreasonable increase in the liability of the PBGC insurance fund; and (iii) July 17, 2009 was to be established as the date of termination of the Retirement Income Plan. NNI worked to voluntarily assign trusteeship of the Retirement Income Plan to the PBGC and avoid further court involvement in the termination process.

On September 8, 2009, pursuant to an agreement between the PBGC and the Retirement Plan Committee, the Retirement Income Plan was terminated with a termination date of July 17, 2009, and the PBGC was appointed trustee of the plan.

The PBGC has filed a proof of claim against NNI and each of the Debtors in the Chapter 11 Proceedings for the unfunded benefit liabilities of the Nortel Networks Retirement Income Plan, a defined benefit pension plan sponsored by NNI, (“U.S. Pension Plan”) in the amount of $546. The PBGC has also filed unliquidated claims for contributions necessary to satisfy the minimum funding standards, a claim for insurance premiums, interest and penalties, and a claim for shortfall and amortization charges. Under ERISA, the PBGC may have the ability to impose certain claims and liens on NNI and certain NNI subsidiaries and affiliates (including liens on assets of certain Nortel entities not subject to the Creditor Protection Proceedings). Nortel has recorded a liability of $334 representing Nortel’s current best estimate of the expected allowed claim amount in accordance with ASC 852 in relation to these claims. To the extent that information available in the future indicates a difference from the recognized amounts, the provision will be adjusted.

Settlement Agreement with Former and Disabled Canadian Employee Representatives

As discussed in note 2, on February 8, 2010, the Canadian Debtors entered into the Settlement Agreement in relation to the Canadian registered pension plans, post-retirement benefits and post-employment benefits. The Settlement Agreement, as amended, was approved by the Canadian Court on March 31, 2010. The Canadian registered pension plans were transferred to the replacement administrator, Morneau Sobeco Limited Partnership, on September 30, 2010. Nortel remained as plan sponsor and, in its capacity as plan sponsor of the Canadian registered pension plans, amended the plans to cease future service accruals effective September 30, 2010. Benefit payments in the Canadian post-retirement benefit plan and the Canadian long-term disability plan will cease on December 31, 2010.

As a result of the approved cessation of post-retirement benefit payments on December 31, 2010, Nortel recorded the impacts of the Settlement Agreement in accordance with FASB ASC 715-60 “Defined Benefit Plans — Other Post Retirement” (“ASC 715-60”), which required a derecognition of the liability and deferred actuarial gains totaling $432 in the first quarter of 2010 in reorganization items. In the nine months ended September 30, 2010, Nortel has recorded in reorganization items a charge of $429 representing its current best estimate of the expected allowed claim amount in accordance with ASC 852 in relation to the participant claims for future years benefits they will no longer receive due to the cessation of the plans. To the extent that information available in the future indicates a difference from the recognized amounts, the provision will be adjusted.

As a result of the amendments to cease future service accruals for the Canadian Pension Plans, Nortel remeasured the Canadian Pension Plans using assumptions consistent with a wind-up basis of accounting as this

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

is Nortel’s best estimate of current assumptions and recorded the impacts of this remeasurement in the third quarter of 2010 in accordance with FASB ASC 715-30 “Defined Benefit Plans — Pension” (ASC 715-30). A curtailment loss of $490 was recorded to the statement of operations in reorganization items in the third quarter of 2010. As a result of this remeasurement, Nortel changed its pension discount rate, a key assumption used in estimating pension benefit costs, for the Canadian Pension Plans. This resulted in a change in the weighted average pension discount rate to 4.6% from 5.8% at December 31, 2009. In addition, as a result of the remeasurement, Nortel was required to adjust the liability for impacts from the curtailment loss and changes in assumptions at the re-measurement date. The effect of these adjustments and the related foreign currency translation adjustment was to increase pension liabilities by $579 and accumulated other comprehensive loss (before tax) by $89.

Impacts of workforce reductions and divestiture activities

As a result of workforce reductions in connection with the Creditor Protection Proceedings and the divestiture activities, Nortel remeasured the post-retirement benefit obligations for the U.S. and Canada and recorded the impacts of these remeasurements in the first quarter of 2010 in accordance with ASC 715-60. The curtailment and remeasurement impacts related to the Canadian post-retirement benefit obligations were recorded in addition to the Settlement Agreement impacts described above. Curtailment gains of $6 and $7 were recorded to the statement of operations in the U.S. and Canada, respectively. As a result of these remeasurements, Nortel changed its post-retirement discount rate, a key assumption used in estimating post-retirement benefit costs, for the U.S. and Canada. This resulted in a change in the weighted average post-retirement discount rate to 5.9% from 6.0% at December 31, 2009. In addition as a result of the remeasurements, Nortel was required to adjust the liability for impacts from the curtailment gain and changes in assumptions at the re-measurement date. For the U.S, the effect of these adjustments was to decrease post-retirement liabilities by $3 and accumulated other comprehensive loss (before tax) by $3. For Canada, the effect of this adjustment and the related foreign currency translation adjustment was to increase post-retirement liabilities by $15 and accumulated other comprehensive loss (before tax) by $18.

As a result of additional workforce reductions in connection with the Creditor Protection Proceedings and the divestiture activities, Nortel remeasured the post-retirement benefit obligation for the U.S. and recorded the impacts of this remeasurement in the second quarter of 2010 in accordance with ASC 715-60. A curtailment gain of $4 was recorded to the statement of operations in the U.S. in the second quarter of 2010. As a result of this remeasurement, Nortel changed its post-retirement discount rate, a key assumption used in estimating post-retirement benefit costs, for the U.S. This resulted in a change in the weighted average post-retirement discount rate to 5.4% from 5.9% at March 31, 2010. In addition, as a result of the remeasurement, Nortel was required to adjust the liability for impacts from the curtailment gain and changes in assumptions at the re-measurement date. The effect of these adjustments was to increase post-retirement liabilities by $5 and accumulated other comprehensive loss (before tax) by $9.

As a result of additional workforce reductions in connection with the Creditor Protection Proceedings, Nortel remeasured the post-retirement benefit obligation for the U.S. and recorded the impacts of this remeasurement in the third quarter of 2010 in accordance with ASC 715-60. A curtailment gain of $0.4 was recorded to the statement of operations in the U.S. in the third quarter of 2010. As a result of this remeasurement, Nortel changed its post-retirement discount rate, a key assumption used in estimating post-retirement benefit costs, for the U.S. This resulted in a change in the weighted average post-retirement discount rate to 5.1% from 5.4% at June 30, 2010. In addition, as a result of the remeasurement, Nortel was required to adjust the liability for impacts from the curtailment gain and changes in assumptions at the re-measurement date. The effect of these adjustments was to increase post-retirement liabilities by $6 and accumulated other comprehensive loss (before tax) by $6.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

U.S. Healthcare Reform Acts

In March 2010, the President of the United States signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act and the Health Care Education and Affordability Reconciliation Act (the Acts). The Acts contain provisions that could impact Nortel’s accounting for retiree medical benefits in future periods. However, the ultimate extent of that impact, if any, on Nortel cannot be determined until final regulations are promulgated under the Acts and additional interpretations of the Acts become available. Nortel will continue to assess the accounting implications of the Acts as related regulations and interpretations of the Acts become available. Based on the analysis to date of the provisions in the Acts for which the impacts are reasonably determinable, a re-measurement of Nortel’s post-retirement plan liabilities is not required at this time.

Pension and Post Retirement Benefits

The following details the net pension expense for the defined benefit plans for the following periods:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      

Pension expense:

        

Service cost

   $ 1      $ 2      $ 7      $ 8   

Interest cost

     51        60        153        182   

Expected return on plan assets

     (38     (57     (114     (173

Amortization of prior service cost

     1        1        2        2   

Amortization of net losses (gains)

     10        (1     30        (2

Curtailment, contractual and special termination losses (gains)

     490        75        491        78   

Settlement losses (gains)

     —          (46     —          (44
                                

Net pension expense

   $ 515      $ 34      $ 569      $ 51   
                                

The following details the net cost components of post-retirement benefits other than pensions for the following periods:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      

Post-retirement benefit cost:

        

Service cost

   $ —        $ 1      $ 1      $ 2   

Interest cost

     3        9        14        26   

Amortization of prior service cost

     (1     (2     (3     (7

Amortization of net gains

     —          (2     (3     (8

Settlement gain

     —          —          (68     —     

Curtailment gain

     —          (4     (382     (17
                                

Net post-retirement benefit cost

   $ 2      $ 2      $ (441   $ (4
                                

During the nine months ended September 30, 2010 and 2009, contributions of $27 and $40, respectively, were made to the defined benefit plans and $28 and $28, respectively, to the post-retirement benefit plans. Nortel does not expect to contribute any additional amounts in 2010 to the defined benefit pension plans, and expects to contribute an additional $11 in 2010 to the post-retirement benefit plans for a total contribution of $39.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

14. Guarantees

Nortel’s requirement to make payments (either in cash, financial instruments, other assets, NNC common shares or through the provision of services) to a third party will be triggered as a result of changes in an underlying economic characteristic (such as interest rates or market value) that is related to an asset, a liability or an equity security of the guaranteed party or a third party’s failure to perform under a specified agreement.

The following table provides a summary of Nortel’s guarantees as of September 30, 2010:

 

    Carrying Amount
of Liability
    Maximum
Potential Liability  (m)
 

Business sale and business combination agreements

   

Third party claims (a)

  $ 1      $ 4   

Specified annual sales volume (b)

    9        9   

Intellectual property indemnification obligations (c)

    —          —     

Lease agreements (d)

    —          11   

Receivable securitizations (e)

    —          —     

Other indemnification agreements

   

EDC Support Facility (f)

    21        54   

Global Class Action Settlement (g)

    —          —     

Sale lease-back (h)

    —          4   

Real estate indemnification (i)

    —          —     

Bankruptcy (j)

    —          1   

Real estate residual value guarantee (k)

    23        23   

UK Defined Benefit Plan guarantee (l)

    681        681   
               

Total

  $ 735      $ 787   
               

 

(a) Includes guarantees in connection with agreements for the sale of all or portions of an investment or a Nortel business, including certain discontinued operations and guarantees related to the escrow of shares as part of business combinations in prior periods. Nortel has indemnified the purchaser of an investment or a Nortel business in the event that a third party asserts a claim against the purchaser that relates to a liability retained by Nortel relating to business events occurring prior to the sale, such as tax, environmental, litigation and employment matters. In certain agreements, Nortel also indemnifies counterparties for losses incurred from litigation that may be suffered by counterparties arising under guarantees related to the escrow of shares in business combinations. Some of these types of guarantees have indefinite terms while others have specific terms extending to no later than 2012. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for these guarantees, based on the probability of payout and expected payout, if required.
(b) In conjunction with the sale of a subsidiary to a third party, Nortel guaranteed to the purchaser that specified annual sales volume levels would be achieved by the business sold over a ten-year period ended December 31, 2007. Nortel’s guarantee to the purchaser was governed by the laws of the purchaser’s jurisdiction. As such, the purchaser has the right to claim such payments under the volume guarantee until January 31, 2018, under the statute of limitations of such jurisdiction. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future.
(c)

Nortel has periodically entered into agreements with customers and suppliers that include intellectual property indemnification obligations that are customary in the industry. These agreements generally require

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Nortel to compensate the other party for certain damages and costs incurred as a result of third party intellectual property obligations arising from these transactions. These types of guarantees typically have indefinite terms; however, under some agreements, Nortel has provided specific terms extending to February 2011. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future.

(d) Nortel has entered into agreements with its lessors to guarantee the lease payments of certain assignees of its facilities. Generally, these lease agreements relate to facilities Nortel vacated prior to the end of the term of its lease. These lease agreements require Nortel to make lease payments throughout the lease term if the assignee fails to make scheduled payments. Most of these lease agreements also require Nortel to pay for facility restoration costs at the end of the lease term if the assignee fails to do so. These lease agreements have expiration dates through June 2015. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.
(e) Nortel has agreed to indemnify certain of its counterparties in certain receivables securitization transactions. Certain receivables securitization transactions include indemnifications requiring the repurchase of the receivables, under certain conditions, if the receivable is not paid by the obligor. The indemnification provisions generally expire upon the earlier of either expiration of the securitization agreements, which extended through 2009, or collection of the receivable amounts by the purchaser. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.
(f) Nortel has also agreed to indemnify Export Development Canada (“EDC”) under the EDC Support Facility against any legal action brought against EDC that relates to the provision of support previously provided under the EDC Support Facility. Approximately $21 has been paid out to third party beneficiaries by EDC under guarantees supporting Nortel performance obligations. Nortel has reimbursement obligations to EDC for such payments. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so during the pendency of the Creditor Protection Proceedings.
(g) On March 17, 2006, in connection with the agreements to settle two significant U.S. and all but one Canadian class action lawsuits, which became effective on March 20, 2007 following approval of the agreements by the appropriate courts (Global Class Action Settlement), Nortel announced that it had reached an agreement with the lead plaintiffs on the related insurance and corporate governance matters, including Nortel’s insurers agreeing to pay $229 in cash towards the settlement and Nortel agreeing with its insurers to certain indemnification obligations. Nortel believes that it is unlikely that these indemnification obligations will materially increase its total cash payment obligations under the Global Class Action Settlement. As of September 30, 2010, Nortel has not made any significant payments to settle such obligations and does not expect to do so in the future.
(h) On June 27, 2007, NNL entered into a sale lease-back agreement where it agreed to provide an indemnity to the purchaser with respect to union and employee termination matters. The sale agreement requires NNL to compensate the purchaser for any costs in the event that NNL fails to effectively satisfy termination obligations to union employees; if a reinstatement application is brought by the union or non-union employees; or if the purchaser is required to re-hire selected union employees. The indemnification provision expires upon the retirement of the last former employee. The nature of the indemnification prevents Nortel from making a reasonable estimate of the maximum term of the indemnification. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

(i) On February 14, 2008, NNI entered into an agreement whereby it indemnified the landlord of a property against certain obligations that the sub-tenant may assert against the landlord. The nature of the indemnification prevents Nortel from making a reasonable estimate of the maximum term of the indemnification. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future.
(j) On February 28, 2008, NNL entered into a guarantee agreement in which it agreed to repay to the bankruptcy estate of a certain debtor, any interim dividends paid from the bankruptcy estate that NNL is not entitled to in the event that a creditor steps forward with a claim that requires a re-distribution of funds between the creditors. The nature of the indemnification prevents Nortel from making a reasonable estimate of the maximum term of the indemnification. As of September 30, 2010, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.
(k) On July 15, 1999, NNL entered into a guarantee and sales agency agreement whereby it agreed to provide the landlord of a property a residual value guarantee upon the termination of the related property lease. The amount of the guarantee became fixed upon termination of the lease on the property as of June 30, 2010.
(l) NNL has irrevocably and unconditionally guaranteed NNUK’s punctual performance under the U.K. defined benefit pension plan funding agreement (“Pension Guarantee”). Pursuant to a further guarantee agreement NNL has indemnified the trustees of the U.K. defined benefit pension plan on the insolvency of NNUK and consequent windup of such plan. Nortel has recorded liabilities of $531 and $150 for the Pension Guarantee and the insolvency guarantee, respectively, representing Nortel’s current best estimates of the expected allowed claim amount in accordance with ASC 852 in relation to each claim. The Pensions Regulator and Trustee of the Plan have filed a claim related to the Pension Guarantee for an amount of $803 and related to the insolvency guarantee of $150. To the extent that information available in the future indicates a difference from the recognized amounts, the provision will be adjusted.
(m) The nature of some guarantees and indemnification arrangements generally prevents Nortel from making a reasonable estimate of the maximum potential amount it could be required to pay under such agreements. For this reason, no amount has been included in the disclosure in these circumstances.

Product warranties

The following summarizes the accrual for product warranties that was recorded as part of other accrued liabilities in the condensed consolidated balance sheet as of September 30, 2010:

 

Balance as of December 31, 2009

   $ 58   

Payments

     (20

Warranties issued

     20   

Revisions

     (55

Reclassified as held for sale

     (1
        

Balance as of September 30, 2010

   $ 2   
        

15. Fair Value

ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820, among other things, requires Nortel to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Fair value hierarchy

ASC 820 provides a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Nortel’s assumptions with respect to how market participants would price an asset or liability. These two inputs used to measure fair value fall into the following three different levels of the fair value hierarchy:

Level 1: Quoted prices for identical instruments in active markets that are observable.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are non-active; inputs other than quoted prices that are observable, and derived from or corroborated by observable market data.

Level 3: Valuations derived from valuation techniques in which one or more significant inputs are unobservable. This hierarchy requires the use of observable market data when available.

Determination of fair value

The following section describes the valuation methodologies used by Nortel to measure different instruments at fair value, including an indication of the level in the fair value hierarchy in which each instrument is classified. Where applicable, the descriptions include the key inputs and significant assumptions used in the valuation models.

Investments

When available, Nortel uses quoted market prices to determine fair value of certain exchange-traded equity securities; such items are classified in Level 1 of the fair value hierarchy.

The assets within Nortel’s defined benefit pension plan are valued using fair value instruments. Nortel primarily utilizes observable (Level 1 and Level 2) inputs in determining the fair value of the assets.

Long-term debt

The fair value of Nortel’s publicly traded debt instruments is determined using quoted market prices and are classified as Level 1 in the fair value hierarchy. The carrying amount of Nortel’s publicly traded debt, which is included in liabilities subject to compromise, as at September 30, 2010 was $4,169. The fair value of Nortel’s publicly traded debt as at September 30, 2010 was $3,190.

16. Commitments

Bid, performance-related and other bonds

Nortel has entered into bid, performance-related and other bonds associated with various contracts. Bid bonds generally have a term of less than twelve months, depending on the length of the bid period for the applicable contract. Other bonds primarily relate to warranty, rental, real estate and customs contracts. Performance-related and other bonds generally have a term consistent with the term of the underlying contract. The various contracts to which these bonds apply generally have terms ranging from one to five years. Any potential payments which might become due under these bonds would be related to Nortel’s non-performance under the applicable contract. Historically, Nortel has not made material payments under these types of bonds,

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

and as a result of the Creditor Protection Proceedings, does not anticipate that it will be required to make such payments during the pendency of the Creditor Protection Proceedings.

The following table sets forth the maximum potential amount of future payments under bid, performance-related and other bonds, net of the corresponding restricted cash and cash equivalents, as of:

 

    September 30,
2010
    December 31,
2009
 

Bid and performance-related bonds (a)

  $ 25      $ 31   

Other bonds (b)

    2        19   
               

Total bid, performance-related and other bonds

  $ 27      $ 50   
               

 

(a) Net of restricted cash and cash equivalent amounts of $7 and $17 as of September 30, 2010 and December 31, 2009, respectively.
(b) Net of restricted cash and cash equivalent amounts of $17 and $16 as of September 30, 2010 and December 31, 2009, respectively.

Venture capital financing

Nortel has entered into agreements with selected venture capital firms where the venture capital firms make and manage investments in start-up businesses and emerging enterprises. The agreements require Nortel to fund requests for additional capital up to its commitments when and if requests for additional capital are solicited by any of the venture capital firms. Nortel had remaining commitments, if requested, of $9 as of September 30, 2010. These commitments expire at various dates through to 2017.

17. Earnings (loss) per common share

The following table details the weighted-average number of NNC common shares outstanding for the purposes of computing basic and diluted earnings (loss) per common share for the following periods:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
        2010  (a)             2009  (a)         2010 (a)     2009 (a)  
    (Number of common shares in millions)  

Net loss from continuing operations

  $ (644   $ (351   $ (1,826   $ (838

Net earnings (loss) from discontinued operations

    (5     (157     28        (451
                               

Net loss attributable to Nortel Networks Corporation

  $ (649   $ (508   $ (1,798   $ (1,289

Basic weighted-average shares outstanding:

       

Issued and outstanding

    499        499        499        499   
                               

Weighted-average shares dilution adjustments — exclusions:

       

Stock options and other share-based awards

    —          —          —          8   

1.75% Convertible Senior Notes

    18        18        18        18   

2.125% Convertible Senior Notes

    18        18        18        18   

Basic and diluted earnings (loss) per common share:

       

from continuing operations

  $ (1.29   $ (0.70   $ (3.66   $ (1.68
                               

from discontinued operations

  $ (0.01   $ (0.32   $ 0.06      $ (0.90
                               

 

(a) As a result of the net loss for the three and nine months ended September 30, 2010 and 2009, all potential dilutive securities in these periods are considered anti-dilutive.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

18. Shareholders’ deficit

The following are the changes in shareholders’ deficit during the nine months ended September 30, 2010:

 

    NNC
Common
Shares
    Additional
Paid-in
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Non-controlling
Interests
    Total  

Balance as of December 31, 2009

  $ 35,604      $ 3,623      $ (41,876   $ (1,124   $ 729      $ (3,044

Impact of Equity Investees

    —          —          —          59        1        60   

Net income (loss)

    —          —          (1,798     —          8        (1,790

Impact of deconsolidated subsidiaries

    —          —          —          967        —          967   

Capital repayment by LGN

    —          —          —          —          (80     (80

Dividend payment

    —          —          —          —          (7     (7

Foreign currency translation adjustment

    —          —          —          103        (8     95   

Unrealized loss on investments — net

    —          —          —          (21     —          (21

Unamortized pension and post-retirement actuarial losses and prior service cost — net (a)

    —          —          —          (173     —          (173

Other

    —          (26     (1            (25     (52
                                               

Balance as of September 30, 2010

  $ 35,604      $ 3,597      $ (43,675   $ (189   $ 618      $ (4,045
                                               

 

(a) This amount includes settlement and curtailment amounts for pension and post-retirement benefit plans.

The following are the components of comprehensive income (loss), net of tax, for the three and nine months ended:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Net loss including noncontrolling interests

   $ (645   $ (505   $ (1,790   $ (1,254

Other comprehensive loss adjustments:

        

Impact of Equity Investees

     —          47        60        (58

Impact of deconsolidated subsidiaries

     —          —          967        —     

Change in foreign currency translation adjustment

     (23     (39     95        (77

Unrealized loss on investments — net (a)

     —          3        (21     6   

Unamortized pension and post-retirement actuarial losses and prior service cost — net

     (89     (30     (173     (55
                                

Comprehensive loss including noncontrolling interests

     (757     (524     (862     (1,438

Comprehensive income attributable to noncontrolling interests

     (3     (18     —          (48
                                

Comprehensive loss attributable to Nortel Networks Corporation

   $ (760   $ (542   $ (862   $ (1,486
                                

 

(a) Certain securities deemed available-for-sale by Nortel were measured at fair value. Unrealized holding losses related to these securities were excluded from net loss and are included in accumulated other comprehensive loss until realized. Unrealized loss on investments was net of tax of nil for the three and nine months ended September 30, 2010 and 2009, respectively.

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

19. Share-based compensation plans

On February 27, 2009, Nortel obtained Canadian Court approval to terminate its equity-based compensation plans (the Nortel 2005 Stock Incentive Plan, As Amended and Restated, the Nortel Networks Corporation 1986 Stock Option Plan, As Amended and Restated and the Nortel Networks Corporation 2000 Stock Option Plan) and certain equity-based compensation plans assumed in prior acquisitions, including all outstanding equity under these plans (stock options, stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and performance stock units (“PSUs”)), whether vested or unvested, which include stock options, SARs, RSUs and PSUs granted to employees of the Equity Investees. As at December 31, 2009, all share-based compensation instruments were forfeited and/or cancelled. As a result of the cancellation and expiration of the plans in 2009, no related share-based compensation expenses were recognized in 2010.

Share-based compensation

The following table provides the share-based compensation expense for the three and nine months ended September 30, 2009:

 

     Three Months Ended
September 30
     Nine Months Ended
September 30
 

Share-based compensation expense:

     

DSUs (a)

   $ —         $ —     

Options

     —           44   

RSUs (a)

     —           34   

PSU — rTSRs

     —           7   

PSU — Management OMs

     —           1   
                 

Total share-based compensation expense reported — net of tax (b)

   $ —         $  86 (c) 
                 

 

(a) Compensation related to employer portion of RSUs and DSUs was net of tax of nil in each period.
(b) Includes nil and $13 recorded in discontinued operations for the three and nine months ended September 30, 2009, respectively.
(c) Represents consolidated expense and excludes $15 related to the Equity Investees. See note 22.

20. Liabilities subject to compromise

As a result of the Creditor Protection Proceedings, pre-petition liabilities may be subject to compromise or may otherwise be affected by a court-approved plan and generally, actions to enforce or otherwise effect payment of pre-petition liabilities are stayed. Although pre-petition claims are generally stayed, under the Creditor Protection Proceedings, the Debtors are permitted to undertake certain actions designed to stabilize the Debtors’ operations including, among other things, payment of employee wages and benefits, maintenance of Nortel’s cash management system, satisfaction of customer obligations, payments to suppliers for goods and services received after the Petition Date and retention of professionals. The Debtors have been paying and intend to continue to pay undisputed post-petition claims in the ordinary course of business. As further described in note 2, under the Creditor Protection Proceedings, the Debtors have certain rights, which vary by jurisdiction, to reject, repudiate or no longer continue to perform various types of contracts or arrangements. Damages resulting from rejecting, repudiating or no longer continuing to perform a contract or arrangement are treated as general unsecured claims and will be classified as liabilities subject to compromise. ASC 854 requires pre-petition liabilities of the debtor that are subject to compromise to be reported at the claim amounts expected to be allowed, even if they may be settled for lesser amounts.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Nortel has accounted for its Equity Investees under the equity method of accounting from the Petition Date to May 31, 2010. Therefore, the liabilities of the Equity Investees that are subject to compromise are not included in the consolidated results.

Liabilities subject to compromise consist of the following:

 

     September 30,
2010
     December 31,
2009
 

Trade and other accounts payable

   $ 430       $ 207   

Restructuring liabilities

     193         163   

Long-term debt

     4,242         4,306   

Notes payable

     180         —     

Pension obligations

     1,962         1,335   

Postretirement obligations other than pensions

     842         794   

Other accrued liabilities

     1,407         489   

Other

     61         64   
                 

Total liabilities subject to compromise

   $ 9,317       $ 7,358   
                 

As of September 30, 2010, the Canadian Debtors and U.S. Debtors have received approximately 8,528 claims asserting approximately $41,632 in aggregate outstanding liquidated claims. Some of these claims are unliquidated and are therefore not reflected in the aggregate claim amount above. This amount excludes the value of claims that have been subject to Notices of Disallowance from the Canadian Monitor or that have been withdrawn, expunged, or disallowed by the U.S. Court as of September 30, 2010. The Canadian Debtors and U.S. Debtors continue to investigate differences between the claim amounts filed by creditors and claim amounts determined by the Canadian Debtors and U.S. Debtors. Certain claims filed may be duplicative (particularly given the multiple jurisdictions involved in the Creditor Protection Proceedings), based on contingencies that have not occurred, or may be otherwise overstated, and would therefore be subject to revision or disallowance. The determination of Nortel’s liabilities subject to compromise considers these factors, and these liabilities are subject to change as a result of the ongoing investigation by the Canadian Debtors and U.S. Debtors of filed proofs of claim.

Although the Canadian Debtors and U.S. Debtors have and may continue to object to various court filings made throughout the Creditor Protection Proceedings, as of September 30, 2010, 1,486 claims had been objected to by the U.S. Debtors. As of September 30, 2010, as a result of these objections, the U.S. Debtors have resolved 1,329 claims, reducing the aggregate amount claimed against the U.S. Debtors by approximately $214. Although the Canadian Court and U.S. Court have established bar dates, subject to exceptions, by which certain proofs of claim against the relevant Canadian Debtors and U.S. Debtors were required to be filed if the claimants were to receive any distribution under the Creditor Protection Proceedings, certain further claims are and may be permitted. In addition, the Canadian Debtors and U.S. Debtors anticipate that additional proofs of claim will be the subject of future objections as such proofs of claim are reconciled. Accordingly, the ultimate number and amount of allowed claims is not determinable at this time. See note 2 for additional information on the claims process.

Since the Petition Date, Nortel has and may continue to enter into court-approved and other agreements relating to settlement of certain pre-Petition Date claim amounts. As of September 30, 2010, the Canadian Debtors and U.S. Debtors have agreed to net payments and forgiveness of accounts receivables in certain circumstances of approximately $128 in the aggregate relating to certain asserted pre-Petition Date claims and related liabilities, subject to adjustment in certain circumstances and excluding liabilities the Nortel is required to satisfy pursuant to local legislation and amounts Nortel has agreed to pay pursuant to the IFSA and the FCFSA,

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

each as described in note 2. These agreements may also include the release of other disputed and unliquidated amounts as well as certain post-Petition Date claim amounts.

The amounts currently classified as liabilities subject to compromise may be subject to future adjustments depending on actions of the applicable courts, further developments with respect to disputed claims, determinations of the secured status of certain claims, if any, the values of any collateral securing such claims, or other events.

Classification for purposes of these financial statements of any pre-petition liabilities on any basis other than liabilities subject to compromise is not an admission of fact or legal conclusion by Nortel as to the manner of classification, treatment, allowance, or payment in the Creditor Protection Proceedings, including in connection with any plan that may be approved by any relevant court and that may become effective pursuant a court’s order.

21. Related party transactions

In the ordinary course of business, Nortel engages in transactions with certain of its equity-owned investees and certain other business partners. These transactions are sales and purchases of goods and services under usual trade terms and are measured at their exchange amounts.

Transactions with related parties for the three and nine months ended September 30 are summarized as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Revenues:

           

LGE (a)

   $ —         $ 3       $ 6       $ 9   

Vertical Communications, Inc. (“Vertical”) (b)

     —           3         5         7   

Other

     —           4         6         21   
                                   

Total

   $ —         $ 10       $ 17       $ 37   
                                   

Purchases:

           

LGE (a)

     —           27         42         66   

GNTEL Co., Ltd. (“GNTEL”) (c)

     —           10         18         34   

Other

     1         3         7         10   
                                   

Total

   $ 1       $ 40       $ 67       $ 110   
                                   

 

(a) LGE holds a noncontrolling interest in LGN. Nortel’s sales and purchases to the date of the sale of its interest in LGN relate primarily to certain inventory-related items. As of December 31, 2009, accounts payable to LGE was $38.
(b) LGN currently owns a noncontrolling interest in Vertical. Vertical supports LGN’s efforts to distribute Nortel’s products to the North American market.
(c) Nortel held a noncontrolling interest in GNTEL through its business venture LGN. Nortel’s purchases from GNTEL relate primarily to installation and warranty services. As of December 31, 2009, accounts payable to GNTEL was nil.

Nortel made capital repayments of nil and $42 to LGE during the three months ended September 30, 2010 and 2009, respectively. Nortel made capital repayments of $80 and $71 to LGE during the nine months ended September 30, 2010 and 2009, respectively.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

As of September 30, 2010 and December 31, 2009, accounts receivable from related parties were nil and $8, respectively. As of September 30, 2010 and December 31, 2009, accounts payable to related parties were nil and $40, respectively.

Transactions with the Equity Investees are also considered related party transactions prior to June 1, 2010. See note 22 for information on related party transactions involving the Equity Investees.

22. Investment in Equity Investees

As discussed in note 1, Nortel accounted for its interest in the Equity Investees under the equity method of accounting in accordance with ASC 323, from the Petition Date to May 31, 2010. The Equity Investees include the EMEA Subsidiaries as well as their subsidiaries, which include certain entities in EMEA as well as certain entities in Australia. Only certain of the entities included in the Equity Investees have filed for creditor protection at September 30, 2010. Under the equity method of accounting, Nortel recorded its initial investments at their estimated fair value as of the Petition Date, being the date the entities that comprise the Equity Investees were deconsolidated by Nortel. Nortel subsequently recognized its interests in the losses and capital transactions of the Equity Investees and gave effect to the elimination of unrealized intercompany profits and losses arising from transactions between Nortel and its consolidated subsidiaries and entities that comprise the Equity Investees.

At March 31, 2010, Nortel’s net investment in the Equity Investees was in a net liability position. Until May 31, 2010, in accordance with ASC 323, Nortel had continued to recognize losses in excess of its net investment in the Equity Investees as it had been concluded that it was committed to provide non-financial support to the investees. On commencement of the application of the cost method; however, Nortel concluded that this was no longer applicable and has recognized a loss which is classified in reorganization items (see note 5) for the net impact of the cessation of equity accounting, reflecting the net carrying value of the investments. This loss is presented separately from the recognition of NNL’s estimated obligations under guarantees it has provided for the previously equity accounted for investees.

The following table summarizes financial information for the Equity Investees operations for the 2010 and 2009 periods:

 

     Nine Months Ended
September 30,
    Three Months
Ended
September 30,
2009
 
     2010 (a)     2009    

Revenues from continued operations

   $ 243      $ 720      $ 226   

Revenues from discontinued operations

     4        372        122   
                        

Total revenues

   $ 247      $ 1,092      $ 348   
                        

Gross profit

     49        274        77   

Selling, general and adminstrative expense

     116        399        129   

Research and development expense

     8        102        37   

Reorganization items

     13        130        52   

Investments and other (income) expense

     (44     —          —     

Other

     6        91        18   
                        

Net loss

   $ (50   $ (448   $ (159
                        

 

(a) The 2010 results only include the five months ended May 31 as the Equity Investees are accounted for under the cost method effective June 1, 2010.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

To provide information that may be useful to the users of these financial statements, the disclosure set out below is provided to identify certain significant events, transactions or balances that have impacted the combined financial information of the Equity Investees.

Employee benefit plans

On January 14, 2009, as a result of the U.K. Administration Proceedings, the U.K. defined benefit pension plan entered the Pension Protection Fund (“PPF”) assessment process and all further service cost accruals and contributions ceased. Employees who were currently enrolled in the U.K. defined benefit pension plan were given the option of participating in the U.K. defined contribution scheme. As a result of these changes NNUK remeasured the pension obligations related to the U.K. defined benefit pension plan on January 14, 2009, and recorded the impacts of this remeasurement in the first quarter of 2009 in accordance with ASC 715-30. The ceasing of service cost accruals and changes to key assumptions as a result of the remeasurement resulted in a curtailment gain of approximately $22. In addition as a result of the remeasurement, NNUK was required to adjust the liability for impacts from the curtailment gain, changes in assumptions, and asset losses at the remeasurement date. The effect of this adjustment and the related foreign currency translation adjustment was to increase pension liabilities and accumulated other comprehensive loss (before tax) by $107. This adjustment had no statement of operations impact.

The PPF assessment process can take up to two years, or longer, and will result in the PPF deciding whether it needs to take on the U.K. defined benefit pension plan or whether there are sufficient assets to secure equivalent or greater than PPF benefits through a “buy out” with an insurance company. If the PPF decides it needs to take on the U.K. defined benefit pension plan, the expected claim amount will be significantly more than the carrying amount of the liability. See note 14 for discussion of Nortel’s guarantees in relation to the U.K. defined benefit pension plan.

Pension expense for the Equity Investees for the nine months ended September 30, 2010 and 2009 was $54 and $91, respectively. During the nine months ended September 30, 2010 and 2009, contributions of $4 and $34, respectively, were made to the defined benefit plans in the Equity Investees. The 2010 operating results only include the five months ended May 31 as the Equity Investees are accounted for under the cost method effective June 1, 2010. Nortel expects to contribute an additional $1 in 2010 to the defined benefit pension plans in the Equity Investees for a total contribution of $5.

Cash contributions in 2010 to these plans have been significantly impacted as a result of the Creditor Protection Proceedings. As a result of the U.K. Administration Proceedings, following Nortel’s contribution in January 2009, all further contributions to the UK defined benefit pension plan ceased pursuant to the direction of the U.K. Administrators, which is reflected in the numbers above. Nortel continues to evaluate its pension obligations in the context of the Creditor Protection Proceedings and as a result these amounts may continue to change as a result of events or other factors that are uncertain or unknown at this time.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Reorganization items — net

Reorganization items represent the direct and incremental costs related to the Creditor Protection Proceedings such as revenues, expenses such as professional fees directly related to the Creditor Protection Proceedings, realized gains and losses, and provisions for losses resulting from the reorganization and restructuring of the business. Reorganization items for the 2010 and 2009 periods related to the Equity Investees consisted of the following:

 

     Nine Months Ended
September 30,
    Three Months
Ended
September 30,
2009
 
     2010 (a)     2009    

Professional fees

   $ (39   $ (105   $ (37

Interest income

     2        5        2   

Lease repudiation

     —          2        —     

Employee incentive plans

     (9     (11     (5

Penalties

     —          (9     (1

Settlements

     (3     —          —     

Gain on divestitures

     28        —          —     

Other

     8        (12     (11
                        

Total reorganization items — net

   $ (13   $ (130   $ (52
                        

 

(a) The 2010 results only include the five months ended May 31 as the Equity Investees are accounted for under the cost method effective June 1, 2010.

Related party transactions

In the ordinary course of business, Nortel engages in transactions with the Equity Investees. These transactions are sales and purchases of goods and services under usual trade terms and are measured at their exchange amounts. All material transactions between Nortel and the Equity Investees to May 31, 2010 have been eliminated in Nortel’s condensed consolidated financial statements.

The Equity Investees related party transactions with Nortel for the 2010 and 2009 periods consisted of the following:

 

     Nine Months Ended
September 30,
     Three Months
Ended
September 30,
2009
 
     2010 (a)      2009     

Sales

   $ 21       $ 92       $ 40   

Purchases

     46         162         61   

 

(a) The 2010 results only include the five months ended May 31 as the Equity Investees are accounted for under the cost method effective June 1, 2010.

As of June 1, 2010, the Equity Investees are being accounted for under the cost method; therefore, there are no related party balances as of September 30, 2010. As of December 31, 2009, accounts receivable and accounts payable with related parties were $56 and $405, respectively.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

23. Contingencies

Creditor Protection Proceedings

As discussed in note 2, on January 14, 2009, the Canadian Debtors obtained an order from the Canadian Court for creditor protection and commenced ancillary proceedings under chapter 15 of the U.S. Bankruptcy Code, the U.S. Debtors filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code, and each of the EMEA Debtors obtained an administration order from the English Court. After the Petition Date, the Israeli Debtors initiated similar proceedings in Israel. One of Nortel’s French subsidiaries, Nortel Networks SA, was placed into secondary proceedings in France and NNCI filed a voluntary petition for relief under Chapter 11 in the U.S. Court and became a party to the Chapter 11 Proceedings. Generally, as a result, all actions to enforce or otherwise effect payment or repayment of liabilities of any Debtor preceding the Petition Date, as well as pending litigation against any Debtor, are stayed as of the Petition Date. Absent further order of the applicable courts and subject to certain exceptions and, in Canada, potential time limits, no party may take any action to recover on pre-petition claims against any Debtor.

Pension Benefit Guaranty Corporation Complaint

The PBGC has filed a proof of claim against NNI and each of the U.S. Debtors for the unfunded benefit liabilities of the U.S. Pension Plan in the amount of $546. The PBGC has also filed unliquidated claims for contributions necessary to satisfy the minimum funding standards, a claim for insurance premiums, interest and penalties, and a claim for shortfall and amortization charges. Under ERISA, the PBGC may have the ability to impose certain claims and liens on NNI and certain NNI subsidiaries and affiliates (including liens on assets of certain Nortel entities not subject to the Creditor Protection Proceedings). See note 13.

The Pensions Regulator “Warning Notice”

According to various claims filed by the trustee of the U.K. defined benefit pension plan and the PPF against certain Debtors, the U.K. defined benefit pension plan has a purported deficit estimated (on a buy-out basis) of £2,100 or $3,300 as at January 2009. In January 2010, The Pensions Regulator, purporting to act under The Pensions Act 2004 (U.K.) (“U.K. Statute”) issued a “warning notice” (“Warning Notice”) to certain Nortel entities, including, among others, the Canadian Debtors and the U.S. Debtors. The Pensions Regulator is a statutory agency charged with responsibility for regulating the operations and administration of occupational pension schemes in the U.K., such as the U.K. defined benefit pension plan. The Warning Notice is the first step in a process set forth under the U.K. Statute to enable The Pensions Regulator to issue a financial support direction (“FSD”) under the U.K. Statute directing affiliates of NNUK to provide financial support to eliminate the purported deficit. In the Warning Notice, The Pensions Regulator identifies certain Nortel entities, including, among others, NNC, NNL, NNI and NNCI as targets of a procedure before the determination panel of the Pensions Regulator to determine whether to issue a FSD (U.K. Pension Proceeding). On February 26, 2010, the Canadian Debtors obtained an order of the Canadian Court, which included, among other things, (i) a declaration that the purported commencement of proceedings and exercise of rights by The Pensions Regulator breaches the Initial Order; and (ii) a declaration that any result obtained in the U.K. in breach of the stay under the CCAA Proceedings would not be recognized in the Canadian claims process. Also on February 26, 2010, the U.S. Debtors obtained an order of the U.S. Court enforcing the automatic stay under the U.S. Bankruptcy Code against the trustee of the U.K. defined benefit pension plan and the PPF, which is fully applicable to the trustee and PPF’s participation against the U.S. Debtors in the U.K. Pension Proceeding. In addition, the order of the U.S. Court provides that with respect to the U.S. Debtors, such proceedings are deemed void and without force or effect. The Pensions Regulator appealed the decision of the Canadian Court which appeal was heard and dismissed on June 16, 2010, by the Ontario Court of Appeal. In addition, the trustee of the U.K. defined benefit

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

pension plan has brought a motion before the Canadian Court to have the stay lifted, to allow the U.K. Pension Proceeding to go forward as a “permitted proceeding”, which motion was initially set for hearing on May 31, 2010, but was subsequently adjourned without date on the consent of all interested parties. The trustee of the U.K. defined benefit pension plan and the PPF have also appealed the decision of the U.S. Court enforcing the stay, and this appeal is currently pending. On August 5, 2010, a U.S. Magistrate Judge issued a report and recommendation that the order of the U.S. Court be affirmed. Notwithstanding the orders of the Canadian Court and the U.S. Court and the dismissal of The Pension Regulator’s appeal by the Ontario Court of Appeal, the FSD proceedings commenced in the U.K. on June 2, 2010, and on June 25, 2010, the determinations panel of The Pension Regulator issued a determinations notice indicating that a FSD would be issued against certain Debtors including, among others, NNC, NNL, NNI and NNCI. On July 23, 2010, certain Nortel entities filed an appeal of the determinations notice with the U.K. appeal tribunal. As a result, as of the date hereof, no FSD has been issued. Nortel is of the view that the determinations notice and any FSD are null and void given the court decisions noted above.

Securities Class Action Claim against former CEO and former CFO

On May 18, 2009, a complaint was filed in the U.S. District Court for the Southern District of New York alleging violations of federal securities law between the period of May 2, 2008 through September 17, 2008, against Mike Zafirovski (Nortel’s former President and Chief Executive Officer) and Pavi Binning (Nortel’s former Executive Vice President, Chief Financial Officer and Chief Restructuring Officer). Although Nortel is not a named defendant, this lawsuit has been stayed as a result of the Creditor Protection Proceedings. Messrs Zafirovski and Binning have filed claims in the U.S. Court for indemnification and contribution for potential liability arising out of this matter in amounts to be determined.

ERISA Lawsuit

Beginning in December 2001, Nortel, together with certain of its then-current and former directors, officers and employees, were named as a defendant in several purported class action lawsuits pursuant to ERISA. These lawsuits have been consolidated into a single proceeding in the U.S. District Court for the Middle District of Tennessee. This lawsuit is on behalf of participants and beneficiaries of the Nortel Long-Term Investment Plan, who held shares of the Nortel Networks Stock Fund during the class period, which has yet to be determined by the court. The lawsuit alleges, among other things, material misrepresentations and omissions to induce participants and beneficiaries to continue to invest in and maintain investments in NNC common shares through the investment plan. The court has not yet ruled as to whether the plaintiff’s proposed class action should be certified. As a result of the Creditor Protection Proceedings, on September 25, 2009, the district court ordered the case administratively closed.

Canadian Pension Class Action

On June 24, 2008, a purported class action lawsuit was filed against Nortel and NNL in the Ontario Superior Court of Justice in Ottawa, Canada alleging, among other things, that certain recent changes related to Nortel’s pension plan did not comply with the Pension Benefits Act (Ontario) or common law notification requirements. The plaintiffs seek declaratory and equitable relief, and unspecified monetary damages. As a result of the Creditor Protection Proceedings, this lawsuit has been stayed.

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

 

Nortel Statement of Claim Against its Former Officers

In January 2005, Nortel and NNL filed a Statement of Claim in the Ontario Superior Court of Justice against Messrs. Frank Dunn, Douglas Beatty and Michael Gollogly, Nortel’s former senior officers who were terminated for cause in April 2004, seeking the return of payments made to them under Nortel’s bonus plan in 2003. One-half of any recovery from this litigation is subject to the Global Class Action Settlement (see note 14).

Former Officers’ Statements of Claim Against Nortel

In April 2006, Mr. Dunn filed a Notice of Action and Statement of Claim in the Ontario Superior Court of Justice against Nortel and NNL asserting claims for wrongful dismissal, defamation and mental distress, and seeking punitive, exemplary and aggravated damages, out-of-pocket expenses and special damages, indemnity for legal expenses incurred as a result of civil and administrative proceedings brought against him by reason of his having been an officer or director of the defendants, pre-judgment interest and costs. Mr. Dunn has further brought an application before the Ontario Superior Court of Justice against Nortel and NNL seeking an order that, pursuant to its by-laws, Nortel reimburse him for all past and future defense costs he has incurred as a result of proceedings commenced against him by reason of his being or having been a director or officer of Nortel.

In May and October 2006, respectively, Messrs Gollogly and Beatty filed Statements of Claim in the Ontario Superior Court of Justice against Nortel and NNL asserting claims for, among other things, wrongful dismissal and seeking compensatory, aggravated and punitive damages, and pre-and post-judgment interest and costs.

As a result of the Creditor Protection Proceedings, these lawsuits have been stayed.

Except as otherwise described herein, in each of the matters described above, the plaintiffs are seeking an unspecified amount of monetary damages. Nortel is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to Nortel of the above matters, which, unless otherwise specified, seek damages from the defendants of material or indeterminate amounts or could result in fines and penalties. Nortel cannot determine whether these actions, suits, claims and proceedings will, individually or collectively, have a material adverse effect on its business, results of operations, financial condition or liquidity. Except as otherwise described herein, Nortel intends to defend the above actions, suits, claims and proceedings in which it is a defendant, litigating or settling cases where in management’s judgment it would be in the best interest of stakeholders to do so. Nortel will continue to cooperate fully with all authorities in connection with the regulatory and criminal investigations.

Nortel is also a defendant in various other suits, claims, proceedings and investigations that arise in the normal course of business.

Environmental matters

Nortel’s business is subject to a wide range of continuously evolving environmental laws in various jurisdictions. Nortel seeks to operate its business in compliance with these changing laws and regularly evaluates their impact on operations, products and facilities. Nortel has a corporate environmental management system standard and an environmental program to promote such compliance.

Nortel is exposed to liabilities and compliance costs arising from its past generation, management and disposal of hazardous substances and wastes. As of September 30, 2010, the accruals on the consolidated balance

 

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(Under Creditor Protection Proceedings as of January 14, 2009 — note 2)

Notes to Condensed Consolidated Financial Statements (unaudited) — (Continued)

 

sheet for environmental matters were $9. Based on information available as of September 30, 2010, management believes that the existing accruals are sufficient to satisfy probable and reasonably estimable environmental liabilities related to known environmental matters. Any additional liabilities that may result from these matters, and any additional liabilities that may result in connection with other locations currently under investigation, are not expected to have a material adverse effect on the business, results of operations, financial condition and liquidity of Nortel.

Nortel has remedial activities under way at six sites that are either currently or previously owned. An estimate of Nortel’s anticipated remediation costs associated with all such sites, to the extent probable and reasonably estimable, is included in the environmental accruals referred to above in an approximate amount of $9. At one additional site an agreement has been reached to settle obligations via the claim process. The amount is not material.

Nortel is also listed as a potentially responsible party under the U.S. Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) at three Superfund sites in the U.S. Agreements have been reached to settle these obligations via the claim process. The amount is not material.

24. Subsequent events

In addition to the events identified in note 2, the Company has evaluated subsequent events through the filing date and determined that no other significant events occurred which require disclosure.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

TABLE OF CONTENTS

 

Executive Overview

     63   

Results of Operations

     87   

Segment Information

     97   

Liquidity and Capital Resources

     101   

Off-Balance Sheet Arrangements

     107   

Application of Critical Accounting Policies and Estimates

     108   

Accounting Changes and Recent Accounting Pronouncements

     118   

Outstanding Share Data

     118   

Environmental Matters

     118   

Legal Proceedings

     119   

Cautionary Notice Regarding Forward-Looking Information

     119   

The following Management’s Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Nortel Networks Corporation. The MD&A should be read in combination with our unaudited condensed consolidated financial statements and the accompanying notes. All monetary amounts in this MD&A are in millions and in United States (U.S.) Dollars except per share amounts or unless otherwise stated.

Certain statements in this MD&A contain words such as “could”, “expect”, “may”, “anticipate”, “believe”, “intend”, “estimate”, “plan”, “envision”, “seek” and other similar language and are considered forward-looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections which we believe are reasonable but which are subject to important assumptions, risks and uncertainties and may prove to be inaccurate. Consequently, our actual results could differ materially from our expectations set out in this MD&A. In particular, see the Risk Factors section of this report and elsewhere herein as well as our Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Annual Report) for factors that could cause actual results or events to differ materially from those contemplated in forward-looking statements. Unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Where we say “we”, “us”, “our”, “Nortel” or “the Company”, we mean Nortel Networks Corporation or Nortel Networks Corporation and its subsidiaries, as applicable. Where we say NNC, we mean Nortel Networks Corporation. Where we refer to the “industry”, we mean the telecommunications industry.

 

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Executive Overview

Creditor Protection Proceedings

Prior to our significant business divestitures discussed below, we operated in a highly volatile telecommunications industry that is characterized by vigorous competition for market share and rapid technological development. For a number of years, our operating costs generally exceeded our revenues, resulting in negative cash flow. A number of factors contributed to these results, including competitive pressures in the telecommunications industry, an inability to sufficiently reduce operating expenses, costs related to ongoing restructuring efforts described below, significant customer and competitor consolidation, customers cutting back on capital expenditures and deferring new investments, and the poor state of the global economy.

Prior to 2009, we took a wide range of steps to attempt to address these issues, including a series of restructurings that reduced the number of worldwide employees from more than 90,000 in 2000 to approximately 30,000 (including employees in joint ventures) as of December 31, 2008. These restructuring measures, however, did not provide adequate relief from the significant pressures we were experiencing. As global economic conditions dramatically worsened beginning in September 2008, we experienced significant pressure on our business and faced a deterioration of our cash and liquidity, globally as well as on a regional basis, as customers across all businesses suspended, delayed and reduced their capital expenditures. The extreme volatility in the financial, foreign exchange, equity and credit markets globally and the expanding economic downturn and prolonged recessionary period compounded the situation.

In addition, we made significant cash payments related to our restructuring programs, the Global Class Action Settlement (as defined in the Legal Proceedings section of our 2009 Annual Report), debt servicing costs and pension plans over the past several years. Due to the adverse conditions in the financial markets globally, the value of the assets held in our pension plans declined significantly resulting in significant increases to pension plan liabilities that could have resulted in a significant increase in future pension plan contributions. It became increasingly clear that the struggle to reduce operating costs during a time of decreased customer spending and massive global economic uncertainty was putting substantial pressure on our liquidity position globally, particularly in North America.

Market conditions further restricted our ability to access capital markets, which was compounded by actions taken by rating agencies with respect to our credit ratings. In December 2008, Moody’s Investor Service, Inc. (Moody’s) issued a downgrade of the Nortel family rating from B3 to Caa2. With no access to the capital markets, limited prospects of the capital markets opening up in the near term, substantial interest carrying costs on over $4,000 of unsecured public debt, and significant pension plan liabilities expected to increase in a very substantial manner principally due to the adverse conditions in the financial markets globally, it became imperative for us to protect our cash position.

On January 14, 2009 (Petition Date), after extensive consideration of all other alternatives, with the unanimous authorization of our board of directors after thorough consultation with our advisors, we initiated creditor protection proceedings in multiple jurisdictions under the respective restructuring regimes of Canada, under the Companies’ Creditors Arrangement Act (CCAA) (CCAA Proceedings), the U.S. under Chapter 11 of the U.S. Bankruptcy Code (Chapter 11) (Chapter 11 Proceedings), the United Kingdom (U.K.) under the Insolvency Act 1986 (U.K. Administration Proceedings), and subsequently, Israel under the Israeli Companies Law 1999 (Israeli Administration Proceedings). On May 28, 2009, one of our French subsidiaries, Nortel Networks SA (NNSA) was placed into secondary proceedings (French Secondary Proceedings). The CCAA Proceedings, Chapter 11 Proceedings, U.K. Administration Proceedings, Israeli Administration Proceedings and French Secondary Proceedings are together referred to as the “Creditor Protection Proceedings”. On July 14, 2009, Nortel Networks (CALA) Inc. (NNCI), a U.S. based subsidiary with operations in the Caribbean and Latin America (CALA) region, also filed a voluntary petition for relief under Chapter 11 in the U.S. Bankruptcy Court for the District of Delaware (U.S. Court) and became a party to the Chapter 11 Proceedings. We initiated the

 

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Creditor Protection Proceedings with a consolidated cash balance, as at December 31, 2008, of approximately $2,400, in order to preserve our liquidity and fund operations during the process.

On June 19, 2009, we announced that we were advancing in discussions with external parties to sell our businesses. To date, we have completed divestitures of substantially all of our businesses including: (i) the sale of substantially all of our Code Division Multiple Access (CDMA) business and Long Term Evolution (LTE) Access assets to Telefonaktiebolaget LM Ericsson (Ericsson); (ii) the sale of substantially all of the assets of our Enterprise Solutions (ES) business globally, including the shares of Nortel Government Solutions Incorporated (NGS) and DiamondWare, Ltd., to Avaya Inc. (Avaya); (iii) the sale of the assets of our Wireless Networks (WN) business associated with the development of Next Generation Packet Core network components (Packet Core Assets) to Hitachi, Ltd. (Hitachi); (iv) the sale of certain portions of our Layer 4-7 data portfolio to Radware Ltd. (Radware); (v) the sale of substantially all of the assets of our Optical Networking and Carrier Ethernet businesses to Ciena Corp. (Ciena); (vi) the sale of substantially all of the assets of our Global System for Mobile communications (GSM)/GSM for Railways (GSM-R) business to Ericsson and Kapsch CarrierCom AG (Kapsch); (vii) the sale of substantially all of the assets of our Carrier VoIP and Application Solutions (CVAS) business to GENBAND Inc. (now known as GENBAND U.S. LLC (GENBAND)); and (viii) the sale of NNL’s 50% plus 1 share interest in LG-Nortel Co. Ltd. (LGN), our Korean joint venture with LG-Electronics, Inc. (LGE), to Ericsson. In addition, we have completed a court-approved bidding process and have received court approvals in the U.S. and Canada for the planned divestiture of substantially all of the assets of our global Multi Service Switch (MSS) business to Ericsson.

Throughout the creditor protection process we have worked with our advisors and stakeholders to conduct the sales of businesses and assets and other restructuring matters in a fair, efficient and responsible manner in order to maximize value for our creditors, and in almost all matters, resolution has been reached on a consensual basis. These activities have been and continue to be monitored closely by the courts, the Canadian Monitor, the U.K. Administrators, the U.S. Principal Officer (as defined below), the U.S. Creditors’ Committee, the Bondholder Group, each as defined below, and other creditor groups.

Since determining in June 2009 that selling our businesses was the best path forward, approximately $3,150 in net proceeds have been generated through the completed sales of businesses. To date, auctions for sale of five businesses have yielded $1,225 more in proceeds than initially set out in ‘stalking horse’ sale agreements. Substantially all proceeds received in connection with the completed sales of businesses and assets are being held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined. Through the sales completed or announced to date, we have preserved 13,000 jobs for our employees with the purchasers of these businesses.

While numerous milestones have been met, significant work remains under the Creditor Protection Proceedings. A Nortel business services group (NBS) was established in 2009 to provide global transitional services to purchasers of our businesses, in fulfillment of contractual obligations under transition services agreements (TSAs) entered into in connection with the sales of our businesses and assets. These services include maintenance of customer and network service levels during the integration process, and providing expertise and infrastructure in finance, supply chain management, information technology (IT), research and development (R&D), human resources and real estate necessary for the orderly and successful transition of businesses to purchasers over a period of up to 24 months from the closing of the sales. NBS is also focused on maximizing the recovery of our remaining accounts receivable, inventory and real estate assets, independent of the TSAs.

A core corporate group (Corporate Group) was also established in 2009 and continues to be focused on a number of key actions, including the sale of remaining businesses and assets, as well as exploring strategic alternatives to maximize the value of our intellectual property. The Corporate Group is also responsible for ongoing restructuring matters, including the creditor claims process, planning toward conclusion of the Creditor Protection Proceedings and any distributions to creditors. The Corporate Group also continues to provide administrative and management support to our affiliates around the world while completing the orderly wind down of the remaining operations.

 

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With the sale of substantially all of our businesses, the interdependency between the debtor estates is expected to continue to diminish, and thus the estates have started to prepare for the separation of various corporate functions to allow each estate to become standalone. An extensive analysis is underway to segregate most of these functions such that the Canadian Debtors and the U.S. Debtors can operate independent of one another.

We are seeking expressions of interest from potential buyers and partners regarding options that could maximize the value of our intellectual property portfolio. No decision has been made as to how to realize this value, whether through sale, licensing, some combination of the two or other alternatives. The solicitation process is being conducted in a manner similar to the court-approved sales of our significant businesses and is expected to take several months.

With the sale of our main businesses and the focus of NBS and the Corporate Group on the remaining work, Pavi Binning, former Chief Restructuring Officer (CRO), Chief Financial Officer (CFO) and Executive Vice President (EVP) and the Board of Directors had jointly determined that it was an appropriate point for Mr. Binning to step down from his position and to depart from Nortel. Effective March 21, 2010, Mr. Binning stepped down from his role as CRO, CFO and EVP, and for a short period thereafter, Mr. Binning stayed on as Special Advisor to assist in the completion of the announced business sales and in the transition of certain of his responsibilities. Effective March 22, 2010, John Doolittle assumed the role of CFO of NNC and NNL in addition to his current responsibilities leading the Corporate Group. In light of the milestones met to date and the focus of the remaining work, the position of CRO was not filled.

“Debtors” as used herein means: (i) us, together with NNL and certain other Canadian subsidiaries (collectively, Canadian Debtors) that filed for creditor protection pursuant to the provisions of the CCAA in the Ontario Superior Court of Justice (Canadian Court); (ii) Nortel Networks Inc. (NNI), Nortel Networks Capital Corporation (NNCC), NNCI and certain other U.S. subsidiaries (U.S. Debtors) that have filed voluntary petitions under Chapter 11 in the U.S. Court; (iii) certain Europe, Middle East and Africa (EMEA) subsidiaries (EMEA Debtors) that made consequential filings under the Insolvency Act 1986 in the High Court of England and Wales (English Court) (including NNSA, a French subsidiary that has commenced secondary proceedings in France); and (iv) certain Israeli subsidiaries that made consequential filings under the Israeli Companies Law 1999 in the District Court of Tel Aviv.

CCAA Proceedings

On the Petition Date, the Canadian Debtors obtained an initial order from the Canadian Court (Initial Order) for creditor protection for 30 days, pursuant to the provisions of the CCAA, which has since been extended to February 28, 2011 and is subject to further extension by the Canadian Court. There is no guarantee that the Canadian Debtors will be able to obtain court orders or approvals with respect to motions the Canadian Debtors may file from time to time to extend further the applicable stays of actions and proceedings against them. Pursuant to the Initial Order, the Canadian Debtors received approval to continue to undertake various actions in the normal course in order to maintain stable and continuing operations during the CCAA Proceedings.

Under the terms of the Initial Order, Ernst & Young Inc. was named as the court-appointed monitor under the CCAA Proceedings (Canadian Monitor). The Canadian Monitor has reported and will continue to report to the Canadian Court from time to time on the Canadian Debtors’ financial and operational position and any other matters that may be relevant to the CCAA Proceedings. In addition, the Canadian Monitor may advise and, to the extent required, assist the Canadian Debtors on matters relating to the Creditor Protection Proceedings. On August 14, 2009, the Canadian Court approved an order that permits the Canadian Monitor to take on an enhanced role with respect to the oversight of the business, sales processes, claims processes and other restructuring activities under the CCAA Proceedings. On May 27, 2009 and July 22, 2009, representative counsel was appointed on behalf of the former employees of the Canadian Debtors and on behalf of the continuing employees of the Canadian Debtors, respectively (Representative Counsel). Our management and the Canadian

 

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Monitor meet regularly with Representative Counsel and creditor groups to provide status updates and share information with them that has been shared with the representatives of other major stakeholders.

As a consequence of the CCAA Proceedings, generally, all actions to enforce or otherwise effect payment or repayment of liabilities of any Canadian Debtor arising prior to the Petition Date and substantially all pending claims and litigation against the Canadian Debtors and their officers and directors have been stayed until February 28, 2011, or such later date as may be ordered by the Canadian Court. In addition, the CCAA Proceedings have been recognized by the U.S. Court as “foreign proceedings” pursuant to the provisions of Chapter 15 of the U.S. Bankruptcy Code, giving effect in the U.S. to the stay granted by the Canadian Court. A cross-border court-to-court protocol (as amended) has also been approved by the U.S. Court and the Canadian Court. This protocol provides the U.S. Court and the Canadian Court with a framework for the coordination of the administration of the Chapter 11 Proceedings and the CCAA Proceedings on matters of concern to both courts.

The Canadian Court has also granted charges against some or all of the assets of the Canadian Debtors and any proceeds from any sales thereof, including a charge in favor of the Canadian Monitor, its counsel and counsel to the Canadian Debtors as security for payment of certain professional fees and disbursements; a charge in favor of Goldman, Sachs & Co. as security for fees and expenses payable for certain financial advisory services; charges against NNL’s and Nortel Networks Technology Corporation’s (NNTC) facility in Ottawa, Ontario in favor of NNI (Ottawa Charge) with respect to an intercompany revolving loan agreement (NNI Loan Agreement); a charge in favor of NNI as security for excess payment by NNI of certain corporate overhead and R&D services provided by NNL to the U.S. Debtors; a charge to support an indemnity for the directors and officers of the Canadian Debtors relating to certain claims that may be made against them in such role, as further described below; in addition to the Ottawa Charge mentioned above, charges on the property of each of the Canadian Debtors as security for their respective obligations under the NNI Loan Agreement; an intercompany charge in favor of: (i) any U.S. Debtor that loans or transfers money, goods or services to a Canadian Debtor; (ii) any EMEA Debtors who provide goods or services to the Canadian Debtors; (iii) NNL for any amounts advanced by NNL to NNTC following the Petition Date; and (iv) Nortel Networks UK Limited (NNUK) for certain payments due by NNL to NNUK out of the allocation of sale proceeds NNL actually receives from future material asset sales, subject to certain conditions. Recently the court approved an additional charge against all of the property of the Canadian Debtors to secure payment of the amounts that have been determined to be payable to participants under the Special Incentive Plan (as defined below). A further charge has been granted in favor of certain former employees and long term disability employees who are beneficiaries under the Settlement Agreement (as defined below) against all of the property of the Canadian Debtors to secure payment of the medical, dental, income, termination and pension payments agreed to be paid by the Canadian Debtors under the Settlement Agreement.

Chapter 11 Proceedings

Also on the Petition Date, the U.S. Debtors, other than NNCI, filed voluntary petitions under Chapter 11 with the U.S. Court. The U.S. Debtors received approval from the U.S. Court for a number of motions enabling them to continue to operate their businesses generally in the ordinary course. Among other things, the U.S. Debtors received approval to continue paying employee wages and certain benefits in the ordinary course; to generally continue their cash management system, including approval of a revolving loan agreement between NNI as lender and NNL as borrower with an initial advance to NNL of $75, to support NNL’s ongoing working capital and general corporate funding requirements; and to continue honoring customer obligations and paying suppliers for goods and services received on or after the Petition Date. On July 14, 2009, NNCI also filed a voluntary petition for relief under Chapter 11 in the U.S. Court and thereby became one of the U.S. Debtors subject to the Chapter 11 Proceedings, although the petition date for NNCI is July 14, 2009. On July 17, 2009, the U.S. Court entered an order of joint administration that provided for the joint administration, for procedural purposes only, of NNCI’s case with the pre-existing cases of the other U.S. Debtors.

 

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As required under the U.S. Bankruptcy Code, on January 22, 2009, the United States Trustee for the District of Delaware appointed an official committee of unsecured creditors, which currently includes The Bank of New York Mellon, Pension Benefit Guaranty Corporation (PBGC) and Law Debenture Trust Company of New York (U.S. Creditors’ Committee). The U.S. Creditors’ Committee has the right to be heard on all matters that come before the U.S. Court with respect to the U.S. Debtors. There can be no assurance that the U.S. Creditors’ Committee will support the U.S. Debtors’ positions on matters to be presented to the U.S. Court. In addition, a group purporting to hold substantial amounts of our publicly traded debt has organized (Bondholder Group). Our management and the Canadian Monitor have met with the Bondholder Group and its advisors to provide status updates and share information with them that has been shared with other major stakeholders. Disagreements between the Debtors and the U.S. Creditors’ Committee and the Bondholder Group could protract and negatively impact the Creditor Protection Proceedings and the Debtors’ ability to operate.

On December 8, 2009, we announced that NNI had entered into an agreement with John Ray for his appointment as principal officer of each of the U.S. Debtors (U.S. Principal Officer) and to work with Nortel management, the Canadian Monitor, the U.K. Administrators and various retained advisors, in providing oversight of the conduct of the businesses of the U.S. Debtors in relation to various matters in connection with the Chapter 11 Proceedings. This appointment was approved by the U.S. Court on January 6, 2010.

On June 21, 2010, the U.S. Debtors filed a motion seeking to terminate certain U.S. retiree and long-term disability benefits effective as of August 31, 2010. The U.S. Debtors filed a notice of withdrawal of this motion with the U.S. Bankruptcy Court on July 16, 2010. It is possible that the U.S. Debtors will seek modification or termination of some or all of these benefits at a later time.

On July 12, 2010, the U.S. Debtors filed their proposed plan of reorganization (the Plan) under Chapter 11 with the U.S. Court. Pursuant to the Plan, each U.S. Debtor will either be reorganized to the extent the U.S. Debtors determine it is necessary or beneficial to do so for the purpose of fulfilling its obligations under the asset sale agreements and TSAs, selling or otherwise disposing of its assets and fulfilling its obligations under the Plan, or will be liquidated. The U.S. Debtors filed a proposed disclosure statement for the Plan with the U.S. Court on September 3, 2010. The effectiveness of the Plan and the U.S. Debtors’ exit of the Chapter 11 Proceedings is subject to several conditions, including U.S. Court approval of the disclosure statement, as amended, obtaining the requisite number of votes in favor of the Plan from the solicited creditors of each U.S. Debtor, confirmation of the Plan by order of the U.S. Court and the satisfaction of other conditions precedent.

As a consequence of the commencement of the Chapter 11 Proceedings, generally, all actions to enforce or otherwise effect payment or repayment of liabilities of any U.S. Debtor preceding the Petition Date and substantially all pending claims and litigation against the U.S. Debtors have been automatically stayed for the pendency of the Chapter 11 Proceedings (absent any court order lifting the stay). In addition, the U.S. Debtors applied for and obtained an order in the Canadian Court recognizing the Chapter 11 Proceedings in the U.S. as “foreign proceedings” in Canada and giving effect, in Canada, to the automatic stay under the U.S. Bankruptcy Code.

Administration Proceedings

Also on the Petition Date, the EMEA Debtors made consequential filings and each obtained an administration order from the English Court under the Insolvency Act 1986. The filings were made by the EMEA Debtors under the provisions of the European Union’s Council Regulation (EC) No 1346/2000 on Insolvency Proceedings (EC Regulation) and on the basis that each EMEA Debtor’s center of main interests was in England. The U.K. Administration Proceedings currently extend to January 13, 2012, subject to further extension. Under the terms of the orders, a representative of Ernst & Young LLP (in the U.K.) and a representative of Ernst & Young Chartered Accountants (in Ireland) were appointed as joint administrators with respect to the EMEA Debtor in Ireland, and representatives of Ernst & Young LLP were appointed as joint administrators for the other EMEA Debtors (collectively, U.K. Administrators) to manage each of the EMEA Debtors’ affairs, business and

 

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property under the jurisdiction of the English Court and in accordance with the applicable provisions of the Insolvency Act 1986. The Insolvency Act 1986 provides for a moratorium during which creditors may not, without leave of the English Court or consent of the U.K. Administrators, wind up the company, enforce security, or commence or progress legal proceedings. All of our operating EMEA subsidiaries except those in the following countries are included in the U.K. Administration Proceedings: Nigeria, Russia, Ukraine, Israel, Norway, Switzerland, South Africa and Turkey.

The U.K. Administration Proceedings have been recognized by the U.S. Court as “foreign main proceedings” pursuant to the provisions of Chapter 15 of the U.S. Bankruptcy Code, giving effect in the U.S. to the moratorium provided by the Insolvency Act 1986.

Certain of our Israeli subsidiaries (Israeli Debtors) commenced separate creditor protection proceedings in Israel (Israeli Administration Proceedings). On January 19, 2009, an Israeli court (Israeli Court) appointed administrators over the Israeli Debtors (Israeli Administrators). The orders of the Israeli Court provide for a “stay of proceedings” in respect of the Israeli Debtors whose creditors are prevented from taking steps against the companies or their assets and which, subject to further orders of the Israeli Court, remains in effect during the Israeli Administration Proceedings.

On May 28, 2009, at the request of the U.K. Administrators of NNSA, the Commercial Court of Versailles, France (French Court) ordered the commencement of secondary proceedings in respect of NNSA. The French Secondary Proceedings consist of liquidation proceedings and NNSA is no longer authorized to continue its business operations.

Significant Business Divestitures

CDMA and LTE Access Assets

On June 19, 2009, we announced that we, NNL, and certain of our other subsidiaries, including NNI, had entered into a “stalking horse” asset sale agreement with Nokia Siemens Networks B.V. (NSN) for the planned sale of substantially all of our CDMA business and LTE Access assets for $650. This sale required a court-approved bidding process, known as a “stalking horse” or 363 Sale under Chapter 11 that allowed other qualified bidders to submit higher or otherwise better offers. Bidding procedures were approved by the U.S. Court and Canadian Court in late June 2009. Competing bids were required to be submitted by July 21, 2009 and an auction with the qualified bidders was completed on July 24, 2009. Ericsson emerged as the successful bidder for a purchase price of $1,130, subject to certain post closing purchase price adjustments. The purchase price has been finalized for a purchase price adjustment of $1. We obtained U.S. Court and Canadian Court approvals for the sale to Ericsson on July 28, 2009. On November 13, 2009, we announced that following satisfaction of all closing conditions, the sale had concluded. Approximately 2,500 Nortel employees received offers of employment from Ericsson. In connection with this transaction, NNL and NNI paid an aggregate break-up fee of $19.5 plus $3 in expense reimbursements to NSN.

Nortel determined that the fair value less estimated costs to sell exceeded the carrying value of the CDMA business and LTE Access assets and liabilities and therefore no impairment was recorded on the reclassification of these assets to held for sale. A gain on disposal of the CDMA business and LTE Access assets was recognized as part of reorganization items in the fourth quarter of fiscal 2009. The related CDMA and LTE Access financial results of operations have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP.

Packet Core Assets

On September 21, 2009, we announced that we planned to sell, by “open auction”, the Packet Core Assets of our WN business. The Packet Core Assets consist of software to support the transfer of data over existing wireless networks and the next generation of wireless communications technology including relevant non-patent

 

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intellectual property, equipment and other related tangible assets, as well as a non-exclusive license of certain relevant patents and other intellectual property. The Packet Core Assets exclude legacy packet core components for our GSM and Universal Mobile Telecommunications System (UMTS) businesses. On October 25, 2009, in accordance with court-approved procedures, our principal operating subsidiary, NNL, and NNI, entered into an agreement with Hitachi for the sale of our Packet Core Assets for a purchase price of $10. On October 28, 2009, Nortel obtained U.S. Court and Canadian Court approval of the sale to Hitachi. On December 8, 2009, we announced that following satisfaction of all closing conditions, the sale was concluded. A gain on disposal of the Packet Core Assets was recognized as part of reorganization items in the fourth quarter of fiscal 2009. The related Packet Core financial results of operations have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP.

Enterprise Solutions Business

On July 20, 2009, we announced that we, NNL, and certain of our other subsidiaries, including NNI and NNUK, had entered into a “stalking horse” asset and share sale agreement with Avaya for our North American, CALA and Asian ES business, and an asset sale agreement with Avaya for the EMEA portion of our ES business for a purchase price of $475. These agreements included the sale of substantially all of the assets of the ES business globally as well as the shares of NGS and DiamondWare, Ltd. This sale required a court-approved sale process under Chapter 11 that allowed other qualified bidders to submit higher or otherwise better offers. Bidding procedures were approved by the U.S. Court and Canadian Court on August 4, 2009. Competing bids were required to be submitted by September 4, 2009 and an auction with the qualified bidders commenced on September 11, 2009. On September 14, 2009, Avaya emerged as the successful bidder for the sale of substantially all of the assets of the ES business globally as well as the shares of NGS and DiamondWare, Ltd. for a purchase price of $900 in cash, subject to certain post closing purchase price adjustments, with an additional pool of $15 reserved for an employee retention program. We obtained U.S. Court and Canadian Court approvals for the sale to Avaya on September 16, 2009. On December 18, 2009, Nortel announced that the sale of substantially all of these assets had been completed. Under the terms of the sale, approximately 6,000 Nortel employees transferred to Avaya. The sale of certain ES assets held by Israeli subsidiaries was subsequently approved by the Israeli Court on December 21, 2009. All other closing conditions had been satisfied as of December 18, 2009.

Nortel determined that the fair value less estimated costs to sell exceeded the carrying value of the ES business and NGS assets and liabilities and therefore no impairment was recorded on the reclassification of these assets to held for sale. A gain on disposal of the ES business and NGS was recognized in the fourth quarter of fiscal 2009. The related ES business and NGS financial results of operations have been classified as discontinued operations for all periods presented as they met the definition of a component of an entity as required under U.S. GAAP. For further information about discontinued operations see note 4 to the accompanying unaudited condensed consolidated financial statements.

Optical Networking and Carrier Ethernet Businesses

On October 7, 2009, we announced that we, NNL, and certain of our other subsidiaries, including NNI and NNUK, had entered into a “stalking horse” asset sale agreement with Ciena for our North American, CALA and Asian Optical Networking and Carrier Ethernet businesses, and an asset sale agreement with Ciena for the EMEA portion of our Optical Networking and Carrier Ethernet businesses for a purchase price of $390 in cash, and 10 million shares of Ciena common stock. These agreements include the planned sale of substantially all the assets of our Optical Networking and Carrier Ethernet businesses globally. This sale required a court-approved sale process under Chapter 11 that allowed other qualified bidders to submit higher or otherwise better offers. Bidding procedures were approved by the U.S. Court and Canadian Court on October 15, 2009. Competing bids were ultimately required to be submitted by November 17, 2009. On November 22, 2009, in accordance with court-approved procedures, we concluded an auction for the sale of these assets to Ciena, who emerged as the successful bidder, agreeing to pay $530 in cash, subject to certain post closing purchase price adjustments, plus

 

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$239 principal amount of Ciena convertible notes due June 2017. At a joint hearing on December 2, 2009, we obtained U.S. Court and Canadian Court approvals for the sale to Ciena. On March 19, 2010, we announced that we had completed the sale of substantially all of the assets of our Optical Networking and Carrier Ethernet businesses to Ciena and that Ciena had elected, as permitted by the terms of the sale, to replace the $239 principal amount of convertible notes with cash consideration of $244, and thus pay an all cash purchase price of approximately $774. The purchase price was reduced at closing for a working capital adjustment of approximately $62. The purchase price has been finalized and the sales proceeds were subject to a further working capital downward adjustment of $19 in the second quarter of 2010. In conjunction with the sale of our Ottawa Carling Campus, we are required to exercise our early termination rights on the facility lease with Ciena and will be required to pay Ciena $33.5 at closing. See “Executive Overview — Sale of Ottawa Carling Campus” for further information.

The related Optical Networking and Carrier Ethernet businesses assets and liabilities were classified as held for sale beginning in the fourth quarter of 2009. We determined that the fair value less estimated costs to sell exceeded the carrying value of the Optical Networking and Carrier Ethernet businesses assets and liabilities and therefore no impairment was recorded on the reclassification of these assets to held for sale. A gain on disposal of the Optical Networking and Carrier Ethernet businesses assets and liabilities has been recognized as part of reorganization items in the first quarter of 2010. The related Optical Networking and Carrier Ethernet businesses’ financial results of operations have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP.

GSM/GSM-R Business

On September 30, 2009, we announced that we planned to sell by “open auction” substantially all of the assets of our global GSM/GSM-R business. The sale included the transfer of specified patents predominantly used in the GSM business and the grant of non-exclusive licenses of other relevant patents. This sale required a court-approved sale process under Chapter 11 that allowed other qualified bidders to submit offers. Bidding procedures were approved by the U.S. Court and Canadian Court on October 15, 2009. Competing bids were required to be submitted by November 16, 2009. An auction with the qualified bidders concluded on November 24, 2009, with Ericsson and Kapsch emerging as the successful bidders for the sale of these assets for a total purchase price of $103 in cash, subject to certain post closing purchase price adjustments. On November 18, 2009, Kapsch filed its bid for the GSM/GSM-R assets of NNSA with the French Administrator and the French Liquidator. On March 3, 2010, Kapsch filed an irrevocable and unconditional bid for such assets with the French Administrator and the French Liquidator and the French Court approved the sale to Kapsch on March 30, 2010. Nortel obtained U.S. Court and Canadian Court approvals for the sale to Ericsson and Kapsch on December 2, 2009. On March 31, 2010, we announced that we had completed the sale of substantially all of the assets of our global GSM/GSM-R business to Ericsson and Kapsch for aggregate proceeds of $103. The purchase price with respect to the sale to Ericsson has been finalized and the sales proceeds were subject to a further working capital downward adjustment of $6 in the second quarter of 2010. The purchase price with respect to the sale to Kapsch is also subject to a further working capital adjustment pending finalization between the parties.

The related GSM/GSM-R business assets and liabilities were classified as held for sale beginning in the fourth quarter of 2009. We determined that the fair value less estimated costs to sell exceeded the carrying value of the GSM/GSM-R business assets and liabilities and therefore no impairment was recorded on the reclassification of these assets to held for sale. A gain on disposal of the GSM/GSM-R business assets and liabilities has been recognized as part of reorganization items in the first quarter of 2010. The related GSM/GSM-R business financial results of operations have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP.

 

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CVAS Business

On December 23, 2009, we announced that we, NNL, and certain of our other subsidiaries, including NNI and NNUK, had entered into a “stalking horse” asset sale agreement with GENBAND for our North American, CALA and Asian CVAS business, and an asset sale agreement with GENBAND for the EMEA portion of our CVAS business for a purchase price of $282, subject to balance sheet and other adjustments estimated at the time at approximately $100, resulting in estimated net proceeds of approximately $182. These agreements include the planned sale of substantially all the assets of the CVAS business globally. This sale required a court-approved sale process under Chapter 11 that allowed other qualified bidders to submit higher or otherwise better offers. Bidding procedures were approved by the Canadian Court on January 6, 2010 and the U.S. Court on January 8, 2010. Competing bids were required to be submitted by February 23, 2010. No bids were received prior to the bid deadline. On February 24, 2010, we announced that we would not proceed to auction and would work towards closing the asset sale agreements with GENBAND. At a joint hearing on March 3, 2010, Nortel obtained U.S. Court and Canadian Court approval of the sale to GENBAND. On May 28, 2010, we announced that we had completed the sale of substantially all of the assets of the CVAS business to GENBAND.

The related CVAS business assets and liabilities were classified as held for sale beginning in the first quarter of 2010. We determined that the fair value less estimated costs to sell exceeded the carrying value of the CVAS business assets and liabilities and therefore no impairment was recorded on the reclassification of these assets to held for sale. A gain on disposal of the CVAS business assets and liabilities has been recognized as part of reorganization items in the second quarter of 2010. The related CVAS business financial results of operations have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP.

LGN Joint Venture

On May 27, 2009, we announced that NNL decided to seek a buyer for its majority stake (50% plus 1 share) in LGN, our Korean joint venture with LGE. Our affiliates based in Asia, including LGN, have not filed for creditor protection; however, pursuant to the ongoing Creditor Protection Proceedings, NNL filed a motion with the Canadian Court and received approval for a proposed sale process that has been agreed with LGE and the appointment of Goldman, Sachs & Co. to assist with the proposed divestiture. On April 20, 2010, we announced that NNL entered into a share purchase agreement dated April 21, 2010 with Ericsson. The agreement provides for the sale of NNL’s 50% plus 1 share interest, including preferred shares, in LGN, for a purchase price of $242 in cash, subject to certain purchase price adjustments. Approval of the Ontario Superior Court of Justice was obtained on May 3, 2010. The purchase price has now been finalized.

At the same time, NNL entered into a termination agreement with LGE, whereby the joint venture between LGE and NNL would terminate upon the share purchase by Ericsson being completed. Pursuant to this termination agreement LGE agreed to waive certain rights it has vis-à-vis the sale of NNL’s shares in LGN. In addition, certain Nortel ancillary agreements were terminated or amended and certain LGE ancillary agreements were terminated.

On June 29, 2010, we announced that NNL had completed the sale of its 50% plus one share interest in LGN to Ericsson.

In addition to the sale proceeds, prior to closing, NNL received approximately 50% of a capital reduction paid out by LGN to its shareholders, NNL and LGE, in the amount of 200 billion Korean Won (approximately CAD $181). NNL received CAD $83, net of withholding taxes.

The related financial results of operations of LGN have been classified as discontinued operations for all periods presented beginning in the second quarter of 2010 as they met the definition of a component of an entity as required under U.S. GAAP. For further information about discontinued operations see note 4 to the accompanying unaudited condensed consolidated financial statements. A gain on disposal related to the sale of NNL’s interest in LGN has been recognized as part of discontinued operations in the second quarter of 2010.

 

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MSS Business

On August 27, 2010, we announced that we, NNL, and certain of our other subsidiaries, including NNI and NNUK, had entered into a “stalking horse” asset sale agreement with PSP Holding LLC, a special purpose entity to be fully funded at closing by Marlin Equity Partners (Marlin) and Samnite Technologies Inc., a communications technology company based in Ottawa, for the planned sale of substantially all of our North American, CALA and Asian MSS business, and an asset sale agreement with Marlin for the sale of substantially all of the assets of the EMEA portion of its MSS business for a purchase price of $39 in cash. This sale required a court-approved sale process under Chapter 11 that allowed other qualified bidders to submit higher or otherwise better offers. Bidding procedures were approved by the U.S. Court and Canadian Court on September 1, 2010. Competing bids were ultimately required to be submitted by September 21, 2010. On September 24, 2010, we concluded a successful auction. Ericsson emerged as the successful bidder, for the sale of substantially all assets of the MSS business globally, for a purchase price of $65 in cash. The agreements are subject to certain working capital and other purchase price adjustments. The agreements also include the planned sale of the associated Data Packet Network and Services Edge Router (Shasta) product groups. They also include certain intellectual property related to the MSS business. The sale was approved by the U.S. and Canadian courts on September 30, 2010. The sale is subject to approvals by certain court appointed administrators in EMEA, as well as regulatory approvals and other customary closing conditions. In some EMEA jurisdictions, this transaction is also subject to compliance with information and consultation obligations with employee representatives prior to finalization of the terms of the sale. We are targeting to close the sale early in the first quarter 2011.

The related MSS business assets and liabilities were classified as held for sale beginning in the third quarter of 2010. We determined that the fair value less estimated costs to sell exceeded the carrying value of the MSS business assets and liabilities and therefore no impairment was recorded on the reclassification of these assets as held for sale. The related financial results of operations of the MSS business have not been classified as discontinued operations as they did not meet the definition of a component of an entity as required under U.S. GAAP.

Purchase Price Adjustments

With respect to the divestitures discussed above, Nortel’s sale agreements generally provide for post-closing adjustments to the stated purchase price based on the actual value of certain assets and liabilities as of the closing date relative to an estimate of those amounts at closing. Adjustments may be made for, among other things: (i) changes in net working capital; (ii) changes in amounts to be paid in respect of transferred employees, including such items as accrued compensation and vacation days, retirement benefits and severance amounts; and (iii) changes in amounts related to assets being transferred outside the United States, including purchase price reductions for assets in EMEA that are unable to be transferred due to further creditor protection proceedings and fixed purchase price reductions for assets transferred in China and India. In addition, some asset sale agreements include additional purchase price adjustments that depend on variations between estimated and actual inventory, net debt, standard margin and deferred profits of the businesses sold, under U.S. GAAP. None of these adjustments have materially changed, or are expected to materially change, the purchase price associated with the divestitures discussed above, other than as noted above. We have finalized the purchase price with respect to the sales of our CDMA business and LTE Access assets, Optical Networking and Carrier Ethernet businesses, GSM business sold to Ericsson and NNL’s interest in LGN.

Transition Services Agreements

We have entered into TSAs in connection with certain of the completed divestitures discussed above. We are contractually obligated under such TSAs to provide transition services to certain purchasers of our businesses and assets, such as IT, order management, supply chain, service and technical support, finance, certain back office and legal services. We have, subject to certain limitations, agreed to indemnify purchasers for losses in connection with a breach of our obligations under the TSAs or for certain other claims or losses that might arise under the TSAs. We receive income from the TSAs, which is reported in our financial statements under “Billings under transition services agreements”.

 

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In connection with the sale of substantially all of our CDMA business and LTE Access assets in 2009, we entered into a TSA with Ericsson pursuant to which we agreed to provide certain transition services for a period of up to 24 months after closing of the transaction.

In connection with the sale of substantially all of our ES business in 2009, we entered into a TSA with Avaya pursuant to which we agreed to provide certain transition services for a period of up to 18 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction.

In connection with the sale of substantially all of our Optical Networking and Carrier Ethernet businesses, we entered into a TSA with Ciena pursuant to which we agreed to provide certain transition services for a period of up to 24 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction.

In connection with the sale of substantially all of our GSM/GSM-R business, we entered into a TSA with Ericsson pursuant to which we agreed to provide certain transition services for a period of up to 18 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction and a TSA with Kapsch pursuant to which we agreed to provide certain transition services for a period of up to 12 months after closing of the transaction.

In connection with the sale of substantially all of our CVAS business, we entered into a TSA with GENBAND pursuant to which we agreed to provide certain transition services for a period of up to 18 months (up to 12 months in certain jurisdictions in EMEA) after closing of the transaction.

In connection with the planned sale of substantially all of our MSS business, subject to completion of the divestiture, at closing, we expect to enter into a TSA with Ericsson pursuant to which we would agree to provide certain transition services commencing at the closing of the transaction and continuing through no later than June 30, 2011.

Sale of Ottawa Carling Campus

On October 19, 2010, we announced that as part of our focus on maximizing value for our stakeholders, NNL and NNTC entered into a sale agreement with Public Works and Government Services Canada (PWGSC) for the sale of our Ottawa Carling Campus, for a cash purchase price of CAD$208. The Ottawa Carling Campus is located on 370 acres of land in Ottawa’s national Capital Commission Greenbelt, and is comprised of 11 interconnected buildings totaling over 2 million square feet. The sale, targeted to close at end of year, is subject to customary closing conditions as well as approval of certain governmental authorities. The Canadian Court approved the sale on November 8, 2010.

The sale agreement provides for Nortel to continue to occupy parts of the Ottawa Carling Campus for varying periods of time to facilitate our continuing work on our global restructuring including work under the TSAs with the various buyers of our sold businesses. All other existing leases will be assumed by PWGSC, including leases with buyers of our sold businesses. With respect to the lease with Ciena, the purchaser of the Optical Networking and Carrier Ethernet business, we are directed by PWGSC under the sale agreement to exercise, on closing, our early termination rights under the lease, shortening the lease from 10 years to 5 years. This will result, pursuant to the lease with Ciena, in the repayment to Ciena of $33.5 from the escrowed sale proceeds from the business sale.

The sale agreement further provides that at closing title will be delivered free and clear of all encumbrances, including the Ottawa Charge in favor of NNI with respect to the NNI Loan Agreement, under which $75 plus accrued interest is outstanding and is due on December 31, 2010. NNL intends to repay this outstanding amount with the proceeds from the sale of the Ottawa Carling Campus.

 

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Further Divestitures

The Creditor Protection Proceedings may result in additional sales or divestitures; however, we can provide no assurance we will be able to complete any further sale or divestiture on acceptable terms or at all. On February 18, 2009, the U.S. Court approved procedures for the sale or abandonment by the U.S. Debtors of assets with a de minimis value. The Canadian Debtors can generally take similar actions with the approval of the Canadian Monitor. In France, the French Administrator and French Liquidator have the ability to deal with assets of de minimis value in a similar way under statute. There is no formal concept of “abandonment of assets with a de minimis value” in the U.K. Administration Proceedings, although the U.K. Administrators will ordinarily not take any steps to deal with assets where there is no benefit to creditors in them doing so. As Nortel continues to advance in discussions to sell its other businesses, it will consult with the Canadian Monitor, the U.K. Administrators, the U.S. Principal Officer, the U.S. Creditors’ Committee, the Bondholder Group and other stakeholders as appropriate (including the French Administrator, the French Liquidator and the Israeli Administrators as necessary), and any proposed divestiture may be subject to the approval of affected stakeholders and the relevant courts. There can be no assurance that any further proposed sale or divestiture will be developed, confirmed or approved, where required, by any of the relevant courts or affected stakeholders.

Liquidation of Subsidiaries

With the completed sales of substantially all of our businesses, we are focused on maximizing proceeds and cash flows with respect to remaining assets. This includes the winding up of our remaining operations and subsidiaries globally, which may involve orderly wind-ups as well as commencement of liquidation proceedings, as the circumstances warrant.

Events may impact when, and if, an entity is deemed to be in liquidation including local statutory requirements and court approvals. As such approvals and events occur, we will evaluate whether a change in basis of accounting is appropriate, and in all such cases, we will assess the carrying values of those entities’ assets when it appears likely entities will be approved for liquidation. Generally, we expect that an entity deemed to be in liquidation will result in a loss of control, deconsolidation of the entity, and accounting for the entity on a cost investment basis. We recorded nil and a loss of $74 for the three and nine months ended September 30, 2010, respectively, related to seven entities, which are included in reorganization items. Subsequent to September 30, 2010, events have occurred resulting in certain additional entities being placed in liquidation or pending approval to be liquidated. See note 5 of the accompanying unaudited condensed consolidated financial statements for additional information about reorganization items.

Divestiture Proceeds Received

As at September 30, 2010, of the approximately $3,150 in net proceeds generated through the completed sales of businesses, proceeds of approximately $3,134 had been received. These divestiture proceeds include the following approximate amounts:

 

  (a) $1,070 from the sale of substantially all of our CDMA business and LTE Access assets;

 

  (b) $18 from the sale of our Layer 4-7 data portfolio;

 

  (c) $10 from the sale of our Packet Core Assets;

 

  (d) $924 from the sale of substantially all of the assets of our ES business, including the shares of DiamondWare, Ltd. and NGS;

 

  (e) $631 from the sale of substantially all of the assets of our Optical Networking and Carrier Ethernet businesses;

 

  (f) $67 from the sale of our North American GSM business;

 

  (g) $21 from the sale of our GSM business outside of North America (excluding our GSM business in CALA) and our global GSM-R business;

 

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  (h) $155 from the sale of substantially all of our CVAS business;

 

  (i) $234 from the sale of NNL’s 50% plus one share interest in LGN; and

 

  (j) $4 from the sale of various Nortel business assets.

The accompanying unaudited condensed consolidated financial statements have been prepared by us. Of the $3,134 in proceeds received from divestitures as of September 30, 2010, $2,828 is being held in escrow and an additional $234, reflecting proceeds from the sale of LGN, is included in restricted cash, which is currently reported in NNL solely for financial reporting purposes. The ultimate determination of the final allocation of such proceeds among the various Nortel legal entities, including entities that are not consolidated in the condensed consolidated financial statements, has not yet occurred and may be materially different from the NNL classification and related amounts shown in these financial statements. The IFSA (as defined below) and the escrow agreements for sales divestiture proceeds entered into by NNL, NNI and other Nortel legal entities provide for the processes for determining the final allocation of divestiture proceeds among such entities, either through joint agreement or, failing such agreement, other dispute resolution proceeding. Adjustments to the NNL classification and any related amounts arising from the ultimate allocation will be recognized when finalized. The NNL classification and related amounts shown in the accompanying unaudited condensed consolidated financial statements are not determinative of, and have not been accepted by any debtor estate, any party in interest in the Creditor Protection Proceedings or any court overseeing such proceedings, for purposes of deciding, the final allocation of divestiture proceeds.

Over the past several months, the Canadian Debtors, the Canadian Monitor, U.S. Debtors, EMEA Debtors, the U.K. Administrators, U.S. Creditors’ Committee, Bondholder Group and certain other interested parties (Mediation Parties) have held discussions in an attempt to agree to allocation of the sale proceeds now held in escrow and to reach resolution of all inter-state matters. As a result of these efforts, the Mediation Parties have agreed that the proceeds allocation process, as well as the process for settling certain inter-estate claims, would be aided by the appointment of a neutral mediator to review the positions and viewpoints of the various Mediation Parties. A confidential, non-binding mediation has been scheduled during the period from November 11 to 16, 2010. No assurances can be given over the outcome of the mediation process.

As at September 30, 2010, a further $140 in the aggregate was expected to be received in connection with the divestitures of substantially all of our CDMA business and LTE Access assets, our ES business, including the shares of DiamondWare, Ltd. and NGS, the assets of our Optical Networking and Carrier Ethernet businesses, and our global GSM/GSM-R and CVAS businesses, subject to the satisfaction of various conditions including performance under the TSAs. Such amounts, when received, will also be held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined. Subsequent to September 30, 2010, we have received nil of the $140.

Business Operations

During the Creditor Protection Proceedings, and until the completion of any further proposed divestitures or a decision to cease operations in certain countries is made, the remaining businesses and operations of the Debtors continue to operate under the jurisdictions and orders of the applicable courts and in accordance with applicable legislation while we continue to focus on the sale of remaining businesses and assets. We have continued to engage with our existing customer base in an effort to maintain delivery of products and services, minimize interruptions as a result of the Creditor Protection Proceedings and our divestiture efforts and resolve any interruptions in a timely manner. At the beginning of the proceedings, we established a senior procurement team, along with appropriate advisors, to address supplier issues and concerns as they arose to ensure ongoing supply of goods and services and minimize any disruption in our global supply chain. This procedure continues to function effectively and any supply chain issues are being dealt with on a timely basis.

 

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Contracts

Under the U.S. Bankruptcy Code, the U.S. Debtors may assume, assume and assign, or reject certain executory contracts including unexpired leases, subject to the approval of the U.S. Court and certain other conditions. Pursuant to the Initial Order of the Canadian Court, the Canadian Debtors are permitted to repudiate any arrangement or agreement, including real property leases. Any reference to any such agreements or instruments and to termination rights or a quantification of our obligations under any such agreements or instruments is qualified by any overriding rejection, repudiation or other rights the Debtors may have as a result of or in connection with the Creditor Protection Proceedings. The administration orders granted by the English Court do not give any similar unilateral rights to the U.K. Administrators. The U.K. Administrators and, in the case of NNSA, the French Administrator and the French Liquidator decide in each case whether an EMEA Debtor should continue to perform under an existing contract on the basis of whether it is in the interests of that administration to do so. Claims may arise as a result of a Debtor rejecting, repudiating or no longer continuing to perform under any contract or arrangement, which claims would usually be unsecured. Since the Petition Date, the Debtors have assumed and rejected or repudiated various contracts, including real property leases and commercial agreements. The Debtors will continue to review other contracts throughout the Creditor Protection Proceedings.

Since the Petition Date, we have periodically entered into agreements with other suppliers, including contract manufacturers, to address issues and concerns as they arise in order to ensure ongoing supply of goods and services and minimize any disruption in its global supply chain. In certain circumstances, some of these agreements include advance deposit or escrow obligations, or purchase commitments in order to mitigate the risk associated with supplying us during the pendency of the Creditor Protection Proceedings.

Creditor Protection Proceeding Claims

On August 4, 2009, the U.S. Court approved a claims process in the U.S. for claims that arose prior to the Petition Date. Pursuant to this claims process, proofs of claim, except in relation to NNCI, had to be received by the U.S. Claims Agent, Epiq Bankruptcy Solutions, LLC (Epiq), by September 30, 2009 (subject to certain exceptions as provided in the order establishing the claims bar date). On December 2, 2009, the U.S. Court approved January 25, 2010 as the deadline for receipt by Epiq of proofs of claim against NNCI (subject to certain exceptions as provided in the order establishing the claims bar date).

On July 30, 2009, we announced that the Canadian Court approved a claims process in Canada in connection with the CCAA Proceedings. Pursuant to this claims process, subject to certain exceptions, proofs of claim for claims arising prior to the Petition Date had to be received by the Canadian Monitor by no later than September 30, 2009. This claims bar date does not apply to certain claims, including inter-company claims as between the Canadian Debtors or as between any of the Canadian Debtors and their direct or indirect subsidiaries and affiliates (other than joint ventures), compensation claims by current or former employees or directors of any of the Canadian Debtors, and claims of current or former directors or officers for indemnification and/or contribution, for which claims notification deadlines have yet to be set by the Canadian Court. Proofs of claim for claims arising on or after the Petition Date as a result of the restructuring, termination, repudiation or disclaimer of any lease, contract or other agreement or obligation had to, or must be, received by the Canadian Monitor by the later of September 30, 2009 or 30 days after a proof of claim package has been sent by the Canadian Monitor to the person in respect of such claim. On September 16, 2010, the Canadian Court approved a methodology for the review and determination of claims filed against the Canadian Debtors. Also on September 16, 2010, the Canadian Court and U.S. Court approved a cross-border claims protocol to address the level of cooperation and consultation on issues between the Canadian Debtors and the U.S. Debtors with respect to overlapping and same-creditors’ claims between the two debtor estates. The U.K. Administrators commenced an informal creditor claim submission and evaluation process in July 2010. Creditors will also have the opportunity to take part in a formal claims admission and proving process in accordance with English insolvency law provisions in due course.

 

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The accompanying unaudited condensed consolidated financial statements for the quarterly period ended September 30, 2010 generally do not include the outcome of any current or future claims relating to the Creditor Protection Proceedings, other than as described in this report. Certain claims filed may have priority over those of the Debtors’ unsecured creditors. The Debtors are reviewing all claims filed and have commenced the claims reconciliation process. Differences between claim amounts determined by the Debtors and claim amounts filed by creditors will be investigated and resolved pursuant to a claims resolution process approved by the relevant court or, if necessary, the relevant court will make a final determination as to the amount, nature and validity of claims. Certain claims that have been filed may be duplicative (particularly given the multiple jurisdictions involved in the Creditor Protection Proceedings), based on contingencies that have not occurred, or may be otherwise overstated, and would therefore be subject to revision or disallowance. The settlement of claims cannot be finalized until the relevant creditors and courts approve a plan. In light of the number of creditors of the Debtors, the claims resolution process may take considerable time to complete. See note 20 of the accompanying unaudited condensed consolidated financial statements for additional information about claims.

Interim and Final Funding and Settlement Agreements

Historically, we have deployed our cash through a variety of intercompany borrowing and transfer pricing arrangements to allow us to operate on a global basis and to allocate profits, losses and certain costs among the corporate group. In particular, the Canadian Debtors have continued to allocate profits, losses and certain costs among the corporate group through transfer pricing agreement payments (TPA Payments). Other than one $30 payment made by NNI to NNL in respect of amounts that could arguably be owed in connection with the transfer pricing agreement, TPA Payments had been suspended since the Petition Date. However, the Canadian Debtors and the U.S. Debtors, with the support of the U.S. Creditors’ Committee and the Bondholder Group, as well as the EMEA Debtors (other than NNSA), entered into an Interim Funding and Settlement Agreement (IFSA) dated June 9, 2009 under which NNI paid $157 to NNL, in four installments during the period ended September 30, 2009 in full and final settlement of TPA Payments for the period from the Petition Date to September 30, 2009. Similarly, except for two shortfall payments totaling $20, the IFSA provides for a full and final settlement of any and all TPA Payments owing between certain EMEA entities and the U.S. and Canada for the period from the Petition Date through December 31, 2009. A portion of this funding may be repayable by NNL to NNI in certain circumstances. The IFSA was approved by the U.S. Court and Canadian Court on June 29, 2009 and on June 23, 2009, the English Court confirmed that the U.K. Administrators were at liberty to enter into the IFSA on behalf of each of the EMEA Debtors (except for NNSA which was authorized to enter into the IFSA by the French Court on July 7, 2009). NNSA acceded to the IFSA on September 11, 2009.

On December 23, 2009, we announced we, NNL, NNI, and certain other Canadian Debtors and U.S. Debtors entered into a Final Canadian Funding and Settlement Agreement (FCFSA). The FCFSA provides, among other things, for the settlement of certain intercompany claims, including in respect of amounts determined to be owed by NNL to NNI under our transfer pricing arrangements for the years 2001 through 2005. As part of the settlement, NNL has agreed to the establishment of a pre-filing claim in favor of NNI in the CCAA Proceedings in the net amount of approximately $2,063 (FCFSA Claim), which claim will not be subject to any offset. The FCFSA also provides that NNI will pay to NNL approximately $190, which has been received, over the course of 2010, which amount includes the contribution of NNI and certain U.S. affiliates towards certain estimated costs to be incurred by NNL, on their behalf, for the duration of the Creditor Protection Proceedings. The FCFSA also provides for the allocation of certain other anticipated costs to be incurred by the parties, including those relating to the divestiture of our various businesses. On January 21, 2010, we obtained approvals from the Canadian Court and the U.S. Court of the FCFSA and the creation and allowance of the FCFSA Claim. In addition, we obtained various other approvals from the Canadian Court and U.S. Court including authorization for NNL and NNI to enter into advance pricing agreements with the U.S. and Canadian tax authorities to resolve certain transfer pricing issues, on a retrospective basis, for the taxable years 2001 through 2005. In addition, in consideration of a settlement payment of $37.5, the United States Internal Revenue Service (IRS) released all of its claims against NNI and other members of NNI’s consolidated tax group for the years 1998 through 2008. As a result of this settlement, the IRS stipulated that its claim against NNI filed in the Chapter 11 Proceedings in the

 

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amount of approximately $3,000 was reduced to the $37.5 settlement payment. This settlement was a condition of the FCFSA and was approved by the U.S. Court on January 21, 2010. NNI made the settlement payment to the IRS on February 22, 2010.

APAC Debt Restructuring Agreement

As a consequence of the Creditor Protection Proceedings, certain amounts of intercompany payables to certain Nortel subsidiaries (APAC Agreement Subsidiaries) in the Asia-Pacific (APAC) region as of the Petition Date became impaired. To enable the APAC Agreement Subsidiaries to continue their respective business operations and to facilitate any potential divestitures, the Debtors have entered into an Asia Restructuring Agreement (APAC Agreement). Under the APAC Agreement, the APAC Agreement Subsidiaries have paid a portion of certain of the APAC Agreement Subsidiaries net intercompany debt outstanding as of the Petition Date (Pre-Petition Intercompany Debt) to the Canadian Debtors, the U.S. Debtors and the EMEA Debtors (including NNSA). A further portion of the Pre-Petition Intercompany Debt will be repayable from time to time only to the extent of such APAC Agreement Subsidiary’s net cash balance at the relevant time, and subject to certain reserves and provisions. All required court approvals with respect to the APAC Agreement have been obtained in the U.S. and Canada; however, implementation of the APAC Agreement for certain parties in other jurisdictions remains subject to receipt of outstanding regulatory approvals.

Export Development Canada Support Facility

Effective January 14, 2009, NNL entered into an agreement with EDC (Short-Term Support Agreement) to permit continued access by NNL to the EDC support facility (EDC Support Facility), for post-filing support of up to $30. The EDC Support Facility provided for the issuance of support in the form of guarantee bonds or guarantee type documents issued to financial institutions that issue letters of credit or guarantee, performance or surety bonds, or other instruments in support of Nortel’s contract performance. On June 18, 2009, NNL and EDC entered into a cash collateral agreement (Cash Collateral Agreement) in connection with the EDC Support Facility. NNL provided cash collateral of $6.5 for all outstanding post-petition support in accordance with the terms of the Cash Collateral Agreement, of which an aggregate of $6.2 has been released in the first nine months of 2010, and the charge that was previously granted by the Canadian Court over certain of Nortel’s assets in favor of EDC is no longer in force or effect. The Short-Term Support Agreement expired without further extension on December 18, 2009. NNL’s obligations under the EDC Support Facility are guaranteed by NNI and as of September 30, 2010, there was approximately $0.3 of outstanding post-petition support utilized under the EDC Support Facility. Subsequent to September 30, 2010, the remaining $0.3 has been released and, as a result, there is no further outstanding post-petition support utilized under the EDC Support Facility. At September 30, 2010, there was $32 outstanding related to pre-filing support utilized under the EDC Support Facility.

Other Contracts and Debt Instruments

Our filings under Chapter 11 and the CCAA constituted events of default or otherwise triggered repayment obligations under the instruments governing substantially all of the indebtedness issued or guaranteed by NNC, NNL, NNI and NNCC. In addition, we may not be in compliance with certain other covenants under indentures, the EDC Support Facility and other debt or lease instruments, and the obligations under those agreements may have been accelerated. We believe that any efforts to enforce such payment obligations against the U.S. Debtors are stayed as a result of the Chapter 11 Proceedings. Although the CCAA does not provide an automatic stay, the Canadian Court has granted a stay to the Canadian Debtors that currently extends to February 28, 2011. Pursuant to the U.K. Administration Proceedings, a moratorium has commenced during which creditors may not, without leave of the English Court or consent of the U.K. Administrators, enforce security, or commence or progress legal proceedings. The Israeli Administration Proceedings also provide for a stay which remains in effect during the pendency of such proceedings.

 

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The Creditor Protection Proceedings may have also constituted events of default under other contracts and leases of the Debtors. In addition, the Debtors may not be in compliance with various covenants under other contracts and leases. Depending on the jurisdiction, actions taken by counterparties or lessors based on such events of default and other breaches may be unenforceable as a result of the Creditor Protection Proceedings.

In addition, the Creditor Protection Proceedings may have caused, directly or indirectly, defaults or events of default under the debt instruments and/or contracts and leases of certain of our non-Debtor entities. These events of default (or defaults that become events of default) could give counterparties the right to accelerate the maturity of this debt or terminate such contracts or leases.

Flextronics

On January 14, 2009, we announced that NNL had entered into an amendment to arrangements (Amending Agreement) with a major supplier, Flextronics Telecom Systems, Ltd. (Flextronics). Under the terms of the Amending Agreement, NNL agreed to commitments to purchase $120 of existing inventory by July 1, 2009 and to make quarterly purchases of other inventory, and to terms relating to payment and pricing. Flextronics had notified us of its intention to terminate certain other arrangements upon 180 days’ notice (in July 2009) pursuant to the exercise by Flextronics of its contractual termination rights, while the other arrangements between the parties would continue in accordance with their terms. Following subsequent negotiations, we resolved various ongoing disputes and issues relating to the interpretation of the Amending Agreement and confirmed, among other things, our obligation to purchase inventory in accordance with existing plans of record of $25, which obligation was fulfilled in the first quarter of 2010. In addition, one of the supplier agreements with Flextronics was not terminated on July 12, 2009, as originally referenced in the Amending Agreement, but instead was extended to December 2009, with a further extension for certain products to September 2010.

We and Flextronics entered into an agreement dated November 20, 2009, which was approved by the U.S. and Canadian courts on December 2, 2009, that, among other things, provides a mechanism for the transfer of our supply relationship to purchasers of our other businesses or assets. In addition, this agreement resolves certain receivable amounts from and payable amounts due to Flextronics.

Since the Petition Date, we have periodically entered into agreements with other suppliers to address issues and concerns as they arise in order to ensure ongoing supply of goods and services and minimize any disruption in its global supply chain. In certain circumstances some of these agreements include advance deposit or escrow obligations, or purchase commitments in order to mitigate the risk associated with supplying us during the pendency of the Creditor Protection Proceedings.

Value, Listing and Trading of NNC Common Shares and NNL Preferred Shares

On January 14, 2009, we received notice from the New York Stock Exchange (NYSE) that it decided to suspend the listing of Nortel Networks Corporation common shares (NNC common shares) on the NYSE. The NYSE stated that its decision was based on the commencement of the CCAA Proceedings and Chapter 11 Proceedings. As previously disclosed, we also were not in compliance with the NYSE’s price criteria pursuant to the NYSE’s Listed Company Manual because the average closing price of NNC common shares was less than $1.00 per share over a consecutive 30-trading-day period as of December 11, 2008. Subsequently, on February 2, 2009, NNC common shares were delisted from the NYSE. NNC common shares are currently quoted in the over-the-counter market in the Pink Sheets under the symbol “NRTLQ”.

On January 14, 2009, we received notice from the Toronto Stock Exchange (TSX) that it had begun reviewing the eligibility of NNC and NNL securities for continued listing on the TSX. However, the TSX stopped its review after concluding that the review was stayed by the Initial Order obtained by the Canadian Debtors pursuant to the CCAA Proceedings.

 

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On February 5, 2009, the U.S. Court also granted a motion by the U.S. Debtors to impose certain restrictions and notification procedures on trading in NNC common shares and NNL preferred shares in order to preserve valuable tax assets in the U.S., in particular net operating loss carryovers and certain other tax attributes of the U.S. Debtors.

On June 19, 2009 (and several times subsequently), we announced that we do not expect that holders of NNC common shares and NNL preferred shares will receive any value from the Creditor Protection Proceedings and we expect that the proceedings will ultimately result in the cancellation of these equity interests. As a result, we applied to delist the NNC common shares and NNL applied to delist the NNL preferred shares from trading on the TSX and delisting occurred on June 26, 2009 at the close of trading.

As a result of the TSX delisting, certain sellers of NNC common shares and NNL preferred shares who are not residents of Canada (non-residents) for purposes of the Income Tax Act (Canada) may be liable for Canadian tax and may be subject to tax filing requirements in Canada as a result of the sale of such shares after June 26, 2009. Also, purchasers of NNC common shares and NNL preferred shares from non-residents may have an obligation to remit 25% of the purchase price to the Canada Revenue Agency. Parties to sales of NNC common shares or NNL preferred shares involving a non-resident seller should consult their tax advisors or the Canada Revenue Agency. The statements herein are not intended to constitute, nor should they be relied upon as, tax advice to any particular seller or purchaser of NNC common shares or NNL preferred shares.

Annual General Meeting of Shareholders

We and NNL obtained an order from the Canadian Court under the CCAA Proceedings relieving NNC and NNL from the obligation to call and hold annual meetings of their respective shareholders by the statutory deadline of June 30, 2009, and directing them to call and hold such meetings within six months following the termination of the stay period under the CCAA Proceedings.

Directors’ and Officers’ Compensation and Indemnification

The Initial Order of the Canadian Court in the CCAA Proceedings ordered the Canadian Debtors to indemnify directors and officers of the Canadian Debtors for claims that may be made against them relating to failure of the Canadian Debtors to comply with certain statutory payment and remittance obligations. The Initial Order also included a charge against the property of the Canadian Debtors in an aggregate amount not exceeding CAD$90 as security for such indemnification obligations. On February 26, 2010, the NNC and NNL boards of directors (Nortel Boards) approved the reduction in the amount of the charge to an aggregate amount not exceeding CAD$45 on the condition that such reduction shall have been approved by an order of the Canadian Court which order shall provide for certain related releases in respect of such claims. The reduction in the amount of the charge was approved by the Canadian Court on March 31, 2010.

In addition, in conjunction with the Creditor Protection Proceedings, we established a directors’ and officers’ trust (D&O Trust) in the amount of approximately CAD$12. The purpose of the D&O Trust is to provide a trust fund for the payment of liability claims (including defense costs) that may be asserted against individuals who serve as directors and officers of NNC, or as directors and officers of other entities at NNC’s request (such as subsidiaries and joint venture entities), by reason of that association with NNC or other entity, to the extent that such claims are not paid or satisfied out of insurance maintained by NNC and NNC is unable to indemnify the individual. Such liability claims would include claims for unpaid statutory payment or remittance obligations of NNC or such other entities for which such directors and officers have personal statutory liability but will not include claims for which NNC is prohibited by applicable law from providing indemnification to such directors or officers. The D&O Trust also may be drawn upon to maintain directors’ and officers’ insurance coverage in the event NNC fails or refuses to do so. The D&O Trust will remain in place until the later of December 31, 2015 or three years after all known actual or potential claims have been satisfied or resolved, at which time any remaining trust funds will revert to NNC.

 

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Certain Nortel entities have not filed for bankruptcy protection (Cascade Subsidiaries). Under the laws of various jurisdictions in which the Cascade Subsidiaries operate, the directors, officers and agents of the Cascade Subsidiaries may be subject to personal liability. In order to protect individuals serving as directors on the boards of the Cascade Subsidiaries and to facilitate participation by the Cascade Subsidiaries in our sales of businesses and assets, NNL and NNI have contributed to a trust (Trust), which will indemnify individuals serving as directors on the boards and as officers or agents of the Cascade Subsidiaries and their successors, if any, for any claims resulting from their service as a director, officer or agent of a Cascade Subsidiary, subject to limited exceptions. The Trust was approved by the Canadian Court and the U.S. Court on March 31, 2010.

Under the Nortel Networks Corporation Directors’ Deferred Share Compensation Plan and the NNL Directors’ Deferred Share Compensation Plan (DSC Plans), non-employee directors could elect to receive all or a portion of their compensation for services rendered as a member of the Nortel Boards, any committees thereof, and as board or committee chairperson, in share units, in cash or a combination of share units and cash. As part of the relief sought in the CCAA Proceedings, we requested entitlement to pay the directors their compensation in cash on a current basis, notwithstanding the terms of, or elections under the DSC Plans, during the period in which the directors continue as directors in the CCAA Proceedings. On the Petition Date, the Canadian Court granted an order providing that our directors are entitled to receive remuneration in cash on a then-current basis at then-current compensation levels less an overall $0.025 reduction. Without this court order, to the extent that directors had elected to receive their compensation in the form of share units, the directors would have received no compensation for their services on a go-forward basis. Since the Petition Date, share units credited under the DSC Plans have not been settled even though several directors have retired from the Nortel Boards. We do not expect to settle any share units held under the DSC Plans in the future. Directors may have an unsecured claim in the CCAA Proceedings with respect to their share unit holdings.

Subsequently, in connection with the reduction in the size of the Nortel Boards from nine directors to three directors and the assumption by the Nortel Boards of additional roles and responsibilities previously discharged by certain committees thereof, the Nortel Boards amended the terms for director compensation effective August 11, 2009. For further information on the changes to director compensation in 2009, see “Director Compensation for Fiscal Year 2009” in the “Executive and Director Compensation” section of the 2009 Annual Report.

Workforce Reductions; Employee Compensation Program Changes

We have taken and expect to take further, ongoing workforce and other cost reduction actions as we work through the Creditor Protection Proceedings. On the Petition Date, we employed approximately 30,300 employees globally. Through the sales of our businesses and cost reduction activities, including the 5,000 net reductions announced on February 25, 2009, we have reduced the workforce to approximately 2,000 employees as at September 30, 2010. Given the Creditor Protection Proceedings, we have discontinued all remaining activities under our previously announced restructuring plans as of the Petition Date. For further information, see the “Post-Petition Date Cost Reduction Activities” section of this report.

We continued the Nortel Networks Limited Annual Incentive Plan (Incentive Plan) in 2010 for all eligible employees. The Incentive Plan permits quarterly award determinations and payouts for the business units and semi-annual award determinations and payouts for the Corporate Group and NBS.

Where required, we have obtained court approvals for retention and incentive compensation plans for certain key eligible employees deemed essential to the business during the Creditor Protection Proceedings. In March 2009, we obtained U.S. Court and Canadian Court approvals for a key employee incentive and retention program for employees in North America, CALA and Asia. The program consisted of the Nortel Networks Corporation Key Executive Incentive Plan (KEIP) and the Nortel Networks Corporation Key Employee Retention Plan (KERP). See “Key Executive Incentive Plan and Key Employee Retention Plan” in the “Executive and Director Compensation” section of the 2009 Annual Report for further information on the KEIP and the KERP.

 

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On March 20, 2009, we obtained Canadian Court approval to terminate the Nortel Networks Corporation Change in Control Plan. For further information on this plan, see “CIC Plan” in the “Executive and Director Compensation” section of the 2009 Annual Report.

On March 4, 2010, we obtained U.S. Court approval and on March 8, 2010 we obtained Canadian Court approval for the Nortel Special Incentive Plan (Special Incentive Plan), which is designed to retain personnel at all levels of Corporate Group and NBS critical to complete our remaining work. The Special Incentive Plan was developed in consultation with independent expert advisors taking into account the availability of more stable and competitive employment opportunities available to these employees elsewhere. The Special Incentive Plan was supported by the Canadian Monitor, U.S. Creditors’ Committee and the Bondholders Group. Representative Counsel to former Canadian employees was also advised of the Special Incentive Plan prior to its approval by the Canadian Court and U.S. Court. Approximately 88 percent of the Special Incentive Plan’s costs are being funded by the purchasers of our businesses, pursuant to the terms of sales agreements. Certain purchasers have required that we retain key employees around the world to ensure that the transition to them of the acquired businesses is as effective and efficient as possible.

On February 27, 2009, we obtained Canadian Court approval to terminate our equity-based compensation plans (the Nortel 2005 Stock Incentive Plan, As Amended and Restated (2005 SIP), the Nortel Networks Corporation 1986 Stock Option Plan, As Amended and Restated (1986 Plan) and the Nortel Networks Corporation 2000 Stock Option Plan (2000 Plan)) and certain equity plans assumed in prior acquisitions, including all outstanding equity under these plans (stock options, stock appreciation rights (SARs), restricted stock units (RSUs) and performance stock units (PSUs)), whether vested or unvested. We sought this approval given the decreased value of NNC common shares and the administrative and associated costs of maintaining the plans to us as well as the plan participants. As at December 31, 2009, all options under the remaining equity-based compensation plans assumed in prior acquisitions had expired. See note 19, “Share-based compensation plans”, to the accompanying unaudited condensed consolidated financial statements, for additional information about our share-based compensation plans.

Settlement Agreement with Former and Disabled Canadian Employee Representatives

On February 8, 2010, the Canadian Debtors reached an agreement on certain employment related matters regarding our former Canadian employees, including our Canadian registered pension plans and benefits for Canadian pensioners and our employees on long term disability (LTD). We entered into a settlement agreement with court-appointed representatives of our former Canadian employees, pensioners and LTD beneficiaries, Representative Counsel, the Canadian Auto Workers’ union and the Canadian Monitor (Settlement Agreement). The Settlement Agreement, as amended, was approved by the Canadian Court on March 31, 2010.

The Settlement Agreement provided that we would continue to administer the Nortel Networks Negotiated Pension Plan and the Nortel Networks Limited Managerial and Non-Negotiated Pension Plan (Canadian Pension Plans) until September 30, 2010, at which time these Canadian Pension Plans were transitioned, in accordance with the Ontario Pension Benefits Act, to Monreau Sobeco Limited Partnership, a replacement administrator appointed by the Office of the Superintendent of Financial Services. We, as well as the Canadian Monitor, took all reasonable steps to complete the transfer of the administration of the Canadian Pension Plans to the new administrator. We continued to fund these Canadian Pension Plans consistent with the current service and special payments we had been making during the course of the CCAA Proceedings through March 31, 2010, and thereafter continued to make current service payments until September 30, 2010.

For the remainder of 2010, we will continue to pay medical and dental benefits to our pensioners and survivors and our LTD beneficiaries in accordance with the current benefit plan terms and conditions. Life insurance benefits will continue unchanged until December 31, 2010 and will continue to be funded consistent with 2009 funding. Further, we will pay income benefits to the LTD beneficiaries and to those receiving survivor income benefits and survivor transition benefits through December 31, 2010. The employment of the LTD

 

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beneficiaries will terminate on December 31, 2010. The parties have agreed to work toward a court-approved distribution, in 2010, of the assets of Nortel’s Health and Welfare Trust, the vehicle through which we generally have historically funded these benefits, with the exception of the income benefits described above, which we will pay directly. The Canadian Court approved the Canadian Monitor’s motion regarding a proposed allocation methodology with respect to the funds held in Nortel’s Health and Welfare Trust for distribution to beneficiaries of the trust.

The Settlement Agreement also provides that we will establish a fund of CAD$4.2 for termination payments of up to CAD$0.003 per employee to be made to eligible terminated employees as an advance against their claims under the CCAA Proceedings.

A charge in the maximum amount of CAD$57 against the Canadian Debtors’ assets has been established as security in support of the payments to be made by us under the Settlement Agreement, which amount will be reduced by the amount of payments made. The Settlement Agreement also sets out the relative priority for claims to be made in respect of the deficiency in the Canadian Pension Plans and Nortel’s Health and Welfare Trust. Under the Settlement Agreement, these claims will rank as ordinary unsecured claims in the CCAA Proceedings.

A group of 39 LTD beneficiaries sought leave to appeal the Canadian Court’s approval of the Settlement Agreement to the Ontario Court of Appeal. The leave motion was denied and the motion was dismissed by the Ontario Court of Appeal on May 31, 2010.

See note 13 in the accompanying unaudited condensed consolidated financial statements for further information on our pension and employee benefits plans.

Basis of Presentation and Going Concern Issues

For periods ending after the Petition Date, we reflect adjustments to our financial statements in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 852 “Reorganization” (ASC 852), on the basis that that we will continue as a going concern. After consideration of the guidance available in Financial Accounting Standards Board (FASB) Accounting Standards Codification ASC 810 “Consolidation” (ASC 810) and ASC 852, the financial statements as of and for the three and nine months ended September 30, 2010 have been presented on a basis that consolidates subsidiaries consistent with the basis of accounting applied in 2008 and prior except that, as disclosed further below, certain of our subsidiaries in EMEA, NNUK, NNSA and Nortel Networks (Ireland) Limited and their subsidiaries (collectively, EMEA Subsidiaries), were accounted for under the equity method from the Petition Date up to May 31, 2010 and as an investment under the cost method of accounting thereafter, as discussed below.

ASC 852, which is applicable to companies that have filed petitions under applicable bankruptcy code provisions and as a result of the Creditor Protection Proceedings is applicable to us, generally does not change the manner in which financial statements are prepared. However, it does require that the financial statements for periods subsequent to the filing of an applicable bankruptcy petition distinguish transactions and events that are directly associated with a reorganization from the ongoing operations of the business. For this reason, our revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the Creditor Protection Proceedings must be reported separately as reorganization items in the statements of operations beginning in the quarter ended March 31, 2009. The balance sheets must distinguish pre-petition liabilities subject to compromise from both those pre-petition liabilities that are not subject to compromise and post-petition liabilities. Liabilities that may be affected by a plan of reorganization must be reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. In addition, reorganization items must be disclosed separately in the statements of cash flows. We adopted ASC 852 effective on January 14, 2009 and have segregated those items outlined above for all reporting periods subsequent to such date.

 

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As further described above, beginning on the Petition Date, we and certain of our subsidiaries in Canada, the U.S., and in certain EMEA countries filed for creditor protection under the relevant jurisdictions of the U.S., the U.K. and subsequently commenced separate proceedings in Israel, followed by secondary proceedings in France. We continue to exercise control over our subsidiaries located in Canada, the U.S., CALA and Asia (other than entities in Australia which are wholly-owned subsidiaries of NNUK and therefore are included in the Equity Investees, as defined below), and our financial statements are prepared on a consolidated basis with respect to those subsidiaries. Based on our review of the applicable accounting guidance, we determined that we did not exercise all of the elements of control over the EMEA Subsidiaries once they filed for creditor protection and, in accordance with ASC 810, were required to deconsolidate the EMEA Subsidiaries, as well as their subsidiaries (collectively, the Equity Investees). However, we continued to exercise significant influence over the operating and financial policies of the Equity Investees. As a result, from the Petition Date to May 31, 2010, we accounted for our interests in the Equity Investees under the equity method in accordance with FASB ASC 323 “Investments — Equity Method and Joint Ventures” (ASC 323). On the Petition Date, the Equity Investees were in a net liability position. As the carrying values of the Equity Investees’ net liabilities were not considered to have differed materially from their estimated fair values and due to continuing involvement by us and our consolidated subsidiaries continuing involvement with the Equity Investees, including NNL’s guarantee of the U.K. pension liability (see “Liquidity and Capital Resources — Future Uses and Sources of Liquidity — Pension and post-retirement obligations” of the 2009 Annual Report), we concluded that the initial carrying value of our investment in these consolidated financial statements should reflect the Equity Investees’ net liabilities and no gain or loss was recognized on deconsolidation.

As of May 31, 2010, we determined that we no longer had significant influence over the operating and financial policies of the EMEA Subsidiaries due to the significance of the completed dispositions, the ongoing role and decision making authority of the U.K. Administrators, and as we are not committed to provide further support to the Equity Investees. As such, we have accounted for the Equity Investees as an investment using the cost method of accounting as of June 1, 2010 on a prospective basis. As a result, the financial position and results of operations of the Equity Investees are not reflected in our consolidated financial results after May 31, 2010. See note 1 to the accompanying unaudited condensed consolidated financial statements for further discussion of this change in accounting. In the context of the Creditor Protection Proceedings, we continue to evaluate the method of accounting for all of our subsidiaries.

We will continue to evaluate our remaining consolidated subsidiaries for the appropriateness of the accounting applied to these investments as the Creditor Protection Proceedings progress.

The accompanying unaudited condensed consolidated financial statements are prepared in accordance with U.S. GAAP but do not include all information and notes required in the preparation of annual consolidated financial statements. Although we are headquartered in Canada, the accompanying unaudited condensed consolidated financial statements are expressed in U.S. Dollars as the greater part of our financial results and net assets are denominated in U.S. Dollars.

The accompanying unaudited condensed consolidated financial statements do not purport to reflect or provide for the consequences of the Creditor Protection Proceedings. In particular, such unaudited condensed consolidated financial statements do not purport to show: (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (b) as to pre-petition liabilities, all amounts that may be allowed for claims or contingencies, or the status and priority thereof, or the amounts at which they may ultimately be settled; (c) as to shareholders’ accounts, the effect of any changes that may be made in our capitalization; (d) as to operations, the effect of any future changes that may be made in our business; or (e) as to divestiture proceeds held in escrow, the final allocation of these proceeds as between various Nortel legal entities, which will ultimately be determined either by joint agreement or through a dispute resolution proceeding (see note 2 to the accompanying unaudited condensed consolidated financial statements).

 

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The ongoing Creditor Protection Proceedings and completed and proposed divestitures of our businesses and assets raise substantial doubt as to whether we will be able to continue as a going concern. The accompanying unaudited condensed consolidated financial statements have been prepared using U.S. GAAP and the rules and regulations of the U.S. Securities and Exchange Commission (SEC). While the Debtors have filed for and been granted creditor protection, the accompanying unaudited condensed consolidated financial statements continue to be prepared using the going concern basis, which assumes that we will be able to realize our assets and discharge our liabilities in the normal course of business for the foreseeable future. During the Creditor Protection Proceedings, and until the completion of any further proposed divestitures or a decision to cease operations in certain countries is made, the businesses of the Debtors continue to operate under the jurisdictions and orders of the applicable courts and in accordance with applicable legislation. We have continued to operate our remaining businesses by renewing and seeking to grow our business with existing customers, competing for new customers, continuing R&D investments in product portfolios until the related businesses or assets are sold, and ensuring the ongoing supply of goods and services through the supply chain in an effort to maintain or improve customer service and loyalty levels. We have also continued our focus on cost containment and cost reduction initiatives during this time. It is our intention to continue to operate our businesses in this manner to maintain and maximize the value of our remaining businesses until they are sold or otherwise addressed. However, it is not possible to predict the outcome of the Creditor Protection Proceedings and, as such, the realization of assets and discharge of liabilities are each subject to significant uncertainty. If the going concern basis is not appropriate, adjustments will be necessary to the carrying amounts and/or classification of our assets and liabilities. Further, a court-approved plan in connection with the Creditor Protection Proceedings could materially change the carrying amounts and classifications reported in the accompanying unaudited condensed consolidated financial statements.

Reporting Requirements

As a result of the Creditor Protection Proceedings, we are periodically required to file various documents with and provide certain information to the Canadian Court, the U.S. Court, the English Court, the Canadian Monitor, the U.S. Creditors’ Committee, the U.S. Trustee and the U.K. Administrators. Depending on the jurisdictions, these documents and information may include statements of financial affairs, schedules of assets and liabilities, monthly operating reports, information relating to forecasted cash flows, as well as certain other financial information. Such documents and information, to the extent they are prepared or provided by us, will be prepared and provided according to requirements of relevant legislation, subject to variation as approved by an order of the relevant court. Such documents and information may be prepared or provided on an unconsolidated, unaudited or preliminary basis, or in a format different from that used in the financial statements included in our periodic reports filed with the SEC. Accordingly, the substance and format of these documents and information may not allow meaningful comparison with our regular publicly-disclosed financial statements. Moreover, these documents and information are not prepared for the purpose of providing a basis for an investment decision relating to our securities, or for comparison with other financial information filed with the SEC.

As part of Nortel’s ongoing cost reduction activities, on March 11, 2010, NNC, NNL, NNI and NNCC each filed notifications under the U.S. Securities Exchange Act of 1934 (Exchange Act) indicating they had less than 300 holders of each of their respective series of outstanding debt securities and related guarantees as of January 1, 2010. As a result, NNC is no longer required to include supplemental condensed consolidating financial information regarding the guarantors and non-guarantors of the debt securities in the notes to the financial statements. On March 18, 2010, NNL also filed a notification to de-register its common stock under the Exchange Act, which relieves it of having to file certain periodic reports including Forms 10-K, 10-Q and 8-K. NNL remains a reporting issuer under applicable Canadian securities laws and, as a result, will remain subject to continuous disclosure requirements, including the filing of annual and quarterly financial statements and management’s discussion and analysis of financial results under applicable Canadian securities laws. On April 15, 2010, NNL obtained exemptive relief from the Canadian securities regulatory authorities permitting NNL to satisfy certain of its Canadian continuous disclosure requirements by filing certain disclosures prepared in accordance with specified U.S. disclosure requirements for its financial years ended or ending December 31, 2009 and 2010.

 

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For a full discussion of the risks and uncertainties we face as a result of the Creditor Protection Proceedings, including the risks mentioned above, see the Risk Factors section of our 2009 Annual Report. Further information pertaining to our Creditor Protection Proceedings may be obtained through our website at www.nortel.com. Certain information regarding the CCAA Proceedings, including the reports of the Canadian Monitor, is available at the Canadian Monitor’s website at www.ey.com/ca/nortel. Documents filed with the U.S. Court and other general information about the Chapter 11 Proceedings are available at http://chapter11.epiqsystems.com/nortel. The content of the foregoing websites is not a part of this report.

Our Business

In the first quarter of 2010, we completed the sale of substantially all of our Optical Networking and Carrier Ethernet businesses to Ciena, which were included in our MEN segment, and the sale of substantially all of our GSM/GSM-R business to Ericsson and Kapsch, which was included in our WN segment. In the second quarter of 2010, we completed the sale of substantially all of our CVAS business to GENBAND, which was included in our CVAS segment, and the sale of NNL’s interest in LGN to Ericsson.

As of September 30, 2010, our three reportable segments were WN, CVAS, and MEN:

 

   

The WN segment provides wireline and wireless networks and related services that help service providers and cable operators supply mobile voice, data and multimedia communications services for individuals and enterprises using cellular telephones, personal digital assistants, laptops, soft-clients, and other wireless computing and communications devices. As of September 30, 2010, WN includes the residual CDMA and GSM businesses.

 

   

The CVAS segment offers circuit- and packet-based voice switching products that provide local, toll, long distance and international gateway capabilities for local and long distance telephone companies, wireless service providers, cable operators and other service providers. As of September 30, 2010, CVAS includes the residual CVAS business.

 

   

The MEN segment offers solutions designed to deliver carrier-grade Ethernet transport capabilities focused on meeting customer needs for higher performance and lower cost, with a portfolio that includes Optical Networking, Carrier Ethernet switching, and MSS products and related services. As of September 30, 2010, MEN includes the residual Optical Networking and Carrier Ethernet solutions businesses and the MSS business. As discussed above, we entered into sale agreements with Ericsson for the planned sale of substantially all the assets of the MSS business. These assets and liabilities have been classified as assets held for sale.

Comparative periods have been recast to conform to the current segment presentation.

 

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Results of Operations — Continuing Operations

As discussed above, the Equity Investees were accounted for under the equity method of accounting from the Petition Date to May 31, 2010 and are accounted for under the cost method of accounting and thus are no longer included in the consolidated results of operations as of June 1, 2010. Further, the information provided in this “Results of Operations — Continuing Operations” for the three and nine months ended September 30, 2010 includes results relating to certain significant businesses and assets that have been sold, including substantially all of our Optical Networking and Carrier Ethernet businesses, GSM/GSM-R business and CVAS business. See “Executive Overview — Creditor Protection Proceedings — Significant Business Divestitures”. The results of our Enterprise Solutions Business and LGN are presented as discontinued operations. See “Results of Operations — Discontinued Operations”.

Revenues

The following table sets forth our revenue by geographic location of the customers:

 

     For the Three Months ended September 30,     For the Nine Months ended September 30,  
       2010          2009          $ Change       % Change     2010      2009      $ Change     % Change  

United States

   $ 30       $ 730       $ (700     (96   $ 341       $ 1,972       $ (1,631     (83

EMEA (a)

     1         2         (1     (50     3         4         (1     (25

Canada

     1         82         (81     (99     45         238         (193     (81

Asia (b)

     51         74         (23     (31     155         393         (238     (61

CALA

     2         54         (52     (96     48         198         (150     (76
                                                                    

Total revenues

   $ 85       $ 942       $ (857     (91   $ 592       $ 2,805       $ (2,213     (79
                                                                    

 

(a) Excludes amounts related to Equity Investees of nil and $205 for Q3 2010 and Q3 2009, respectively, and $222 and $673 for the nine months ended September 30, 2010 and September 30, 2009, respectively.
(b) Excludes amounts related to Equity Investees of nil and $19 for Q3 2010 and Q3 2009, respectively, and $18 and $43 for the nine months ended September 30, 2010 and September 30, 2009, respectively.

For further discussion of the developments in our various reportable segments, including by geographical region, see “Segment Information.”

Revenues in 2010 have been significantly impacted by the divestitures of the CDMA/LTE Access business in the fourth quarter of 2009, the divestitures of the Optical Networking and Carrier Ethernet and GSM/GSM-R businesses in the first quarter of 2010 and the divestiture of the CVAS business in the second quarter of 2010. The decreases in revenues for each region for the third quarter of 2010 and the first nine months of 2010 as compared to the third quarter of 2009 and the first nine months of 2009, respectively, as provided in the table above, were primarily attributable to the divestitures.

Gross Margin

 

     For the Three Months ended September 30,     For the Nine Months ended September 30,  
     2010     2009     $ Change     % Change     2010     2009     $ Change     % Change  

Gross profit

   $ (3   $ 434      $ (437     (101   $ 100      $ 1,254      $ (1,154     (92

Gross margin

     -3.5     46.1       (49.6 points     16.9     44.7       (27.8 points

Q3 2010 vs. Q3 2009

Gross profit for the third quarter of 2010 was a loss of $3 compared to earnings of $434 in the third quarter of 2009 and gross margin for the third quarter of 2010 was negative 3.5% compared to 46.1% in the third quarter

 

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of 2009. The decrease in gross profit was primarily due to the business divestitures noted above and as result of costs related to delivering the TSAs continuing to be recorded in cost of revenues, the recovery of which is recorded in other operating income.

First nine months of 2010 vs. first nine months of 2009

Gross profit for the first nine months of 2010 was $100 compared to $1,254 in the first nine months of 2009 and gross margin for the first nine months of 2010 was 16.9% compared to 44.7% in the first nine months of 2009. The decrease in gross profit was primarily due to the business divestitures noted above and as result of costs related to delivering the TSAs continuing to be recorded in cost of revenues, the recovery of which is recorded in other operating income.

SG&A and R&D Expenses

 

     For the Three Months ended September 30,     For the Nine Months ended September 30,  
       2010          2009          $ Change       % Change       2010          2009        $ Change     % Change  

SG&A expense

   $ 108       $ 141       $ (33     (23   $ 409       $ 494       $ (85     (17

R&D expense

     3         173         (170     (98     106         574         (468     (82

Q3 2010 vs. Q3 2009

SG&A expense decreased to $108 in the third quarter of 2010 from $141 in the third quarter of 2009, a decrease of $33 or 23%. R&D expense decreased to $3 in the third quarter of 2010 from $173 in the third quarter of 2009, a decrease of $170 or 98%. The business divestitures noted above resulted in decreases in SG&A and R&D expenses. R&D and SG&A expenses also decreased due to higher charges related to workforce reduction activities in the third quarter of 2009 compared to the third quarter of 2010. The decrease in SG&A expense was partially offset by a change in methodology in the second quarter of 2010 resulting in ceasing the allocation of certain SG&A expenses related to corporate overhead costs to R&D and cost of revenues.

First nine months of 2010 vs. first nine months of 2009

SG&A expense decreased to $409 in the first nine months of 2010 from $494 in the first nine months of 2009, a decrease of $85 or 17%. R&D expense decreased to $106 in the first nine months of 2010 from $574 in the first nine months of 2009, a decrease of $468 or 82%. The decreases in SG&A and R&D expenses were primarily due to the business divestitures noted above. The decreases in both R&D and SG&A expenses were also due to charges related to the cancellation of certain equity based compensation plans in the first nine months of 2009 and higher charges related to workforce reduction activities in the first nine months of 2009 compared to the first nine months of 2010. SG&A expense was also impacted in the first nine months of 2010 by a change in methodology resulting in ceasing the allocation of certain SG&A expenses related to corporate overhead costs to R&D and cost of revenues.

 

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Pre-Petition Date Cost Reduction Plans

The following table sets forth charges (recovery) incurred by restructuring plan:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
      2010         2009         2010         2009    

Charge (recovery) by Restructuring Plan:

       

November 2008 Restructuring Plan

  $ —        $ —        $ (3   $ (13

2008 Restructuring Plan

    —          —          (2     (27

2007 Restructuring Plan

    —          (2     (1     (16

2006 Restructuring Plan

    —          —            —     

2004 and 2001 Restructuring Plans

    —          (51     1        (74
                               

Total charge (recovery) excluding discontinued operations

  $ —        $ (53   $ (5   $ (130
                               

As a result of the Creditor Protection Proceedings, we ceased taking any further actions under our previously announced workforce and cost reduction plans as of January 14, 2009. Any revisions to actions taken up to that date under previously announced workforce and cost reduction plans will continue to be accounted for under such plans, and will be classified in cost of revenues, SG&A and R&D as applicable. Any remaining actions under these plans will be accounted for under the workforce reduction plan announced on February 25, 2009 (see note 11 to the accompanying unaudited condensed consolidated financial statements). Our contractual obligations are subject to re-evaluation in connection with the Creditor Protection Proceedings and, as a result, expected cash outlays relating to contract settlement and lease costs are subject to change. As well, we are not following our pre-Petition Date practices with respect to the payment of severance in jurisdictions under the Creditor Protection Proceedings.

Recoveries primarily result from lease repudiations and other liabilities relinquished due to the Creditor Protection Proceedings and severance related accruals released from pre-Petition Date restructuring plans and reestablished under post-Petition Date cost reduction activities. For a description of our previously announced restructuring plans and further details of the charges (recovery) incurred, including by profit and loss category and by segment, see note 10 to the accompanying unaudited condensed consolidated financial statements.

Post-Petition Date Cost Reduction Activities

In connection with the Creditor Protection Proceedings, we have commenced certain workforce and other cost reduction activities and will undertake further workforce and cost reduction activities during this process. The actions related to these activities are expected to occur as they are identified. The following current estimated charges are based upon accruals made in accordance with U.S. GAAP. The current estimated total charges to earnings and cash outlays are subject to change as a result of our ongoing review of applicable law. In addition, the current estimated total charges to earnings and cash outlays do not reflect all potential claims or contingency amounts that may be allowed under the Creditor Protection Proceedings and thus are also subject to change.

Workforce Reduction Activities

On February 25, 2009, we announced a workforce reduction plan to reduce our global workforce by approximately 5,000 net positions which, upon completion, was expected to result in total charges to earnings of approximately $270 with expected total cash outlays of approximately $160 and the balance classified as a liability subject to compromise. Included in these amounts are actions related to the Equity Investees, which are described in note 22 to the accompanying unaudited condensed consolidated financial statements. On a consolidated basis, excluding amounts related to the Equity Investees, the plan was expected to result in total

 

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charges to earnings of approximately $168 with expected and total cash outlays of approximately $77 with the balance classified as a liability subject to compromise.

Subsequent to the February 25, 2009 announcement, as we continued to progress through the Creditor Protection Proceedings additional workforce reductions were deemed necessary to achieve the broader cost reduction initiative. On a consolidated basis, absent amounts related to Equity Investees, the incremental workforce reductions were expected to result in charges to earnings and cash outlays of $176 and $89, respectively, with the balance being classified as subject to compromise.

As of March 31, 2010, on a consolidated basis, excluding amounts related to the Equity Investees, we completed all 2009 announced workforce reductions discussed above, resulting in a net workforce reduction of 4,625 with charges to earnings and cash outlays of approximately $117 and $38, respectively, with the balance being classified as subject to compromise.

In addition to the concluded 2009 workforce reduction plans discussed above, we have continued cost reduction initiatives during 2010. For the three and nine months ended September 30, 2010, approximately $6 and $37, respectively, of the total charges relating to the net workforce reduction of 100 and 1,130 positions, respectively, were incurred. For the three and nine months ended September 30, 2010, we incurred workforce reduction recovery of nil and $2, respectively, and charges of $3 and $65, respectively, for discontinued operations. As we continue to progress through the Creditor Protection Proceedings, we expect to incur charges and cash outlays related to workforce and other cost reduction strategies. We will continue to report future charges and cash outlays under the broader strategy of the post petition cost reduction plan.

The following table sets forth charges by profit and loss category:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Cost of revenues

   $ 1       $ 5       $ 12       $ 25   

SG&A

     4         14         17         38   

R&D

     1         2         8         13   
                                   

Total workforce reduction charge

   $ 6       $ 21       $ 37       $ 76   
                                   

The following table sets forth charges incurred by segment:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

WN

   $ 3       $ 12       $ 6       $ 51   

CVAS

     2         6         23         16   

MEN

     1         3         8         9   
                                   

Total charges

   $ 6       $ 21       $ 37       $ 76   
                                   

Other Cost Reduction Activities

During the three and nine months ended September 30, 2010, Nortel’s real estate related cost reduction activities resulted in charges of $2 and $8, respectively, which were recorded against SG&A and reorganization items. During the three and nine months ended September 30, 2010, Nortel recorded plant and equipment write downs of nil and $11, respectively, against SG&A and reorganization items, and additional charges of nil and $13, respectively, against reorganization items for lease repudiations and other contract settlements. As of September 30, 2010, Nortel’s real estate and other cost reduction balances were approximately $31, of which $29 is classified as subject to compromise.

 

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Other Operating (Income) Expense — Net

The components of other operating income — net were as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
       2010         2009         2010         2009    

Royalty license income — net

   $ (3   $ (5   $ (9   $ (8

Litigation charges (recovery) — net

     —          1        (3     1   

Billings under TSAs

     (93     —          (242     —     

Other — net

     2        48        4        48   
                                

Other operating (income) expense — net

   $ (94   $ 44      $ (250   $ 41   
                                

Q3 2010 vs. Q3 2009

In the third quarter of 2010, other operating income — net was $94, due primarily to billings related to TSAs as described in “Executive Overview — Creditor Protection Proceedings — Transition Services Agreements”. In the third quarter of 2009, other operating expense — net was $44, due primarily to Other-net of $48 which primarily includes curtailment losses related to certain of our defined benefit pension plans and post-retirement benefit plans.

First nine months of 2010 vs. first nine months of 2009

In the first nine months of 2010, other operating income — net was $250, due primarily to billings related to TSAs as described in “Executive Overview — Creditor Protection Proceedings — Transition Services Agreements”. In the first nine months of 2009, other operating expense — net was $41 due primarily to Other-net of $48 which primarily includes curtailment losses related to certain of our defined benefit pension plans and post-retirement benefit plans, partially offset by royalty income of $8 from cross patent license agreements.

Other Income (Expense) — Net

The components of other income (expense) — net were as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
       2010         2009         2010         2009    

Rental income

   $ 21      $ —        $ 50      $ —     

Gain (loss) on sale and impairments of investments

     (1     (3     7        (4

Currency exchange gains (loss) — net

     (44     61        (44     29   

Other — net

     6        (1     1        (8
                                

Other income (expense) — net

   $ (18   $ 57      $ 14      $ 17   
                                

Q3 2010 vs. Q3 2009

In the third quarter of 2010, Other income (expense) — net was expense of $18, primarily comprised of currency exchange losses of $44 due to the strengthening of the Canadian Dollar against the U.S. Dollar, partially offset by rental income of $21. In the third quarter of 2009, Other income (expense) — net was income of $57, primarily due to currency exchange gains of $61, partially offset by a loss of $3 on the sale and write-down of investments.

 

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First nine months of 2010 vs. first nine months of 2009

In the first nine months of 2010, Other income (expense) — net was income of $14, primarily comprised of rental income of $50, partially offset by currency exchange losses of $44 due to the strengthening of the Canadian Dollar against the U.S. Dollar. In the first nine months of 2009, Other income (expense) — net was income of $17, primarily due to currency exchange gains of $29, partially offset by Other-net of $8.

Interest Expense

Interest expense has remained relatively consistent in the third quarter and first nine months of 2010 compared to the third quarter and first nine months of 2009. In accordance with ASC 852, interest expense in the U.S. incurred post-Petition Date is not recognized for accounting purposes. As a result, $3 and $9 of interest payable on debt issued by the U.S. Debtors, including NNI, has not been accrued in the accompanying unaudited condensed consolidated financial statements for the third quarter and first nine months of 2010, respectively. In the third quarter and first nine months of 2010, we have continued to accrue for interest expense of $77 and $227, respectively, in our normal course of operations related to debt issued by NNC or NNL in Canada until we obtain a claims determination order that adjudicates the claims. During the pendency of the Creditor Protection Proceedings, we generally have not and do not expect to make payments to satisfy the interest obligations of the Debtors.

Reorganization Items — net

Reorganization items represent the direct and incremental costs related to the Creditor Protection Proceedings such as revenues, expenses such as professional fees directly related to the Creditor Protection Proceedings, realized gains and losses, and provisions for losses resulting from the reorganization and restructuring of the business. Reorganization items, excluding amounts incurred by the EMEA Subsidiaries consisted of the following:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
        2010             2009             2010             2009      

Professional fees (a)

  $ (47   $ (33   $ (127   $ (86

Interest income (b)

    3        3        10        13   

Lease repudiation (c)

    —          34        (3     57   

Employee incentive plans (d)

    (10     (4     (31     (21

Penalties (e)

    —          —          —          (14

Pension, post-retirement and post-employment plans (f)

    (451     (215     (445     (215

Settlements (g)

    —          —          (2     —     

Loss on deconsolidation (h)

    —          —          (74     —     

Gain (loss) on divestitures (i)

    (25     —          840        —     

Loss on sale or impairment of stranded assets (j)

    (4     —          (142     —     

NNUK pension guarantee (k)

    —          —          (634     —     

EMEA deconsolidation adjustment (l)

    —          —          (763     —     

Other (m)

    5        (9     (49     (24
                               

Total reorganization items — net

  $ (529   $ (224   $ (1,420   $ (290
                               

 

(a) Includes financial, legal, real estate and valuation services directly associated with the Creditor Protection Proceedings.
(b) Reflects interest earned due to the preservation of cash as a result of the Creditor Protection Proceedings.
(c) Nortel has rejected a number of leases, resulting in the recognition of non-cash gains and losses. Nortel may reject additional leases or other contracts in the future, which may result in recognition of material gains and losses.

 

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(d) Relates to retention and incentive plans for certain key eligible employees deemed essential during the Creditor Protection Proceedings.
(e) Relates to liquidated damages on early termination of contracts.
(f) Includes amounts related to the Settlement Agreement. See note 13 to the accompanying unaudited condensed consolidated financial statements for further information.
(g) Includes net payments pursuant to settlement agreements since the Petition Date, and in some instances the extinguishment of net liabilities. See note 20 to the accompanying unaudited condensed consolidated financial statements for further information on settlements.
(h) Relates to deconsolidation of certain entities in connection with the Creditor Protection Proceedings.
(i) Relates to the gains and loss on various divestitures. See note 2 to the accompanying unaudited condensed consolidated financial statements for further information.
(j) Includes sale and impairments on certain long lived assets. See note 8 to the accompanying unaudited condensed consolidated financial statements for further information.
(k) Relates to the NNUK pension guarantees. See note 14 to the accompanying unaudited condensed consolidated financial statements for further information.
(l) Relates to the change due to the deconsolidation of the Equity Investees and the application of the cost method of accounting. See note 1 and 22 to the accompanying unaudited condensed consolidated financial statements for further information.
(m) Includes other miscellaneous items directly related to the Creditor Protection Proceedings, such as loss on disposal of certain assets, and foreign exchange.

Income Tax Expense

During the third quarter and first nine months ended September 30, 2010, Nortel recorded tax recoveries of $4 and $37, respectively, on loss from continuing operations before income taxes and equity in net loss of associated companies and Equity Investees of $644 and $1,801, respectively. The tax recovery of $37 is largely comprised of $10 of income taxes on current year profits in various jurisdictions offset by decreases in uncertain tax positions and other taxes of $9 and the reversal of previously accrued income taxes and interest of $38.

During the third quarter and nine months ended September 30, 2009, Nortel recorded a tax expense of $8 and $21, respectively, on loss from continuing operations before income taxes and equity in net loss of associated companies of $180 and $350, respectively. The tax expense of $21 was largely comprised of $13 of income taxes in profitable jurisdictions, primarily in Asia, and the provision of $24 of income taxes due to adjustments relating to transfer pricing and uncertain tax positions. This was offset by the adjustment of prior year estimates of $15 and a benefit of $1 from various tax credits and R&D related incentives. Previously included in continuing operations, Nortel reallocated to discontinued operations tax expense of $7 relating to the accrual of the deferred tax liability associated with NNL’s investment in LGN.

We continue to assess the valuation allowance recorded against our deferred tax assets on a quarterly and annual basis. The valuation allowance is in accordance with FASB ASC 740 “Income Taxes” (ASC 740), which requires us to establish a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of a company’s deferred tax assets will not be realized. We previously recorded a full valuation allowance in 2008 against our net deferred tax asset in all tax jurisdictions other than joint ventures in Korea and Turkey. Based on the available evidence, we have determined that a full valuation allowance continues to be necessary as at September 30, 2010 for all jurisdictions. For additional information, see “Application of Critical Accounting Policies and Estimates — Income Taxes” in this section of this report.

 

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Results of Operations — Equity Investees

As discussed above, the Equity Investees were accounted for under the equity method of accounting from the Petition Date through May 31, 2010 and are accounted for under the cost method of accounting beginning June 1, 2010. Therefore, the Equity in net loss of Equity Investees for the nine months ended September 30, 2010 only includes the results of the Equity Investees through May 31, 2010 and is not included for the third quarter of 2010. Equity in net loss of Equity Investees was a loss of $159 for the three months ended September 30, 2009. Equity in net loss of Equity Investees was a loss of $50 for the nine months ended September 30, 2010 compared to a loss of $448 for the nine months ended September 30, 2009. The following discussion relates to the key components comprising the Equity Investees’ net loss.

The general trends related to our consolidated revenues, gross margin, SG&A expense and R&D expense for the first nine months of 2010 discussed above were also applicable to the Equity Investees. See “Results of Operation — Continuing Operations”.

Revenues

Q3 2009

Revenues in the third quarter of 2009 were $226, excluding $122 in discontinued operations, comprised primarily of $205 in EMEA and $19 in Asia. The MEN segment revenue of $105 was comprised of $63 and $42 from the optical networking solutions business and data networking and security business, respectively. The WN segment revenue was $62 resulting primarily from the GSM and UMTS solutions business. The CVAS segment revenue was $57.

First nine months of 2010 vs. first nine months of 2009

Revenues in the first nine months of 2010 up to May 31, 2010 were $243, excluding $4 in discontinued operations, comprised primarily of $222 in EMEA. The MEN segment revenue of $109 was comprised of $69 and $40 from the data networking and security business and optical networking solutions business, respectively. The WN segment revenue was $53 resulting primarily from the GSM residual business. The CVAS segment revenue was $75.

Revenues in the first nine months of 2009 were $720, excluding $372 in discontinued operations, comprised primarily of $667 in EMEA and $43 in Asia. The MEN segment revenue of $345 was comprised of $191 and $154 from the optical networking solutions business and data networking and security business, respectively. The WN segment revenue was $207 resulting primarily from the GSM and UMTS solutions business. The CVAS segment revenue was $159.

Gross Margin

Q3 2009

Gross profit was $77 and gross margin was 22.0% for the third quarter of 2009.

First nine months of 2010 vs. first nine months of 2009

Gross profit was $49 and gross margin was 19.8% for the first nine months of 2010 up to May 31, 2010. Gross profit was $274 and gross margin was 25.1% for the first nine months of 2009.

SG&A and R&D Expense

Q3 2009

SG&A and R&D expenses were $129 and $37, respectively, for the third quarter of 2009.

 

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First nine months of 2010 vs. first nine months of 2009

SG&A and R&D expenses were $116 and $8, respectively, for the first nine months of 2010 up to May 31, 2010. SG&A and R&D expenses were $399 and $102, respectively, for the first nine months of 2009.

Reorganization Items — net

The components of reorganization items — net were as follows:

 

     Nine Months Ended September 30,     Three Months
Ended
September 30,

2009
 
     2010 (a)       2009      

Professional fees

   $ (39   $ (105   $ (37

Interest income

     2        5        2   

Lease repudiation

     —          2        —     

Employee incentive plans

     (9     (11     (5

Penalties

     —          (9     (1

Settlements

     (3     —          —     

Gain on divestitures

     28        —          —     

Other

     8        (12     (11
                        

Total reorganization items — net

   $ (13   $ (130   $ (52
                        

 

(a) The 2010 results only include the five months ended May 31 as the Equity Investees are accounted for under the cost method effective June 1, 2010.

See “Results of Operations — Continuing Operations — Reorganization Items — net” for a description of the nature of these reorganization items.

 

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Results of Operations — Discontinued Operations

As discussed above, we have completed the sale of substantially all of the assets of the ES business globally, including the shares of DiamondWare, Ltd. and NGS. These assets and liabilities were classified as held for sale at September 30, 2009. NNL completed the sale of its 50% plus one share interest in LGN in the second quarter of 2010. The LGN assets and liabilities were classified as held for sale in the second quarter of 2010. The related ES, NGS and LGN financial results of operations have been classified as discontinued operations for all periods presented. See “Executive Overview — Creditor Protection Proceedings — Significant Business Divestitures”.

Q3 2010 vs. Q3 2009

ES

Loss from discontinued operations, net of taxes, for the third quarter of 2010 for ES was $5. Revenues for the third quarter of 2010 were nil with a negative gross profit of $1 for ES related to the residual business not transferred to Avaya. Additionally, ES incurred SG&A expense of $1.

Loss from discontinued operations, net of taxes, for the third quarter of 2009 for ES was $164. Revenues for the third quarter of 2009 were $353 with a gross profit of $111 for ES. SG&A and R&D expenses were $142 and $59, respectively.

LGN

Earnings from discontinued operations, net of taxes, for the third quarter of 2009 for LGN were $7. Revenues for the third quarter of 2009 were $102, with a gross profit of $36 for LGN. SG&A and R&D expenses were $14 and $11, respectively.

First nine months of 2010 vs. first nine months of 2009

ES

Loss from discontinued operations, net of taxes, for the first nine months of 2010 for ES was $14. Revenues for the first nine months of 2010 were $11 with a negative gross profit of $2 for ES related to the residual business not transferred to Avaya. Additionally, ES incurred SG&A expense of $10.

Loss from discontinued operations, net of taxes, for the first nine months of 2009 for ES was $488. Revenues for the first nine months of 2009 were $1,064 with a gross profit of $336 for ES. SG&A and R&D expenses were $453 and $207, respectively. Also included in the loss from discontinued operations were $48 in goodwill impairment charges related to ES.

LGN

Earnings from discontinued operations, net of taxes, for the first nine months of 2010 for LGN were $42. We recorded a gain of $53 on the sale of NNL’s interest in LGN to Ericsson in the second quarter of 2010. Revenues for the first nine months of 2010 were $210 with a gross profit of $58 for LGN. These earnings were partially offset by SG&A and R&D expenses of $37 and $31, respectively.

Earnings from discontinued operations, net of taxes, for the first nine months of 2009 for LGN were $37. Revenues for the first nine months of 2009 were $489 with a gross profit of $175 for LGN. SG&A and R&D expenses were $46 and $36, respectively.

For further information about discontinued operations see note 4 to the accompanying unaudited condensed consolidated financial statements.

 

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Segment Information

How We Measure Business Performance

In the first quarter of 2010, our then CRO (effective March 21, 2010 and for the remainder of the first quarter of 2010, the CRO’s title was changed to Special Advisor) and the President of NBS were both identified as Chief Operating Decision Makers in assessing the performance of and allocating resources to our operating segments. The CRO was responsible for the remaining businesses and the President of NBS was responsible for the contracts included in operating segments that did not transfer to the purchasers of the divested businesses. As a result of the departure of the CRO, the Chief Strategy Officer and Business Unit President became the Chief Operating Decision Maker (CODM) in the second quarter of 2010 responsible for the remaining businesses, while the President of NBS continues to be the CODM responsible for the contracts included in operating segments that did not transfer, as noted above. In the third quarter of 2010, the primary financial measure used by the Chief Strategy Officer and Business Unit President and the President of NBS was Management Operating Margin (Management OM). Management OM is not a recognized measure under U.S. GAAP. It is a measure defined as total revenues, less total cost of revenues, SG&A and R&D expense relating to our consolidated entities. Management OM percentage is a non-U.S. GAAP measure defined as Management OM divided by revenue. Beginning in the third quarter of 2010, the financial information for our reportable segments, including Management OM, no longer includes the results of the Equity Investees for any period, which is consistent with how we manage our remaining businesses following the sale of substantially all of our businesses. For a full reconciliation of Management OM to net earnings (loss) under U.S. GAAP, see note 9 to the accompanying unaudited condensed consolidated financial statements. Our management believes that these measures are meaningful measurements of operating performance and provide greater transparency to investors with respect to our performance, as well as supplemental information used by management in its financial and operational decision making.

These non-U.S. GAAP measures should be considered in addition to, but not as a substitute for, the information contained in our unaudited condensed consolidated financial statements prepared in accordance with U.S. GAAP. Although these measures may not be equivalent to similar measurement terms used by other companies, they may facilitate comparisons to our historical performance and our competitors’ operating results. Comparative periods have been recast to conform to the current segment presentation.

Wireless Networks

The following table sets forth segment revenues and Management OM for the WN segment:

 

     For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 
     2010      2009      $ Change     % Change     2010      2009      $ Change     % Change  

Segment Revenues

                    

CDMA solutions

   $ 12       $ 441       $ (429     (97   $ 34       $ 1,348       $ (1,314     (97

GSM and UMTS solutions

     19         160         (141     (88     157         433         (276     (64
                                                                    

Total Segment Revenues

   $ 31       $ 601       $ (570     (95   $ 191       $ 1,781       $ (1,590     (89
                                                                    

Management OM

   $ 16       $ 187       $ (171     (91   $ 83       $ 453       $ (370     (82
                                                                    

We completed the sale of substantially all of our CDMA business and LTE Access assets to Ericsson on November 13, 2009 and the sale of substantially all of our GSM/GSM-R business to Ericsson and Kapsch on March 31, 2010. The GSM business in CALA was sold to Ericsson on June 4, 2010. Following the completion of the sales, WN includes only the residual CDMA and GSM businesses.

Q3 2010 vs. Q3 2009

WN revenues decreased to $31 in the third quarter of 2010 from $601 in the third quarter of 2009, a decrease of $570 or 95%, due to decreases across all businesses and regions.

 

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WN Management OM decreased to $16 in the third quarter of 2010 from $187 in the third quarter of 2009, a decrease of $171. This decrease was a result of a decrease in gross profit of $304, partially offset by decreases in both R&D and SG&A expenses of $80 and $53, respectively.

WN gross profit decreased to $15 from $319, while gross margin decreased to 48.4% from 53.1%.

The decreases in WN revenues, Management OM and gross profit are all primarily due to the sale of substantially all of our CDMA business and LTE Access assets to Ericsson in the fourth quarter of 2009, the sale of substantially all of our GSM/GSM-R business to Ericsson and Kapsch in the second quarter of 2010 and the sale of the GSM business in CALA to Ericsson in the second quarter of 2010.

First nine months of 2010 vs. first nine months of 2009

WN revenues decreased to $191 in the first nine months of 2010 from $1,781 in the first nine months of 2009, a decrease of $1,590 or 89%, due to decreases across all businesses and regions.

WN Management OM decreased to $83 in the first nine months of 2010 from $453 in the first nine months of 2009, a decrease of $370. This decrease was a result of a decrease in gross profit of $824, partially offset by decreases in both R&D and SG&A expenses of $280 and $174, respectively.

WN gross profit decreased to $103 from $927, while gross margin increased to 53.9% from 52.0%.

The decreases in WN revenues, Management OM and gross profit are all primarily due to the sale of substantially all of our CDMA business and LTE Access assets to Ericsson in the fourth quarter of 2009, the sale of substantially all of our GSM/GSM-R business to Ericsson and Kapsch in the second quarter of 2010 and the sale of the GSM business in CALA to Ericsson in the second quarter of 2010.

Carrier VoIP and Application Solutions

The following table sets forth segment revenues and Management OM for the CVAS segment:

 

     For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 
     2010     2009      $ Change     % Change     2010     2009     $ Change     % Change  

Segment Revenues

                 

Circuit and packet voice solutions

   $ 4      $ 151       $ (147     (97   $ 166      $ 381      $ (215     (56
                                                                 

Total Segment Revenues

   $ 4      $ 151       $ (147     (97   $ 166      $ 381      $ (215     (56
                                                                 

Management OM

   $ (4   $ 14       $ (18     (129   $ (52   $ (19   $ (33  
                                                                 

On May 28, 2010, we completed the sale of substantially all of the assets of the CVAS business to GENBAND. Following the completion of the sale, CVAS includes the residual CVAS business.

Q3 2010 vs. Q3 2009

CVAS revenues decreased to $4 in the third quarter of 2010 from $151 in the third quarter of 2009, a decrease of $147 or 97%, due to decreases across all regions.

CVAS Management OM decreased to a loss of $4 in the third quarter of 2010 from $14 in the third quarter of 2009, a decrease of $18. This decrease was a result of a decrease in gross profit of $78, partially offset by decreases in R&D and SG&A expenses of $34 and $26, respectively.

 

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CVAS gross profit decreased to a loss of $1 from a profit of $77, while gross margin decreased to negative 25.0% from 51.0%.

The decreases in CVAS revenues, Management OM and gross profit are all primarily due to the sale of substantially all of the assets of the CVAS business to GENBAND in the second quarter of 2010.

First nine months of 2010 vs. first nine months of 2009

CVAS revenues decreased to $166 in the first nine months of 2010 from $381 in the first nine months of 2009, a decrease of $215 or 56%, due to decreases across all regions.

CVAS Management OM decreased to a loss of $52 in the first nine months of 2010 from a loss of $19 in the first nine months of 2009, a decrease of $33. This decrease was a result of a decrease in gross margin of $117, partially offset by a decrease in R&D and SG&A expenses of $56 and $28, respectively.

CVAS gross profit decreased to $53 from $170, while gross margin decreased to 31.9% from 44.6%.

The decreases in CVAS revenues, Management OM and gross profit are all primarily due to the sale of substantially all of the assets of the CVAS business to GENBAND in the second quarter of 2010. In the first quarter of 2010, there were also decreases in revenues due to revenues from certain customers in 2009 that were not repeated in 2010 which were partially offset by the impact of favorable foreign exchange fluctuations in Canada and an increase in new business along with associated services contracts in 2010 in the U.S.

Metro Ethernet Networks

The following table sets forth segment revenues and Management OM for the MEN segment:

 

    For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 
    2010     2009     $ Change     % Change     2010     2009     $ Change     % Change  

Segment Revenues

               

Optical networking solutions

  $ 16      $ 178      $ (162     (91   $ 147      $ 590      $ (443     (75

Data networking and secutiry solutions

    32        12        20        167        86        53        33        62   
                                                               

Total Segment Revenues

  $ 48      $ 190      $ (142     (75   $ 233      $ 643      $ (410     (64
                                                               

Management OM

  $ 5      $ (22   $ 27        $ (28   $ (39   $ 11     
                                                               

On March 19, 2010, we completed the sale of substantially all of the assets of our Optical Networking and Carrier Ethernet businesses to Ciena. Following the completion of the sale, MEN includes the residual Optical Networking and Carrier Ethernet solutions business, and the MSS business, which is included in data networking and security solutions.

Q3 2010 vs. Q3 2009

MEN revenues decreased to $48 in the third quarter of 2010 from $190 in the third quarter of 2009, a decrease of $142 or 75%, due to decreases across all regions.

Revenues in the optical networking solutions business decreased by $162 as a result of the sale of our Optical Networking and Carrier Ethernet businesses to Ciena in the first quarter of 2010.

The increase in the data networking and security solutions business of $20 was primarily due to increases in MSS business in the U.S.

 

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MEN Management OM increased to earnings of $5 in the third quarter of 2010 from a loss of $22 in the third quarter of 2009, due to decreases in both R&D and SG&A expenses of $49 and $29, respectively, partially offset by a decline in gross profit of $51.

MEN gross profit decreased to $12 in the third quarter of 2010 from $63 in the third quarter of 2009, while gross margin decreased to 25.0% from 33.2%. Gross profit decreased primarily as a result of the divestiture of our Optical Networking and Carrier Ethernet businesses in the first quarter of 2010. R&D expense decreased primarily due to the cancellation of certain R&D programs and reduced spending in maturing technologies, partially offset by the unfavorable impact of foreign exchange fluctuations. The decrease in SG&A expense was mainly due to headcount reductions. Further, both R&D and SG&A expenses decreased as a result of the divestiture of our Optical Networking and Carrier Ethernet businesses.

First nine months of 2010 vs. first nine months of 2009

MEN revenues decreased to $233 in the first nine months of 2010 from $643 in the first nine months of 2009, a decrease of $410 or 64%, due to decreases across all regions.

Revenues in the optical networking solutions business decreased by $443 as a result of the sale of our Optical Networking and Carrier Ethernet businesses to Ciena in the first quarter of 2010.

The increase in the data networking and security solutions business of $33 was primarily due to increases in MSS business in the U.S.

MEN Management OM increased to a loss of $28 in the first nine months of 2010 from a loss of $39 in the first nine months of 2009 due to a decline in gross profit of $168, partially offset by decreases in both R&D and SG&A expenses of $102 and $77, respectively.

MEN gross profit decreased to $54 in the first nine months of 2010 from $222 in the first nine months of 2009, while gross margin decreased from 34.5% to 23.2%.

Gross profit decreased primarily as a result of the divestiture of our Optical Networking and Carrier Ethernet businesses to Ciena in the first quarter of 2010, delayed spending by customers in the first quarter of 2010 due to the divestiture, price erosion and increased inventory provisions, partially offset by the favorable impact of foreign exchange. R&D expense decreased primarily due to the cancellation of certain R&D programs and reduced spending in maturing technologies, partially offset by the unfavorable impact of foreign exchange fluctuations. The decrease in SG&A expense was mainly due to headcount reductions. Further, both R&D and SG&A expenses decreased as a result of the divestiture of our Optical Networking and Carrier Ethernet businesses.

 

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Liquidity and Capital Resources

Overview

As of September 30, 2010, our cash and cash equivalents balance was $1,686.

Our consolidated cash is held globally in various Nortel consolidated entities and joint ventures as follows, as of September 30, 2010: $834 in the U.S., $293 in Asia, $189 in Canada, $144 in CALA, $108 in joint ventures, $104 in China and $14 in EMEA. These amounts exclude restricted cash of $3,239, comprised of $3,206 in Canada, $25 in the U.S. and $8 in Asia. See “Executive Overview — Creditor Protection Proceedings — Divestiture Proceeds Received” for further information regarding NNL restricted cash in Canada. Cash of $844 held by our Equity Investees is no longer included in our consolidated cash balance as a result of the change to cost accounting (see “Executive Overview — Basis of Presentation and Going Concern Issues”).

Since June 2009, approximately $3,150 in net proceeds have been generated through the completed sales of businesses of which approximately $3,134 have been received as of September 30, 2010. As at September 30, 2010, $2,828 of the divesture proceeds received is being held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined. An additional $234, reflecting proceeds from the sale of LGN, is included in restricted cash. As at September 30, 2010, a further $140 in the aggregate was expected to be received in connection with the sales completed to date, subject to the satisfaction of various conditions. Such amount, when received, will also be held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined. Subsequent to September 30, 2010, Nortel’s escrow agent has received nil of the $140. See “Executive Overview — Creditor Protection Proceedings — Divestiture Proceeds Received”.

Historically, we have deployed our cash throughout the corporate group, through a variety of intercompany borrowing and transfer pricing arrangements. As a result of the Creditor Protection Proceedings, cash is generally available to fund operations in particular jurisdictions, but generally is not available to be freely transferred between jurisdictions, regions, or outside joint ventures, other than for normal course intercompany trade and pursuant to specific court-approved agreements as discussed below. Thus, there is greater pressure and reliance on cash balances and generation capacity in specific regions and jurisdictions.

Since the Petition Date, we have generally maintained use of our cash management system and consequently have minimized disruption to our operations pursuant to various court approvals and agreements obtained or entered into in connection with the Creditor Protection Proceedings. We continue to conduct ordinary course trade transactions between the Debtors and Nortel companies that are not included in the Creditor Protection Proceedings. The Canadian Debtors and the U.S. Debtors have also each entered into agreements with the EMEA Debtors governing the settlement of certain intercompany accounts, including for the purchase of goods and services. The terms of these agreements were last extended to May 31, 2010. The parties continue discussions on further extending the agreements to reflect the significantly reduced volume of intercompany transactions resulting from the business divestitures, which extensions would be subject to agreement of the parties and, in the case of the Canada-EMEA agreement, with the consent of the Canadian Monitor and U.K. Administrators. In the meantime, ongoing day to day trade of goods and services and settlement of post-filing intercompany accounts continues in the normal course. During the pendency of the Creditor Protection Proceedings we generally have not and do not expect to make payments to satisfy any of the interest obligations of the Debtors.

Historically, we have relied upon additional cash management provisions including a transfer pricing model that determines the prices that are charged for goods and services transferred between our subsidiaries and the allocation of profit and loss based upon certain R&D costs. In particular, the Canadian Debtors allocated profits, losses and certain costs among the corporate group through TPA Payments. Other than one $30 payment made by NNI to NNL in respect of amounts that could arguably be owed in connection with the transfer pricing agreement, TPA Payments had been suspended since the Petition Date and, as a result, NNL’s cash flow has been

 

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significantly impacted. As discussed earlier, the Canadian Debtors, the U.S. Debtors, with the support of the U.S. Creditors’ Committee and the Bondholder Group, as well as the EMEA Debtors (other than NNSA, which acceded to the IFSA on September 11, 2009), entered into the IFSA dated June 9, 2009 under which NNI has paid $157 to NNL, in four installments during 2009 in full and final settlement of TPA Payments for the period from the Petition Date to September 30, 2009.

As also discussed earlier, on December 23, 2009, we announced that we, NNL, NNI, and certain other Canadian Debtors and U.S. Debtors have entered into the FCFSA, which provides, among other things, for the settlement of certain intercompany claims, including in respect of amounts determined to be owed by NNL to NNI under our transfer pricing arrangements for the years 2001 through 2005. The FCFSA also provides that NNI will pay to NNL approximately $190 over the course of 2010 in full and final settlement of all obligations pursuant to the transfer pricing agreements among the Nortel group entities, which includes the contribution of NNI and certain U.S. affiliates towards certain estimated costs to be incurred by NNL on their behalf for the duration of the Creditor Protection Proceedings. In addition, in consideration of a settlement payment of $37.5, the IRS released all of its tax claims against NNI and other members of NNI’s consolidated tax group for the years 1998 through 2008. NNI made the settlement payment to the IRS on February 22, 2010. See “Executive Overview- Creditor Protection Proceedings — Interim and Final Funding and Settlement Agreement” for further information about the IFSA and FCFSA.

A revolving loan agreement between NNI, as lender, and NNL, as borrower, was approved by the Canadian Court and, subject to certain conditions, approved by the U.S. Court on an interim basis. An initial amount of $75 was approved and drawn, and the remaining $125 provided for under the agreement is subject to U.S. Court approval. We are not seeking U.S. Court approval to draw down the remaining $125. The loan bears interest at 10% per annum, and is secured by a charge on our Ottawa, Ontario facility, and subject to certain conditions, an intercompany charge, each as approved by the Canadian Court. NNL’s obligations under the loan are unconditionally guaranteed by NNTC and each of the other Canadian Debtors. The agreement currently matures on December 31, 2010 and NNL intends to repay this outstanding amount with the proceeds from the sale of the Ottawa Carling Campus.

Under the Cash Collateral Agreement, which was entered into in connection with the EDC Facility, NNL provided cash collateral of $6.5 for all outstanding post-petition support in accordance with the terms of the Cash Collateral Agreement, of which $6.2 has been released in the first nine months of 2010, see “Executive Overview — Creditor Protection Proceedings — Export Development Canada Support Facility”. We have established other cash collateralized facilities in certain jurisdictions including Canada and the U.S. to support our bonding needs. These other facilities can be used as an alternative to the EDC Support Facility. Approximately $13 of cash collateral has been posted by Nortel in support of non-EDC performance bonds and letter of credit facilities.

To enable the APAC Agreement Subsidiaries to preserve their assets and businesses, the Debtors entered into the APAC Agreement. Under the APAC Agreement, the Pre-Petition Intercompany Debt of the APAC Agreement Subsidiaries was restructured to subordinate a portion of their debt. Under the APAC Agreement, the APAC Agreement Subsidiaries have paid a portion of certain of the Pre-Petition Intercompany Debt. The Canadian Debtors, the U.S. Debtors and the EMEA Debtors have received to date approximately $20, $30 and $23, respectively, in aggregate in respect of the APAC Agreement. A further portion of the Pre-Petition Intercompany Debt will be repayable from time to time only to the extent of such APAC Agreement Subsidiary’s net cash balance at the relevant time, and subject to certain reserves and provisions. See “Executive Overview — Creditor Protection Proceedings — APAC Debt Restructuring Agreement”.

We continue several initiatives to generate cost reductions and decrease the rate of cash outflow during the Creditor Protection Proceedings. Some of these initiatives include the workforce reduction plan announced on February 25, 2009 and other ongoing workforce and cost reduction activities and reviews of our real estate and other property leases, IT equipment agreements, supplier and customer contracts and general discretionary spending as well as our new organizational structure announced on August 10, 2009. With the completed sales of

 

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substantially all of our businesses, we are focused on maximizing proceeds with respect to remaining assets. This includes the winding up of our remaining operations and subsidiaries globally, which can involve orderly wind-ups as well as commencement of liquidation proceedings, as the circumstances warrant.

Our current cash management system and cash on hand to fund our operations is subject to ongoing review and approval by the Canadian Monitor, the U.S. Principal Officer, and, with respect to the Equity Investees, the U.K. Administrators, and may be impacted by the Creditor Protection Proceedings. There is no assurance that (i) we will be able to maintain our current cash management system; (ii) we will generate sufficient cash to fund and wind up our operations; (iii) the current support under the EDC Support Facility or other cash collateralized facilities in certain jurisdictions will be sufficient for our business needs or that we will not have to provide further cash collateral; or (iv) the Debtors will be able to access proceeds in a timely manner from the divestitures as the Debtors continue discussions on allocation of proceeds from the divestitures of our businesses and assets.

Cash Flows

Our total consolidated cash and cash equivalents excluding restricted cash decreased by $312 in the first nine months of 2010 to $1,686, primarily due to cash flows attributable to discontinued operations and the net cash used in continuing operations.

 

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Our liquidity and capital resources are primarily impacted by: (i) current cash and cash equivalents, (ii) operating activities, (iii) investing activities, (iv) financing activities and (v) foreign exchange rate changes. The following table summarizes our cash flows by activity and cash on hand for the nine months ended and as of September 30, 2010 and 2009:

 

     For the Nine Months Ended
September 30,
 
     2010     2009     Change  

Net loss attributable to NNC

   $ (1,798   $ (1,289   $ (509

Net (earnings) loss from discontinued operations, net of tax

     (28     451        (479

Non-cash items

     1,895        645        1,237   

Changes in operating assets and liabilities:

      

Accounts receivable — net

     281        319        (38

Inventories — net

     36        86        (50

Accounts payable

     (59     64        (123
                        
     258        469        (211

Changes in other operating assets and liabilities

      

Deferred costs

     20        74        (54

Income taxes

     (73     (7     (66

Payroll, accrued and contractual liabilities

     44        142        (98

Deferred revenue

     3        (28     31   

Advanced billings in excess of revenues recognized to date on contracts

     (77     (110     33   

Restructuring liabilities

     (19     (32     13   

Other

     (27     (90     63   
                        
     (129     (51     (78

Net cash from (used in) operating activities of continuing operations

     198        225        (40

Net cash from (used in) operating activities of discontinued operations

     (377     (4     (373
                        

Net cash from (used in) operating activities

     (179     221        (413

Net cash from (used in) investing activities of continuing operations

     (221     24        (245

Net cash from (used in) investing activities of discontinued operations

     203        7        196   
                        

Net cash from (used in) investing activities

     (18     31        (49

Net cash used in financing activities of continuing operations

     (23     (54     31   

Net cash from financing activities of discontinued operations

     (77     (29     (48
                        

Net cash used in financing activities

     (100     (83     (17

Effect of foreign exchange rate changes on cash and cash equivalents

     11        51        (27

Cash and cash equivalents of liquidated entities

     (26     —          (26

Reduction of cash and cash equivalents of deconsolidated entities

     —          —          —     
                        

Net cash from (used in) continuing operations

     (61     246        (307

Net cash from (used in) discontinued operations

     (251     (26     (225
                        

Net increase (decrease) in cash and cash equivalents

     (312     220        (532

Cash and cash equivalents at beginning of period

     1,998        2,397        (399

Less: Cash and cash equivalents of Equity Investees

     —          (761     761   
                        

Adjusted cash and cash equivalents at beginning of period

     1,998        1,636        362   

Cash and cash equivalents at end of period

     1,686        1,856        (170

Less: Cash and cash equivalents of discontinued operations at end of period

     —          (346     346   
                        

Cash and cash equivalents of continuing operations at end of period

   $ 1,686      $ 1,510      $ 176   
                        

 

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Operating Activities

In the first nine months of 2010, our net cash used in operating activities of $179 resulted from a net loss attributable to NNC of $1,826, net of discontinued operations of $28, net cash used in discontinued operations of $377 and net uses of cash of $129 due to changes in other operating assets and liabilities, partially offset by adjustments for non-cash items of $1,895 and cash of $258 from changes in operating assets and liabilities. The net cash used in other operating activities was mainly due to the reduction of advance billings of $77, the reduction of income taxes of $73, the change in other of $27 and the decrease in restructuring liabilities of $19, partially offset by the change in payroll, accrued and contractual liabilities of $44 and the change in deferred costs of $20. The primary non-cash items were $1,279 in reorganization items under ASC 852, other of $424 consisting primarily of funding to LGN discontinued operations, pension and other accruals of $83, amortization and depreciation of $51 and equity in net loss of equity investee of $50.

In the first nine months of 2009, our net cash from operating activities of $221 resulted from cash of $469 from changes in operating assets and liabilities plus adjustments for non-cash items of $645, partially offset by a net loss attributable to NNC of $838, net of discontinued operations of $451, and net uses of cash of $51 due to changes in other operating assets and liabilities. The net cash used in other operating activities was mainly due to the reduction of advance billings of $110, the change in other of $90, the change in restructuring liabilities of $32 and the change in deferred revenues of $28, partially offset by the change in payroll, accrued and contractual liabilities of $142 and the change in deferred cost of $74. The use of cash for payroll, accrued and contractual liabilities was primarily due to sales compensation accruals, SG&A and interest accruals. The primary additions to our net loss for non-cash items were $448 equity in net loss of Equity Investees, reorganization items under ASC 852 of $265, pension and other accruals of $153, amortization and depreciation of $139, share-based compensation expense of $73 primarily related to the cancellation of certain share-based compensation plans, and earnings attributable to non-controlling interests of $16.

For additional information with respect to the increase in our deferred tax asset valuation allowance, see the “Application of Critical Accounting Policies and Estimates — Income Taxes” section of this report.

Investing Activities

In the first nine months of 2010, net cash used in investing activities was $18 primarily due to an increase in restricted cash and cash equivalents of $1,221 and expenditures for plant and equipment of $8, partially offset by proceeds related to sale of businesses and assets of $987, net cash provided by discontinued operations of $203 and a decrease in short-term and long-term investments of $24 as a result of proceeds received from the Reserve Primary Fund.

In the first nine months of 2009, net cash from investing activities was $31 primarily due to proceeds on disposals of plant and equipment of $87, a decrease in short-term and long-term investments of $40 and net cash provided by discontinued operations of $7, partially offset by an increase in restricted cash and cash equivalents of $82 and expenditures for plant and equipment of $26.

Financing Activities

In the first nine months of 2010, cash used in financing activities was $100, due to cash used in discontinued operations of $77, dividends paid by subsidiaries to noncontrolling interests of $19 and a net decrease in capital leases payable of $4.

In the first nine months of 2009, cash used in financing activities was $83, primarily due to a net decrease in notes payable of $41 and cash used in discontinued operations of $29.

 

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Other Items

In the first nine months of 2010, our cash position was positively impacted by $11 due to the favorable effects of changes in foreign exchange rates primarily from movements of the Canadian Dollar, the Euro and the British Pound against the U.S. Dollar.

In the first nine months of 2009, our cash position was positively impacted by $51 due to the favorable effects of changes in foreign exchange rates primarily from movements of the Euro and the British Pound against the U.S. Dollar.

Fair Value Measurements

The assets within our defined benefit pension plans are valued using fair value measurements. We primarily utilize observable (Level 1 and Level 2) inputs in determining the fair value of the assets. See note 15 to the accompanying unaudited condensed consolidated financial statements for additional information.

Future Uses and Sources of Liquidity

The matters described below, to the extent that they relate to future events or expectations, may be significantly affected by our Creditor Protection Proceedings. Those proceedings will involve, or may result in, various restrictions on our activities, the need to obtain third party approvals for various matters and potential impacts on vendors, suppliers, customers and others with whom we may conduct or seek to conduct business. In particular, as a result of the Creditor Protection Proceedings, our current expectation on global pension plan funding in 2010 is subject to change and funding beyond 2010 is uncertain at this time.

Future Uses of Liquidity

Our cash requirements for the 12 months commencing October 1, 2010 are primarily expected to consist of funding for operations and the following items:

 

   

professional fees in connection with the Creditor Protection Proceedings of approximately $199;

 

   

cash contributions to our defined benefit pension plans and our post-retirement and post-employment benefit plans of approximately $46;

 

   

costs related to workforce reductions and real estate actions of approximately $21; and

 

   

capital expenditures of approximately $1 primarily related to R&D.

Contractual cash obligations

Our contractual cash obligations for operating leases, obligations under post-Petition Date cost reduction activities, employee benefit obligations and other long-term liabilities reflected on the balance sheet remained substantially unchanged as of September 30, 2010 from the amounts disclosed as of December 31, 2009 in our 2009 Annual Report, except for where we have applied the accounting under ASC 852. Our current contractual obligations are subject to re-evaluation in connection with our Creditor Protection Proceedings. See “Executive Overview — Basis of Presentation and Going Concern Issues” for more information.

Future Sources of Liquidity

Available Support Facilities; Interim and Final Funding Settlement Agreements; APAC Agreement

NNL is a party to the EDC Support Facility, which provides for the issuance of support in the form of guarantee bonds or guarantee type documents issued to financial institutions that issue letters of credit or guarantee, performance or surety bonds, or other instruments in support of Nortel’s contract performance. We

 

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have established other cash collateralized facilities in certain jurisdictions including Canada and the U.S. to support our bonding needs. These other facilities can be used as an alternative to the EDC Support Facility. See “Executive Overview — Creditor Protection Proceedings — EDC Support Facility” for further information.

The Canadian Debtors and the U.S. Debtors are parties to the IFSA and the FCFSA. See “Executive Overview- Creditor Protection Proceedings — Interim and Final Funding and Settlement Agreement” for further information about the IFSA and FCFSA.

The Debtors are parties to the APAC Agreement. See “Executive Overview — Creditor Protection Proceedings — APAC Debt Restructuring Agreement” for further details.

Off-Balance Sheet Arrangements

Bid, Performance-Related and Other Bonds

During the normal course of business, we have provided bid, performance, warranty and other types of bonds, which we refer to collectively as bonds, via financial intermediaries to various customers in support of commercial contracts, typically for the supply of telecommunications equipment and services. If we fail to perform under the applicable contract, the customer may be able to draw upon all or a portion of the bond as a remedy for our failure to perform. An unwillingness or inability to issue bid and performance related bonds could have a material negative impact on our revenues and gross margin. The contracts that these bonds support generally have terms ranging from one to five years. Bid bonds generally have a term of less than twelve months, depending on the length of the bid period for the applicable contract. Performance-related and other bonds generally have a term consistent with the term of the underlying contract. Historically, we have not made material payments under these types of bonds and as a result of the Creditor Protection Proceedings we do not anticipate that we will be required to make any such payments during the pendency of the Creditor Protection Proceedings.

The following table provides information related to these types of bonds as of:

 

     September 30,
2010
     December 31,
2009
 

Bid and performance-related bonds (a)

   $ 25       $ 31   

Other bonds (b)

     2         19   
                 

Total bid, performance-related and other bonds

   $ 27       $ 50   
                 

 

(a) Net of restricted cash and cash equivalent amounts of $7 and $17 as of September 30, 2010 and December 31, 2009, respectively.
(b) Net of restricted cash and cash equivalent amounts of $17 and $16 as of September 30, 2010 and December 31, 2009, respectively.

 

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Application of Critical Accounting Policies and Estimates

Our accompanying unaudited condensed consolidated financial statements are based on the selection and application of U.S. GAAP, which require us to make significant estimates and assumptions. We believe that the following accounting policies and estimates may involve a higher degree of judgment and complexity in their application and represent our critical accounting policies and estimates: revenue recognition, provisions for doubtful accounts, provisions for inventory, income taxes and pension and post-retirement benefits.

In general, any changes in estimates or assumptions relating to revenue recognition, provisions for doubtful accounts, provisions for inventory and other contingencies (excluding legal contingencies) are directly reflected in the results of our reportable operating segments. Changes in estimates or assumptions pertaining to our tax asset valuations, our pension and post-retirement benefits and our legal contingencies are generally not reflected in our reportable operating segments, but are reflected on a consolidated basis.

We have discussed the application of these critical accounting policies and estimates with the audit committee of our board of directors.

Revenue Recognition

Our material revenue streams are the result of a wide range of activities, from custom design and installation over a period of time to a single delivery of equipment to a customer. Our networking solutions also cover a broad range of technologies and are offered on a global basis. As a result, our revenue recognition policies can differ depending on the level of customization and essential services within the solution and the contractual terms with the customer. Therefore, management must use significant judgment in determining how to apply the current accounting standards and interpretations, not only based on the overall solution, but also within solutions based on reviewing the level and types of services required and contractual terms with the customer. As a result, our revenues may fluctuate from period to period based on the mix of solutions sold and the geographic region in which they are sold.

We have regularly entered into multiple contractual agreements with the same customer. When a customer arrangement involves multiple deliverables where the deliverables are governed by more than one authoritative standard, we evaluate all deliverables to determine whether they represent separate units of accounting based on the following criteria:

 

   

whether the delivered item has value to the customer on a stand-alone basis;

 

   

whether there is objective and reliable evidence of the fair value of the undelivered item(s); and

 

   

if the contract includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and is substantially in our control.

Our determination of whether deliverables within a multiple element arrangement can be treated separately for revenue recognition purposes involves significant estimates and judgment, such as whether fair value can be established for undelivered obligations and/or whether delivered elements have stand-alone value to the customer. Changes to our assessment of the accounting units in an arrangement and/or our ability to establish fair values could significantly change the timing of revenue recognition. Our assessment of which authoritative standard is applicable to an element also can involve significant judgment.

If sufficient evidence of fair value cannot be established for an undelivered element, revenue and related cost for delivered elements are deferred until the earlier of when fair value is established or all remaining elements have been delivered. Once there is only one remaining element to be delivered within the unit of accounting, the deferred revenue and costs are recognized based on the revenue recognition guidance applicable to the last delivered element.

 

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Many of our products are integrated with software that is embedded in our hardware at delivery and where the software is essential to the functionality of the hardware. In those cases where indications are that software is more than incidental to the product, such as where the transaction includes software upgrades or enhancements, we apply software revenue recognition rules to determine the amount and timing of revenue recognition. The assessment of whether software is more than incidental to the hardware requires significant judgment and may have a significant impact on the timing of recognition of revenue and related costs.

For elements related to customized network solutions and certain network build-outs, revenues are recognized generally using the percentage-of-completion method. In using the percentage-of-completion method, revenues are generally recorded based on the percentage of costs incurred to date on a contract relative to the estimated total expected contract costs. Significant judgment is required when estimating total contract costs and progress to completion on the arrangements as well as whether a loss is expected to be incurred on the contract. Management uses historical experience, project plans and an assessment of the risks and uncertainties inherent in the arrangement to establish these estimates. Uncertainties include implementation delays or performance issues that may or may not be within our control. Changes in these estimates could result in a material impact on revenues and net earnings (loss). If we are unable to develop reasonably dependable cost or revenue estimates, the completed contract method is applied under which all revenues and related costs are deferred until the contract is completed.

Revenue for hardware that does not require significant customization, and where any software is considered incidental, is recognized provided that persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured.

For hardware, delivery is considered to have occurred upon shipment provided that risk of loss, and in certain jurisdictions, legal title, has been transferred to the customer.

For software arrangements involving multiple software and software-related elements, we allocate revenue using vendor specific objective evidence to determine fair value, which is based on prices charged when the element is sold separately. Software revenue is recognized when persuasive evidence of an arrangement exists, the software is delivered in accordance with all terms and conditions of the customer contracts, the fee is fixed or determinable and collectibility is probable. Revenue related to PCS, including technical support and unspecified when-and-if available software upgrades, is recognized ratably over the PCS term.

We make certain sales through multiple distribution channels, primarily resellers and distributors. These customers are generally given certain rights of return. Accruals for estimated sales returns and other allowances and deferrals are recorded as a reduction of revenue at the time of revenue recognition. These provisions are based on contract terms and prior claims experience and involve significant estimates. If these estimates are significantly different from actual results, our revenue could be impacted.

The collectibility of trade and notes receivables is also critical in determining whether revenue should be recognized. As part of the revenue recognition process, we determine whether trade or notes receivables are reasonably assured of collection and whether there has been deterioration in the credit quality of our customers that could result in our inability to collect the receivables. Our estimates and judgment regarding customer credit quality could significantly impact the timing and amount of revenue recognition.

The complexities of our contractual arrangements result in the deferral of revenue for a number of reasons. We have a significant deferred revenue balance relative to our consolidated revenue. Recognition of this deferred revenue over time can have a material impact on our consolidated revenue in any period and result in significant fluctuations.

The impact of the deferral of revenues on our liquidity is discussed in “Liquidity and Capital Resources —Operating Activities” above.

 

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The following table summarizes our deferred revenue balances:

 

    As of        
    September 30,
2010
    December 31,
2009
    $ Change     % Change  

Deferred revenue

  $ 13      $ 209      $ (196     (94

Advance billings

    8        76        (68     (89
                               

Total deferred revenue

  $ 21      $ 285      $ (264     (93
                               

Total deferred revenue decreased by $264 in the first nine months of 2010 as a result of reductions related to reclassifications to gain (loss) on divestitures of $245 and the net release of approximately $66, partially offset by $48 reclassified from held for sale related to contracts ultimately retained. The general trends related to our consolidated revenues also contributed to the decrease. See “Results of Operations — Continuing Operations.” The release of deferred revenue to revenue is net of additional deferrals recorded during the first nine months of 2010.

Provisions for Doubtful Accounts

In establishing the appropriate provisions for trade, notes and long-term receivables due from customers, we make assumptions with respect to their future collectibility. Our assumptions are based on an individual assessment of a customer’s credit quality as well as subjective factors and trends. Generally, these individual credit assessments occur prior to the inception of the credit exposure and at regular reviews during the life of the exposure and consider:

 

   

age of the receivables;

 

   

customer’s ability to meet and sustain its financial commitments;

 

   

customer’s current and projected financial condition;

 

   

collection experience with the customer;

 

   

historical bad debt experience with the customer;

 

   

the positive or negative effects of the current and projected industry outlook; and

 

   

the economy in general.

Once we consider all of these individual factors, an appropriate provision is then made, which takes into consideration the likelihood of loss and our ability to establish a reasonable estimate.

In addition to these individual assessments, a regional accounts past due provision is established for outstanding trade accounts receivable amounts based on a review of balances greater than nine months past due. A regional trend analysis, based on past and expected write-off activity, is performed on a regular basis to determine the likelihood of loss and establish a reasonable estimate.

The following table summarizes our accounts receivable and long-term receivable balances and related reserves:

 

    As of  
    September 30,
2010
    December 31,
2009
 

Gross accounts receivable

  $ 201      $ 641   

Provision for doubtful accounts

    (8     (16
               

Accounts receivable — net

  $ 193      $ 625   
               

Accounts receivable provision as a percentage of gross accounts receivable

    4     2

 

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Provisions for Inventories

Management must make estimates about the future customer demand for our products when establishing the appropriate provisions for inventories.

When making these estimates, we consider general economic conditions and growth prospects within our customers’ ultimate marketplace, and the market acceptance of our current and pending products. These judgments must be made in the context of our customers’ shifting technology needs and changes in the geographic mix of our customers. With respect to our provisioning policy, in general, we fully reserve for surplus inventory in excess of demand forecast or that we deem to be obsolete. Generally, our inventory provisions have an inverse relationship with the projected demand for our products. For example, our provisions usually increase as projected demand decreases due to adverse changes in the conditions mentioned above. We have experienced significant changes in required provisions in recent periods due to changes in strategic direction, such as discontinuances of product lines, as well as declining market conditions. A misinterpretation or misunderstanding of any of these conditions could result in inventory losses in excess of the provisions determined to be appropriate as of the balance sheet date.

Our inventory includes certain direct and incremental deferred costs associated with arrangements where title and risk of loss was transferred to customers but revenue was deferred due to other revenue recognition criteria not being met. We have not recorded excess and obsolete provisions against this type of inventory.

The following table summarizes our inventory balances and other related reserves:

 

    As of  
    September 30,
2010
    December 31,
2009
 

Gross inventory

  $ 98      $ 356   

Inventory provisions

    (69     (129
               

Inventories — net (a)

  $ 29      $ 227   
               

Inventory provisions as a percentage of gross inventory

    70     36

Inventory provisions as a percentage of gross inventory excluding deferred costs (b)

    78     61

 

(a) Includes the long-term portion of inventory related to deferred costs of nil and $44 as of September 30, 2010 and December 31, 2009, respectively, which is included in other assets.
(b) Calculated excluding deferred costs of $9 and $144 as of September 30, 2010 and December 31, 2009, respectively.

Inventory provisions decreased by $60 primarily as a result of $10 reclassified as held for sale, $52 of scrapped inventory, $44 transferred related to divestitures, $11 of previously reserved inventory that was subsequently sold (including $10 of consigned inventory), partially offset by $43 of additional inventory provisions, $11 related to the recognition of zero net value inventory previously excluded from the gross inventory provision and foreign exchange adjustments of $3. In the future, we may be required to make significant adjustments to these provisions for the sale and/or disposition of inventory that was provided for in prior periods.

Income Taxes

As of September 30, 2010, our net deferred tax asset was nil. As of December 31, 2009, our net deferred tax asset was $13. The reduction of $13 was primarily due to the sale of the LGN joint venture and the reversal of the deferred tax liability of $7 associated with NNL’s investment in LGN.

 

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Our deferred tax assets are mainly comprised of net operating loss carryforwards, capital loss carryforwards, tax credit carryforwards and deductible temporary differences, which are available to reduce future income taxes payable in our significant tax jurisdictions (namely Canada and the U.S.). The realization of our net deferred tax asset is dependent on the generation of future pre-tax income sufficient to realize the tax deductions and credits. In June 2009, we concluded that the sale of our remaining businesses was the best path forward. As described in note 2 to the accompanying unaudited condensed consolidated financial statements, we disposed of substantially all of our CDMA business and LTE Access assets to Ericsson, our Packet Core Assets to Hitachi, substantially all of the assets of our ES business to Avaya, substantially all of our assets of the Optical Networking and Carrier Ethernet businesses to Ciena, substantially all of our assets of our GSM/GSM-R business to Ericsson and Kapsch and substantially all of the assets of the CVAS business to GENBAND. We have entered into TSAs with the buyers of these businesses and are in the process of selling our remaining businesses and assets. Certain of these disposals have been considered positive evidence in the determination of future income available to support the realization of the remaining net deferred tax assets. However, due to Nortel’s history of losses, the uncertainty concerning the forecasted income for 2010 and beyond, the uncertainty concerning the estimated final proceeds allocation by jurisdiction and Nortel’s limited ability to control the ultimate closing of any remaining transactions, Nortel believes that it is still appropriate to maintain a full valuation allowance in all jurisdictions.

Transfer Pricing

Nortel had previously entered into Advanced Pricing Arrangements (APA) with the U.S. and Canadian taxation authorities in connection with its intercompany transfer pricing and cost sharing arrangements between Canada and the U.S. These arrangements expired in 1999 and 2000. In 2002, Nortel filed APA requests with the taxation authorities in the U.S., Canada and the U.K. that applied to the 2001 through 2005 taxation years (2001-2005 APA). In February 2010, Nortel and the U.S. and Canadian taxing authorities settled and executed the 2001-2005 APA resulting in a reallocation of losses from NNI to NNL in the amount of $2,000. The taxing authorities made no disclosure to Nortel of the basis upon which they agreed to such reallocation. Nortel continues to apply the transfer pricing methodology proposed in the 2001- 2005 APA requests to the other parties subject to the transfer pricing methodology in preparing its tax returns and its accounts for its 2001 to 2005 taxation years. The other parties are the U.K., France, Ireland and Australia.

The U.K. and Canadian tax authorities are also parties to negotiations with respect to the 2001-2005 APA. We are uncertain of the U.K.’s response to the agreement reached between the U.S. and Canadian tax authorities. Since the U.S. and Canadian tax authorities did not express a view on the proposed transfer pricing methodology, no adjustment has been made to the transfer pricing methodology that we submitted in our 2001-2005 APA application. It is also uncertain whether the Creditor Protection Proceedings will have any impact on the ultimate resolution of the U.K. and Canadian APA, and it is possible that the U.K. and Canadian tax authorities may advance negotiations regarding their 2001-2005 bilateral APA. Although the ultimate outcome of these negotiations is uncertain, there may be a further reallocation of historical losses from Canada to the U.K. This reallocation of losses is not expected to result in a material impact to Nortel’s consolidated tax expense. We continue to monitor the progress of the remaining APA negotiations and will analyze the existence of any new evidence, when available. We may make adjustments to the deferred tax and valuation allowance assessments, as appropriate, as additional evidence becomes available in future quarters.

Although we continue to apply the transfer pricing methodology that was requested in the previously withdrawn 2007-2010 APA to the 2006 through to the 2008 taxation years, the ultimate outcome is uncertain and the ultimate reallocation of losses cannot be determined at this time. Other than in the U.S., there could be a further material shift in historical earnings between the above mentioned parties. If these matters are resolved unfavorably, they could have a material effect on Nortel’s consolidated financial position, results of operations and/or cash flows.

 

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Tax Contingencies

The accounting estimates related to the liability for uncertain tax positions require us to make judgments regarding the sustainability of each uncertain tax position based on its technical merits. If we determine it is more likely than not a tax position will be sustained based on its technical merits, we record the impact of the position in our unaudited condensed consolidated financial statements at the largest amount that is greater than 50% likely of being realized upon ultimate settlement. These estimates are updated at each reporting date based on the facts, circumstance and information available. For purposes of intraperiod allocation, we include all changes in reserves relating to historical periods for uncertain tax positions in continuing operations. We are also required to assess at each reporting date whether it is reasonably possible that any significant increases or decreases to the unrecognized tax benefits will occur during the next twelve months. Our liability for uncertain tax positions was $19 as of September 30, 2010, of which $2 is included in liabilities subject to compromise.

Actual income tax expense, income tax assets and liabilities could vary from these estimates due to future changes in income tax laws, significant changes in the jurisdictions in which we operate, or unpredicted results from the final assessment of each year’s liability by various taxing authorities. These changes could have a significant impact on our financial position.

We are subject to ongoing examinations by certain taxation authorities of the jurisdictions in which we operate. We regularly assess the status of these examinations and the potential for adverse outcomes to determine the adequacy of our provision for income and other taxes. We believe that we have adequately provided for tax adjustments that we believe are more likely than not to be realized as a result of any ongoing or future examination.

As at September 30, 2010, we no longer consolidate the following entities and therefore, other than amounts accrued through guarantees, the tax uncertainty liabilities associated with these assessments are no longer accrued in our financial statements:

 

  (a) the tax authorities in Brazil have completed an examination of prior taxable years and have issued in the past assessments in the amount of $85 for the taxation years 1999 and 2000. We are currently in the process of appealing these assessments and in the past we have fully provided for the income tax liability in respect of these assessments.

 

  (b) the tax authorities in Colombia have issued an assessment relating to the 2003 tax year proposing adjustments to increase taxable income, resulting in an additional tax liability of $18 inclusive of interest and penalties. We had previously recorded an income tax liability of $18 to fully reserve against this assessment.

 

  (c) the tax authorities in France have issued notices of assessments against one of the Equity Investees in respect of the 2001, 2002 and 2003 taxation years. After adjusting these assessments to reflect the resolution of certain withholding tax issues, these assessments collectively propose adjustments to increase taxable income of approximately $1,130, additional income tax liabilities of $44, inclusive of interest, as well as certain adjustments to withholding and other taxes of approximately $16, exclusive of applicable interest and penalties subsequent to the assessment date. Other than the withholding and other taxes, we have sufficient loss carryforwards to offset the majority of the proposed assessment. However, no amount had been provided for these assessments since we believe that the proposed assessments are without merit, and any potential tax adjustments that could result from these ongoing examinations cannot be quantified at this time. In February 2010, we received a notice from the France tax authorities cancelling $80 of the assessments relating to the withholding tax amounts. We did not receive a similar assessment from the French tax authorities for the 2004 tax year. In 2006, we discussed settling the audit adjustment without prejudice at the field agent level for the purpose of accelerating the process to either the courts or Competent Authority proceedings under the Canada-France tax treaty. We withdrew from the discussions during the first quarter of 2007 and entered into Mutual Agreement Procedures with the competent authority under the Canada-France tax treaty to settle the dispute and avoid double taxation.

 

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Pension and Post-retirement Benefits

We maintain various retirement programs, one or more of which covers substantially all of our employees, which consist of defined benefit, defined contribution and investment plans. We maintain defined contribution programs available to substantially all of our North American employees. Additionally, we sponsor traditional defined benefit programs that are closed to new entrants. See below regarding the PBGC termination of the U.S. Retirement Income Plan on September 8, 2009. As discussed above, the administration of the Canadian Pension Plans transferred on September 30, 2010 to Morneau Sobeco Limited Partnership. Although these programs represent our major retirement programs, we also have smaller pension plan arrangements in other countries.

We also provide other benefits, including post-retirement benefits and post-employment benefits. Employees previously enrolled in the capital accumulation and retirement programs offering post-retirement benefits are eligible for company sponsored post-retirement health care and/or death benefits, depending on age and/or years of service. As discussed above, the Canadian post-retirement benefits will terminate on December 31, 2010.

These plans include significant pension and post-retirement benefit obligations that are calculated based on actuarial valuations. Key assumptions are made at the annual measurement date in determining these obligations and related expenses, including expected rates of return on plan assets and discount rates.

On July 17, 2009, the PBGC provided a notice to NNI that the PBGC had determined under the Employee Retirement Income Securities Act of 1974 (ERISA) that: (i) the Nortel Networks Retirement Income Plan (the Retirement Income Plan), a defined benefit pension plan sponsored by NNI, will be unable to pay benefits when due; (ii) under Section 4042(c) of ERISA, the Retirement Income Plan must be terminated in order to protect the interests of participants and to avoid any unreasonable increase in the liability of the PBGC insurance fund; and (iii) July 17, 2009 was to be established as the date of termination of the Retirement Income Plan. NNI worked to voluntarily assign trusteeship of the Retirement Income Plan to the PBGC and avoid further court involvement in the termination process.

On September 8, 2009, pursuant to an agreement between the PBGC and the Retirement Plan Committee, the Retirement Income Plan was terminated with a termination date of July 17, 2009, and the PBGC was appointed trustee of the plan. A settlement gain of $86 was recorded to earnings in the U.S. in the third quarter of 2009 in reorganization items.

The PBGC has filed a proof of claim against NNI and each of the Debtors in the Chapter 11 Proceedings for the unfunded benefit liabilities of the Nortel Networks Retirement Income Plan, a defined benefit pension plan sponsored by NNI, (U.S. Pension Plan) in the amount of $546. The PBGC has also filed unliquidated claims for contributions necessary to satisfy the minimum funding standards, a claim for insurance premiums, interest and penalties, and a claim for shortfall and amortization charges. Under ERISA, the PBGC may have the ability to impose certain claims and liens on NNI and certain NNI subsidiaries and affiliates (including liens on assets of certain Nortel entities not subject to the Creditor Protection Proceedings). We have recorded a liability of $334 representing our current best estimate of the expected allowed claim amount in accordance with ASC 852 in relation to these claims. To the extent that information available in the future indicates a difference from the recognized amounts, the provision will be adjusted.

As discussed above, the Canadian Debtors entered into the Settlement Agreement in relation to the Canadian registered pension plans, post-retirement benefits and post-employment benefits. See “Executive Overview — Creditor Protection Proceedings — Settlement Agreement with Former and Disabled Canadian Employee Representatives”. The Canadian Pension Plans were transferred to the replacement administrator, Morneau Sobeco Limited Partnership, on September 30, 2010. We remained as plan sponsor and, in our capacity as plan sponsor of the Canadian Pension Plans, amended the plans to cease future service accruals effective September 30, 2010. Benefit payments by us in the Canadian post-retirement benefit plan and the Canadian long-term disability plan will cease on December 31, 2010.

 

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As a result of the approved cessation of post-retirement benefit payments on December 31, 2010, we recorded the impacts of the Settlement Agreement in accordance with FASB ASC 715-60 “Defined Benefit Plans — Other Post Retirement” (ASC 715-60), which required a derecognition of the liability and deferred actuarial gains totaling $432 to earnings in reorganization items in the first quarter of 2010. For the nine months ended September 30, 2010, we have also recorded in earnings in reorganization items a charge of $429 representing our current best estimate of the expected allowed claim amount in accordance with ASC 852 in relation to the participant claims for future years benefits they will no longer receive due to the cessation of the plans. To the extent that information available in the future indicates a difference from the recognized amounts, the provision will be adjusted.

As a result of the amendments to cease future service accruals for the Canadian Pension Plans, we remeasured the Canadian Pension Plans using assumptions consistent with a wind-up basis of accounting as this is our best estimate of current assumptions and recorded the impacts of this remeasurement in the third quarter of 2010 in accordance with FASB ASC 715-30 “Defined Benefit Plans — Pension” (ASC 715-30). A curtailment loss of $490 was recorded to the statement of operations in reorganization items in the third quarter of 2010. As a result of this remeasurement, we changed our pension discount rate, a key assumption used in estimating pension benefit costs, for the Canadian Pension Plans. This resulted in a change in the weighted average pension discount rate to 4.6% from 5.8% at December 31, 2009. In addition, as a result of the remeasurement, we were required to adjust the liability for impacts from the curtailment loss and changes in assumptions at the re-measurement date. The effect of these adjustments and the related foreign currency translation adjustment was to increase pension liabilities by $579 and accumulated other comprehensive loss (before tax) by $89.

In March 2010, the President of the United States signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act and the Health Care Education and Affordability Reconciliation Act (the Acts). The Acts contain provisions that could impact our accounting for retiree medical benefits in future periods. However, the ultimate extent of that impact, if any, on us cannot be determined until final regulations are promulgated under the Acts and additional interpretations of the Acts become available. We will continue to assess the accounting implications of the Acts as related regulations and interpretations of the Acts become available. Based on the analysis to date of the provisions in the Acts for which the impacts are reasonably determinable, a re-measurement of our post-retirement benefit plan liabilities is not required at this time.

Significant changes in net periodic pension and post-retirement benefit expense may occur in the future due to changes in our key assumptions including expected rate of return on plan assets and discount rate resulting from economic events. In developing these assumptions, we evaluated, among other things, input from our actuaries and matched the plans’ expected benefit payments to spot rates of high quality corporate bond yield curves.

For 2010, our expected rate of return on plan assets was 7.0% for defined benefit pension plans. Also for 2010, our discount rate on a weighted-average basis for pension expenses decreased from 7.1% to 5.8% for the defined benefit pension plans and remained unchanged from 2009 for post-retirement benefit plans at 6.0%, prior to the remeasurement discussed below. We will continue to evaluate our discount rates at least annually and make adjustments as necessary, which could change the pension and post-retirement obligations and expenses in the future. For a sensitivity analysis of changes in these assumptions, please refer to our 2009 Annual Report —Management’s Discussion and Analysis of Financial Condition and Results of Operations — Application of Critical Accounting Policies and Estimates — Pension and Post-retirement Benefits.

At December 31, 2009, we had net actuarial losses, before taxes, included in accumulated other comprehensive income/loss related to the defined benefit plans of $1,826, of which $1,169 related to the Equity Investees. These actuarial losses could result in an increase to pension expense in future years depending on several factors, including whether such losses exceed the corridor in accordance with ASC 715-30, whether there is a change in the amortization period, and whether a plan is terminated or settled. The post-retirement benefit

 

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plans had actuarial gains, before taxes, of $77 included in accumulated other comprehensive loss at the end of 2009. Actuarial gains and losses included in accumulated other comprehensive loss in excess of the corridor are being recognized over an approximately 10 year period, which represents the weighted-average expected remaining service life of the active employee group. Actuarial gains and losses arise from several factors including experience and assumption changes in the obligations and from the difference between expected returns and actual returns on assets. During the second quarter, as a result of the EMEA Subsidiaries, as well as those entities the EMEA Subsidiaries control, being accounted for under the cost method of accounting as of May 31, 2010, accumulated other comprehensive income/loss was reduced by $967, the EMEA Subsidiaries, as well as those entities the EMEA Subsidiaries control, accumulated other comprehensive income/loss balance as at May 31, 2010.

As a result of workforce reductions in connection with the Creditor Protection Proceedings and the divestiture activities, we remeasured the post-retirement benefit obligations for the U.S. and Canada and recorded the impacts of these remeasurements in the first quarter of 2010 in accordance with ASC 715-60. Curtailment gains of $6 and $7 were recorded to the statement of operations in the U.S. and Canada, respectively. As a result of these remeasurements, we changed our post-retirement discount rate, a key assumption used in estimating post-retirement benefit costs, for the U.S. and Canada. This resulted in a change in the weighted average post-retirement discount rate to 5.9% from 6.0% at December 31, 2009. In addition, as a result of the remeasurements, we were required to adjust the liability for impacts from the curtailment gain and changes in assumptions at the re-measurement date. For the U.S, the effect of these adjustments was to decrease post-retirement liabilities by $3 and accumulated other comprehensive loss (before tax) by $3. For Canada, the effect of this adjustment and the related foreign currency translation adjustment was to increase post-retirement liabilities by $15 and accumulated other comprehensive loss (before tax) by $18.

As a result of additional workforce reductions in connection with the Creditor Protection Proceedings and the divestiture activities, we remeasured the post-retirement benefit obligation for the U.S. and recorded the impacts of this remeasurement in the second quarter of 2010 in accordance with ASC 715-60. A curtailment gain of $4 was recorded to the statement of operations in the U.S. in the second quarter of 2010. As a result of this remeasurement, we changed our post-retirement discount rate, a key assumption used in estimating post-retirement benefit costs, for the U.S. This resulted in a change in the weighted average post-retirement discount rate to 5.4% from 5.9% at March 31, 2010. In addition, as a result of the remeasurement, we were required to adjust the liability for impacts from the curtailment gain and changes in assumptions at the re-measurement date. The effect of these adjustments was to increase post-retirement liabilities by $5 and accumulated other comprehensive loss (before tax) by $9.

As a result of additional workforce reductions in connection with the Creditor Protection Proceedings, we remeasured the post-retirement benefit obligation for the U.S. and recorded the impacts of this remeasurement in the third quarter of 2010 in accordance with ASC 715-60. A curtailment gain of $0.4 was recorded to the statement of operations in the U.S. in the third quarter of 2010. As a result of this remeasurement, we changed our post-retirement discount rate, a key assumption used in estimating post-retirement benefit costs, for the U.S. This resulted in a change in the weighted average post-retirement discount rate to 5.1% from 5.4% at June 30, 2010. In addition, as a result of the remeasurement, we were required to adjust the liability for impacts from the curtailment gain and changes in assumptions at the re-measurement date. The effect of these adjustments was to increase post-retirement liabilities by $6 and accumulated other comprehensive loss (before tax) by $6.

Assuming current funding rules and current plan design, estimated 2010 cash contributions to our defined benefit pension plans and our post-retirement benefit plans are approximately $27 and $39, respectively. Our 2010 cash contributions to these plans are significantly impacted as a result of the Creditor Protection Proceedings.

 

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UK Pension Guarantee

On January 14, 2009, as a result of the U.K. Administration Proceedings, the U.K. defined benefit pension plan entered the Pension Protection Fund (PPF) assessment process and all further service cost accruals and contributions ceased. Employees who were currently enrolled in our U.K. defined benefit pension plan were given the option of participating in the U.K. defined contribution scheme. As a result of these changes, NNUK remeasured its pension obligations related to its U.K. defined benefit pension plan on January 14, 2009, and recorded the impacts of this remeasurement in the first quarter of 2009 in accordance with ASC 715-30. The ceasing of service cost accruals and changes to key assumptions as a result of the remeasurement resulted in a curtailment gain of approximately $22. In addition, as a result of the remeasurement, NNUK was required to adjust the liability for impacts from the curtailment gain, changes in assumptions, and asset losses at the remeasurement date. The effect of this adjustment and the related foreign currency translation adjustment was to increase pension liabilities and accumulated other comprehensive loss (before tax) by $107. This adjustment had no statement of operations impact.

The PPF assessment process can take up to two years, or longer, and will result in the PPF deciding whether it needs to take on the U.K. defined benefit pension plan or whether there are sufficient assets to secure equivalent or greater than PPF benefits through a “buy out” with an insurance company. If the PPF decides it needs to take on the U.K. defined benefit pension plan, the expected claim amount will be significantly more than the carrying amount of the liability.

According to various claims filed by the trustee of the U.K. defined benefit pension plan and the PPF against certain Debtors, the U.K. defined benefit pension plan has a purported deficit estimated (on a buy-out basis) of £2,100 or $3,300 as at January 2009. In January 2010, The Pensions Regulator, purporting to act under The Pensions Act 2004 (U.K.) (U.K. Statute), issued a “warning notice” (Warning Notice) to certain Nortel entities, including, among others, the Canadian Debtors and the U.S. Debtors. The Pensions Regulator is a statutory agency charged with responsibility for regulating the operations and administration of occupational pension schemes in the U.K., such as the U.K. defined benefit pension plan. The Warning Notice is the first step in a process set forth under the U.K. Statute to enable The Pensions Regulator to issue a financial support direction (FSD) under the U.K. Statute directing affiliates of NNUK to provide financial support to eliminate the purported deficit. In the Warning Notice, The Pensions Regulator identifies certain Nortel entities, including, among others, NNC, NNL, NNI and NNCI as targets of a procedure before the determination panel of The Pensions Regulator to determine whether to issue a FSD (U.K. Pension Proceeding). On February 26, 2010, the Canadian Debtors obtained an order of the Canadian Court, which included, among other things, (i) a declaration that the purported commencement of proceedings and exercise of rights by The Pensions Regulator breaches the Initial Order; and (ii) a declaration that any result obtained in the U.K. in breach of the stay under the CCAA Proceedings would not be recognized in the Canadian claims process. Also on February 26, 2010, the U.S. Debtors obtained an order of the U.S. Court enforcing the automatic stay under the U.S. Bankruptcy Code against the trustee of the U.K. defined benefit pension plan and the PPF, which is fully applicable to the trustee and PPF’s participation against the U.S. Debtors in the U.K. Pension Proceeding. In addition, the order of the U.S. Court provides that with respect to the U.S. Debtors, such proceedings are deemed void and without force or effect. The Pensions Regulator appealed the decision of the Canadian Court, which appeal was heard and dismissed on June 16, 2010, by the Ontario Court of Appeal. In addition, the trustee of the U.K. defined benefit pension plan has brought a motion before the Canadian Court to have the stay lifted, to allow the U.K. Pension Proceeding to go forward as a “permitted proceeding”, which motion was initially set for hearing on May 31, 2010 but was subsequently adjourned without date on the consent of all interested parties. The trustee of the U.K. defined benefit pension plan and the PPF have also appealed the decision of the U.S. Court enforcing the stay, and this appeal is currently pending. On August 5, 2010, a U.S. Magistrate Judge issued a report and recommendation that the order of the U.S. Court be affirmed. Notwithstanding the orders of the Canadian Court and the U.S. Court and the dismissal of The Pension Regulator’s appeal by the Ontario Court of Appeal, the FSD proceedings commenced in the U.K. on June 2, 2010, and on June 25, 2010, the determinations panel of The Pension Regulator issued a determinations notice indicating that a FSD would be issued against certain Debtors

 

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including, among others, NNC, NNL, NNI and NNCI. On July 23, 2010, certain Nortel entities filed an appeal of the determinations notice with the U.K. appeal tribunal. As a result, as of the date hereof, no FSD has been issued. We are of the view that the determinations notice and any FSD are null and void given the court decisions noted above.

Pursuant to an intercompany guarantee agreement relating to the U.K. defined benefit pension plan, NNL has indemnified the U.K. pension trust for any amounts due that NNUK does not pay under a Funding Agreement executed on November 21, 2006. Pursuant to a further intercompany guarantee agreement NNL has indemnified the trustees of the U.K. defined benefit pension plan on the insolvency of NNUK and consequent windup of such plan. We have recorded a liability of $681 representing our current best estimate of the expected allowed claim amount in accordance with ASC 852 in relation to these claims. To the extent that information available in the future indicates a difference from the recognized amounts, the provision will be adjusted. See note 14 to the accompanying unaudited condensed consolidated financial statements.

Accounting Changes and Recent Accounting Pronouncements

Accounting Changes

Our financial statements are based on the selection and application of accounting policies based on accounting principles generally accepted in the U.S. Please see note 3 to the accompanying unaudited condensed consolidated financial statements for a summary of the accounting changes that we have adopted on or after January 1, 2010.

Recent Accounting Pronouncements

For detailed information regarding recent accounting pronouncements and the impact thereof on our financial statements, see note 1 to the accompanying unaudited condensed consolidated financial statements.

Outstanding Share Data

As of November 8, 2010, we had 498,206,366 NNC common shares outstanding.

Environmental Matters

We are exposed to liabilities and compliance costs arising from our past generation, management and disposal of hazardous substances and wastes. As of September 30, 2010, the accruals on the consolidated balance sheet for environmental matters were $9. Based on information available as of September 30, 2010, management believes that the existing accruals are sufficient to satisfy probable and reasonably estimable environmental liabilities related to known environmental matters. Any additional liabilities that may result from these matters, and any additional liabilities that may result in connection with other locations currently under investigation, are not expected to have a material adverse effect on our business, results of operations, financial condition and liquidity.

We have remedial activities underway at six sites that are either currently or previously owned. An estimate of our anticipated remediation costs associated with all such sites, to the extent probable and reasonably estimable, is included in the environmental accruals referred to above in an approximate amount of $9. At one additional site, an agreement has been reached to settle obligations through the claim process. The amount is not material.

We are also listed as a potentially responsible party under the U.S. Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, at two Superfund sites in the U.S. Agreements have been reached to settle these obligations via the claims process. The amount is not material.

 

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For a discussion of environmental matters, see note 23, to the accompanying unaudited condensed consolidated financial statements.

Legal Proceedings

For a discussion of our legal proceedings, see the Legal Proceedings section of this report.

Cautionary Notice Regarding Forward-Looking Information

Certain statements in this report may contain words such as “could”, “expect”, “may”, “should”, “will”, “anticipate”, “believe”, “intend”, “estimate”, “target”, “plan”, “envision”, “seek” and other similar language and are considered forward-looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections about the operating environment, economies and markets in which we operate. These statements are subject to important assumptions, risks and uncertainties that are difficult to predict, and the actual outcome may be materially different. Our assumptions, although considered reasonable by us at the date of this report, may prove to be inaccurate and consequently our actual results could differ materially from the expectations set out herein.

Actual results or events could differ materially from those contemplated in forward-looking statements as a result of the following: (i) risks and uncertainties relating to the Creditor Protection Proceedings including: (a) risks associated with our ability to: stabilize the business and maximize the value of our businesses; obtain required approvals and successfully consummate pending and future divestitures; ability to satisfy transition services agreement obligations in connection with the divestiture of operations; successfully conclude ongoing discussions for the sale of our other assets or businesses; develop, obtain required approvals for, and implement a court-approved plan; resolve ongoing issues with creditors and other third parties whose interests may differ from ours; generate cash from operations and maintain adequate cash on hand in each of our jurisdictions to fund operations within the jurisdiction during the Creditor Protection Proceedings; arrange for alternative funding; if necessary, arrange for sufficient debtor-in-possession or other financing; continue to have cash management arrangements and obtain any further required approvals from the Canadian Monitor, the U.K. Administrators, the French Administrator, the French Liquidator, the Israeli Administrators, the U.S. Creditors’ Committee, or other third parties; raise capital to satisfy claims, including our ability to sell assets to satisfy claims against us; maintain R&D investments; realize full or fair value for any assets or business that are divested; utilize net operating loss carryforwards and certain other tax attributes in the future; avoid the substantive consolidation of NNI’s assets and liabilities with those of one or more other U.S. Debtors; operate our business effectively under the new organizational structure, and in consultation with the Canadian Monitor, the U.S. Creditors’ Committee and the U.S. principal officer, and work effectively with the U.K. Administrators, French Administrator, French Liquidator and Israeli Administrators in their respective administration of the EMEA businesses subject to the Creditor Protection Proceedings; continue as a going concern; actively and adequately communicate on and respond to events, media and rumors associated with the Creditor Protection Proceedings that could adversely affect our relationships with customers, suppliers, partners and employees; retain and incentivize key employees; retain, or if necessary, replace major suppliers on acceptable terms and avoid disruptions in our supply chain; maintain current relationships with reseller partners, joint venture partners and strategic alliance partners; obtain court orders or approvals with respect to motions filed from time to time; resolve claims made against us in connection with the Creditor Protection Proceedings for amounts not exceeding our recorded liabilities subject to compromise; prevent third parties from obtaining court orders or approvals that are contrary to our interests; reject, repudiate or terminate contracts; and (b) risks and uncertainties associated with: limitations on actions against any Debtor during the Creditor Protection Proceedings; the values, if any, that will be ascribed pursuant to any court-approved plan to outstanding Nortel securities and, in particular, that we do not expect that any value will be prescribed to the NNC common shares or the NNL preferred shares in any such plan; the delisting of NNC common shares from the NYSE; and the delisting of NNC common shares and NNL preferred shares from the TSX; and (ii) risks and uncertainties relating to our business including: the sustained economic downturn and volatile market conditions and resulting negative impact on our business, results of operations and

 

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financial position and its ability to accurately forecast its results and cash position; cautious capital spending by customers as a result of factors including current economic uncertainties; fluctuations in foreign currency exchange rates; any requirement to make larger contributions to defined benefit plans in the future; a high level of debt, arduous or restrictive terms and conditions related to accessing certain sources of funding; the sufficiency of workforce and cost reduction initiatives; any negative developments associated with our suppliers and contract manufacturers including our reliance on certain suppliers for key optical networking solutions components and on one supplier for most of its manufacturing and design functions; potential penalties, damages or cancelled customer contracts from failure to meet contractual obligations including delivery and installation deadlines and any defects or errors in our products; significant competition, competitive pricing practices, industry consolidation, rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles, and other trends and industry characteristics affecting the telecommunications industry; a failure to protect our intellectual property rights; any adverse legal judgments, fines, penalties or settlements related to any significant pending or future litigation actions; failure to maintain integrity of our information systems; and changes in regulation of the Internet or other regulatory changes.

For additional information with respect to certain of these and other factors, see the “Risk Factors” section of the 2009 Annual Report. Unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 4. Controls and Procedures

Capitalized terms used in this Item 4 of Part I and not otherwise defined, have the meaning set forth for such terms in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this report.

Management Conclusions Concerning Disclosure Controls and Procedures

We carried out an evaluation under the supervision and with the participation of management, including the Chief Financial Officer (CFO) John M. Doolittle, pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (Exchange Act), of the effectiveness of our disclosure controls and procedures as at September 30, 2010. Based on this evaluation, management, including the CFO, have concluded that our disclosure controls and procedures as at September 30, 2010 were effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required and that it is accumulated and communicated to our management, including the CFO, as appropriate, to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) under the Exchange Act. Our internal control over financial reporting is intended to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that:

 

   

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

 

   

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and the Board of Directors; and

 

   

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Changes in Internal Control Over Financial Reporting

On January 14, 2009, we commenced the Creditor Protection Proceedings and adopted ASC 852. In connection with these events, during the first quarter of 2009, we introduced processes to: (1) determine the Debtors’ pre- and post-petition liabilities and identify those liabilities subject to compromise; (2) assess certain claims received from creditors; and (3) determine the proper accounting treatment required for contracts, liabilities and operating expenses, including restructuring activities and reorganization expenses during the pendency of the Creditor Protection Proceedings. Complexities exist in introducing such processes given the multiple-jurisdiction element of our Creditor Protection Proceedings. During the first nine months of 2010, we completed several business divestitures and streamlined our business infrastructure and implement processes to separate and track financial performance in connection with our transition services obligations associated with these divestitures. These changes continued to materially affect our internal control over financial reporting during the third quarter of 2010 or are reasonably likely to continue to materially affect our internal control over financial reporting. Additional process changes may be necessary in the future. Management continues to take actions necessary to address the resources, processes and controls related to these changes, while maintaining effective control over financial reporting.

 

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PART II

OTHER INFORMATION

Capitalized terms used in this Part II and not otherwise defined, have the meaning set forth for such terms in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this report.

 

ITEM 1. Legal Proceedings

There have been no material developments in our material legal proceedings as previously reported in our 2009 Annual Report, First Quarter 2010 Quarterly Report on Form 10-Q and Second Quarter 2010 Quarterly Report on Form 10-Q. For additional discussion of other material legal proceedings, see “Contingencies” in note 23 of the accompanying unaudited condensed consolidated financial statements.

 

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ITEM 1A. Risk Factors

Certain statements in this report may contain words such as “could”, “expect”, “may”, “should”, “will”, “anticipate”, “believe”, “intend”, “estimate”, “target”, “plan”, “envision”, “seek” and other similar language and are considered forward-looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections. In addition, other written or oral statements that are considered forward-looking may be made by us or others on our behalf. These statements are subject to important assumptions, risks and uncertainties that are difficult to predict and actual outcomes may be materially different. The Creditor Protection Proceedings are having a direct impact on our business and are exacerbating these risks and uncertainties. In particular, the risks described herein and in our 2009 Annual Report could cause actual events to differ materially from those contemplated in forward-looking statements. Unless otherwise required by applicable securities laws, we do not have any intention or obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the “Risk Factors” section in our 2009 Annual Report which could materially affect our business, results of operations, financial condition or liquidity. The risks described in our 2009 Annual Report are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial also may materially adversely affect our business, results of operations, financial condition and liquidity. The risks described in our 2009 Annual Report have not materially changed.

 

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ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

Global Class Action Settlement: We entered into agreements to settle two significant U.S. and all but one Canadian class action lawsuits, collectively the Global Class Action Settlement, which became effective on March 20, 2007 following approval of the agreements by the appropriate courts. In accordance with the terms of the Global Class Action Settlement, a total of 62,866,775 NNC common shares were to be issued. During the three-month period ended September 30, 2010, no NNC common shares were issued in accordance with the settlement. Almost all of the NNC common shares issuable in accordance with the settlement have been distributed to claimants and plaintiffs’ counsel, most of them in the second quarter of 2008. The issuance of the 62,866,775 NNC common shares is exempt from registration pursuant to Section 3(a)(10) of the Securities Act.

 

ITEM 6. Exhibits

Pursuant to the rules and regulations of the SEC, we have filed certain agreements as exhibits to this Quarterly Report on Form 10-Q. These agreements may contain representations and warranties by the parties. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in our public disclosure, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe our actual state of affairs at the date hereof and should not be relied upon.

 

Exhibit

No.

  

Description

10.1*    Share Purchase Agreement by and between Nortel Networks Limited and Telefonaktiebolaget LM Ericsson (PUBL) Relating to Shares of Capital Stock of LG-NORTEL Co. LTD. dated April 21, 2010 (Filed as Exhibit 99.1 to Nortel Networks Corporation’s Current Report on Form 8-K dated July 6, 2010)
10.2    Asset Sale Agreement by and among Nortel Networks Corporation (NNC), Nortel Networks Limited, Nortel Networks Inc. and certain other subsidiaries of NNC as Sellers and PSP Holding LLC dated August 26, 2010
10.3    Asset Sale Agreement by and among Nortel Networks Corporation (NNC), Nortel Networks Limited, Nortel Networks Inc. and certain other subsidiaries of NNC as Sellers and Telefonaktiebolget LM Ericsson (PUBL) dated September 24, 2010
31    Certification of the Senior Vice President, Corporate Services and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32    Certification of the Senior Vice President, Corporate Services and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

* Incorporated by reference.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

NORTEL NETWORKS CORPORATION

(Registrant)

 

Chief Financial Officer     Chief Accounting Officer
/S/    JOHN M. DOOLITTLE     /S/    CLARKE GLASPELL

John M. Doolittle

Senior Vice-President, Corporate Services and

Chief Financial Officer

   

Clarke Glaspell

Controller

Date: November 12, 2010

 

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