10-K 1 d10k.htm FORM 10-K Form 10-K
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

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

For the fiscal year ended December 31, 2008

 

¨ 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 000-30758

Nortel Networks Limited

(Exact name of registrant as specified in its charter)

 

Canada   62-12-62580
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
195 The West Mall,
Toronto, Ontario, Canada
  M9C 5K1
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number including area code: (905) 863-7000

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

None   None

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  ¨    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes  ¨    No  þ

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 filing requirements for the past 90 days.

Yes  þ    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨


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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. (Check one)

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  þ

On February 20, 2009, 1,460,978,638 common shares of Nortel Networks Limited were issued and outstanding, all of which are held by Nortel Networks Corporation. The common shares of the registrant are not traded on any stock exchange.

 

 

 


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TABLE OF CONTENTS

 

PART I   

ITEM 1.

   Business    1
   Overview    1
   Creditor Protection Proceedings    1
   Business Segments    6
   Sales and Distribution    12
   Backlog    12
   Product Standards, Certifications and Regulations    12
   Sources and Availability of Materials    13
   Seasonality    13
   Acquisitions and Divestitures    13
   Research and Development    14
   Intellectual Property    15
   Employee Relations    15
   Environmental Matters    16
   Financial Information about Segments and Product Categories    16
   Financial Information by Geographic Area    16
   Working Capital    16
   Glossary of Certain Technical Terms    17

ITEM 1A.

   Risk Factors    19

ITEM 1B.

   Unresolved Staff Comments    32

ITEM 2.

   Properties    32

ITEM 3.

   Legal Proceedings    33

ITEM 4.

   Submission of Matters to a Vote of Security Holders    36
PART II   

ITEM 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    36

ITEM 6.

   Selected Financial Data (Unaudited)    37

ITEM 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    38
   Executive Overview    38
   Results of Operations    51
   Segment Information    62
   Liquidity and Capital Resources    70
   Off-Balance Sheet Arrangements    79
   Application of Critical Accounting Policies and Estimates    79
   Accounting Changes and Recent Accounting Pronouncements    96
   Outstanding Share Data    99
   Market Risk    99
   Environmental Matters    99
   Legal Proceedings    99
   Cautionary Notice Regarding Forward-Looking Information    99

ITEM 7A.

   Quantitative and Qualitative Disclosures About Market Risk    102
   Termination of Derivative Hedging Instruments    102
   Foreign Currency Exchange Risk    102
   Interest Rate Risk    103
   Equity Price Risk    103

ITEM 8.

   Financial Statements and Supplementary Data    104

ITEM 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    199

ITEM 9A.

   Controls and Procedures    199
   Management Conclusions Concerning Disclosure Controls and Procedures    199
   Management’s Report on Internal Control Over Financial Reporting    199
   Changes in Internal Control Over Financial Reporting    199

ITEM 9B.

   Other Information    200
PART III   

ITEM 10.

   Directors, Executive Officers and Corporate Governance    201

 

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ITEM 11.

   Executive and Director Compensation    217

ITEM 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    258

ITEM 13.

   Certain Relationships and Related Transactions, and Board Independence    268

ITEM 14.

   Principal Accountant Fees and Services    268
PART IV   

ITEM 15.

   Exhibits and Financial Statement Schedules    270

SIGNATURES

   280

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

NORTEL, NORTEL (Logo), NORTEL NETWORKS, the GLOBEMARK, NT, AGILE COMMUNICATIONS ENVIRONMENT, NORTEL GOVERNMENT SOLUTIONS and WEB.ALIVE are trademarks of Nortel Networks.

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

NYSE is a trademark of the New York Stock Exchange, Inc.

S&P and STANDARD & POOR’S are trademarks of The McGraw-Hill Companies, Inc.

All other trademarks are the property of their respective owners.

 

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PART I

 

ITEM 1.

Business

Overview

Nortel supplies end-to-end networking products and solutions that help organizations enhance and simplify communications. These organizations range from small businesses to multi-national corporations involved in all aspects of commercial and industrial activity, to federal, state and local government agencies and the military. They include cable operators, wireline and wireless telecommunications service providers, and Internet service providers.

Our networking solutions include hardware and software products and services designed to reduce complexity, improve efficiency, increase productivity and drive customer value. We design, develop, engineer, market, sell, supply, license, install, service and support these networking solutions worldwide. We have technology expertise across carrier and enterprise, wireless and wireline, applications and infrastructure. We have made investments in technology research and development (R&D), and have had strong customer loyalty earned over more than 100 years of providing reliable technology and services.

The Company has its principal executive offices at 195 The West Mall, Toronto, Ontario, Canada M9C 5K1, (905) 863-7000. The Company is the principal operating subsidiary of Nortel Networks Corporation (NNC). The Company was incorporated in Canada as the Northern Electric Company, Limited on January 15, 1914, as a successor to the business of Northern Electric and Manufacturing Company, Limited, a subsidiary of Bell Canada incorporated in 1885.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports are available free of charge under “Investor Relations” at www.nortel.com (our website), as soon as reasonably practicable after providing them to the United States (U.S.) Securities and Exchange Commission (SEC). Our Code of Business Conduct is also available on our website, and any future amendments to it will be posted there. Any waiver of a requirement of our Code of Business Conduct, if granted by the boards of directors of the Company and NNC or their audit committees, will be posted on our website as required by law. Information contained on our website is not incorporated by reference into this or any such reports. The public may read and copy these reports at the SEC’s Public Reference Room at 100 F Street NE, Washington, DC 20549 (1-800-SEC-0330). Also, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding certain issuers including the Company and NNC, at www.sec.gov. The Company is not a foreign private issuer, as defined in Rule 3b-4 under the U.S. Securities Exchange Act of 1934 as amended (Exchange Act).

All dollar amounts in this report are in millions of U.S. Dollars, except for Part III hereof, and except as otherwise stated.

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

Many of the technical terms used in this report are defined in the Glossary of Certain Technical Terms beginning at page 17.

Creditor Protection Proceedings

We operate in a highly volatile telecommunications industry that is characterized by vigorous competition for market share and rapid technological development. In recent years, our operating costs have generally exceeded our revenues, resulting in negative cash flow. A number of factors have 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.

In recent years, we have taken a wide range of steps to attempt to address these issues, including a series of restructurings that have 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. In particular, in 2005, under the direction of new management, we began to develop a Business Transformation Plan with the goal of addressing our most significant operational challenges, simplifying organizational structure, and maintaining a strong focus on revenue generation and improved operating margins including quality improvements and cost reductions. These actions have included: (i) the outsourcing of nearly all manufacturing and production to a number of key suppliers,

 

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including, in particular, Flextronics Telecom Systems, Ltd. (Flextronics), (ii) the substantial consolidation of key R&D expertise in Canada and China, (iii) decisions to dispose of or exit certain non-core businesses, such as our UMTS Access business unit, (iv) the creation and/or expansion of joint venture relationships (such as LG-Nortel in Korea and our joint venture in China, Guangdong-Nortel Telecommunications Equipment Company Ltd. of China), (v) establishing alliances with various large organizations such as Microsoft, IBM and Dell, (vi) real estate optimizations, including the sale of our former headquarters in Brampton, Ontario, Canada, and (vii) the continued reorientation of our business from a traditional supplier of telecommunications equipment to a focus on cutting edge networking hardware and software solutions.

These restructuring measures, however, have not provided adequate relief from the significant pressures we are 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 potentially prolonged recessionary period have compounded the situation.

In addition, we have made significant cash payments related to our restructuring programs, the Global Class Action Settlement (as defined in Item 3), 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 has 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 put 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 recent 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.

After extensive consideration of all other alternatives, we determined, with the unanimous authorization of our Board of Directors after thorough consultation with our advisors, that a comprehensive financial and business restructuring could be most effectively and quickly achieved within the framework of creditor protection proceedings in multiple jurisdictions. As a consequence, on January 14, 2009 (Petition Date), we initiated creditor protection under the respective restructuring regimes of Canada under the Companies’ Creditors Arrangement Act (CCAA) (CCAA Proceedings), in the U.S. under the Bankruptcy Code (Chapter 11 Proceedings), the United Kingdom (U.K.) under the Insolvency Act 1986 (U.K. Administration Proceedings), and subsequently,Israel (Israeli Proceedings). Our affiliates in Asia including LG-Nortel, in the Caribbean and Latin American (CALA) region, and the Nortel Government Solutions (NGS) business, are not included in these proceedings.

We initiated the Creditor Protection Proceedings (as defined below) with a consolidated cash balance, as at December 31, 2008, of $2,400, in order to preserve our liquidity and fund operations during the restructuring process. The Creditor Protection Proceedings will allow us to reassess our business strategy with a view to developing a comprehensive financial and business restructuring plan (comprehensive restructuring plan) (also referred to as a “plan of reorganization” in the U.S., or a “plan of compromise or arrangement” in Canada).

“Debtors” as used herein means (i) us, together with NNC 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) and certain other U.S. subsidiaries (U.S. Debtors) that filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware (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 English High Court of Justice (English Court), and (iv) certain Israeli subsidiaries that made consequential filings under the Israeli Companies Law 1999 in the District Court of Tel Aviv. The CCAA Proceedings, Chapter 11 Proceedings, U.K. Administration Proceedings and the Israeli Proceedings are together referred to as the Creditor Protection Proceedings.

Pursuant to the order of the Canadian Court, Ernst & Young Inc. was named as the court-appointed monitor (Canadian Monitor) under the CCAA Proceedings. As required under the U.S. Bankruptcy Code, the United States Trustee for the District of Delaware (U.S. Trustee) appointed an official committee of unsecured creditors on January 22, 2009 (U.S. Creditors’ Committee). In addition, a group purporting to hold substantial amounts of our publicly traded debt has organized (the Bondholder

 

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Group). The role of the Bondholder Group in the Chapter 11 Proceedings and the CCAA Proceedings has not yet been formalized and may develop and change over the course of such proceedings. Pursuant to the terms of the orders of the English Court, 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 our EMEA Debtor in Ireland, and representatives of Ernst & Young LLP were appointed as joint administrators for the other EMEA Debtors (collectively, U.K. Administrators).

For further information on the Creditor Protection Proceedings, see “Executive Overview - Creditor Protection Proceedings” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of this report.

Business Operations

During the Creditor Protection Proceedings, the businesses of the Debtors continue to operate under the jurisdictions and orders of the applicable courts and in accordance with applicable legislation. 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 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 decide whether an EMEA Debtor should perform under a contract on the basis of whether it is in the interests of the administration to do so. Any claims which result from an EMEA Debtor rejecting or repudiating any contract or arrangement will usually be unsecured. The accompanying audited consolidated financial statements do not include the effects 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. As of the date of the filing of this report, it is not possible to determine the extent of claims filed and to be filed, whether such claims will be disputed and whether they will be subject to discharge in the Creditor Protection Proceedings. It is also not possible at this time to determine whether to establish any additional liabilities in respect of claims. The Debtors are beginning to review all claims filed and are beginning the claims reconciliation process.

On February 23, 2009, the U.S. Court authorized the U.S. Debtors to reject certain unexpired leases of non-residential real property and related subleases as of February 28, 2009.

Comprehensive Restructuring Plan

We are in the process of stabilizing our business to maximize the chances of preserving all or a portion of the enterprise and evaluating our various operations to determine how to narrow our strategic focus in an effective and timely manner, in consultation with our business and financial advisors. While we undertake this process, our previously announced intention to explore the divestiture of our MEN business has been put on hold. We have also decided to discontinue our mobile WiMAX business and sell our Layer 4-7 data portfolio (see below). Further, we will be significantly reducing our investment in our carrier Ethernet switch/router (CESR) portfolio while continuing to ship products and support our installed base of carrier Ethernet customers. We will continue to utilize our carrier Ethernet technology in our other MEN and other solutions. The Creditor Protection Proceedings and the development of a comprehensive restructuring plan may result in additional sales or divestitures, but we can provide no assurance that we will be able to complete any 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 minimus value. The Canadian Debtors and EMEA Debtors can generally take similar actions with the approval of the Canadian Monitor and the U.K. Administrators, respectively. As we work on developing a comprehensive restructuring plan, we will consult with the Canadian Monitor, the U.K. Administrators and the U.S. Creditors’ Committee, and any such plan would eventually be subject to the approval of affected creditors and the relevant courts. There can be no assurance that any such plan will be confirmed or approved by any of the relevant courts or affected creditors, or that any such plan will be implemented successfully.

 

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Developments Related to our Creditor Protection Proceedings

 

 

 

We entered into an agreement with Export Development Canada (EDC) to permit continued access by us 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 (EDC Support Facility), for up to $30 of support, for an interim period that currently extends to May 1, 2009. Amounts outstanding under the EDC Support Facility are secured by a charge against all of the property of the Canadian Debtors.

 

 

 

Our filings under the Chapter 11 Proceedings and the CCAA Proceedings constituted events of default under the instruments governing substantially all of the indebtedness issued or guaranteed by us, NNC, NNI and NNCC. In addition, we may not be in compliance with certain other covenants under the indentures related to certain of our debt, the EDC Support Facility and other debt or lease instruments.

 

 

 

We entered into an amendment to arrangements with a major supplier, Flextronics. We continue to work with Flextronics throughout this process.

 

 

 

Since the Petition Date, we have generally maintained use of our cash management system pursuant to various court approvals and agreements obtained or entered into in connection with the Creditor Protection Proceedings, including a revolving loan agreement between NNI as lender and us as borrower. An initial amount of $75 was drawn, and the remaining $125 under the loan is subject to U.S. Court approval.

 

 

 

NNC common shares were delisted from the New York Stock Exchange (NYSE).

 

 

 

The Toronto Stock Exchange (TSX) notified us that it had begun a review of the eligibility for continued listing of securities of NNC and NNL, but stopped its review after concluding that the review was stayed by the initial order obtained by the Canadian Debtors in the CCAA Proceedings.

 

 

 

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

 

 

 

On February 25, 2009, we announced a workforce reduction plan of approximately 5,000 net positions. We also announced that we will seek to implement, and request court approval where required for, retention and incentive compensation for certain key eligible employees. On February 27, 2009, we obtained Canadian Court approval for the termination of our equity-based compensation plans, including all outstanding equity under the plans.

 

 

 

On March 2, 2009, we announced the appointment of Pavi Binning as chief restructuring officer of Nortel and NNC, a position he will hold in addition to his existing duties as chief financial officer. He will continue to report to the president and chief executive officer.

 

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Please see “Executive Overview – Creditor Protection Proceedings” in the MD&A section of this report, “Compensation Discussion and Analysis” in the Executive and Director Compensation section of this report, and the Risk Factors section of this report, for a full discussion of these and other significant events, and the risks and uncertainties we face as a result of the Creditor Protection Proceedings. See also note 1, “Creditor Protection and Restructuring” to the accompanying audited consolidated financial statements.

Further information pertaining to our Creditor Protection Proceedings may be obtained through our website at www.nortel.com/restructuring. 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.

Other 2008 and 2009 Developments

 

 

 

Mobile WiMAX: On January 29, 2009, we announced that we decided to discontinue our mobile WiMAX business and end our joint agreement with Alvarion Ltd.

 

 

 

Dividends: On November 10, 2008, our Board of Directors of decided to suspend the declaration of further dividends on our cumulative redeemable class A preferred shares series 5 (NNL series 5 preferred shares) and non-cumulative redeemable class A preferred shares series 7 (NNL series 7 preferred shares, and collectively with the NNL series 5 preferred shares, the NNL preferred shares) following payment on November 12, 2008 of the previously declared monthly dividend on those shares.

 

 

 

Acquisitions and Divestitures: On February 19, 2009, we announced that we have entered into a “stalking horse” asset purchase agreement to sell certain portions of our Applications Delivery Portfolio to Radware Ltd. for approximately $18. We have received orders from the U.S. Court and the Canadian Court that establish bidding procedures for an auction that will allow other qualified bidders to submit higher or otherwise better offers. In August 2008, we acquired 100% of the issued and outstanding stock of Diamondware, Ltd.; and we purchased substantially all of the assets and certain liabilities of Pingtel Corp. from Bluesocket Inc. In August 2008, LG-Nortel purchased certain assets and liabilities of LGE’s Wireless Local Loop (WLL) business, and acquired 100% of the stock of Novera Optics Korea Inc. and Novera Optics, Inc.

Business Environment

In 2008, we faced significant challenges from new technologies, higher operational expectations and increased competitiveness, creating new levels of complexity. These challenges were heightened by the expanding global economic downturn and extreme volatility in global financial markets. As global economic conditions dramatically worsened over recent months, we continued to experience significant pressure on our business and deterioration of our cash and liquidity as customers across all our businesses, in particular in North America, responded to increasingly worsening macroeconomic and industry conditions and uncertainty by suspending, delaying and reducing their capital expenditures. The extreme volatility in the financial, foreign exchange and credit markets globally has compounded the situation, further impacting customer orders as well as normal seasonality trends. As a result,

 

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our financial results, in particular in the second half of 2008, were negatively impacted across all of our business segments. We are

continuing to experience significant pressure due to global economic conditions and additionally, we are seeing further impact to our business as a result of the Creditor Protection Proceedings.

In the enterprise communications market, enterprises are looking for partners that can manage their communications in a more cost-effective manner, streamline operations, and help them keep up with the growing speed of business and Unified Communications. The service provider market in 2008 was focused on third-generation (3G) wireless network deployment, VoIP and products and services that will allow delivery of voice, data and video over IP networks (such as carrier switches/routers, broadband access and next-generation optical networks).

We operate on a global basis, and market conditions vary geographically. In emerging markets, customers continued to focus primarily on connectivity solutions, especially for wireless. In established markets, such as North America and Western Europe, service providers are upgrading their networks to enable new types of services, such as IPTV and mobile video. Regulatory issues in certain countries and regions have impacted market growth. We continued to see the trend known as hyperconnectivity, which represents a means by which companies can enable a more productive workforce, provide richer, more sophisticated communications experiences, and foster stronger, deeper relationships with customers.

Our Business

We transformed our R&D structure to a model based on 20% investment in emerging, future technology, 60% investment in current and maturing technologies and 20% investment earmarked for support of our legacy technologies. We increased our focus on Unified Communications, applications, carrier VoIP, and innovation in general, and our partnerships with industry leaders. Key areas of investment in 2008 included Unified Communications, 4G broadband wireless technologies, carrier Ethernet, next — generation optical, advanced applications and services, secure networking, professional services for Unified Communications and multimedia services.

As announced on November 10, 2008, under a new operating model effective January 1, 2009, we decentralized several corporate functions and transitioned to a vertically integrated business unit structure to give greater financial and operational control to the business units, increase accountability for overall performance, and reduce the duplication inherent in matrix organizations. Enterprise customers are served by a business unit responsible for product and portfolio development, R&D, marketing and sales, partner and channel management, strategic business development and associated functions. Service provider customers are now served by two business units with full responsibility for all product, services, applications, portfolio, business and market development, marketing and R&D functions: Carrier Networks (consisting of wireless and carrier VoIP, applications and solutions) and Metro Ethernet Networks. A dedicated global carrier sales organization supports both business units.

Our Global Services business unit will be decentralized and transitioned to the other business segments by April 1, 2009 in an attempt to minimize any negative impact on our customer service activities. Commencing with the first quarter of 2009, services results will be reported across all reportable segments. Also commencing with the first quarter of 2009, we will begin to report LG-Nortel as a separate reportable segment. Prior to that time, the results of LG-Nortel were reported across all segments. The previously announced decentralization of our Global Operations organization has been put on hold and will be part of our planning around the comprehensive restructuring plan.

We remain committed to integrity through effective corporate governance practices, maintaining effective internal control over financial reporting and enhanced compliance. We continue to focus on increasing employee awareness of ethical issues through various means such as on-line training and our Code of Business Conduct.

Business Segments

Our 2008 reportable segments were Carrier Networks (CN), Enterprise Solutions (ES), Metro Ethernet Networks (MEN) and Global Services (GS).

Sales of approximately $1,126 to Verizon Communications Inc. (including Verizon Wireless) constituted approximately 11% of our 2008 consolidated revenue, of which approximately $701 was in the Carrier Networks segment.

 

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Carrier Networks

We offer wireline and wireless networks that help service providers and cable operators supply mobile voice, data and multimedia communications services to individuals and enterprises using cellular telephones, personal digital assistants, laptops, soft-clients, and other wireless computing and communications devices. We also offer 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.

Service providers are focused on products and solutions that offer the latest broadband technology and services and support converged data, voice and multimedia communications over a single network for greater cost efficiency, capacity, speed, quality, performance, resiliency, security and reliability.

We seek to provide our customers with products and expertise spanning the gap between legacy and future-focused network environments. Our Carrier Networks segment focuses on supporting customers as they transition from circuit voice to converged IP networks and from 2G and 3G to 4G wireless networks. Carrier Networks also focuses on enabling wireless applications that allow service providers to offer new services that can generate new streams of revenues and boost customer loyalty and retention.

Our Carrier Networks portfolio includes 3G and 2.5G mobility networking solutions based on CDMA, GSM, GSM-R, GPRS and EDGE technologies. These include an array of indoor and outdoor base transceiver stations designed for capacity, performance, flexibility, scalability and investment protection.

We also offer 4G mobile broadband solutions for service providers based on OFDM and MIMO technologies, and have been developing solutions based on LTE. We own significant OFDM and MIMO patents and are considered a leader in the development of these standards, which provide a common foundation for LTE and WLAN (802.11n). We have completed early LTE trials with companies such as T-Mobile and LGE. We have also been continuing to conduct LTE trials with major services providers in North America.

Our Carrier VoIP solutions offer a variety of voice over packet products (softswitches, media gateways, international gateways), multimedia communication servers, SIP-based application servers, IMS products, optical products, WAN switches and digital-based telephone switches. As of the end of 2008, we had more than 300 Carrier VoIP and applications customers around the world.

Our product development for Carrier Networks is focused on next-generation mobile broadband, enhanced residential and business services, cable solutions, and converged voice and data solutions for wireline and wireless service providers. We continue to focus on VoIP to drive broad-based deployment of SIP, pre-IMS IP-based applications and IMS.

Carrier Networks competitors include Ericsson, Alcatel-Lucent, Motorola, Samsung, Nokia Siemens Networks, Huawei, ZTE, Sonus and Cisco. The most important competitive factors include best-in-class technology, features, product quality and reliability, customer and supplier relationships, warranty and customer support, network management, availability, interoperability, price and cost of ownership, regulatory certification and customer financing. Capital costs are becoming less important as operating costs and device subsidies (often given by service providers to their customers for purchase of handheld devices) become a bigger part of the service provider business case.

We ranked second globally in CDMA revenues in 2008, according to the Dell’Oro Group and have benefited from customer network upgrades to 3G technology, like CDMA2000 1x and CDMA EV-DO Rev A, for faster broadband wireless access. GSM, though declining, is expected to remain the largest telecommunications equipment market for several years and is dominated by Ericsson and Nokia Siemens Networks. We have GSM customers across North America, CALA, EMEA, and Asia, with support for those seeking to delay the move to UMTS or seeking to move directly to 4G. We believe that 4G will deliver significantly improved capacity and performance at a lower overall cost. 4G is expected to arrive in parallel with established application and device ecosystems.

Sales to Verizon Communications Inc. constituted more than 10% of Carrier Networks 2008 revenue, and sales to one other customer constituted more than 9%. The loss of either of these customers could have a material adverse effect on the Carrier Networks segment.

 

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Significant Carrier Networks Developments

 

 

 

Selected by China Telecom as a key vendor in the evolution of its CDMA network in seven Chinese provinces; other CDMA wins with Cleartalk and U.S. Cellular; 3G CDMA wins with Telefonica O2 Czech Republic, Multi-Links and Sky Link Ekaterinburg.

 

 

 

Retained number one GSM-R market position globally and won new contracts with China Railway, Deutsche Bahn, Algeria Railway and ADIF in Spain.

 

 

 

Carrier VoIP win with Clearwire to enable VoIP services to U.S. customers, as well as Carrier VoIP wins with Comstar United Telesystems in Russia, LG Dacom in Korea, and du in the United Arab Emirates.

 

 

 

We now have over 120 regional service providers in North America using our VoIP softswitch solution for rural service providers (CS 1500).

 

 

 

Introduced key new Carrier IP solutions including our Adaptive Application Engine (a software-based application enabling IP voice and multimedia services with Web 2.0), and our IP Powered Home Solution (enables service providers to bundle personal Internet, TV and home phone services into customizable packages).

Enterprise Solutions

We provide enterprise communications solutions addressing the headquarters, branch and home office needs of large and small businesses globally across a variety of industries, including healthcare and financial service providers, retailers, manufacturers, utilities, educational institutions and government agencies.

We offer Unified Communications solutions that help remove the barriers between voice, email, conferencing, video and instant messaging. For the hyperconnected enterprise, this means faster decisions, increased productivity and the ability to provide a simple and consistent user experience across all types of communication. The market is preparing for the integration of communications-enabled applications into business processes, using presence-based Unified Communications technologies and SOA.

Our extensive Enterprise Solutions portfolio addresses the needs of businesses of all sizes with reliable, secure and scalable products spanning Unified Communications, Ethernet routing and multiservice switching, IP and digital telephony (including phones), wireless LANs, security, IP and SIP contact centers, self-service solutions, messaging, conferencing, and SIP-based multimedia solutions.

Our Innovative Communications Alliance with Microsoft provides seamless technology integration for customers looking to coordinate desktop software suites with business communications solutions. We have now attained more than 1,000 alliance customers globally. The Nortel-IBM alliance provides delivery of communications-enabled applications and business processes through the use of SOA. Through these alliances, we have sought to improve our competitive position in the enterprise market and the coverage and efficiency of our channels to market.

The global enterprise equipment market segments in which we compete can generally be categorized as Unified Communications, communications-enabled multimedia applications and data networking. IBM and Microsoft continue to participate in Unified Communications. Aggressive competitor pricing, trade-in programs and open source solutions have increased competitive pressures. Cisco, Avaya, Alcatel-Lucent, Siemens Enterprise Communications and NEC are our primary competitors in the Unified Communications and multimedia applications market. Cisco is our primary competitor in the data market, followed by others such as HP Procurve, 3Com and Foundry.

Competitive factors include best-in-class technology and features, price and total cost of ownership, warranty and customer support, installed base, customer and supplier relationships, product quality, product reliability, product availability, ability to comply with regulatory and industry standards on a timely basis, end-to-end portfolio coverage, distribution channels, alternative solutions from service providers, and achieving appropriate size and scale.

We collaborate with various channel partners, including major global service providers. We continue to work through large service providers, large value-added resellers, and our two-tier value-added distribution system to better serve large companies as well as mid-market and SMBs. We have also created simplified accreditation and ‘fast-track’ training programs to lower partner cost of entry for selling our SMB portfolio.

 

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One customer makes up more than 10% of Enterprise Solutions 2008 revenue. The loss of this customer could have a material adverse effect on the Enterprise Solutions segment.

Significant Enterprise Solutions Developments

 

 

 

Expanded our Unified Communications portfolio with the introduction of solutions including our Agile Communications Environment, Ethernet Routing Switch 5600, Software Communications Server 500 (SCS500), Interactive Communications Portal, and delivered cost-saving Mobile Communication 3100 (MC 3100) and BCM450 products to market.

 

 

 

Announced new carrier-hosted solutions with Microsoft and IBM that are designed to enhance productivity and offer powerful Unified Communications to SMBs; received the IBM IMPACT Innovation Award for our IBM SOA foundation resource (Agile Communications Environment).

 

 

 

Named Official Network Infrastructure Partner for the London 2012 Olympic and Paralympic Games, secured on the heels of our Vancouver 2010 Olympic and Paralympic Winter Games win.

 

 

 

Key wins in the hospitality market, including Unified Communications contracts from the Vancouver Canucks, the New York Mets for their new Citi Field, and Las Vegas properties such as the Venetian and the Palazzo.

 

 

 

New financial institution customers include Dubai Financial Market, Australia’s New England Credit Union, and London-based HSBC.

 

 

 

New Unified Communications wins in the area of medical communications include M. D. Anderson Cancer Center Orlando; Carolinas HealthCare System; King Fahad Medical City, one of the largest healthcare providers in the Middle East; Brussels-based Jan Yperman Hospital; and Sharjah Teaching Hospital in the United Arab Emirates.

 

 

 

Secured a key government contract with the U.S. Social Security Administration for what is expected to be the world’s largest enterprise VoIP deployment: a ten-year, $300 telephone systems replacement project. We also secured new wins with the State of Georgia and China’s Ministry of Water Resources.

Global Services

Today’s service providers and enterprises face a wide range of communications challenges, including pressures not only to manage, but often to reduce their IT costs, ensure network security and keep up with ever-evolving innovation and communications needs. We believe we are well suited to meet these challenges because of our extensive experience in designing, installing and operating both enterprise and carrier networks around the world.

We are focused on opportunities to transform networks to IP, implementation of next-generation wireless technologies, delivery of Unified Communications and multimedia solutions, and helping customers manage their networks from a performance and cost efficiency perspective.

We provide a broad range of network services that help our customers focus on their core businesses, while we look after the intricacies of their networking needs. We support a broad range of multi-vendor, multi-technology systems, including services to design, deploy, support and evolve networks. We offer leading solutions for contact centers, Unified Communications and telepresence systems, and a broad range of managed services. Our customers include SMBs as well as large global enterprises; municipal, regional and federal government agencies; wireline and wireless service providers; cable operators; and MVNOs.

Our Global Services group offers a broad range of services, comprised of four main service product groups: (i) network implementation services, including network integration, planning, installation, optimization and security services; (ii) network support services, including technical support, hardware maintenance, equipment spares logistics and on-site engineers; (iii) network managed services, including services related to the monitoring and management of customer networks and hosted solutions; and (iv) network application services, including applications development, integration and communications-enabled application solutions.

 

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We sell services on a direct basis in the carrier and service provider markets, and employ both direct and indirect sales models for the enterprise market. Our model allows channel partners to partner with us in the delivery of a service, or invest to become fully capable in the delivery of that service.

Our key competitors in Global Services include Ericsson, Nokia Siemens Networks, Alcatel-Lucent and Motorola in the carrier market, and Cisco, Avaya and Siemens Enterprise in the enterprise market. As well, in 2008 we both partnered and competed with global system integrators such as IBM and HP. Principal competitive factors include size and scale, global presence and brand recognition, technology leadership, flexible pricing models, solutions focus and multi-vendor expertise.

Three customers make up over 18% of Global Services 2008 revenue. The loss of any of these customers could have a material adverse effect on the Global Services segment.

Significant Global Services Developments

 

 

 

Signed Deloitte as a global managed telepresence services customer; announced new joint managed telepresence offering for global resale with Verizon Business; became first Polycom Global telepresence Certified Plus Partner; provided telepresence services for FORTUNE Brainstorm: GREEN conference.

 

 

 

Awarded contracts to provide managed contact center services for India’s Bharti Airtel, Dubai’s Roads and Transport Authority, and the Carolinas HealthCare System. Also deployed managed contact center services for the Georgia Governor’s Office of Customer Service, updating and consolidating 30 contact centers to improve the performance and responsiveness of ‘1.800.georgia.’

 

 

 

Provided build, operate, maintain, consulting and/or project management services for customers such as Dubai telecom services provider du, Multi-Links Telecommunications in Nigeria and Palestine Telecommunications.

 

 

 

Consulted with and provided various managed security services for customers including the Spring, Texas Independent School District, the Kentucky Department of Education and healthcare provider Liverpool Women’s NHS Foundation Trust.

 

 

 

Teamed with M. D. Anderson Cancer Center Orlando to develop an award-winning patient discharge solution. Also agreed to provide various application design, integration and management services for Memorial Hospital at Gulfport, Mississippi, Turk Telecom, the New York Mets’ new Citi Field and the Vancouver Canucks’ General Motors Place.

 

 

 

Announced a Service Assurance Solution based on IBM Tivoli Netcool Carrier VoIP Manager software and our consulting, integration, customization and performance monitoring services, for service providers seeking greater network capacity and performance with lower costs.

Metro Ethernet Networks

As applications converge over IP, Ethernet is evolving from a technology for business-to-business communications to an infrastructure capable of delivering next-generation, IP-based voice, video and data applications. IP-based video traffic, in particular, is accelerating this shift to an Ethernet infrastructure. Internet video, residential broadcast TV, video on demand, and new wireless broadband multimedia applications are driving significantly increased bandwidth requirements. Many service providers are now looking to Ethernet as the transport technology for these new video services, in addition to other voice and data services for residential and business customers.

Our MEN solutions are designed to deliver carrier-grade Ethernet transport capabilities focused on meeting customer needs for higher performance and lower cost for emerging video-intensive applications. The MEN portfolio includes optical networking, carrier Ethernet switching and multiservice switching products. With our extensive experience in the optical and Ethernet arenas, MEN solutions use technology innovation to drive scale, simplicity and cost savings for our customers.

Key to delivering the capacity and service agility to the network are our Adaptive Intelligent All Optical solutions. Built with innovative eDCO and ROADM technologies, these solutions deliver the required bandwidth for high speed services, as well as incorporating network planning and engineering functions that can improve network provisioning and restoration times.

 

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Our 40G Adaptive Optical Engine technology can quadruple network capacity while being deployable over any fiber, which can allow service providers to reduce engineering and equipment expense, and upgrade quickly and cost-effectively from 10G to 40G, and ultimately to 100G when 100G becomes available. We had over 40 customer wins since the product became generally available in May 2008.

With their ability to switch new IP-based applications, deliver Ethernet connectivity services and maintain efficient transport of data traffic on legacy equipment, our packet optical transport platforms give our customers flexibility and agility. This enables them to react quickly to changing customer and service requirements to capitalize on the trends driving the industry.

We are seeking to standardize our technologies in the Institute of Electrical and Electronics Engineers, Metro Ethernet Forum, Optical Internetworking Forum, and the International Telecommunications Union –Telecommunications Standardization Sector bodies where PBB/PBT/PLSB are the focus of increasing standardization activity. The cornerstone of this activity, PBB, was ratified as an IEEE standard (IEEE 802.1ah) in August 2008. We believe these initiatives will prove beneficial for extending the simplicity and ease-of-use of Ethernet beyond connectivity services to include network transport and service definitions.

Our multiservice switch portfolio can offer reduced networking costs for service providers and enterprises through network consolidation, supporting multiple networking technologies such as ATM, frame relay, IP and voice on a single platform.

Throughout the transition to next generation packet-based networks, MEN solutions are designed to provide a comprehensive and consistent solution for all parts and layers of optical and Ethernet networks. We provide one network and domain management system for optical and Ethernet services, retaining key elements of circuit-based operation for Ethernet services. We believe that our ability to plan, manage, and troubleshoot networks via this single management system provides an advantage to our customers through cost savings and increased end-user satisfaction.

Our principal competitors in the global optical market are large communications companies such as Alcatel-Lucent, Huawei, Nokia Siemens Networks, Fujitsu and Cisco, as well as others that address specific niches within this market, such as Ciena, ADVA, Tellabs and Infinera.

Top vendors in the passive optical networking market include Mitsubishi, Tellabs, Alcatel-Lucent, Motorola, and Huawei. Cisco and Alcatel-Lucent have leading market shares in the existing carrier Ethernet market. Other competitors include Foundry, Huawei, Hitachi Cable and Extreme. We believe the carrier Ethernet market will divide into two camps: one that supports Ethernet over MPLS (multi-protocol label switching) solutions and the other that favors native carrier Ethernet switching solutions such as ours.

Two customers make up over 20% of MEN 2008 revenue. The loss of either one of these customers could have a material adverse effect on the MEN segment.

Significant MEN Developments

 

 

 

Introduced the industry’s first volume deployable 40G/100G solution, which enables four times the network throughput over existing network architectures while providing a foundation that can simply and affordably increase capacity tenfold.

 

 

 

Our 40G Adaptive Optical Engine was selected by Bell Canada to provide enhanced network bandwidth within the Montreal-New York, Toronto-Chicago and Toronto-Montreal traffic corridors, and by Mediacom in the U.S. to expand its capacity to deliver high-bandwidth applications like HDTV and Video on Demand with a new backbone network.

 

 

 

Secured new 40G contracts and deployed networks with Telus in Canada, SK Broadband in South Korea, RASCOM in Eastern Europe, KPN in Belgium, Neos Networks in the U.K., and TDC in Denmark.

 

 

 

Showcased 100G technology with major tier-one service providers including conducting the world’s first live 100G network trial with Comcast.

 

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Received new optical wins with China Cable Television Network, Romanian Educational Network and Banverket ICT, one of Sweden’s largest suppliers of network services.

Please see the Risk Factors section of this report for risks to our segments and our business generally and resulting from the Creditor Protection Proceedings and other matters.

Sales and Distribution

Under a new operating model effective January 1, 2009, we decentralized several corporate functions including our sales and distribution activities, and transitioned to a vertically integrated business unit structure. Enterprise customers are now served by dedicated ES sales, marketing, partner and channel management teams. CN and MEN are now supported by a dedicated global carrier sales organization responsible for service provider sales, business and market development and marketing.

These sales forces market and sell Nortel products and services to customers located in Canada, the U.S., CALA, EMEA and the Asia region. Our sales offices are aligned with customers on a country and regional basis. For instance, we have dedicated sales account teams for certain major service provider customers located near the customers’ main purchasing locations. Also, in some instances, we partner with companies that are not wholly-owned by Nortel, such as Nortel Networks Netas Telekomunikasyon A.S. in Turkey, and our joint venture LG-Nortel in Korea. In addition, teams within the regional sales groups work directly with top regional enterprises, and are also responsible for managing regional distribution channels. We also have decentralized marketing, product management and technical support teams, for ES, and for CN and MEN, respectively, dedicated to providing individual product line support to their respective global sales and support teams.

In some regions, we also use sales agents or representatives who assist us when we interface with our customers. In addition, we have some non-exclusive distribution agreements with distributors in all of our regions, primarily for enterprise products. Certain service providers, system integrators, value-added resellers and stocking distributors act as our non-exclusive distribution channels under those agreements.

Backlog

Our order backlog was approximately $4,100 and $5,100 as of each of December 31, 2008 and 2007, respectively. The backlog consists of confirmed orders as well as $1,994 of deferred revenues as of December 31, 2008, as compared to $3,109 of deferred revenues as of December 31, 2007. A portion of our deferred revenues and advanced billings are non-current and we do not expect to fill them in 2009. Most orders are typically scheduled for delivery within twelve months, although in some cases there could be significant amounts of backlog relating to revenue deferred for longer periods. These orders are subject to future events that could cause the amount or timing of the related revenue to change, such as rescheduling or cancellation of orders by customers (in some cases without penalty), or customers’ inability to pay for or finance their purchases. Backlog should not be viewed as an indicator of our future performance and could be affected by our Creditor Protection Proceedings. A backlogged order may not result in revenue in a particular period, and actual revenue may not be equal to our backlog estimates. Our presentation of backlog may not be comparable with that of other companies.

Product Standards, Certifications and Regulations

Our products are heavily regulated in most jurisdictions, primarily to address issues concerning inter-operability of products of multiple vendors. Such regulations include protocols, equipment standards, product registration and certification requirements of agencies such as Industry Canada, the U.S. Federal Communications Commission, requirements cited in the Official Journal of the European Communities under the New Approach Directives, and regulations of many other countries. For example, our products must be designed and manufactured to avoid interference among users of radio frequencies, permit interconnection of equipment, limit emissions and electrical noise, and comply with safety and communications standards. In most jurisdictions, regulatory approval is required before our products can be used. Delays inherent in the regulatory process may force us to postpone or cancel introduction of products or features in certain jurisdictions, and may result in reductions in sales. Failure to comply with these regulations could result in a suspension or cessation of local sales, substantial costs to modify our products, or payment of fines to regulators. For additional information, see “Environmental Matters” in each of the MD&A and Legal Proceedings sections, and the Risk Factors section, of this report. The operations of our service provider customers are also subject to extensive country-specific regulations.

 

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Sources and Availability of Materials

Our manufacturing and supply chain is based on an outsourced model where we rely primarily on electronic manufacturing services (EMS) suppliers. We believe this model allows us to benefit from leading manufacturing technologies, leverage existing global resources, lower cost of sales, more quickly adjust to fluctuations in market demand, and decrease our investment in plant, equipment and inventories. Substantially all of our manufacturing and related activities are outsourced.

We continue to retain all supply chain strategic management and overall control responsibilities, including customer interfaces, customer service, order management, quality assurance, product cost management, new product introduction, and network solutions integration, testing and fulfillment. We are generally able to obtain sufficient materials and components to meet the needs of our reportable segments. In each segment, we:

 

 

 

Make significant purchases, directly or indirectly through our EMS suppliers, of electronic components and assemblies, optical components, original equipment manufacturer products, software products, outsourced assemblies, outsourced products and other materials and components from many domestic and foreign sources;

 

 

 

Maintain alternative sources for certain essential materials and components; and

 

 

 

Occasionally maintain or request our suppliers to maintain inventories of components or assemblies to satisfy customer demand or minimize effects of possible market shortages.

For more information on our supply arrangements, see “Executive Overview — Creditor Protection Proceedings — Flextronics” and “Liquidity and Capital Resources — Future Uses and Sources of Liquidity —Future Uses of Liquidity” in the MD&A section of this report, and the Risk Factors section of this report. For more information on inventory, see “Application of Critical Accounting Policies and Estimates — Provisions for Inventories” in the MD&A section of this report.

Seasonality

We experienced a seasonal decline in revenues in the first quarter of 2008 compared to the fourth quarter of 2007. Revenues for each quarter, and results through each reportable segment, fluctuated in 2008. The quarterly profile of our business results in 2009 is not expected to be consistent across all reportable segments and may be affected by the Creditor Protection Proceedings. We typically expect a seasonal decline in revenue in the first quarter but there is no assurance that results of operations for any quarter will necessarily be consistent with our historical quarterly profile, or that our historical results are indicative of our expected results in future quarters, especially in light of our Creditor Protection Proceedings. See “Results of Operations” in the MD&A section, and the Risk Factors section, of this report.

Acquisitions and Divestitures

We made the following acquisitions during 2008:

 

 

 

On August 1, 2008, LG-Nortel acquired 100% of the issued and outstanding stock of Novera, which specializes in fiber-optic access solutions that extend high-speed carrier Ethernet services from optical core networks to customer premises.

 

 

 

On August 8, 2008, we purchased substantially all of the assets and certain liabilities of Pingtel. Pingtel was a wholly-owned subsidiary of Bluesocket and is a designer of software-based Unified Communications solutions.

 

 

 

On August 8, 2008, LG-Nortel purchased certain assets and liabilities of LGE’s WLL business. WLL’s products include fixed wireless terminals over CDMA- and GSM-licensed cellular networks.

 

 

 

On August 19, 2008, we acquired 100% of the issued and outstanding stock of Diamondware. Diamondware specializes in high-definition, proximity-based 3D-positional voice technology.

On February 19, 2009, we announced that we entered into a “stalking horse” asset purchase agreement to sell certain portions of our Layer 4-7 Application Delivery portfolio to Radware Ltd. for approximately $18. We have received orders from the U.S. Court and Canadian Court that establish bidding procedures for an auction that will allow other qualified bidders to submit higher or otherwise

 

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better offers. Consummation of the transaction is subject to higher or otherwise better offers, approval of the U.S. Court and the Canadian Court, and satisfaction of other conditions.

As part of our process in developing our comprehensive restructuring plan, our previously announced intention to explore the divestiture of our MEN business has been put on hold.

For additional information, see “Executive Overview — Creditor Protection Proceedings — Comprehensive Restructuring Plan”, and “Executive Overview – Other Significant Business Developments” in the MD&A section of this report.

Research and Development

Through internal R&D initiatives and external R&D partnerships, in 2008 we continued to invest in the development of technologies that we believe address customer needs to reduce operating and capital expenses, transition seamlessly to next-generation converged networks and deploy new, profitable services that we believe will change the way people live, work and play. We have focused on key technologies that we believe will make communications simpler in an emerging era of hyperconnectivity, and enable businesses and consumers to enjoy a true broadband experience in accessing personalized content and services from any location at any time. Indeed, the challenges that must be overcome today (such as fixed-mobile convergence, real-time communications handoff, true presence, extension of enterprise applications to mobile devices and carrier-grade enterprise mobility) are multi-dimensional, spanning the domains of wireless and wireline, service provider and enterprise, and infrastructure and applications.

We have invested in a variety of innovative technologies, primarily focused in the areas of 4G broadband wireless (LTE, OFDM, MIMO), next-generation optical (eDCO, 40G/100G Adaptive Optical Engine), carrier Ethernet (PBB, PBT, PLSB), Unified Communications, web-based applications and services (IMS, SOA), secure networking, professional services for Unified Communications and telepresence.

As at December 31, 2008, we employed approximately 10,235 regular full-time R&D employees. (excluding employees on notice of termination and including employees of our joint ventures). We are taking further workforce reductions that may impact our R&D organization. See “Executive Overview – Creditor Protection Proceedings – Workforce Reduction Plan; Employee Compensation Program Changes” in the MD&A section of this report. We conduct R&D through ten key R&D Centers of Excellence across the globe. We also invest in approximately 50 technology innovation initiatives with more than 20 major universities around the world. We complement our in-house R&D through strategic alliances, partners, and joint ventures with other best-in-class companies. We also work with and contribute to leading research organizations, research networks and international consortia, including the Canadian National Research Network (CANARIE), SURFnet, Massachusetts Institute of Technology, MobileVCE, Olin College, Georgia Tech, University of Texas at Austin, and University of Waterloo.

Standards are a key component of product development, providing an essential framework for adoption of new technologies and services. We participate in approximately 85 global, regional and national standards organizations, forums and consortia, spanning IT and telecom, and we hold leadership positions in many of them.

In 2008, we took some significant steps to enhance our R&D function. In particular, we increased our focus on speed and velocity (in terms of time to market with products and solutions and achieving year-over-year improvement in development cycle time), quality and productivity. Specifically:

 

 

 

As announced as part of our November 10, 2008 business update, portions of the R&D organization have been decentralized and transitioned to a vertically integrated business unit structure to give greater financial and operational control to the business units, increase accountability for overall performance and increase flexibility, agility, and speed to react to the rapidly changing market place.

 

 

 

We maintained targets of dedicating 20% of our R&D budget to focus on emerging markets and adherence to the 20/60/20 rule (20% investment in emerging, future technology, 60% investment in current and maturing technologies and 20% investment earmarked for support of our legacy technologies).

The following table shows our consolidated expenses for R&D in each of the past three fiscal years ended December 31:

 

     2008    2007    2006

R&D expense

   $ 1,574    $ 1,723    $ 1,940

 

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R&D costs incurred on behalf of others*

     8      7      16
                    

Total

   $ 1,582    $ 1,730    $ 1,956
                    

 

*

These costs include research and development charged to customers pursuant to contracts that provided for full recovery of the estimated cost of development, material, engineering, installation and other applicable costs, which were accounted for as contract costs.

Intellectual Property

Intellectual property is fundamental to us and the business of each of our reportable segments. We use intellectual property rights to protect investments in R&D activities, strengthen leadership positions, protect our good name, promote our brand name recognition, enhance competitiveness and otherwise support business goals. We generate, maintain, use and enforce a substantial portfolio of intellectual property rights, including trademarks, and an extensive portfolio of patents covering significant innovations arising from R&D activities. Profits and losses from our R&D efforts are allocated throughout Nortel pursuant to an intercompany arrangement where intellectual property is generally owned by us and licensed to participating Nortel affiliates (i.e., NNI and certain EMEA Debtors) through exclusive and non-exclusive licenses. In 2008, in order to protect a greater number of inventions resulting from our R&D efforts, we significantly increased our expenditures for protection of our intellectual property. Also, we have mutual patent cross-license agreements with several major companies to enable each party to operate with reduced risk of patent infringement claims. In addition, we license certain of our patents and/or technology to third parties, and license certain intellectual property rights from third parties. We sell products primarily under the “Nortel” and “Nortel Networks” trademarks and trade names. We have registered the “Nortel” and “Nortel Networks” trademarks, and many of our other trademarks, in countries around the world.

Employee Relations

At December 31, 2008, we employed approximately 30,239 regular full-time employees (excluding employees on notice of termination and including employees of our joint ventures), including approximately:

 

 

 

10,452 regular full-time employees in the U.S.,

 

 

 

5,859 regular full-time employees in Canada,

 

 

 

5,469 regular full-time employees in EMEA, and

 

 

 

8,459 regular full-time employees in other countries.

We also employ individuals on a regular part-time basis and on a temporary full or part-time time basis, and we engage the services of contractors as required.

On February 25, 2009, we announced that we intend to reduce our workforce by approximately 5,000 net positions, and certain changes to our employee compensation programs.

During 2008, approximately 1,825 regular full-time employees were hired including target hiring of individuals with critical technical skills. Approximately 23% of these new hires were new graduates while 59% were recruited in low cost countries. Notwithstanding the incremental hiring activity, Nortel had a year over year net reduction of approximately 2,250 employees in 2008.

At December 31, 2008, labor contracts covered approximately 2% of our employees, including four contracts covering approximately 2.8% of Canadian employees, three contracts covering approximately 5% of EMEA employees, one contract covering all employees in Brazil, and one contract covering less than 1% of employees in the U.S. (employed by NGS).

For additional information, see note 7, “Special charges”, to the accompanying audited consolidated financial statements and “Executive Overview — Creditor Protection Proceedings — Workforce Reduction Plan; Employee Compensation Program Changes” and “Results of Operations — Special Charges” in the MD&A section of this report.

 

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Environmental Matters

Our business is subject to a wide range of continuously evolving environmental laws in various jurisdictions. We seek to operate our business in compliance with these changing laws and regularly evaluate their impact on operations, products and facilities. Existing and new laws may cause us to incur additional costs. In some cases, environmental laws affect our ability to import or export certain products to or from, or produce or sell certain products in, some jurisdictions, or have caused us to redesign products to avoid use of regulated substances. Although costs relating to environmental compliance have not had a material adverse effect on our capital expenditures, earnings or competitive position to date, there can be no assurance that such costs will not have a material adverse effect going forward. For additional information on environmental matters, see “Environmental Matters” in each of the MD&A and Legal Proceedings sections of this report.

Financial Information about Segments and Product Categories

For financial information about segments and product categories, see note 6, “Segment information”, to the accompanying audited consolidated financial statements, and “Segment Information” in the MD&A section of this report.

Financial Information by Geographic Area

For financial information by geographic area, see note 6, “Segment information”, to the accompanying audited consolidated financial statements and “Results of Operations — Revenues” in the MD&A section of this report.

Working Capital

For a discussion of our working capital practices, see note 12, “Long-term debt”, to the accompanying audited consolidated financial statements, “Liquidity and Capital Resources” and “Application of Critical Accounting Policies and Estimates” in the MD&A section of this report and the Risk Factors section of this report.

 

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GLOSSARY OF CERTAIN TECHNICAL TERMS

40G/100G Adaptive Optical Engine is a technology that employs coherent technology and advanced digital signal processing techniques to enable 40G and 100G transmission over existing 10G network designs.

4G (an abbreviation for Fourth-Generation) is a term used to describe the next complete evolution in wireless communications. A 4G system will be able to provide a comprehensive IP solution where voice, data and streamed multimedia can be given to users on an “anytime, anywhere” basis, and at higher data rates than previous generations.

ATM (Asynchronous Transfer Mode) is a high-performance, cell-oriented switching and multiplexing technology that uses fixed-length packets to carry different types of traffic.

CDMA2000 1x (Code Division Multiple Access) is a 3G digital mobile technology.

CDMA EV-DO Rev A is a 3G digital mobile technology enabling high performance wireless data transmission. Revision A of EV-DO (evolution – data optimized) makes several additions to the protocol while keeping it backward compatible with previous EV-DO technology.

eDCO (electronic Dispersion Compensating Optics) extends wavelengths over 2,000 kilometers without regeneration, amplification or dispersion compensation.

EDGE (Enhanced Data GSM Environment) is a faster version of GSM’s data protocols.

Ethernet is the world’s most widely used standard (IEEE 802.3) for creating a local area network connecting computers and allowing them to share data.

GPRS means General Packet Radio Service.

GSM (Global System for Mobile Communications) is a 2G digital mobile technology.

GSM-R (Global System for Mobile Railway communications) is a secure wireless standard based on GSM for voice and data communication between railway drivers, dispatchers, shunting team members, train engineers, station controllers and other operational staff.

IMS (IP Multimedia Subsystem) is an open industry standard for voice and multimedia communications using the IP protocol as its foundation.

IP (Internet Protocol) is a standard that defines how data is communicated across the Internet.

IT means information technology.

LAN (Local Area Network) is a computer network that spans a relatively small area — usually a single building or group of buildings — to connect workstations, personal computers, printers and other devices.

LTE (Long Term Evolution) is an evolving networking standard expected to enable wireless networks to support data transfer rates up to 100 megabits per second.

MIMO (Multiple Input Multiple Output) uses multiple antennas on wireless devices to send data over multiple pathways and recombine it at the receiving end, improving transmission efficiency, distance, speed and quality.

 

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Mobile WiMAX (Worldwide Interoperability for Microwave Access) is a long-range wireless networking standard for broadband wireless access networks.

MVNO (Mobile Virtual Network Operator) is a wireless service provider without radio spectrum or network infrastructure that buys minutes of use for sales to its customers under its brand from another wireless service provider.

OFDM (Orthogonal Frequency-Division Multiplexing) is a technique used with wireless LANs to transmit large amounts of digital data over a large number of service providers spaced at precise radio frequencies.

PBB (Provider Backbone Bridging) extends the ease-of-use, high capacity and lower cost of Ethernet technology beyond corporate networks to service provider networks by providing sufficient additional addressing space for orders of magnitude greater scalability.

PBT (Provider Backbone Transport) is an innovative technology that delivers the TDM-like connection management characteristics service providers are familiar with to traditionally connectionless Ethernet.

PLSB (Provider Link State Bridging) is a new enhancement to Ethernet that builds on the capabilities of Provider Backbone Transport technology and adds carrier-grade infrastructure capabilities to PBT’s traffic engineered point-to-point model.

ROADM (Reconfigurable Optical Add/Drop Multiplexer) is a component of both our Optical Multiservice Edge 6500 and Common Photonic Layer (CPL) platforms, that enables dynamic optical branching of up to nine different optical paths in addition to basic add/drop of individual wavelengths.

SIP (Session Initiation Protocol) is an IP telephony signaling protocol developed by the IETF (Internet Engineering Task Force) primarily for VoIP but flexible enough to support video and other media types as well as integrated voice-data applications.

SOA (Service Oriented Architecture) uses a range of technologies that define use of loosely coupled software services to support requirements of business processes and software users. SOA allows independent services with defined interfaces to perform tasks in a standard way without having foreknowledge of the calling application.

Telepresence refers to a set of audio and video-conferencing technologies that allow participants to feel as if they are in the presence of other participants at one location, rather than meeting from separate locations via conferencing technology.

UMTS means Universal Mobile Telecommunications System.

Unified Communications uses software and infrastructure to integrate voice, email, instant messaging, conferencing, calendaring and other voice/data applications. It allows people to be reached via their preferred medium (i.e. cell phone, office phone, instant message, email etc.) and helps enterprises reduce delays and increase productivity.

VoIP (Voice over IP) refers to routing voice over the Internet or any IP-based network.

WAN (Wide Area Network) is a wireline and wireless long-distance communications network that covers a wide geographic area, a state or country, for example, to connect LANs.

WLAN means wireless LAN.

 

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ITEM 1A.

Risk Factors

Certain statements in this report contain words such as “could”, “expect”, “may”, “anticipate”, “will”, “believe”, “intend”, “estimate”, “plan”, “envision”, “seek” and other similar language and are considered forward-looking statements. These statements are based on our current expectations, estimates, forecasts and projections about the operating environment, economies and markets in which we operate. 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 risks, uncertainties and assumptions, that are difficult to predict and actual outcomes may be materially different. The Creditor Protection Proceedings will have a direct impact on our business and exacerbate these risks and uncertainties. In particular, the risks described below 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.

You should carefully consider the risks described below before investing in our securities. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial may also impair our business, results of operations, financial condition and liquidity.

We have organized our risks into the following categories:

 

 

 

Risks Relating to Our Creditor Protection Proceedings

 

 

 

Risks Relating to Our Business

 

 

 

Other Risks Relating to Our Liquidity, Financing Arrangements and Capital

Risks Relating to Our Creditor Protection Proceedings

Capitalized terms related to our Creditor Protection Proceedings used in this section and not defined have the meanings set forth for such terms in “Creditor Protection Proceedings – Other 2008 and 2009 Developments” in the Business section of this report.

We, and many of our direct and indirect subsidiaries, are currently subject to Creditor Protection Proceedings and additional subsidiaries could become subject to similar proceedings. Our business, operations and financial position are subject to the risks and uncertainties associated with such proceedings.

For the duration of the Creditor Protection Proceedings, our business, operations and financial position will be subject to the risks and uncertainties associated with such proceedings. These risks, without limitation and in addition to the risks otherwise noted in this report, are comprised of:

Strategic risks, including risks associated with our ability to:

 

 

 

stabilize the business to maximize the chances of preserving all or a portion of the enterprise

 

 

 

develop a comprehensive restructuring plan and narrow our strategic focus in an effective and timely manner

 

 

 

resolve ongoing issues with creditors and other third parties whose interests may differ from ours

 

 

 

obtain creditor, court and any other requisite third party approvals for a comprehensive restructuring plan

 

 

 

successfully implement a comprehensive restructuring plan

 

 

 

dedicate sufficient resources to respond to, and gain market share in, emerging or growth technologies

Financial risks, including risks associated with our ability to:

 

 

 

generate cash from operations and maintain adequate cash on hand

 

 

 

operate within the restrictions and limitations of the current EDC Support Facility or put in place a longer term solution

 

 

 

if necessary, arrange for sufficient debtor-in-possession or other financing during the Creditor Protection Proceedings

 

 

 

continue to maintain currently approved intercompany lending and transfer pricing arrangements and ongoing deployment of cash resources throughout the Company in connection with ordinary course intercompany trade obligations and requirements

 

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continue to maintain our cash management arrangements; and obtain any further approvals from the Canadian Monitor, the U.K. Administrator, the U.S. Creditors’ Committee, or other third parties, as necessary to continue such arrangements

 

 

 

raise capital to satisfy claims, including our ability to sell assets to satisfy claims against us

 

 

 

obtain sufficient exit financing to support a comprehensive restructuring plan

 

 

 

maintain R&D investments

 

 

 

realize full or fair value for any assets or business we may divest as part of a comprehensive restructuring plan

Operational risks, including risks associated with our ability to:

 

 

 

attract and retain customers despite the uncertainty caused by the Creditor Protection Proceedings, particularly for our businesses with increased exposure to “one-time” customers with whom we have not yet established a long-term, ongoing relationship

 

 

 

avoid reduction in, or delay or suspension of, customer orders as a result of the uncertainty caused by the Creditor Protection Proceedings including uncertainty surrounding future R&D expenditures

 

 

 

maintain market share, as our competitors move to capitalize on customer concerns

 

 

 

operate our business effectively in consultation with the Canadian Monitor, and work effectively with the U.K. Administrators in their administration of the business of the EMEA Debtors

 

 

 

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 and attract new employees

 

 

 

retain, or if necessary, replace major suppliers on acceptable terms, including but not limited to Flextronics

 

 

 

avoid disruptions in our supply chain as a result of uncertainties related to our Creditor Protection Proceedings

 

 

 

maintain current relationships with reseller partners, joint venture partners and strategic alliance partners

Procedural risks, including risks associated with our ability to:

 

 

 

obtain court orders or approvals with respect to motions we file from time to time, including motions seeking extensions of the applicable stays of actions and proceedings against us, or obtain timely approval of transactions outside the ordinary course of business, or other events that may require a timely reaction by us or present opportunities for us

 

 

 

resolve the claims made against us in such 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, such as the termination or shortening of the exclusivity period in the U.S. during which we can propose and seek confirmation of a comprehensive restructuring plan, conversion of our Chapter 11 reorganization proceedings to Chapter 7 liquidation cases, or the opening of secondary insolvency proceedings in respect of an EMEA Debtor in that debtor’s own country of incorporation

 

 

 

reject, repudiate or terminate contracts

Because of these risks and uncertainties, and as we have not yet developed a comprehensive restructuring plan, we cannot predict the ultimate outcome of the reorganization process, or predict or quantify the potential impact on our business, financial condition or results of operations. The Creditor Protection Proceedings provide us with a period of time to attempt to stabilize our operations and financial condition and develop a comprehensive restructuring plan. However, it is not possible to predict the outcome of these proceedings and, as such, the realization of assets and discharge of liabilities are each subject to significant uncertainty. Accordingly, substantial doubt exists as to whether we will be able to continue as a going concern. Our continuation as a going concern is dependent upon, among other things, our ability to develop, obtain confirmation or approval and implement a comprehensive restructuring plan; generate cash from operations, maintain adequate cash on hand and obtain sufficient other financing during the Creditor Protection Proceedings and thereafter; resolve ongoing issues with creditors and other third parties; and return to profitability. Even assuming a successful emergence from the Creditor Protection Proceedings, there can be no assurance as to the long-term viability of all or any part of the enterprise. In addition, a long period of operating under Creditor Protection Proceedings may exacerbate the potential harm to our business and further restrict our ability to pursue certain business strategies or require us to take actions that we otherwise would not. These challenges are in addition to business, operational and competitive challenges that we would normally face even absent the Creditor Protection Proceedings.

Continuing or increasing pressure on our business, cash and liquidity could materially and adversely affect our ability to fund and restructure our business operations, react to and withstand the current sustained and expanding economic downturn, as

 

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well as the extraordinarily volatile and uncertain market and industry conditions, and develop and implement a comprehensive restructuring plan. Additional sources of funds may not be available.

Our restructuring measures in recent years have not provided adequate relief from the significant pressures we are 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 potentially prolonged recessionary period have compounded the situation. We are continuing to experience significant pressure due to global economic conditions and additionally, we are seeing further impact to our business as a result of the Creditor Protection Proceedings.

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 in the various jurisdictions is generally available to fund operations in the particular jurisdictions, but generally is not freely transferable between jurisdictions or regions, other than as highlighted in “Liquidity and Capital Resources” in the MD&A section of this report. Thus, there is greater pressure and reliance on cash balances and generation capacity in specific regions and jurisdictions. Under a current agreement with EDC, we have continued access under the EDC Support Facility up to May 1, 2009 for up to $30 of support. We and EDC continue to work together to see if a longer term arrangement, acceptable to both parties, can be reached, but there can be no assurance that we will be able to reach agreement on a longer term arrangement.

Access to additional funds from liquidity-generating transactions, debtor-in-possession financing arrangements or other sources of external financing may not be available to us and, if available, would be subject to market conditions and certain limitations including court approvals and other requisite approvals by the Canadian Monitor, the U.K. Administrators or other third parties.

We cannot provide any assurance that our net cash requirements will be as we currently expect and will be sufficient for the successful development, approval and implementation of a comprehensive restructuring plan.

There can be no assurance that any further required court approvals for any future company transactions will be obtained. Furthermore, there can be no assurance that we will be able to continue to maintain ongoing deployment of cash resources throughout the Company in connection with ordinary course intercompany trade obligations. If our subsidiaries are unable to pay dividends or provide us with loans or other forms of financing in sufficient amounts, or if there are any restrictions on the transfer of cash between us and our subsidiaries, including those imposed by courts, foreign governments and commercial limitations on transfers of cash pursuant to our joint ventures commitments, the cash positions of the Canadian Debtors would likely be under great pressure and our liquidity and our ability to meet our obligations would be adversely affected.

 

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We must continue to restructure and transform our business and the assumptions underlying these efforts may prove to be inaccurate. We may not be able to successfully develop, obtain all requisite approvals for, or implement a comprehensive restructuring plan. Failure to obtain the requisite approvals for, or failure to successfully develop and implement our comprehensive restructuring plan within the time granted by the courts would, in all likelihood, lead to the liquidation of all of our assets.

In order to be successful, we must have a competitive business model that brings innovative products and services to market in a timely way. Pursuant to the ongoing Creditor Protection Proceedings we are working on developing a comprehensive restructuring plan. In order to successfully emerge from the Creditor Protection Proceedings, our senior management will be required to spend significant amounts of time developing a comprehensive restructuring plan, instead of focusing exclusively on business operations.

In connection with the transformation of our business, we have made, and will continue to make, judgments as to whether we should further reduce, relocate or otherwise change our workforce. Costs incurred in connection with workforce reduction efforts may be higher than estimated. Furthermore, our workforce efforts may impair our ability to achieve our current or future business objectives. Any further workforce efforts including reductions may not occur on the expected timetable and may result in the recording of additional charges.

Further, we have made, and will continue to make, judgments as to whether we should limit investment in, exit, or dispose of certain businesses. The Creditor Protection Proceedings and the development of a comprehensive plan of reorganization may result in the sale or divestiture of assets or businesses, but we can provide no assurance that we will be able to complete any sale or divestiture on acceptable terms or at all. Any decision by management to further limit investment in, or exit or dispose of businesses may result in the recording of additional charges. As part of our review of our restructured business, we look at the recoverability of tangible and intangible assets. Future market conditions may indicate these assets are not recoverable based on changes in forecasts of future business performance and the estimated useful life of these assets, and this may trigger further write-downs of these assets which may have a material adverse effect on our business, results of operations and financial condition.

We also must obtain the approvals of the respective courts and creditors, and the Canadian Monitor and U.K. Administrators. We may not receive the requisite approvals and even if we do, a dissenting holder of a claim against us may challenge and ultimately delay the final approval and implementation of a comprehensive restructuring plan. If we are not successful in developing a comprehensive restructuring plan, or if we are successful in developing it but do not receive the requisite approvals, it is unclear whether we would be able to reorganize our businesses and what distributions, if any, holders of claims against us would receive. Should the stay or moratorium period and any subsequent extension thereof not be sufficient to develop and implement a comprehensive restructuring plan or should such plan not be approved by creditors and the courts and, in any such case, the Debtors lose the protection of such stay or moratorium, substantially all of our debt obligations will become due and payable immediately, or subject to acceleration, creating an immediate liquidity crisis that in all likelihood would lead to the liquidation of all of our assets, in which case it is likely that holders of claims would receive substantially less favorable treatment than they would receive if we were able to emerge as a viable, reorganized entity.

During the pendency of the Creditor Protection Proceedings, our financial results may be volatile and may not reflect historical trends. Also, as a result of the Creditor Protection Proceedings, our internal controls are currently subject to review and modification.

During the pendency of the Creditor Protection Proceedings, we expect our financial results to continue to be volatile as asset impairments, asset dispositions, restructuring activities, contract terminations and rejections, and claims assessments may significantly impact our consolidated financial statements. As a result, our historical financial performance is likely not indicative of our financial performance following the Petition Date. Further, we may sell or otherwise dispose of assets or businesses and liquidate or settle liabilities, with court approval, for amounts other than those reflected in our historical financial statements. Any such sale or disposition and any comprehensive restructuring plan could materially change the amounts and classifications reported in our historical consolidated financial statements, which do not give effect to any adjustments to the carrying value of assets or amounts of liabilities that might be necessary as a consequence of a comprehensive restructuring plan. As a result of the Creditor Protection Proceedings, we have adopted the American Institute of Certified Public Accountants’ Statement of Position 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” (SOP 90-7) effective January 14, 2009 and this will require certain changes and additional reporting in our financial statements beginning in the quarter ended March 31, 2009.

 

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Also, as a result of the Creditor Protection Proceedings, our internal controls are currently subject to review and modification, including with respect to the Canadian Monitor and the U.K. Administrators, and we may implement additional controls to accommodate the adoption of SOP 90-7 as well as any of the additional reporting requirements relating to our Creditor Protection Proceedings. The implementation of the foregoing may adversely affect the ability to timely file our reports.

Canadian, U.S. and U.K. laws impair the ability of claimants to take action against us under our existing contracts, including the outstanding notes and related guarantees of us, NNC, NNI and NNCC. Subject to limited exceptions, all actions are stayed and ultimate recoveries cannot be determined at this time.

Generally, in connection with the Creditor Protection Proceedings, 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. The U.S. Bankruptcy Code provides for all actions and proceedings against the U.S. Debtors to be stayed while the Chapter 11 Proceedings are pending. In Canada, the initial order from the Canadian Court also provides for a general stay of actions against the Canadian Debtors, officers and directors. Pursuant to a subsequent order of the Canadian Court issued on February 10, 2009, this stay period was extended to May 1, 2009 and is subject to further extension. With limited exceptions, the stays in effect pursuant to the Chapter 11 Proceedings and CCAA Proceedings generally preclude parties from taking any actions against the Debtors. Similarly, under the U.K. Administration Proceedings, subject to limited exceptions as may be approved by the U.K. Administrators or the English Court, no legal process (including legal proceedings, execution, distress and diligence) may be instituted or continued against the EMEA Debtors.

In particular, the rights of the indenture trustees (who represent the holders of debt securities issued or guaranteed by us, NNC, NNI and NNCC) to enforce remedies for defaults under our debt securities and guarantees are subject to the stays, and could be delayed or limited by the restructuring provisions of applicable Canadian, U.S. and U.K. creditor protection legislation. Moreover, we, NNC, NNI and NNCC have not made, and will likely continue not to make, any payments under our various debt securities during the Creditor Protection Proceedings, and holders of our debt securities may not be compensated for any delays in payment of principal, interest and costs, if any, including the fees and disbursements of the trustees.

A comprehensive restructuring plan, if successfully developed and accepted by the requisite majorities of each affected class of creditors and approved by the relevant courts, would be binding on all creditors within each affected class, including those that did not vote to accept the proposal. The ultimate recovery to creditors and security holders, if any, will not be determined until a comprehensive restructuring plan is developed and approved. At this time we do not know what values, if any, will be prescribed pursuant to any such plan to the securities held by each of these constituencies, or what form or amounts of distributions, if any, they may receive on account of their interests.

An increased portion of our cash and cash equivalents may be restricted as cash collateral if we are unable to secure alternative support for certain obligations arising out of our normal course business activities.

The EDC Support Facility may not provide all the support we require for certain of our obligations arising out of our normal course of business activities. As of December 31, 2008, there was approximately $189 of outstanding support utilized under the EDC Support Facility, approximately $125 of which was outstanding under the small bond sub-facility. Individual bonds supported under the EDC Support Facility currently expire on the fourth anniversary of such individual bond regardless of the termination date of the EDC Support Facility. As a result of the Creditor Protection Proceedings, EDC had the right to suspend or terminate the EDC Support Facility. EDC may also suspend its obligation to issue NNL any additional support if events occur that have a material adverse effect on NNL’s business, financial position or results of operations. On January 14, 2009, Nortel announced that NNL entered into an agreement with EDC to permit continued access by NNL to the EDC Support Facility for an interim period of 30 days for up to a maximum of $30 of support based on Nortel’s then-estimated requirements over the period. On February 10, 2009, NNL and EDC reached a further agreement to permit the extension to run through May 1, 2009. Amounts outstanding under the EDC Support Facility are secured by a charge against all of the property of the Canadian Debtors, EDC and Nortel are continuing to work together to see if a longer term arrangement, acceptable to both parties, can be reached; however there can be no guarantee that a satisfactory outcome will be achieved.

 

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If the EDC Support Facility is terminated or suspended, or if we do not have access to sufficient support under the EDC Support Facility, and if we are unable to secure alternative support, an increased portion of our cash and cash equivalents may be restricted as cash collateral, which would reduce our liquidity, exacerbate the pressure on our cash balances and could have a material adverse effect on our business and our ability to successfully develop, obtain approval for and implement a comprehensive restructuring plan.

If we are unable to attract and retain qualified personnel at reasonable costs, we may not be able to achieve our business objectives, and our ability to successfully emerge from the Creditor Protection Proceedings may be harmed.

We are dependent on the experience and industry knowledge of our senior management and other key employees to execute our current business plans and lead the Company, particularly during the Creditor Protection Proceedings and throughout the development and implementation of a comprehensive restructuring plan. Competition for certain key positions and specialized technical and sales personnel in the high-technology industry remains strong. Our deteriorating financial performance, along with the Creditor Protection Proceedings and further workforce reduction announcements create uncertainty that has led to an increase in unwanted attrition, and challenges in attracting and retaining new qualified personnel. We are at risk of losing or being unable to hire talent critical to a successful reorganization and ongoing operation of our business. Our ability to retain and attract critical talent is restricted in part by the Creditor Protection Proceedings that, among other things, limit our ability to implement a retention program or take other measures to attract new hires to the Company or motivate employees to remain with us. We filed a motion with the U.S. Court on February 27 2009, and intend to file with the Canadian Court on March 2, 2009 seeking court approval to implement certain incentive and retention plans; however, there can be no assurance that these approvals will be obtained. Our future success depends in part on our continued ability to hire, assimilate in a timely manner and retain qualified personnel, particularly in key senior management positions. If we are not able to attract, recruit or retain qualified employees (including as a result of headcount reductions), we may not have the personnel necessary to develop and implement a comprehensive restructuring plan, and our business, results of operations and financial condition could be materially adversely impacted.

Our ability to independently manage our business is restricted during the Creditor Protection Proceedings, and steps or actions in connection therewith may require the approval of the respective courts, the creditors, the Canadian Monitor and the U.K. Administrators.

Pursuant to the various court orders and statutory regimes to which we are subject during the Creditor Protection Proceedings, some or all of the decisions with respect to our business may require consultation with, review by or ultimate approval of one or all of the respective courts in the several jurisdictions, the U.S. Creditors’ Committee, the Bondholder Group, the Canadian Monitor and the U.K. Administrators. In particular, under the U.K. Administration Proceedings, the respective boards of directors of each of the EMEA Debtors have been displaced in favor of the U.K. Administrators who have been appointed by the English Court and empowered to manage the business, affairs and property of the EMEA Debtors. Although we believe that many decision-making powers will be delegated by the U.K. Administrators to current management of the EMEA Debtors, we cannot determine, with any certainty, the extent to which they will be empowered to make and implement decisions without consultation with, review by or ultimate approval of the U.K. Administrators. The lack of independence and the related consulting and reporting requirements are expected to significantly extend the amount of time necessary for the Company to take necessary actions and conclude and execute on decisions, and may make it impossible for us to take actions that we believe are in the best interests of the Company. There can be no assurance that the U.S. Creditors Committee, the Bondholder Group, other creditors, the Canadian Monitor or the U.K. Administrators will support the Debtors’ positions on matters presented to the courts in the future, or on any comprehensive restructuring plan, once developed and proposed. Disagreements between us and these various third parties could protract the Creditor Protection Proceedings, negatively impact the Debtors’ ability to operate and delay the Debtors’ emergence from the Creditor Protection Proceedings.

Transfers or issuances of our equity, or a debt restructuring, may impair or reduce our ability to utilize our net operating loss carryforwards and certain other tax attributes in the future.

Pursuant to U.S. tax rules, a corporation is generally permitted to deduct from taxable income in any year net operating losses (NOLs) carried forward from prior years. We have NOL carryforwards in the U.S. of approximately $1,600 as of December 31, 2008. Our ability to utilize these NOL carryforwards could be subject to a significant limitation if we were to undergo an “ownership change” for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, during or as a result of our Chapter 11 Proceedings. During the Creditor Protection Proceedings, the U.S. Court has entered an order that places certain restrictions on trading in NNC common shares and NNL preferred shares. However, we can provide no assurances that these limitations will prevent an “ownership change” or that our ability to utilize our NOL carryforwards may not be significantly limited as a result of our reorganization.

 

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A restructuring of our debt pursuant to the Creditor Protection Proceedings may give rise to cancellation of indebtedness or debt forgiveness (COD), which if it occurs would generally be non-taxable. If the COD is non-taxable, we will be required to reduce our NOL carryforwards and other attributes such as capital loss carryforwards and tax basis in assets, by an amount equal to the non-recognized COD. Therefore, it is possible that, as a result of the successful completion of a comprehensive restructuring plan, we will have a reduction of NOL carryforwards and/or other tax attributes in an amount that cannot be determined at this time and that could have a material adverse effect on our financial position.

Trading in our securities during the pendency of the Creditor Protection Proceedings is highly speculative, poses substantial risks, and is subject to certain restrictions imposed to protect our NOL carryforwards that are described directly above. NNC common shares have been delisted from the NYSE, which has made our stock significantly less liquid; and the TSX may seek to delist our currently listed NNC common shares and NNL preferred shares.

NNC and NNL securities may have little or no value. Trading prices are very volatile and may bear little or no relationship to the actual recovery, if any, by the holders under any eventual court-approved comprehensive restructuring plan. In such a plan, our existing securities may be cancelled and holders may receive no payment or other consideration in return, or they may receive a payment or other consideration that is less than the trading price or the purchase price of such securities.

In addition, the U.S. Court has entered an order that places certain limitations on trading in certain of our securities to protect our NOL carryforwards. For this reason, investors need our consent or court approval before effecting any transactions in NNC common shares or NNL preferred shares if they hold, or would as a result of the transaction acquire, at least 4.75% of the outstanding NNC common shares or any series of NNL preferred shares.

Effective February 2, 2009, NNC common shares were delisted by the NYSE. NNC common shares currently continue to trade on the TSX and the “over-the-counter” (OTC) market in the U.S., and their price is quoted on the Pink Sheets Electronic Quotation Service (Pink Sheets) maintained by Pink Sheets LLC. There is no assurance that we will be able to re-list our shares on the NYSE or another U.S. exchange following the Creditor Protection Proceedings.

On January 14, 2009, we received notice that the TSX was reviewing the eligibility for continued listing of NNC common shares and NNL preferred shares. The TSX stopped its review after concluding that the review was stayed by the initial order granted by the Canadian Court pursuant to the CCAA Proceedings. However, the TSX could oppose the stay and seek court approval to delist our securities. If those securities are delisted, there can be no assurance that trading in them will continue (through OTC transactions or otherwise).

OTC transactions involve risks in addition to those associated with transactions on a stock exchange. Many OTC stocks trade less frequently and in smaller volumes than stocks listed on an exchange. Accordingly, OTC-traded shares are less liquid and are likely to be more volatile than exchange-traded stocks. The price of NNC common shares is currently electronically displayed on the Pink Sheets in the U.S., which is a quotation medium that publishes market maker quotes for OTC securities. It is not a stock exchange or listing service and is not owned, operated or regulated by any exchange. Investors are advised that Nortel has not taken any steps to have our securities quoted on the Pink Sheets; there is no relationship, contractual or otherwise, between an issuer whose securities are quoted on the Pink Sheets, and Pink Sheets LLC; and Pink Sheets LLC exercises no regulatory oversight over Nortel. Our status on the Pink Sheets is dependent on market makers’ willingness to continue to provide the service of accepting trades of NNC common shares.

Some or all of the U.S. Debtors could be substantively consolidated.

There is a risk that an interested party in the Chapter 11 Proceedings, including any of the U.S. Debtors, could request that the assets and liabilities of NNI, or those of other U.S. Debtors, be substantively consolidated with those of one or more other U.S. Debtors. While it has not been requested to date, we cannot assure you that substantive consolidation will not be requested in the future, or that the U.S. Court would not order it. If litigation over substantive consolidation occurs, or if substantive consolidation is ordered, the ability of a U.S. Debtor that has been substantively consolidated with another U.S. Debtor to make payments required with respect to its debt could be adversely affected. For example, the rights of unsecured debt holders of NNI may be diminished or diluted if NNI were consolidated with one or more entities that have a higher amount of unsecured priority claims or other unsecured claims relative to the value of their assets available to pay such claims.

 

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Risks Relating to Our Business

The sustained and expanding financial crisis and economic downturn could continue to have a negative impact on our business, results of operations and financial condition, and our ability to accurately forecast our results, and it may cause a number of the risks that we currently face to increase in likelihood, magnitude and duration.

We continue to experience significant pressure on our business and deterioration of our cash and liquidity as customers across all our businesses, in particular in North America, respond to increasingly deteriorating macroeconomic and industry conditions and uncertainty by suspending, delaying and reducing their capital expenditures. The extreme volatility in the financial, foreign exchange, equity and credit markets globally has compounded the situation. With this sustained and expanding economic downturn, we expect that we will continue to experience significant pressure on a number of fronts. We are seeing further impact to our business as a result of the Creditor Protection Proceedings. The impact of these events on us going forward will depend on a number of factors, including the recession impacting the U.S., Canadian and global economies, the duration and severity of these events, and whether the recovery period will be brief or prolonged. As a result, we may face new risks as yet unidentified, and a number of risks that we ordinarily face and that are further disclosed in the MD&A section of this report may increase in likelihood, magnitude and duration. These include but are not limited to deferrals or reductions of customer orders, potential deterioration of our customers’ ability to pay or obtain financing, losses or impairment charges, reduced revenue, further deterioration in our cash balances and liquidity due to foreign exchange impacts, increased pension funding obligations, and an inability to move funds between different jurisdictions and access the capital markets and other additional sources of funding. The financial crisis and economic downturn continue to affect us during the Creditor Protection Proceedings. In many circumstances, it is difficult for us to distinguish, with any certainty, the impact these various factors are having individually and collectively on our business, because these factors are adversely impacting our ability to accurately forecast our performance, results and cash position.

We have been and may be further materially and adversely affected by continued cautious capital spending, including as a result of current economic uncertainties, or a change in technology focus by our customers, particularly certain key customers.

Continued cautiousness in capital spending by service providers and other customers may affect our revenues and operating results more than we currently expect and may require us to adjust our current business model. We have focused on larger customers in certain markets, which provide a substantial portion of our revenues and margin. Reduced spending, or a loss, reduction or delay in business from one or more of these customers, a significant change in technology focus or a failure to achieve a significant market share with these customers, could require us to reduce our capital expenditures and investments or take other measures in order to meet our cash requirements, or could otherwise have a material adverse effect on our business, results of operations, financial condition and liquidity, and our ability to emerge from the Creditor Protection Proceedings. Further, the trend towards the sale of converged networking solutions could also lead to reduced capital spending on multiple networks by our customers as well as other significant technology shifts, including for our legacy products, which could materially and adversely affect our business, results of operations and financial condition.

Negative developments associated with our suppliers and contract manufacturers, including any inability to maintain stable, normalized relationships with our suppliers on acceptable terms, our reliance on certain suppliers for key optical networking solutions components, and on a sole supplier for the majority of our manufacturing and design functions, as well as consolidation in the industries in which our suppliers operate, may materially and adversely affect our business, results of operations, financial condition and customer relationships.

Our equipment and component suppliers have experienced, and may continue to experience, consolidation in their industry, and at times financial difficulties, that may result in fewer sources of components or products, increased prices and greater exposure relating to the financial stability of our suppliers. A reduction or interruption in supply of one or more components, or external manufacturing capacity, a significant increase in the price of one or more components, or excessive inventory levels could materially and negatively affect our gross margins and our operating results, and could materially damage customer relationships.

In particular, we currently rely on certain suppliers for key optical networking solutions components, and our supply of these and other components could be materially adversely affected by adverse developments in our supply arrangement with these suppliers. If these suppliers are unable to meet their contractual obligations under our supply arrangements and if we are then unable to make alternative arrangements, it could have a material adverse effect on our revenues, cash flows and relationships with our customers.

 

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As part of the transformation of our supply chain from a vertically integrated manufacturing model to a virtually integrated model, we have outsourced substantially all of our manufacturing capacity, and divested associated assets, to contract manufacturers, including Flextronics. As a result, a significant portion of our supply chain is concentrated with Flextronics. Outsourcing our manufacturing capability to contract manufacturers involves potential challenges in designing and maintaining controls relating to the outsourced operations in an effective and timely manner. We work closely with our suppliers and contract manufacturers to address issues such as cost, quality and timely delivery and to meet increases in customer demand, when needed, and we also manage our internal inventory levels as required. However, we may encounter difficulties, including shortages or interruptions in the supply of quality components and/or products in the future, and we may also encounter difficulties with our concentrated supply chain relationships, which could be compounded by further potential consolidation by our key suppliers. Also, certain key elements of our efforts to transform our business require and are reliant on our suppliers meeting their commitments and working cooperatively and effectively on these transformation aspects.

On January 14, 2009, NNL entered into an amendment to arrangements with a major supplier, Flextronics. While we expect this mutually beneficial relationship to continue, there can be no assurance that the current relationship will be maintained on acceptable terms.

There can be no assurance that we will be able to retain, or if necessary, replace this or other major suppliers on acceptable terms, and our supplier relationships may be adversely affected by the Creditor Protection Proceedings. A reduction or interruption in component supply or external manufacturing capacity, untimely delivery of products, a significant increase in the price of one or more components, or excessive inventory levels or issues that could arise in our concentrated supply chain relationships or in transitioning between suppliers could materially and negatively affect our gross margins and our operating results and could materially damage customer relationships.

We are fully exposed to market risk primarily from fluctuations in foreign currency exchange rates and interest rates. Adverse fluctuations in these markets could negatively impact our business, results of operations and financial condition.

Our foreign currency exchange exposure arises from the increasing proportion of our business that is denominated in currencies other than U.S. Dollars (primarily the Canadian Dollar, the British Pound, the Euro and the Korean Won). These exposures may change as we change the geographic mix of our global business and as our business practices evolve. Currencies may be affected by internal factors as well as developments globally and in other countries. Any increase in our presence in emerging markets, may see an increase in our exposure to emerging market currencies, such as the Indian Rupee and Brazilian Real.

To manage the risk from fluctuations in foreign currency exchange rates and interest rates, we had entered into various derivative hedging transactions in accordance with our policies and procedures. However, as a result of our Creditor Protection Proceedings, the financial institutions that were our counterparties in these transactions have terminated the related instruments. Consequently, we are now fully exposed to these risks and expect to remain so exposed at least until the conclusion of the Creditor Protection Proceedings. Fluctuations in these or other rates could have an adverse effect on our business, results of operations and financial condition. Similarly, our debt is subject to changes in fair value resulting from changes in market interest rates. Even if these instruments continued to be available to us, if they do not meet the hedge effectiveness designation criteria prescribed by certain accounting rules, or if we choose not to pursue such designation, changes in the fair value of the hedge could result in volatility to our statement of operations or have a negative effect on our results of operations.

Our business may suffer if our strategic alliances are terminated or are not successful.

We have a number of strategic alliances with suppliers, developers and members of our industry to facilitate product compatibility, encourage adoption of industry standards or to offer complementary product or service offerings to meet customer needs, including our joint venture with LGE and our alliances with Microsoft and IBM. We believe that cooperation between multiple vendors is critical to the success of our communications solutions for both service providers and enterprises. In some cases, the companies with which we have strategic alliances also compete against us in some of our business areas. If a member of a strategic alliance fails to perform its obligations, if the relationship fails to develop as expected or if the relationship is terminated, we could experience delays in product availability or impairment of our relationships with our customers. Our business may also be adversely affected if our choice of strategic alliance collaborators does not enable us to leverage our existing and future product and service offerings in order to capitalize on expected future market trends (such as convergence in the enterprise market). Furthermore, the uncertainty caused by the Creditor Protection Proceedings could further impact our ability to maintain current relationships with suppliers, developers, reseller partners, joint venture partners and strategic alliance partners.

 

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Our performance may be materially and adversely affected if our expectations regarding market demand for particular products prove to be wrong.

We expect that data communications traffic will grow at a faster rate than the growth expected for voice traffic and that the use of the Internet will continue to increase. We expect that this in turn will lead to the convergence of data and voice through either upgrades of traditional voice networks to transport large volumes of data traffic or the construction of new networks designed to transport both voice and data traffic. Either approach would require significant capital expenditures by service providers.

The demand for certain technologies may be lower than we currently expect or may increase at a slower pace than we currently anticipate. On a regional basis, growth of our revenues from sales of our networking solutions in developing countries, such as China and India, may be less than we anticipate if current customer demand does not translate into future sales, we are unable to establish strategic alliances in key markets or developing countries experience slower growth or fewer deployments of VoIP and wireless data networks than we anticipate.

The market may also develop in an unforeseen direction. Certain events, including the commercial availability and actual implementation of new technologies, or the evolution of other technologies, may occur, that would affect the extent or timing of anticipated market demand, or increase demand for products based on other technologies, or reduce the demand for those technologies we have invested in. Any such change in demand may reduce purchases of our products by our customers, require increased or more rapid expenditures to develop and market different technologies, or provide market opportunities for our competitors.

Certain key and new product evolutions are based on different or competing standards and technologies. There is a risk that the proposals we endorse and pursue may not evolve into an accepted market standard or sufficient active market demand.

If our expectations regarding market demand and direction are incorrect, or the rate of development or acceptance of our next-generation solutions does not meet market demand and customer expectation, or, if sales of our traditional circuit switching solutions decline more rapidly than we anticipate, or if the rate of decline continues to exceed the rate of growth of our next-generation solutions, or if our next-generation solutions are less profitable than the traditional solutions that they replace, it could materially and adversely affect our business, results of operations and financial condition. Furthermore, these risks could be exacerbated by current economic conditions and uncertainty resulting from the Creditor Protection Proceedings.

If we fail to protect our intellectual property rights, or if we are subject to adverse judgments or settlements arising out of disputes regarding intellectual property rights, our business, results of operations and financial condition could be materially and adversely affected.

Our proprietary technology is very important to our business. We rely on patent, copyright, trademark and trade secret laws to protect that technology. Our business is global, and the extent of that protection varies by jurisdiction. The protection of our proprietary technology may be challenged, invalidated or circumvented, and our intellectual property rights may not be sufficient to provide us with competitive advantages.

In particular, we may not be successful in obtaining any particular patent. Even if issued, future patents or other intellectual property rights may not be sufficiently broad to protect our proprietary technology. Competitors may misappropriate our intellectual property, disputes as to ownership may arise, and our intellectual property may otherwise fall into the public domain or similar intellectual property may be independently developed by competitors reducing the competitive benefits of our intellectual property.

Claims of intellectual property infringement or trade secret misappropriation may also be asserted against us, or against our customers in connection with their use of our products or our intellectual property rights may be challenged, invalidated or circumvented, or fail to provide significant competitive advantages. We believe that intellectual property licensed from third parties will remain available on commercially reasonable terms in such cases, however there can be no assurance such rights will be available on such terms and an inability to license such rights could have a material adverse effect on our business. An unfavorable outcome in such a claim could require us to cease offering for sale the products that are the subject of such a claim, pay substantial monetary damages to a third party, make ongoing royalty payments to a third party and indemnify our customers.

Defense or assertion of claims of intellectual property infringement or trade secret misappropriation may require extensive participation by senior management and other key employees and may reduce their time and ability to focus on other aspects of our business. Successful claims of intellectual property infringement or other intellectual property claims against us or our customers, or a

 

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failure by us to protect our proprietary technology, could have a material adverse effect on our business, results of operations and financial condition.

Defects, errors or failures in our products could result in higher costs than we expect and could harm our reputation and adversely affect our business, results of operations and financial condition.

Our products are highly complex, and some of them can be fully tested only when deployed in telecommunications networks or with other equipment. From time to time, our products have contained undetected defects, errors or failures. The occurrence of defects, errors or failures in our products could result in cancellation of orders and product returns, and the loss of or delay in market acceptance of our products, loss of sales and increased operating or support costs. Further, our customers or our customers’ end users could bring legal actions against us, which may be stayed during the Creditor Protection Proceedings, resulting in the diversion of our resources, legal expenses and judgments, fines or other penalties or losses. Any of these occurrences could adversely affect our business, results of operations and financial condition.

We record provisions for estimated costs related to product warranties given to customers to cover defects. These provisions are based in part on historical product failure rates and costs. See “Application of Critical Accounting Policies and Estimates — Provisions for Product Warranties” in the MD&A section of this report. If actual product failure rates or materials replacement, labor or servicing costs are greater than our estimates, our gross margin could be negatively affected.

We face significant emerging and existing competition, may not be able to maintain our market share and may suffer from competitive pricing practices.

We operate in a highly volatile industry that is characterized by industry rationalization and consolidation (both in our competitors and our larger customers), vigorous competition for market share and rapid technological development. Competition is heightened in periods of slow or very limited overall market growth and has been impacted by the adverse conditions in the financial markets globally and, in particular, due to the uncertainties arising from our Creditor Protection Proceedings. These factors could result in aggressive pricing practices and growing competition from smaller niche companies and established competitors, as well as well-capitalized computer systems and communications companies that, in turn, could separately or together with consolidation in the industry have a material adverse effect on our gross margins. These competitors may also seek to capitalize on any opportunities presented during the Creditor Protection Proceedings to enhance their business at our expense. Customers may seek to do business with other vendors that can offer more financial stability that would help to assure them of the availability of future upgrades and support. Increased competition could result in price reductions, negatively affecting our operating results and reducing margins, and could potentially lead to a loss of market share.

The more traditional distinctions between communications equipment providers, computer hardware and software providers and service and solutions companies are blurring with increasing competition between these entities and yet we believe that to be successful going forward it will be increasingly necessary for companies to partner with others in this group in order to offer an integrated and broader based solution. As such distinctions blur, there are new opportunities but increasing uncertainty and risk, including the potential that regulatory decisions or other factors may affect customer spending decisions.

Since some of the markets in which we compete are characterized by the potential for rapid growth and, in certain cases, low barriers to entry and rapid technological changes, smaller, specialized companies and start-up ventures are now, or may in the future become, our principal competitors. In particular, we currently, and may in the future, face increased competition from low cost competitors and other aggressive entrants in the market seeking to grow market share.

Some of our current and potential competitors may have substantially greater marketing, technical and financial resources than we do, including access to the capital markets. These competitors may have a greater ability to provide customer financing in connection with the sale of products and may be able to accelerate product development or engage in aggressive price reductions or other competitive practices, all of which could give them a competitive advantage over us. Our competitors may enter into business combinations or other relationships to create even more powerful, diversified or aggressive competitors.

We may also face competition from the resale of used telecommunications equipment, including our own, by failed, downsized or consolidated high technology enterprises and telecommunications service providers.

Rationalization and consolidation among our customers may lead to increased competition and harm our business.

 

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Continued rationalization and consolidation among our customers could result in our dependence on a smaller number of customers, purchasing decision delays and reductions by the merged companies and our playing a lesser role, or no longer playing a role, in the supply of communications products to the merged companies, and downward pressure on pricing of our products. This rationalization and consolidation could also cause increased competition among our customers and pressure on the pricing of their products and services, which could cause further financial difficulties for our customers and result in reduced spending. Some of our customers have experienced financial difficulty and have filed, or may file, for bankruptcy protection or may be acquired by other industry participants. A rationalization of customers could also increase the supply of used communications products for resale, resulting in increased competition and pressure on the pricing for our new products.

We operate in highly dynamic and volatile industries. If we are unable to develop new products rapidly and accurately predict, or effectively react to, market opportunities, our ability to compete effectively in our industry, and our sales, market share and customer relationships, could be materially and adversely affected.

We operate in highly dynamic and volatile industries. The markets for our products are characterized by rapidly changing technologies, evolving industry standards and customer demand, frequent new product introductions, potential for short product life cycles and, more recently, the convergence of networking and software. Our success and our ability to emerge from the Creditor Protection Proceedings depends, in substantial part, on the timely and successful introduction of timely, cost competitive, innovative and high quality new products and upgrades to replace our legacy products with declining market demand, as well as cost reductions on current products to address the operational speed, bandwidth, efficiency and cost requirements of our customers. Our success will also depend on our ability to comply with emerging industry standards, to sell products that operate with products of other suppliers, to integrate, simplify and reduce the number of software programs used in our portfolio of products, to anticipate and address emerging market trends, to provide our customers with new revenue-generating opportunities and to compete with technological and product developments carried out by others.

The timely development of new, technologically advanced products requires maintaining financial flexibility to react to changing market conditions and significant R&D commitments, as well as the accurate anticipation of technological and market trends. Investments in this environment may result in our R&D and other expenses growing at a faster rate than our revenues, particularly since the initial investment to bring a product to market may be high or market trends could change unexpectedly. We may be unable to continue R&D investment to the same extent and we may not be successful in targeting new market opportunities, in developing and commercializing new products in a timely manner or in achieving market acceptance for our new products, particularly given the limitations imposed as a result of the Creditor Protection Proceedings.

If we fail to respond in a timely and effective manner to unanticipated changes in one or more of the technologies affecting telecommunications and data networking, or our new products or product enhancements fail to achieve market acceptance, our ability to compete effectively in our industry; our sales, market share and customer relationships; and our ability to emerge from the Creditor Protection Proceedings could be materially and adversely affected.

If we fail to manage the higher operational and financial risks associated with our international operations, it could have a material adverse effect on our business, results of operations and financial condition.

We operate in international and emerging markets. In many international markets, long-standing relationships between potential customers and their local suppliers and protective regulations, including local content requirements and approvals, create barriers to entry. In addition, pursuing international opportunities may require significant investments for an extended period before returns on those investments, if any, are realized, which may result in expenses growing at a faster rate than revenues. Furthermore, those opportunities could be adversely affected by, among other factors: reversals or delays in the opening of foreign markets to new competitors or the introduction of new technologies into those markets; a challenging pricing environment in highly competitive new markets; exchange controls; restrictions on repatriation of cash; nationalization or regulation of local industry; economic, social and political risks; taxation; challenges in staffing and managing international opportunities; and acts of war or terrorism.

Difficulties in foreign financial markets and economies and of foreign financial institutions, particularly in emerging markets, could adversely affect demand from customers in the affected countries. An inability to maintain our business in international and emerging markets while balancing the higher operational and financial risks associated with these markets could have a material adverse effect on our business, results of operations and financial condition.

If we are unable to maintain the integrity of our information systems, our business and future prospects may be harmed.

 

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We rely on the security of our information systems, among other things, to protect our proprietary information and information of our customers. If we do not maintain adequate security procedures over our information systems, we may be susceptible to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems to access our proprietary information or that of our customers. Even if we are able to maintain procedures that are adequate to address current security risks, hackers or other unauthorized users may develop new techniques that will enable them to successfully circumvent our current security procedures. The failure to protect our proprietary information could seriously harm our business and future prospects or expose us to claims by our customers, employees or others that we did not adequately protect their proprietary information.

Changes in regulation of the Internet or other regulatory changes may affect the manner in which we conduct our business and may materially and adversely affect our business, operating results and financial condition.

The telecommunications industry is highly regulated by governments around the globe, although market-based reforms are taking place in many countries. Changes in telecommunications regulations, product standards and spectrum availability, or other industry regulation in any country in which we or our customers operate could significantly affect demand for and the costs of our products. For example, regulatory changes could affect our customers’ capital spending decisions, increase competition among equipment suppliers or increase the costs of selling our products, any of which could have a material adverse effect on our business, results of operation and financial condition.

We are subject to various product content laws and product takeback and recycling requirements that will require full compliance in the coming years. As a result of these laws and requirements, we will incur additional compliance costs. See “Environmental Matters” in the Legal Proceedings section of this report. Although compliance costs relating to environmental matters have not resulted in a material adverse effect on our business, results of operations and financial condition in the past, they may result in a material adverse effect in the future. If we cannot operate within the scope of those laws and requirements, we could be prohibited from selling certain products in the jurisdictions covered by such laws and requirements, which could have a material adverse effect on our business, results of operations and financial condition.

Our risk management strategy may not be effective or commensurate to the risks we are facing.

We maintain global blanket policies of insurance of the types and in the amounts of companies of the same size and in the same industry. We have retained certain self-insurance risks with respect to certain employee benefit programs such as worker’s compensation, group health insurance, life insurance and other types of insurance. Our risk management programs and claims handling and litigation processes utilize internal professionals and external technical expertise. If this risk management strategy is not effective or is not commensurate to the risks we are facing, these risks could have a material adverse effect on our business, results of operations, financial condition and liquidity.

We may be required to pay significant penalties or liquidated damages, or our customers may be able to cancel contracts, in the event that we fail to meet contractual obligations including delivery and installation deadlines, which could have a material adverse effect on our revenues, operating results, cash flows and relationships with our customers.

Some of our contracts with customers contain delivery and installation timetables, performance criteria and other contractual obligations which, if not met, could result in our having to pay significant penalties or liquidated damages and the termination of the contract. Our ability to meet these contractual obligations is, in part, dependent on us obtaining timely and adequate component parts, products and services from suppliers and contract manufacturers. Because we do not always have parallel rights against our suppliers, in the event of delays or failures to timely provide component parts and products, such delays or failures could have a material adverse effect on our revenues, operating results, cash flows and relationships with our customers.

Other Risks Relating to Our Liquidity, Financing Arrangements and Capital

We may need to make larger contributions to our defined benefit plans in the future, which could have a material adverse impact on our liquidity and our ability to meet our other obligations.

We currently maintain various defined benefit plans in North America and the U.K. covering various categories of employees and retirees, which represent our major retirement plans. In addition, we have smaller retirement plans in other countries. Effective January 1, 2008, accrual for service was discontinued under our North American defined benefit plans. In November 2006, we reached an agreement with the Trustee of our pension plan in the U.K. that had set the levels of contribution through April 2012. Currently, as a result of the U.K. Administration Proceedings, following our latest contribution in January, all further contributions to

 

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our U.K. defined benefit pension plan have ceased pursuant to the direction of the U.K. Administrators. Our obligations to make contributions to fund benefit obligations under these plans are based on actuarial valuations, which themselves are based on certain assumptions about the long-term operation of the plans, including employee turnover and retirement rates, the performance of the financial markets and interest rates. If future trends differ from the assumptions, the amounts we are obligated to contribute to the plans may increase. If the financial markets perform lower than the assumptions, we may have to make larger contributions in the future than we would otherwise have to make and expenses related to defined benefit plans could increase. Also, if interest rates are lower in the future than we assume they will be, we may be required to make larger contributions than we would otherwise have to make.

In the second half of 2008, we experienced a significant decline in the value of the assets held in our pension plans due to the adverse conditions in the equity markets globally. As a result, the unfunded status of our defined benefit plans and post-retirement plans as at December 31, 2008, increased. Therefore, we may be required to make larger contributions to our defined benefit plans in the future. However, as a result of the Creditor Protection Proceedings, our current expectation on pension plan funding in 2009 is subject to change and funding beyond 2009 is uncertain at this time. If we are required to make significantly larger contributions, reported results could be materially and adversely affected and our cash flow available for other uses may be significantly reduced.

Our high level of debt could materially and adversely affect our business, results of operations, financial condition and liquidity.

In order to finance our business, we have incurred significant levels of debt. A high level of debt, arduous or restrictive terms and conditions related to accessing certain sources of funding, or any significant reduction in, or access to, the EDC Support Facility, could place us at a competitive disadvantage compared to competitors that have less debt and could materially and adversely affect our ability to: fund the operations of our business; borrow money in the future or access other sources of funding; and maintain our flexibility in planning for or reacting to economic downturns, adverse industry conditions and adverse developments in our business; and our ability to withstand such events and to successfully develop, obtain approval for and implement a comprehensive restructuring plan. As a result of the Creditor Protection Proceedings, we have no access to capital markets and may have no access to debtor-in-possession financing arrangements or other sources of funding.

 

ITEM 1B.

Unresolved Staff Comments

None.

 

ITEM 2.

Properties

In 2008, we continued to reduce the size of our facilities as part of the square footage reduction program associated with our 2007 and 2008 Business Transformation plans, vacating approximately 600,000 square feet of operating space. In addition, we fully disposed of another 600,000 square feet of space, eliminating any direct or contingent liability with respect to that space. We sold our ownership position in our Campinas, Brazil location which will be relocating to San Paulo, netting $11 of proceeds. During 2009, we plan to vacate an additional 300,000 square feet and fully dispose of 600,000 square feet. In addition, in connection with our Creditor Protection Proceedings, we are considering rejecting, repudiating or terminating certain leases so as to vacate additional leased properties, and selling additional Nortel-owned sites. For further information see “Results of Operations — Special Charges” in the MD&A section of this report.

We believe that the facilities we will retain will be suitable, adequate and sufficient to meet the needs of the Company while operating in Creditor Protection Proceedings. Most sites are used by multiple business segments for various purposes. As of December 31, 2008, estimated facilities use by segment was 31% Carrier Networks, 21% Enterprise Solutions, 12% MEN, 17% Global Services, and 19% one or more segments and/or corporate facilities. As of December 31, 2008, we operated 189 sites occupying approximately 10.7 million square feet.

 

Type of Site*

   Number
Owned
   Number
Leased
  

Geographic Locations

Manufacturing and repair**

   4    1   

EMEA, CALA and the Asia region

Distribution centers

   —      7   

U.S., EMEA, CALA and the Asia region

Offices (administration, sales and field service)

   2    165   

All geographic regions

Research and development

   3    7   

U.S., Canada, EMEA and the Asia region

            

TOTAL***

   9    180   
            

 

 

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*

Indicates primary use. A number of sites are mixed-use facilities.

 

**

Manufacturing sites in China and Thailand are operated by Nortel joint ventures. The site in China is owned pursuant to land use rights granted by Chinese authorities. Small amounts of integration and test activity are conducted by Nortel in Northern Ireland, Brazil and Turkey.

 

***

Excludes approximately 4.2 million square feet designated as part of planned square footage reduction programs, of which approximately 2.7 million square feet was sub-leased.

In connection with the Creditor Protection Proceedings, the Canadian Debtors have granted a charge against some or all of our and their assets and any proceeds from any sales thereof, as follows and in the following priority:

 

 

 

First, the administration charge, in an amount not to exceed CAD$5 in favor of the Canadian Monitor and its counsel and counsel to the Canadian Debtors against all of the property of the Canadian Debtors, to secure payment of professional fees and disbursements before and after the Petition Date;

 

 

 

Second, the Carling facility charges, in favor of NNI as security for amounts owed by NNL and Nortel Networks Technology Corporation (NNTC) to NNI with respect to a post-Petition Date intercompany revolving loan agreement, against the fee simple interest of NNTC and the leasehold interest of NNL in the real property located at 3500 Carling Avenue, Labs 1-10, Ottawa, Ontario, such charge not to exceed the amount of any such loan plus related interest and fees;

 

 

 

Third, the EDC charge, in favor of EDC against all of the property of the Canadian Debtors as security for new support provided by EDC to NNL under the EDC Support Facility including increases in or renewals or extensions of support existing on the Petition Date;

 

 

 

Fourth, the directors’ charge, against all property of the Canadian Debtors in an amount not exceeding CAD$90, as security for their obligation to indemnify their respective directors and officers for all claims that may be made against them relating to any failure of the Canadian Debtors to comply with certain statutory payment and remittance obligations arising during the CCAA Proceedings, and related legal fees and expenses.

 

 

 

Fifth, the intercompany charge, in favor of any U.S. Debtor that has made or may make a post-Petition Date intercompany loan or other transfer (including of goods or services) to one or more of the Canadian Debtors (including amounts owed by NNL to NNI on the Petition Date under a certain intercompany loan agreement) against the property of the Canadian Debtor that receives such loan or transfer, to secure payments or repayments relating thereto, such charge not to exceed the amount of any such loan or transferred goods or services, plus related interest and fees.

In conjunction with the Creditor Protection Proceedings, we established the D&O Trust in the amount of approximately CAD$12. Its purpose is to provide a trust fund for payment of liability claims (including defense costs) that may be asserted against individuals relating to their service as directors and officers of Nortel entities or joint ventures, to the extent not paid by insurance maintained by us and we are unable to indemnify the individual. Such claims would include claims for unpaid statutory payment or remittance of our obligations or those of such other entities for which such directors and officers have personal liability, to the extent such indemnity is not prohibited by law. The D&O Trust may also be used to maintain directors’ and officers’ insurance in the event NNC fails or refuses to do so.

As a result of the Creditor Protection Proceedings, we are in default with respect to certain contracts, including without limitation certain capital leases of personal property, and certain leases of real property. However, also as a result of the Creditor Protection Proceedings, we believe that all actions against us have been stayed. We may seek to reject, repudiate or terminate certain burdensome contracts as well as leases in connection with our comprehensive restructuring plan.

 

ITEM 3.

Legal Proceedings

Creditor Protection Proceedings: As discussed in “Executive Overview—Creditor Protection Proceedings” in the MD&A section of this report, on January 14, 2009, the Canadian Debtors obtained an order from the Canadian Court for creditor protection and

 

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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. 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.

Global Class Action Settlement: NNC entered into agreements to settle two significant U.S. and all but one Canadian class action lawsuits (Global Class Action Settlement) which became effective on March 20, 2007 following approval of the agreements by the appropriate courts. Administration of the settlement claims is now substantially complete. As of December 31, 2008, almost all of the NNC common shares issuable in accordance with the settlement had been distributed to claimants and plaintiffs’ counsel, most of them in the second quarter of 2008. The cash portion of the settlement has been distributed by the claims administrator to the approved claimants, net of an amount held in reserve by the claims administrator to cover contingencies and certain settlement costs. The settlement also requires that we contribute to the plaintiffs one-half of any recovery from our litigation referenced below against certain of our former senior officers who were terminated for cause in 2004.

U.S. federal grand jury subpoenas: In May 2004 and August 2005, NNC received federal grand jury subpoenas for the production of certain documents in connection with a criminal investigation being conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division. NNC understands that this investigation of NNI and certain former employees has been concluded, and we have been advised that no criminal charges will be filed in the U.S. in connection with this matter.

RCMP charges against former executives: On June 19, 2008, the Royal Canadian Mounted Police (RCMP) announced that it had filed criminal charges against three of our former executives: Frank Dunn, Douglas Beatty and Michael Gollogly. The fraud-related charges include: fraud affecting the public market, falsification of books and documents, and false prospectus. These charges pertain to allegations of criminal activity within Nortel by these former executives during 2002 and 2003. No criminal charges were filed against us, and we are not the target of an investigation by the RCMP.

ERISA lawsuit: Beginning in December 2001, NNC, together with certain of our then-current and former directors, officers and employees, were named as a defendant in several purported class action lawsuits pursuant to the United States Employee Retirement Income Security Act. 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.

Canadian pension class action: On June 24, 2008, a purported class action lawsuit was filed against us and NNC in the Ontario Superior Court of Justice in Ottawa, Canada alleging, among other things, that certain recent changes related to our 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.

Ontario proposed derivative action: In December 2005, an application was filed in the Ontario Superior Court of Justice for leave to commence a shareholders’ derivative action on our behalf against certain of our then-current and former officers and directors. The derivative action alleges, among other things, breach of fiduciary duties, breach of duty of care and negligence, and unjust enrichment in respect of various alleged acts and omissions. If the application is granted, the proposed derivative action would seek on our behalf, among other things, compensatory damages of CAD$1,000 and punitive damages of CAD$10 from the individual defendants. The proposed derivative action would also seek an order directing our Board of Directors to reform and improve our corporate governance and internal control procedures as the court may deem necessary or desirable, and an order that we pay the legal fees and other costs in connection with the proposed derivative action. The application for leave to commence this action has not yet been heard.

 

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Shareholder statement of claim against Deloitte & Touche LLP: On February 8, 2007, a Statement of Claim was filed in the Ontario Superior Court of Justice in the name of Nortel and NNC against Deloitte & Touche LLP. The action was commenced by three shareholders without leave, and without our knowledge or authorization. The three have indicated that they filed the action in anticipation of bringing an application for leave to commence a derivative action on behalf of Nortel against Deloitte under the Canada Business Corporations Act (CBCA), and that the three shareholders would be seeking leave on a retroactive basis to authorize their action. The claim alleges, among other things, breach of contract, negligence, negligent misrepresentation, lack of independence, and breach of fiduciary duty. The claim seeks damages and other relief on our behalf, including recovery of payments that we made to class members as part of the Global Class Action Settlement. The Litigation Committee of our Board of Directors has reviewed the matter and has advised the law firm pursuing the derivative action of our position on the proposed claim. On February 6, 2008, an application was filed by the three shareholders for leave to commence a derivative action in the name of Nortel against Deloitte.

Nortel statement of claim against its former officers: In January 2005, we and NNC filed a Statement of Claim in the Ontario Superior Court of Justice against Messrs. Frank Dunn, Douglas Beatty and Michael Gollogly, our former senior officers who were terminated for cause in April 2004, seeking the return of payments made to them under our bonus plan in 2003. One-half of any recovery from this litigation is subject to the Global Class Action Settlement referenced above.

Former officers’ statements of claims against Nortel: In April 2006, Mr. Dunn filed a Notice of Action and Statement of Claim in the Ontario Superior Court of Justice against us and NNC 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 us and NNC seeking an order that, pursuant to our bylaws, we 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 us and NNC asserting claims for, among other things, wrongful dismissal and seeking compensatory, aggravated and punitive damages, and pre-and post-judgment interest and costs.

Ipernica: In June 2005, Ipernica Limited (formerly known as QSPX Development 5 Pty Ltd), an Australian patent holding firm, filed a lawsuit against NNC in the U.S. District Court for the Eastern District of Texas alleging patent infringement. In April 2007, the jury reached a verdict to award damages to Ipernica in the amount of $28. In March 2008, NNC entered into an agreement to settle all claims, which grants to us a perpetual, world-wide license to various Ipernica patents, and includes a covenant not to sue as well as mutual releases. In connection with this settlement, a payment of $12 was made by NNI to Ipernica in the first quarter of 2008.

Except as otherwise described herein, in each of the matters described above, the plaintiffs are seeking an unspecified amount of monetary damages. We are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to us 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. We cannot determine whether these actions, suits, claims and proceedings will, individually or collectively, have a material adverse effect on our business, results of operations, financial condition or liquidity. Except for matters encompassed by the Ipernica settlement, we intend to defend the above actions, suits, claims and proceedings in which we are a defendant, litigating or settling cases where in management’s judgment it would be in the best interest of shareholders to do so. We will continue to cooperate fully with all authorities in connection with the regulatory and criminal investigations.

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

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 December 31, 2008, the accruals on the consolidated balance sheet for environmental matters were $11. Based on information available as of December 31, 2008, 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 and may be affected by our Creditor Protection Proceedings.

 

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We have remedial activities under way at 11 sites that are either currently or previously owned or occupied facilities. 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 $11.

We are also listed as a potentially responsible party under the U.S. Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) at four Superfund sites in the U.S. (At three of the Superfund sites, we are considered a de minimis potentially responsible party). A potentially responsible party within the meaning of CERCLA is generally considered to be a major contributor to the total hazardous waste at a Superfund site (typically 10% or more, depending on the circumstances). A de minimis potentially responsible party is generally considered to have contributed less than 10% (depending on the circumstances) of the total hazardous waste at a Superfund site. An estimate of our share of the anticipated remediation costs associated with such Superfund sites is expected to be de minimis and is included in the environmental accruals of $11 referred to above.

Liability under CERCLA may be imposed on a joint and several basis, without regard to the extent of our involvement. In addition, the accuracy of our estimate of environmental liability is affected by several uncertainties such as additional requirements which may be identified in connection with remedial activities, the complexity and evolution of environmental laws and regulations, and the identification of presently unknown remediation requirements. Consequently, our liability could be greater than its current estimate.

For a discussion of environmental matters, see note 21, “Contingencies” to the accompanying audited consolidated financial statements.

 

ITEM 4.

Submission of Matters to a Vote of Security Holders

None.

PART II

 

ITEM 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common shares are not listed and posted for trading on any stock exchange. NNC holds 100% of our issued and outstanding common shares. The NNC common shares are publicly traded on the TSX under the symbol “NT”, and have been quoted on the Pink Sheets Electronic Quotation Service, a centralized quotation service maintained by Pink Sheets LLC, under the symbol “NRTLQ”.

 

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ITEM 6.

Selected Financial Data (Unaudited)

The selected financial data presented below was derived from Nortel’s audited consolidated financial statements and related notes thereto included elsewhere in this 2008 Annual Report except for the summarized balance sheet data as of December 31, 2006, 2005 and 2004 and summarized results of operations data for the years ended December 31, 2005 and 2004.

 

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

   2008     2007     2006     2005     2004  

Results of Operations

          

Total revenues

   $ 10,421     $ 10,948     $ 11,418     $ 10,509     $ 9,478  

Research and development expense

     1,574       1,723       1,940       1,874       1,975  

Special charges

     302       210       105       169       181  

Shareholder litigation settlement expense (recovery)

     —         —         —         —         —    

Goodwill impairment

     2,202       —         —         —         —    

Operating earnings (loss)

     (2,029 )     224       65       (262 )     (269 )

Other income—net

     (1,917 )     216       64       160       130  

Income tax benefit (expense)

     (3,195 )     (1,114 )     (60 )     81       20  

Net earnings (loss) from continuing operations

     (7,386 )     (798 )     (41 )     (48 )     (154 )

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

     —         —         —         1       49  

Cumulative effect of accounting changes—net of tax

     —         —         9       —         —    

Net earnings (loss)

     (7,417 )     (840 )     (70 )     (73 )     (127 )
                                        

(Millions of U.S. Dollars)

   2008     2007     2006     2005     2004  

Financial Position as of December 31

          

Total assets

   $ 8,838     $ 17,973     $ 18,882     $ 17,932     $ 17,676  

Total debt(a)

     3,435       2,720       2,700       2,096       2,091  

Minority interests in subsidiary companies

     286       294       243       247       88  

Total shareholders’ equity (deficit)

     (2,315 )     6,010       5,893       5,633       5,949  

 

(a)

Total debt includes long-term debt, long-term debt due within one year and notes payable.

See notes 3, 7, 10, 17 and 21 to the accompanying audited consolidated financial statements for the impact of accounting changes, special charges, reclassifications, acquisitions, divestitures and closures, capital stock and the shareholder litigation settlement expense related to the Global Class Action Settlement, respectively, that affect the comparability of the above selected financial data. See note 1 for discussion regarding Nortel’s ability to continue as a going concern.

 

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ITEM 7.

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

TABLE OF CONTENTS

 

Executive Overview

   38

Results of Operations

   51

Segment Information

   62

Liquidity and Capital Resources

   70

Off-Balance Sheet Arrangements

   79

Application of Critical Accounting Policies and Estimates

   79

Accounting Changes and Recent Accounting Pronouncements

   96

Outstanding Share Data

   99

Market Risk

   99

Environmental Matters

   99

Legal Proceedings

   99

Cautionary Notice Regarding Forward-Looking Information

   99

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 Limited. The MD&A should be read in combination with our audited consolidated financial statements and the accompanying notes. All Dollar amounts in this MD&A are in millions of 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 about the operating environment, economies and markets in which we operate 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 in this annual report on Form 10-K for the year ended December 31, 2008 (2008 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. We are the principal direct operating subsidiary of Nortel Networks Corporation (NNC). NNC holds all of our outstanding common shares but none of our outstanding preferred shares.

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

Executive Overview

Creditor Protection Proceedings

We operate in a highly volatile telecommunications industry that is characterized by vigorous competition for market share and rapid technological development. In recent years, our operating costs have generally exceeded our revenues, resulting in negative cash flow. A number of factors have 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.

 

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In recent years, we have taken a wide range of steps to attempt to address these issues, including a series of restructurings that have 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. In particular, in 2005, under the direction of new management, we began to develop a Business Transformation Plan with the goal of addressing our most significant operational challenges, simplifying the organizational structure and maintaining a strong focus on revenue generation and improved operating margins including quality improvements and cost reductions. These actions have included: (i) the outsourcing of nearly all manufacturing and production to a number of key suppliers, including, in particular, Flextronics, (ii) the substantial consolidation of key research and development (R&D) expertise in Canada and China, (iii) decisions to dispose of or exit certain non-core businesses, such as our Universal Mobile Telecommunications System (UMTS) Access business unit, (iv) the creation and/or expansion of joint venture relationships (such as LG-Nortel Co. Ltd. (LG-Nortel) in Korea our joint venture with LG Electronics, Inc. (LGE) and our joint venture in China, Guangdong-Nortel Telecommunications Equipment Company Ltd., (v) establishing alliances with various large organizations such as Microsoft, IBM and Dell, (vi) real estate optimizations, including the sale of our former headquarters in Brampton, Ontario, Canada, and (vii) the continued reorientation of our business from a traditional supplier of telecommunications equipment to a focus on cutting-edge networking hardware and software solutions.

These restructuring measures, however, have not provided adequate relief from the significant pressures we are 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 potentially prolonged recessionary period have compounded the situation.

In addition, we have made significant cash payments related to our restructuring programs, the Global Class Action Settlement (as defined in the Legal Proceedings section of our 2008 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 has 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 put 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 recent 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.

After extensive consideration of all other alternatives, we determined, with the unanimous authorization of our Board of Directors after thorough consultation with our advisors, that a comprehensive financial and business restructuring could be most effectively and quickly achieved within the framework of creditor protection proceedings in multiple jurisdictions. As a consequence, on January 14, 2009 (Petition Date), we initiated creditor protection proceedings under the respective restructuring regimes of Canada, the respective restructuring regimes of Canada under the Companies’ Creditors Arrangement Act (CCAA) (CCAA Proceedings), in the U.S. under the Bankruptcy Code (Chapter 11 Proceedings), the United Kingdom (U.K.) under the Insolvency Act 1986 (U.K. Administration Proceedings), and subsequently, Israel (Israeli Proceedings). Our affiliates in Asia including LG-Nortel, in the Caribbean and Latin American (CALA) region, and the Nortel Government Solutions (NGS) business, are not included in these proceedings.

 

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NNC and Nortel initiated the Creditor Protection Proceedings (as defined below) with a consolidated cash balance, as at December 31, 2008, of $2,400, in order to preserve our liquidity and fund operations during the restructuring process. The Creditor Protection Proceedings will allow NNC and Nortel to reassess our business strategy with a view to developing a comprehensive financial and business restructuring plan (comprehensive restructuring plan) (also referred to as a “plan of reorganization” in the U.S., or a “plan of compromise or arrangement” in Canada).

“Debtors” as used herein means (i) us, together with Nortel Networks Corporation (NNC) 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) and certain other U.S. subsidiaries (U.S. Debtors) that filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware (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 English High Court of Justice (English Court), and (iv) certain Israeli subsidiaries that made consequential filings under the Israeli Companies Law 1999 in the District Court of Tel Aviv. The CCAA Proceedings, Chapter 11 Proceedings, U.K. Administration Proceedings and the Israeli Proceedings are together referred to as the Creditor Protection Proceedings.

CCAA Proceedings

On the Petition Date, the Canadian Debtors obtained an initial order from the Canadian Court for creditor protection for 30 days, pursuant to the provisions of the CCAA, which was subsequently extended to May 1, 2009 and is subject to further extension by the Canadian Court. 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 Canadian Monitor under the CCAA Proceedings (Canadian Monitor). The Canadian Monitor will 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 the Canadian Debtors on their development of a comprehensive restructuring plan and, to the extent required, assist the Canadian Debtors with a restructuring.

As a consequence of our commencement of the CCAA Proceedings, substantially all pending claims and litigation against the Canadian Debtors and their officers and directors have been stayed until May 1, 2009, or any further extended date as described above. 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, and as a result, substantially all pending claims and litigation against any of the Canadian Debtors operating in the U.S. also have been stayed.

The Canadian Court 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; charges against our and Nortel Networks Technology Corporation’s (NNTC) facility in Ottawa, Ontario; a charge in favor of Export Development Canada (EDC) for its continued support; a charge to support an indemnity for the directors and officers of the

 

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Canadian Debtors relating to certain claims that may be made against them in such role as further described below; and an intercompany charge in favor of any U.S. Debtor that loans or transfers money, goods or services to a Canadian Debtor. For more information, see the Properties section of our 2008 Annual Report.

Chapter 11 Proceedings

Also on the Petition Date, the U.S. Debtors filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code 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 and transition into the Chapter 11 process with as little disruption to their businesses as possible. Among other things, the U.S. Debtors received approval to continue paying employee wages and certain benefits in the ordinary course; to generally continue our cash management system, including 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.

As required under the U.S. Bankruptcy Code, on January 22, 2009, the United States Trustee for the District of Delaware appointed the U.S. Creditors’ Committee as the official committee of unsecured creditors, which currently includes The Bank of New York Mellon, Flextronics Corporation, Airvana, Inc., Pension Benefit Guaranty Corporation 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 or on any comprehensive restructuring plan, once developed and proposed. In addition, a group purporting to hold substantial amounts of our publicly traded debt has organized (the Bondholder Group). The role of the Bondholder Group in the Chapter 11 Proceedings and the CCAA Proceedings has not yet been formalized and may develop and change over the course of such proceedings. Disagreements between the Debtors and the U.S. Creditors’ Committee and the Bondholder Group could protract the Creditor Protection Proceedings, negatively impact the Debtors’ ability to operate and delay the Debtors’ emergence from the Creditor Protection Proceedings.

As a consequence of our commencement of the Chapter 11 Proceedings, 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, NNI 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.

U.K. 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 applications were made by the EMEA Debtors under the provisions of the European Union’s Council Regulation (EC) No 1346/2000 on creditor protection proceedings and on the basis that each EMEA Debtor’s center of main interests is in England. 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 our 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 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 administration orders provide 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. As well, certain of our Israeli subsidiaries have commenced a separate creditor protection process in Israel.

 

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Business Operations

During the Creditor Protection Proceedings, the businesses of the Debtors continue to operate under the jurisdictions and orders of the applicable courts and in accordance with applicable legislation.

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 decide whether an EMEA Debtor should perform under a contract on the basis of whether it is in the interests of the administration to do so. Any claims which result from an EMEA Debtor rejecting or repudiating any contract or arrangement will usually be unsecured. Claims may arise as a result of a Debtor rejecting or repudiating any contract or arrangement.

The accompanying audited consolidated financial statements do not include the effects 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. As of the date of the filing of our 2008 Annual Report, it is not possible to determine the extent of claims filed and to be filed, whether such claims will be disputed and whether they will be subject to discharge in the Creditor Protection Proceedings. It is also not possible at this time to determine whether to establish any additional liabilities in respect of claims. The Debtors are beginning to review all claims filed and are beginning the claims reconciliation process.

On February 23, 2009, the U.S. Court authorized the U.S. Debtors to reject certain unexpired leases of non-residential real property and related subleases as of February 28, 2009.

Comprehensive Restructuring Plan

The Creditor Protection Proceedings will allow us to reassess our business strategy with a view to developing a comprehensive restructuring plan.

We are in the process of stabilizing our business to maximize the chances of preserving all or a portion of the enterprise and evaluating our various operations to determine how to narrow our strategic focus in an effective and timely manner, in consultation with our business and financial advisors. While we undertake this process, our previously announced intention to explore the divestiture of our Metro Ethernet Networks (MEN) business has been put on hold. We have also decided to discontinue our mobile Worldwide Interoperability for Microwave Access (WiMAX) business and sell our Layer 4-7 data portfolio (see below). Further, we will be significantly reducing our investment in our Carrier Ethernet switch/router (CESR) portfolio, while continuing to ship products and support our installed base of Carrier Ethernet customers. We will continue to utilize our carrier Ethernet technology in our other MEN and other solutions. The Creditor Protection Proceedings and the development of a comprehensive restructuring plan may result in additional sales or divestitures, but we can provide no assurance that we will be able to complete any 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 and EMEA Debtors can generally take similar actions with the approval of the Canadian Monitor and the U.K. Administrators, respectively. As we work on developing a comprehensive restructuring plan, we will consult with the Canadian Monitor, the U.K. Administrators and the U.S. Creditors’ Committee, and any such plan would eventually be subject to the approval of affected creditors and the relevant courts. There can be no assurance that any such plan will be confirmed or approved by any of the relevant courts or affected creditors, or that any such plan will be implemented successfully.

 

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Export Development Canada Support Facility; Other Contracts and Debt Instruments

Effective January 14, 2009, NNL entered into an agreement with EDC to permit continued access by NNL to the EDC support facility, which provides for the issuance of support in the form of guarantee bonds or guarantee type documents to financial institutions that issue letters of credit or guarantee, performance or surety bonds, or other instruments in support of Nortel’s contract performance (EDC Support Facility) for an interim period to February 13, 2009, for up to $30 of support based on our then-estimated requirements over the period. On February 10, 2009, EDC agreed to extend this interim period to May 1, 2009. This support is secured by a charge on the Canadian Debtors’ assets. See the Properties section of our 2008 Annual Report. We and EDC continue to work together to see if a longer term arrangement, acceptable to both parties, can be reached.

Our filings under Chapter 11 of the U.S. Bankruptcy Code 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 May 1, 2009. 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 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 unenforcable 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 we had entered into an amendment to arrangements with a major supplier, Flextronics Telecom Systems, Ltd. (Flextronics). Under the terms of the amendment, we 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 has 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 will continue in accordance with their terms. We believe our arrangements with Flextronics are subject to the initial order granted by the Canadian Court that stays our suppliers from terminating their agreements with us. We continue to work with Flextronics throughout this process.

Listing and Trading of NNC Common Shares and NNL Preferred Shares

On January 14, 2009, NNC received notice from the New York Stock Exchange (NYSE) that it decided to suspend the listing of NNC common shares on the NYSE. 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 NYSE. NNC common shares are currently quoted on the Pink Sheets under the symbol “NRTLQ”.

 

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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.

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.

While we are under the Creditor Protection Proceedings, investments in our securities will be highly speculative. NNC common shares and NNL preferred shares may have little or no value and there can be no assurance that they will not be cancelled pursuant to the comprehensive restructuring plan.

Termination of Hedging Activity

To manage the risk from fluctuations in interest rates and foreign currency exchange rates, we had entered into various derivative hedging transactions in accordance with its policies and procedures. However, as a result of the Creditor Protection Proceedings, the financial institutions that were counterparties in respect of these transactions have terminated the related instruments. Consequently, we are now fully exposed to these interest rate and foreign currency risks and are expected to stay exposed at least until the conclusion of the Creditor Protection Proceedings.

Annual General Meeting of Shareholders

We and NNC 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 Canadian Court has ordered the Canadian Debtors to indemnify their respective directors and officers for all claims that may be made against them relating to any failure of the Canadian Debtors to comply with certain statutory payment and remittance obligations arising during the CCAA Proceedings. The Canadian Court has also granted a charge against all property of the Canadian Debtors, in the aggregate amount not exceeding CAD$90, as security for such indemnities and related legal fees and expenses.

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, including Nortel, 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.

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 any outstanding elections, during the period in which

 

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the directors continue as directors in the CCAA Proceedings. On the Petition Date, the Canadian Court granted an order providing that Nortel’s directors are entitled to receive remuneration in cash on a current basis at current compensation levels less an overall $25 thousand reduction notwithstanding the terms of, or elections made under, the DSC Plans.

Workforce Reduction Plan; Employee Compensation Program Changes

On February 25, 2009, we announced a workforce reduction plan. Under this plan, we intend to reduce our global workforce by approximately 5,000 net positions. These reductions include remaining restructuring actions previously announced as part of prior plans, namely plans to shift approximately 200 positions from higher-cost to lower-cost locations and approximately 1,800 remaining workforce reductions. We expect to implement these reductions over the next several months, in accordance with local country legal requirements. We are taking these initial steps as part of our efforts to develop a comprehensive restructuring plan under the Creditor Protection Proceedings. Given the Creditor Protection Proceedings, we have discontinued all remaining activities under our previously announced restructuring plans as of the Petition Date.

Upon completion, the plan is currently expected to result in annual gross savings of approximately $560, with total charges to earnings of approximately $270 and total cash outlays upon terminations of approximately $160. The charges and cash outlays are expected to be incurred in 2009. The current estimated charges are based upon accruing in accordance with requirements under applicable U.S. GAAP accounting literature. The current estimated total charges and cash outlays are subject to change as a result of the ongoing review of regional legislation. The current estimated total charges to earnings and cash outlays do not reflect any claim or contingency amounts that may be allowed under the Creditor Protection Proceedings and thus are subject to change as a result of the Creditor Protection Proceedings.

We also announced on February 25, 2009 several changes to our employee compensation programs. Upon the recommendation of management, our Board of Directors approved no payment of bonuses under the Nortel Annual Incentive Plan (Incentive Plan) for 2008. We will continue our Incentive Plan in 2009 for all eligible full- and part-time employees. The plan is being modified to permit quarterly rather than annual award determinations and payouts, if any. This will provide a more immediate incentive for employees upon the achievement of critical shorter-term corporate performance objectives, including specific operational metrics in support of customer service levels, as we work through the Creditor Protection Proceedings. We are seeking to implement, and request court approval where required, for retention and incentive compensation for certain key eligible employees deemed essential to the business while under court protection. On February 27, 2009, we filed a motion in the U.S. Court for approval of a key employee incentive and retention program. See “Key Executive Incentive Plan and Key Employee Retention Plan” in the Executive and Director Compensation section of our 2008 Annual Report.

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 the 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. No further equity will be awarded in 2009. See note 19, “Share-based compensation plans”, to the audited financial statements that accompany our 2008 Annual Report (2008 Financial Statements), for additional information about our equity-based compensation plans.

Basis of presentation and going concern issues

The accompanying audited consolidated financial statements have been prepared using the same U.S. GAAP and the rules and regulations of the U.S. Securities and Exchange Commission (SEC) as applied by us

 

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prior to the Creditor Protection Proceedings. While the Debtors have filed for and been granted creditor protection, the audited 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. The Creditor Protection Proceedings provide us with a period of time to stabilize our operations and financial condition and develop a comprehensive restructuring plan. Management believes that these actions make the going concern basis appropriate. However, it is not possible to predict the outcome of these proceedings and, as such, the realization of assets and discharge of liabilities are each subject to significant uncertainty. Accordingly, substantial doubt exists as to whether we will be able to continue as a going concern. Further, it is not possible to predict whether the actions taken in any restructuring will result in improvements to our financial condition sufficient to allow us to continue as a going concern. If the going concern basis is not appropriate, adjustments will be necessary to the carrying amounts and/or classification of assets and liabilities. Further, a comprehensive restructuring plan could materially change the carrying amounts and classifications reported in the audited consolidated financial statements. The accompanying audited consolidated financial statements do not reflect any adjustments related to conditions that arose subsequent to December 31, 2008.

For periods ending after the Petition Date, we will reflect adjustments to our financial statements in accordance with American Institute of Certified Public Accountants Statement of Position (SOP) No. 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (SOP 90-7), assuming that we will continue as a going concern. Accordingly, in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, liabilities and obligations whose treatment and satisfaction is dependent on the outcome of the Creditor Protection Proceedings will be segregated and classified as Liabilities Subject to Compromise in the consolidated balance sheet. The ultimate amount of and settlement terms for our pre-petition liabilities are dependent on the outcome of the Creditor Protection Proceedings and, accordingly, are not presently determinable. Pursuant to SOP 90-7, professional fees associated with the Creditor Protection Proceedings and certain gains and losses resulting from reorganization or restructuring of our business will be reported separately as reorganization items. In addition, interest expense will be reported only to the extent that it will be paid during the Creditor Protection Proceedings or that it is probable that it will be an allowed claim under the Creditor Protection Proceedings.

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 consolidated 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 consolidated 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.

Chief Restructuring Officer

On March 2, 2009, we announced the appointment of Pavi Binning as chief restructuring officer of Nortel and NNC, a position he will hold in addition to his existing duties as chief financial officer. He will continue to report to the president and chief executive officer (CEO).

 

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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 2008 Annual Report. For additional information on the Creditor Protection Proceedings, see note 1, “Creditor Protection and Restructuring”, to the 2008 Financial Statements. 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

We supply end-to-end networking products and solutions that help organizations enhance and simplify communications. These organizations range from small businesses to multi-national corporations involved in all aspects of commercial and industrial activity, to federal, state and local government agencies and the military. They include cable operators, wireline and wireless telecommunications service providers, and Internet service providers.

Our networking solutions include hardware and software products and services designed to reduce complexity, improve efficiency, increase productivity and drive customer value. We design, develop, engineer, market, sell, supply, license, install, service and support these networking solutions worldwide. We have technology expertise across carrier and enterprise, wireless and wireline, applications and infrastructure. We have made continued investment in technology R&D, and have had strong customer loyalty earned over more than 100 years of providing reliable technology and services.

We remain committed to integrity through effective corporate governance practices, maintaining effective internal control over financial reporting and an enhanced compliance function. We continue to focus on increasing employee awareness of ethical issues through various means such as on-line training and our Code of Business Conduct.

As of December 31, 2008, our four reportable segments were: Carrier Networks (CN), Enterprise Solutions (ES), Global Services (GS), and Metro Ethernet Networks (MEN):

 

 

 

The CN segment provides wireline and wireless networks 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. CN also 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.

 

 

 

The ES segment provides large and small businesses with reliable, secure and scalable communications solutions including unified communications, Ethernet routing and multiservice switching, IP (internet protocol) and digital telephony (including phones), wireless LANs (local area networks), security, IP and SIP (session initiation protocol) contact centers, self-service solutions, messaging, conferencing, and SIP-based multimedia solutions.

 

 

 

The GS segment provides services for carrier and enterprise customers, offering network implementation services; network support services including technical support, hardware maintenance, equipment spares logistics and on-site engineers; network managed services including monitoring and management of customer networks and hosted solutions; and network application services including applications development, integration and communications-enabled application solutions.

 

 

 

The MEN segment solutions are 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 multiservice switching products.

 

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As announced on November 10, 2008, effective January 1, 2009, we decentralized several corporate functions and transitioned to a vertically integrated business unit structure to give greater financial and operational control to the business units, increase accountability for overall performance, and reduce the duplication inherent in matrix organizations. Enterprise customers are served by a business unit responsible for product and portfolio development, R&D, marketing and sales, partner and channel management, strategic business development and associated functions. Service provider customers are served by two business units with full responsibility for all product, services, applications, portfolio, business and market development, marketing and R&D functions: CN (consisting of wireless and CVAS-carrier VoIP (voice over internet protocol), applications and solutions) and MEN. A dedicated global carrier sales organization supports both business units.

Our Global Services (GS) business unit will be decentralized and transitioned to the other business segments by April 1, 2009 to minimize any impact on our customer service activities. Commencing with the first quarter of 2009, we will begin to report LG-Nortel as a separate reportable segment. Prior to that time, the results of LG-Nortel were reported across all of our reportable segments. Also commencing with the first quarter of 2009, services results will be reported across all reportable segments (CN, ES, MEN and LG-Nortel). The previously announced decentralization of our Global Operations organization has been put on hold and will be part of our planning around the comprehensive restructuring plan.

Other Significant Business Developments

Decision on Mobile WiMAX Business and Alvarion Agreement

On January 29, 2009, we announced that we have decided to discontinue our mobile WiMAX business and end our joint agreement with Alvarion Ltd., originally announced in June 2008. This decision will allow us to narrow our focus in advance of developing a comprehensive restructuring plan and better manage our investments. We are working closely with Alvarion to transition our mobile WiMAX customers to help ensure that ongoing support commitments are met without interruption. This decision is expected to have no impact on our other businesses.

Dividends Suspension

On November 10, 2008, our Board of Directors suspended the declaration of further dividends on our series 5 preferred shares and series 7 preferred shares following payment on November 12, 2008 of the previously declared monthly dividend on those shares. Dividends on the series 5 preferred shares are cumulative and holders of series 5 preferred shares will be entitled to receive unpaid dividends, when declared by our Board of Directors (only as permitted under the Canada Business Corporations Act), at such time as we resume payment of dividends on those shares. As of December 31, 2008, there was $3 of unpaid dividends on the series 5 preferred shares. Dividends on the series 7 preferred shares are non-cumulative and the entitlement of holders of series 7 preferred shares to receive dividends that has not been declared on those shares within 30 days after our 2008 fiscal year end was extinguished effective January 30, 2009. Because of the extinguishment of such dividend entitlement, the holders of series 7 preferred shares will be entitled to receive notice of, and attend, all meetings of our shareholders at which directors are to be elected and will be entitled to one vote per share in respect of the election of directors. These voting rights will cease upon payment of the whole amount of the first dividend declared on the series 7 preferred shares after the time the voting rights first arose. Dividends will not be declared during the Creditor Protection Proceedings and our securities may be cancelled, and holders may receive no payment or other consideration in return, as a result of these proceedings.

Acquisitions and Divestitures

We announced a divestiture planned for 2009 and made several acquisitions in 2008, as described below.

On February 19, 2009, we announced that we have entered into a “stalking horse” asset purchase agreement to sell certain portions of our Application Delivery portfolio to Radware Ltd. for approximately $18. Under the

 

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agreement, the products planned to be acquired by Radware Ltd. include certain Nortel Application Accelerators, Nortel Application Switches and the Virtual Services Switch. While Radware Ltd. would, upon closing, assume ownership, product development and outstanding warranties, the products would still be available and promoted by us in an OEM relationship with Radware Ltd. We have received orders from the U.S. Court and Canadian Court that establish bidding procedures for an auction that will allow other qualified bidders to submit higher or otherwise better offers. A similar motion has been scheduled with the Canadian Court. Consummation of the transaction is subject to higher or otherwise better offers, approval of the U.S. Court and the Canadian Court, and satisfaction of other conditions.

On August 19, 2008, we acquired 100% of the issued and outstanding stock of Diamondware, Ltd. for $5 in cash, plus up to an additional $3 based on the achievement of future business milestones. Diamondware specializes in high-definition, proximity-based 3D-positional voice technology. The purchase price allocation includes $3 for acquired technology and $2 for other intangibles.

On August 8, 2008, LG-Nortel purchased certain assets and liabilities of LGE’s Wireless Local Loop (WLL) business for $3. WLL’s products include fixed wireless terminals over CDMA and GSM licensed cellular networks. The purchase price allocation includes $3 for net tangible assets.

On August 8, 2008, we purchased substantially all of the assets and certain liabilities of Pingtel Corp. from Bluesocket Inc. for $4 in cash and the return of Nortel’s equity stake in Bluesocket purchased during 2007 for $2, plus up to an additional $4 based on the achievement of future business milestones. Pingtel was a wholly-owned subsidiary of Bluesocket and a designer of software-based unified communication solutions. The purchase price allocation of $6 primarily consists of acquired technology.

On August 1, 2008, LG-Nortel, our joint venture with LGE, acquired 100% of the issued and outstanding stock of Novera Optics Korea Inc. and Novera Optics, Inc. (together, Novera) for $18, plus up to an additional $10 based on the achievement of future business milestones. Novera specializes in fiber-optic access solutions that extend high-speed carrier Ethernet services from optical core networks to customer premises. The purchase price allocation includes $9 for acquired technology and $9 for goodwill.

How We Measure Business Performance

Our CEO has been identified as our Chief Operating Decision Maker in assessing the performance of and allocating resources to our operating segments. The primary financial measure used by the CEO is Management Operating Margin (Management OM) (previously called Operating Margin (OM) in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2008). When presented on a consolidated basis, Management OM is not a recognized measure under U.S. Generally Accepted Accounting Principles (U.S. GAAP). It is a measure defined as total revenues, less total cost of revenues, selling, general and administrative (SG&A) and R&D expense. Management OM percentage is a non-U.S. GAAP measure defined as Management OM divided by revenue. 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 audited 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.

 

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Financial Highlights

The following is a summary of our 2008 and 2007 financial highlights:

 

     For the Years Ended December 31,  
     2008     2007     $ Change     % Change  

Revenues

   $ 10,421     $ 10,948     $ (527 )   (5 )

Gross profit

     4,291       4,627       (336 )   (7 )

Gross margin %

     41.2 %     42.3 %     (1.1 points )

Selling, general and administrative expense

     2,184       2,486       (302 )   (12 )

Research and development expense

     1,574       1,723       (149 )   (9 )
                    

Management OM

     533       418       115    

Management OM %

     5.1 %     3.8 %     1.3 points  

Net loss

     (7,417 )     (840 )     (6,577 )   783  

As global economic conditions dramatically worsened over recent months, we continued to experience significant pressure on our business and deterioration of our cash and liquidity as customers across all our businesses, in particular in North America, responded to increasingly worsening macroeconomic and industry conditions and uncertainty by suspending, delaying and reducing their capital expenditures. The extreme volatility in the financial, foreign exchange and credit markets globally has compounded the situation, further impacting customer orders as well as normal seasonality trends. As a result, our financial results, in particular in the second half of 2008, were negatively impacted across all of our business segments. We are continuing to experience significant pressure due to global economic conditions and additionally, we are seeing further impact to our business as a result of the Creditor Protection Proceedings.

During 2008, foreign exchange fluctuations had an unfavorable impact on revenues, SG&A and R&D expenses of $81, $12 and $9, respectively, when compared to 2007. The unfavorable impact on revenues was primarily as a result of unfavorable changes in the foreign exchange rates of the Korean Won, the British Pound and the Canadian Dollar against the U.S. Dollar, partially offset by favorable changes in the foreign exchange rate of the Euro and the Chinese Yuan against the U.S. Dollar. The unfavorable impact on SG&A expense was primarily due to unfavorable changes in the foreign exchange rates of the Euro, the Canadian Dollar and the Chinese Yuan against the U.S. Dollar, partially offset by favorable changes in the foreign exchange rates of the Korean Won and the British Pound against the U.S. Dollar. Further, we recognized significantly less deferred revenue in 2008 compared to 2007.

 

 

 

Revenues decreased 5% to $10,421: Revenues decreased by $527, or 5%, in 2008 compared to 2007 primarily due to decreases in the ES, CN and MEN segments, while GS revenues remained essentially flat. From a geographic perspective, the decrease was across all regions, except Asia. The decrease in the ES segment was mainly due to lower sales volumes related in part to the declining switch market in the U.S. and the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenues in 2007 not repeated to the same extent in 2008. The decrease in CN was mainly due to reduced customer spending as a result of capital expenditure constraints resulting from the expanding economic downturn. The decrease in the MEN segment was primarily due to the completion of a customer contract deliverable that resulted from the termination of a supplier agreement in 2007 not repeated in 2008, significant revenues from a certain customer in 2007 that did not repeat to the same extent in 2008, lower sales volumes as a result of reduced demand for our legacy products. The 5% decrease in revenues is greater than the previously expected decrease of approximately 4% we announced on November 10, 2008, primarily as a result of a greater than anticipated impact to our business from the worsening global economic conditions in the fourth quarter of 2008, in particular in the ES segment.

 

 

 

Gross margin decreased 1.1 percentage point to 41.2%: The decrease was primarily as a result of higher inventory provisions and the unfavorable impacts of regional and product mix, partially offset by the impact of our cost reduction initiatives and the favorable impact of foreign exchange fluctuations.

 

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Management OM increased by $115 to $533: The increase in Management OM was primarily due to decreases in SG&A and R&D expenses of $302 and $149, respectively, partially offset by a decline in gross profit of $336. The decrease in SG&A expense was primarily due to cost savings from our previously announced restructuring activities that included headcount reductions and other cost reduction initiatives, a decrease in sales and marketing efforts in maturing technologies, a decrease in charges related to our employee compensation plans and lower internal control remediation and finance transformation expenses. R&D expense decreased mainly due to reduced spending for maturing technologies and a reduction in mobile WiMAX R&D expenditure as a result of the agreement with Alvarion Ltd. (now terminated), partially offset by an increase in spending on investments in potential growth areas.

The decrease in gross profit was primarily due to a decrease in volume, higher inventory provisions, and lower revenues primarily as a result of the recognition of previously deferred revenues in 2007 not repeated to the same extent in 2008, the unfavorable impacts of regional and product mix and price erosion, and the reduced impact of purchase price variances. This decrease was partially offset by cost reduction initiatives, the favorable impact of foreign exchange fluctuations, and a change in a contract-related accrual in 2008 compared to 2007 and lower warranty costs.

 

 

 

Net loss increased from $840 to $7,417: The increase in net loss was mainly due to the following:

 

 

 

a goodwill impairment charge of $2,202 in 2008 relating to all our reportable segments;

 

 

 

a higher income tax expense largely as a result of an increase in our deferred tax asset valuation allowance of $3,020; and

 

 

 

a provision of $1,836 against intercompany receivables due from our subsidiaries and NNC.

 

 

 

Cash and cash equivalents decreased from $3,526 at December 31, 2007 to $2,390 at December 31, 2008: The decrease in cash and cash equivalents was primarily due to cash used in operating activities of $1,243, cash used in investing activities of $310, cash from financing activities of $601 and net unfavorable foreign exchange impacts of $184.

Results of Operations

Revenues

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

 

         For the Years Ended December 31,        2008 vs. 2007     2007 vs. 2006  
           2008                2007                2006          $ Change     % Change     $ Change     % Change  

United States

   $ 4,427    $ 4,974    $ 5,092    $ (547 )   (11 )   $ (118 )   (2 )

EMEA

     2,422      2,740      3,239      (318 )   (12 )     (499 )   (15 )

Canada

     693      822      720      (129 )   (16 )     102     14  

Asia

     2,300      1,768      1,736      532     30       32     2  

CALA

     579      644      631      (65 )   (10 )     13     2  
                                                 

Consolidated

   $ 10,421    $ 10,948    $ 11,418    $ (527 )   (5 )   $ (470 )   (4 )
                                                 

2008 vs. 2007

In 2008, customers across all our businesses, in particular in North America, responded to increasingly worsening macroeconomic and industry conditions and uncertainty by suspending, delaying and reducing their capital expenditures. The extreme volatility in the financial, foreign exchange and credit markets globally has compounded the situation, further impacting customer orders as well as normal seasonality trends. We continued to experience significant pressure on our business due to these adverse conditions with increasing global impact in the fourth quarter of 2008.

 

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Revenues decreased to $10,421 in 2008 from $10,948 in 2007, a decrease of $527 or 5%. The lower revenues were due to decreases in the U.S., EMEA, Canada and CALA regions, partially offset by an increase in Asia. The decrease in the U.S. was mainly due to reduced customer spending as a result of capital expenditure constraints resulting from the expanding economic downturn, certain customer contracts in 2007 not repeated in 2008 and a decline in sales volumes, partially offset by an increase due to the completion of a certain customer contract obligation resulting in the recognition of previously deferred revenues in 2008. The declines in EMEA and CALA were primarily due to the completion of certain customer contract obligations resulting in the recognition of previously deferred revenue in 2007 that were not repeated in 2008. An additional factor resulting in a decrease in EMEA was declining sales volumes. The decrease in Canada was primarily due to reduced spending by certain customers as a result of a change in technology migration plans. The increase in Asia was mainly due to the completion of certain contract obligations for multiple customers in LG-Nortel resulting in the recognition of previously deferred revenues and higher sales volumes.

U.S.

Revenues decreased by $547 in the U.S. in 2008 compared to 2007, due to a decrease across all segments.

The decrease in the CN segment of $258 was due to lower revenues from the CDMA and the circuit and packet voice solutions businesses, partially offset by an increase in the global system for mobile communications (GSM) and UMTS solutions business. The decrease in the code divisional multiple access (CDMA) solutions business of $192 was primarily due to reduced spending by certain customers as a result of capital expenditure constraints resulting from the expanding economic downturn, certain customer contracts in 2007 not repeated in 2008 and a decline in sales volumes, partially offset by an increase due to the completion of a customer contract obligation resulting in the recognition of previously deferred revenues in 2008. The circuit and packet voice solutions business decreased by $95 mainly due to the completion of several voice over Internet protocol (VoIP) buildouts in 2007 that were not repeated in 2008, as well as reduced customer spending as a result of the expanding economic downturn, and a decline in demand for time-division multiplexing (TDM) products.

The decrease in the MEN segment of $125 was due to revenue decreases in both the data networking and security solutions and optical networking solutions businesses of $65 and $60, respectively. The decrease in the data networking and security solutions business was primarily due to the completion of a certain customer contract deliverable that resulted from the termination of a supplier agreement resulting in the recognition of previously deferred revenue in 2007 not repeated in 2008. The decrease in the optical networking solutions business was due to significant revenues from a certain customer in 2007 that did not repeat to the same extent in 2008 and reduced demand for our legacy products.

ES segment revenues decreased by $123 due to revenue decreases in the data networking and security solutions and circuit and packet voice solutions businesses of $81 and $42, respectively. The decrease in the data networking and security solutions business was primarily due to lower sales volumes related to the declining switch market and the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenues in 2007 not repeated to the same extent in 2008, partially offset by higher sales volumes related to next generation products. The decrease in the circuit and packet voice solutions business largely resulted from a decline in demand for TDM products and certain customer contracts in 2007 not repeated in 2008, partially offset by higher sales volumes across multiple customers.

The decrease in the GS segment of $34 was primarily due to revenue decreases in both the network support services and the network implementation services businesses of $17 and $14, respectively. The declines in the businesses were primarily due to lower sales volumes across multiple customers as a result of capital expenditure constraints resulting from the expanding economic downturn. The decrease in the network implementation services business was partially offset by higher revenues for services related to government business.

 

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EMEA

Revenues in EMEA decreased by $318 in 2008 compared to 2007 due to a decrease across all segments.

The decrease in the CN segment of $155 was primarily due to a decrease in the GSM and UMTS solutions business of $187, partially offset by an increase in the CDMA solutions business of $26. The decrease in the GSM and UMTS solutions business was mainly due to the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenue in 2007 not repeated in 2008 and a decline in sales volumes. The increase in the CDMA solutions business was primarily due to increased sales volumes across multiple customers.

The decrease in the ES segment of $93 was due to decreases in the circuit and packet voice solutions and data networking and security solutions businesses of $76 and $17, respectively. The decrease in the circuit and packet voice solutions business was mainly due to lower sales volumes.

The decrease in the GS segment of $68 was primarily due to a decrease in network support services of $63, as a result of lower sales volumes across multiple customers and the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenue in 2007 not repeated in 2008. This decrease was partially offset by an increase due to the favorable impact of foreign exchange fluctuations.

The decrease in the MEN segment of $2 was due to a decrease in the data networking and security solutions business of $18, partially offset by an increase in the optical networking solutions business of $16. The decrease in the data networking and security solutions business was primarily due to the completion of a certain customer contract obligation that resulted in the recognition of previously deferred revenue in 2007 not repeated in 2008 and a decline in sales volumes across multiple customers related to the declining multi-server switch market, partially offset by an increase as a result of the completion of other customer contract obligations resulting in the recognition of previously deferred revenues. The increase in the optical networking solutions business was primarily due to the completion of certain customer contract obligations resulting in the recognition of previously deferred revenue, volume increases related to our next generation products for long-haul applications, and the favorable impact of foreign exchange fluctuations, partially offset by the completion of other customer contract obligations that resulted in the recognition of previously deferred revenue in 2007 that did not repeat in 2008.

Canada

Revenues decreased by $129 in Canada in 2008 compared to 2007, primarily due to a decrease in the CN segment, partially offset by an increase in the ES segment.

The decrease in the CN segment of $172 was due to decreases in the CDMA solutions and circuit and packet voice solutions businesses of $135 and $37, respectively. The decrease in the CDMA solutions business was primarily due to reduced spending as a result of a change in technology migration plans by certain customers. The decrease in the circuit and packet voice solutions business was mainly due to the completion of several VoIP buildouts in 2007 that were not repeated in 2008, as well as reduced customer spending as a result of the expanding economic downturn and a decline in demand for TDM products.

The increase in the ES segment of $21 was primarily due to an increase in the circuit and packet voice solutions business of $23, mainly as a result of higher sales volumes across several customers primarily in the first six months of 2008.

CALA

Revenues decreased by $65 in CALA in 2008 compared to 2007, primarily due to a decrease in the CN segment, partially offset by an increase in the MEN segment.

The decrease in the CN segment of $81 was mainly due to a decrease in the GSM and UMTS solutions business of $78, primarily from the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenue in 2007 not repeated in 2008.

 

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The increase in the MEN segment of $15 was primarily due to an increase in the optical networking solutions business of $17, mainly from higher sales volumes related to our next generation products for long-haul applications.

Asia

Revenues increased by $532 in Asia in 2008 compared to 2007, primarily due to increases in the CN and GS segments, partially offset by decreases in the MEN and ES segments.

The increase in the CN segment of $485 was primarily due to an increase in the GSM and UMTS solutions and CDMA solutions businesses of $441 and $60, respectively. The increase in the GSM and UMTS solutions business was mainly due to the completion of certain contract obligations for multiple customers in LG-Nortel resulting in the recognition of previously deferred revenues and higher sales volumes, partially offset by a decline in revenues outside of LG-Nortel due to reduced customer spending and price erosion. The increase in the CDMA solutions business was primarily due to the recognition of deferred revenues and an adjustment to revenues, each of which resulted from the completion of obligations in connection with the termination of a customer contract in 2008 as well as higher sales volumes.

The increase in the GS segment of $105 was mainly due to an increase in network implementation services business of $87, primarily due to the recognition of deferred revenues and an adjustment to revenues, each of which resulted from the completion of obligations in connection with the termination of a customer contract in 2008, as well as the completion of a certain customer contract obligation in LG-Nortel resulting in the recognition of previously deferred revenue and higher sales volumes across multiple customers.

The decrease in the MEN segment of $34 was due to a decrease in the optical networking solutions business of $57, partially offset by an increase in the data networking and security solutions business of $23. The decrease in the optical networking solutions business was mainly due to lower sales volumes related to reduced demand for legacy products and significant revenues from certain customers in 2007 that did not repeat to the same extent in 2008. The increase in the data networking and security solutions business was mainly due to higher sales volumes related to a specific customer in the first six months of 2008 and the completion of network deployments in 2008 for certain customers resulting in the recognition of previously deferred revenue.

The decrease in the ES segment of $26 was due to a decrease in the data networking and security solutions business of $35, partially offset by an increase in the circuit and packet voice solutions business of $9. The decrease in the data networking and security solutions business was primarily due to the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenues in 2007 not repeated in 2008 and lower sales volumes, partially offset by the favorable impact of foreign exchange fluctuations.

2007 vs. 2006

Revenues decreased to $10,948 in 2007 from $11,418 in 2006, a decrease of $470 or 4%. The decline was the result of lower revenues in EMEA and the U.S., partially offset by increased revenues in Canada. Revenues decreased in EMEA primarily due to the UMTS Access divestiture in the fourth quarter of 2006 and in the U.S. primarily due to reduced legacy TDM demand, whereas increases in Canada were across all segments due primarily to volume increases.

EMEA

Revenues decreased by $499 in EMEA in 2007 compared to 2006. The decline was due to lower revenues in the CN and GS segments, partially offset by increased revenues in the ES and MEN segments. The decrease in CN segment revenues was primarily due to lower revenues from the GSM and UMTS solutions and CDMA solutions businesses. GSM and UMTS solutions business had a decrease in revenues of $457 as a result of the

 

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UMTS Access divestiture and a decline in demand for Voice and Packet GSM and UMTS Core (GU Core), partially offset by increased demand in GSM Access. The CDMA solutions business had a decline of $74 due to the completion of projects in 2006 and the recognition of previously deferred revenues recorded in 2006 that was not repeated in 2007. Revenues from the GS segment declined by $142, also as a result of the UMTS Access divestiture and lower sales volumes, partially offset by the favorable impact of foreign exchange fluctuations. The increase in ES segment revenues of $155 was due to increased revenues in both the circuit and packet voice solutions and data networking and security solutions businesses in 2007 that were not present in 2006. The increase in revenues in the circuit and packet voice solutions business of $76 was primarily a result of certain supply chain delays in 2006 resulting from difficulty in obtaining components required to meet European Union Restrictions on Hazardous Substances (RoHS) standards and volume increases. Revenues in the data networking and security solutions business increased by $79 as a result of the recognition of previously deferred revenues due to the completion or elimination of customer deliverable obligations for certain products and volume increases. The increased revenues in MEN were due to an increase in optical networking solutions of $93 primarily due to recognition of previously deferred revenues as a result of the completion of certain customer contract deliverables in the first quarter of 2007, increases in volume and favorable foreign exchange impacts due to fluctuations between the Euro and U.S. Dollar. This increase in optical networking solutions was partially offset by a decline in data networking and security solutions of $78 primarily due to the recognition of previously deferred multi-service switch revenues in 2006 that was not repeated in 2007.

U.S.

Revenues decreased by $118 in the U.S. in 2007 compared to 2006. The decline was primarily due to decreased revenues in the CN and Other segments, partially offset by increased revenues in the ES, MEN and GS segments. The decrease in CN of $235 was due to a decrease in the circuit and packet voice solutions and GSM and UMTS solutions businesses. The decline in the circuit and packet voice solutions business of $122 was due to the one-time recognition of previously deferred revenues in the third quarter of 2006 not repeated in 2007 to the same extent and a decline in legacy TDM demand. The GSM and UMTS solutions business decrease of $116 was primarily due to customers focusing on their UMTS Access build-out versus GSM Access or GU Core. The decrease in Other of $22 related to the delay in issuance and, in some cases, cancellation of certain intended contract offerings by the U.S. government. The increase in ES segment revenues was due to an increase in the data networking and security solutions business of $50 primarily due to the recognition of previously deferred revenue and volume increases, partially offset by reduced demand for legacy products, and an increase in the circuit and packet voice solutions business of $6 due to increased volume, partially offset by reduced demand for legacy products. The increase in revenues in the MEN segment was due to the increase in the data networking and security solutions business of $31 and increased optical networking solutions business of $22. The increase in data networking and security solutions was due to the recognition of previously deferred revenue in 2007 as a result of the completion of certain contract deliverables resulting from the termination of a supplier agreement, partially offset by volume decreases due to a decline in the multi switch/service edge router market. The increase in revenues in the GS segment by $30 was primarily due to volume increases in network support services.

Canada

Revenues increased by $102 in Canada in 2007 compared to 2006, due to increased revenues in all of our segments. The increase in CN revenues of $54 was due to an increase in the CDMA solutions business of $41 associated with the continuing rollout of our third generation digital mobile technology known as EV-DO Rev A technology. The primary increase in the MEN revenues of $27 was primarily due to an increase in optical networking solutions of $21 as a result of optical market growth, while the increase in GS of $12 was due to volume increase in network support services.

Asia

Revenues increased by $32 in Asia in 2007 compared to 2006, due primarily to increased revenues in the ES, CN and GS segments, partially offset by a decrease in the MEN segment. The increase in ES revenues was

 

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attributable to an increase in the data networking and security solutions business of $83, primarily as a result of the recognition of previously deferred revenue due to completion or elimination of customer deliverable obligations for certain products, and volume increases. The increase in CN revenues was due to an increase in the CDMA solutions business of $153 primarily as a result of increased investments by certain of our customers in their infrastructure in order to enhance their service offerings within LG-Nortel, our joint venture with LGE. This increase was partially offset by the decreases in the GSM and UMTS solutions of $59 and circuit and packet voice solutions of $20 due to recognition of previously deferred revenues as a result of the completion of certain customer contract deliverables in 2006 that was not repeated in 2007. The increase in GS revenues of $42 was due to new CDMA network rollouts and the release of previously deferred revenue. The decrease in revenues in the MEN segment of $171 was primarily due to the recognition of previously deferred revenues in 2006 that was not repeated in 2007.

CALA

Revenues increased by $13 in CALA. The increase in CALA was due to increased revenues in the ES, GS and MEN segments, partially offset by a decrease in revenues in the CN segment. The increase in ES revenues was due to increased revenues in the circuit and packet voice solutions of $13, while the increase in MEN was due to increased volume in the optical networking solutions business of $20, partially offset by a decrease in the data and networking solutions business of $10. The increase in GS of $13 was primarily in the network implementation services and network application services portfolios with a slight offset in network support services. This increase was partially offset by a decrease in CN of $28 due to a decline in GSM and UMTS solutions of $13 resulting from fluctuation in customer spending, a decrease in CDMA solutions of $9 and circuit and voice packet solutions of $6.

Gross Margin

 

     For the Years Ended December 31,     2008 vs. 2007     2007 vs. 2006
         2008             2007             2006         $ Change     % Change     $ Change    % Change

Gross profit

   $ 4,291     $ 4,627     $ 4,430     $ (336 )   (7 )   $ 197    4

Gross margin

     41.2 %     42.3 %     38.8 %     (1.1) points        3.5 points

2008 vs. 2007

Gross profit decreased to $4,291 in 2008 compared to $4,627 in 2007, a decrease of $336 or 7%. The decrease was primarily due to a decrease in sales volume, and a decrease of $249 in the amount of deferred revenues in 2008 compared to 2007, higher inventory provisions of $196, the unfavorable impacts of regional and product mix and price erosion of $125, and the reduced impact of purchase price variances of $105. This decrease was partially offset by cost reduction initiatives of $192, the favorable impact of foreign exchange fluctuations of $36, a decrease in a contract-related accrual and lower warranty costs, each of $22.

Gross margin decreased to 41.2% in 2008 from 42.3% in 2007, a decrease of 1.1 percentage points, primarily as a result of higher inventory provisions of 1.8 percentage points, the unfavorable impacts of regional and product mix of 1.1 percentage points, partially offset by cost reduction initiatives of 1.8 percentage points and the favorable impact of foreign exchange fluctuations of 0.3 percentage points.

2007 vs. 2006

Gross profit increased to $4,627 in 2007 compared to $4,430 in 2006, an increase of $197 or 4%, primarily due to cost structure improvements of $300 and favorable product and customer mix of $41, partially offset by decreases from volume reductions and lower recognition of previously deferred revenue of $150.

Gross margin increased by 3.5 percentage points primarily due to cost structure improvements that resulted in an improvement of 2.2 percentage points to the gross margin. This increase was partially offset by reductions

 

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in volume and lower recognition of deferred revenue. The favorable impact of product and customer mix was offset by volume and price erosion, resulting in a net increase in gross margin of 1.0 percentage points.

Management OM

 

     For the Years Ended December 31,     2008 vs. 2007    2007 vs. 2006
         2008             2007             2006         $ Change    % Change    $ Change    % Change

Management OM

   $ 533     $ 418     $ (1 )   $ 115    28    $ 419    41,900

Management OM as a percentage of revenue

     5.1 %     3.8 %     0.0 %      1.3 points       3.8 points

2008 vs. 2007

Management OM increased to $533 in 2008 from $418 in 2007, an increase of $115 or 28%. Management OM as a percentage of revenue increased by 1.3 percentage points in 2008 compared to 2007. The increase in Management OM was due to decreases in both SG&A and R&D expenses of $302 and $149, respectively, partially offset by a decrease in gross profit of $336 as explained above. The decrease in SG&A expense was primarily due to cost savings from our previously announced restructuring activities, cost reduction initiatives, headcount reductions, a decrease in sales and marketing efforts in maturing technologies, a decrease in charges related to our employee compensation plans and lower internal control remediation and finance transformation expenses. R&D expense decreased mainly due to reduced spending for maturing technologies and a reduction in mobile WiMAX R&D expenditure as a result of the agreement with Alvarion, partially offset by an increase in spending on investments in potential growth areas.

2007 vs. 2006

Management OM increased from a loss of $1 in 2006 to earnings of $418 in 2007, an increase of $419. Management OM as a percentage of revenue increased by 3.8% in 2007 compared to 2006, primarily as a result of increases in gross profit and decreases in R&D and SG&A expense. R&D expenses decreased by $217, primarily due to reductions of $320 in the CN segment due to the divestiture of the UMTS Access business and reduction in investment in legacy products. This decrease was partially offset by an increase in R&D expenses in the ES and MEN segments of $62 and $29, respectively, to facilitate development of next-generation technologies. SG&A expenses decreased by $5, primarily as a result of lower expenses related to our internal control remediation plans of $30, finance transformation activities of $30 and lower restatement costs of $10, partially offset by increase in charges incurred in relation to our employee compensation plans of $56. The impact of foreign exchange on Management OM was minimal as the favorable impact on revenues was largely offset by the unfavorable impact on cost of revenues, SG&A and R&D.

Special Charges

The following table sets forth special charges by restructuring plan:

 

     For the Years Ended December 31,
         2008             2007            2006    

November 2008 Restructuring Plan

   $ 58     $ —      $ —  

2008 Restructuring Plan

     148       —        —  

2007 Restructuring Plan

     72       171      —  

2006 Restructuring Plan

     (1 )     17      68

2004 Restructuring Plan

     11       9      20

2001 Restructuring Plan

     14       13      17
                     

Total special charges

   $ 302     $ 210    $ 105
                     

 

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As a result of the Creditor Protection Proceedings, we ceased taking any further actions under the previously announced workforce and cost reduction plans as of January 14, 2009. All actions taken up to January 14, 2009 under previously announced workforce and cost reduction plans will continue to be accounted for under such plans. As at December 31, 2008, approximately 1,800 net workforce reductions, and approximately 200 shifts of positions from higher-cost to lower-cost locations, from previously announced restructuring plans remained unactioned and will be accounted for under the workforce reduction plan announced on February 25, 2009. Our contractual obligations are subject to re-evaluation in connection with the Creditor Protection Proceedings and, as a result, expected cash outlays and charges disclosed below relating to contract settlement and lease costs are subject to change.

On November 10, 2008, we announced a restructuring plan that included net workforce reductions of approximately 1,300 positions and shifting approximately 200 additional positions from higher-cost to lower-cost locations (the November 2008 Restructuring Plan, previously referred to as the 2009 Restructuring Plan). We expected total charges to earnings and cash outlays related to workforce reductions to be approximately $130, to be incurred during 2008 and 2009. Approximately $58 of the total charges relating to the net reduction of 550 positions under the November 2008 Restructuring Plan have been incurred as of December 31, 2008. There were no additional workforce reductions under this plan prior to its discontinuance on January 14, 2009. Annualized savings of approximately $60 were achieved under the November 2008 Restructuring Plan from its inception through December 31, 2008.

During the first quarter of 2008, we announced a restructuring plan that included net workforce reductions of approximately 2,100 positions and shifting approximately 1,000 additional positions from higher-cost to lower-cost locations (the 2008 Restructuring Plan). In addition to the workforce reductions, we announced steps to achieve additional cost savings by efficiently managing our various business locations and further consolidating real estate requirements. We expected total charges to earnings and cash outlays related to workforce reductions to be approximately $205 and expected total charges to earnings related to the consolidation of real estate to be approximately $60, including revised fixed costs of $15. Approximately $148 of the total charges relating to the net reduction of approximately 1,500 positions and real estate reduction initiatives under the 2008 Restructuring Plan have been incurred during the year ended December 31, 2008. There were no additional workforce reductions under this plan prior to its discontinuance on January 14, 2009. The portion of the real estate initiatives that were undertaken prior to January 14, 2009 will continue to be accounted for under the 2008 Restructuring Plan. The real estate provision of $7 as at December 31, 2008 relate to discounted cash outlays, net of estimated future sublease revenues, related to leases with payment terms through to 2024. Annualized savings of approximately $265 were achieved under the 2008 Restructuring Plan from its inception through December 31, 2008.

During the first quarter of 2007, we announced a restructuring plan that included workforce reductions of approximately 2,900 positions and shifting approximately 1,000 additional positions from higher-cost locations to lower-cost locations (the 2007 Restructuring Plan). In addition to the workforce reductions, we announced steps to achieve additional cost savings by efficiently managing its various business locations and consolidating real estate requirements. We originally expected charges to earnings and cash outlays for the 2007 Restructuring Plan to be approximately $390 and $370, respectively. Approximately $243 of the total charges relating to the net reduction of approximately 2,150 positions and real estate reduction initiatives under the 2007 Restructuring Plan have been incurred as of December 31, 2008. There were no additional workforce reductions under this plan prior its discontinuance on January 14, 2009. The portion of the real estate initiatives that where undertaken prior to January 14, 2009 will continue to be accounted for under the 2008 Restructuring Plan. The real estate provision of $27 as at December 31, 2008 relate to discounted cash outlays net of estimated future sublease revenues related to leases with payment terms through to 2016. Annualized savings of approximately $430 were achieved under the 2007 Restructuring plan from its inception through December 31, 2008.

During the second quarter of 2006, we announced a restructuring plan that included workforce reductions of approximately 1,900 positions (the 2006 Restructuring Plan). We originally estimated the total charges to earnings and cash outlays associated with the 2006 Restructuring Plan to be approximately $100. During 2007,

 

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the program was determined to be substantially complete resulting in a total reduction of 1,750 positions with a revised total cost of approximately $84. The cost revisions were primarily due to higher voluntary attrition reducing the number of involuntary actions requiring the payment of benefits.

During 2004 and 2001, we implemented work plans to streamline operations through workforce reductions and real estate optimization strategies (the 2004 Restructuring Plan and the 2001 Restructuring Plan). All of the charges with respect to these workforce reductions have been incurred. The real estate provision of $156 in the aggregate as at December 31, 2008 relates to discounted cash outlays net of estimated future sublease revenues related to leases with payment terms through to 2016 for the 2004 Restructuring Plan and the end of 2013 for the 2001 Restructuring Plan.

The following table sets forth special charges by segment for each of the years ended December 31:

 

    Enterprise
Solutions
  Carrier
Networks
    Metro
Ethernet
Networks
  Global
Services
  Other   Total  

November 2008 Restructuring Plan

  $ 15   $ 28     $ 9   $ 6   $ —     $ 58  

2008 Restructuring Plan

    43     63       21     21     —       148  

2007 Restructuring Plan

    11     48       10     3     —       72  

2006 Restructuring Plan

    —       (1 )     —       —       —       (1 )

2004 Restructuring Plan

    3     5       1     2     —       11  

2001 Restructuring Plan

    4     6       2     2     —       14  
                                       

Total special charges for the year ended December 31, 2008

  $ 76   $ 149     $ 43   $ 34   $ —     $ 302  
                                       

2007 Restructuring Plan

  $ 23   $ 105     $ 16   $ 27   $ —     $ 171  

2006 Restructuring Plan

    2     6       2     7     —       17  

2004 Restructuring Plan

    2     4       1     2     —       9  

2001 Restructuring Plan

    2     6       2     3     —       13  
                                       

Total special charges for the year ended December 31, 2007

  $ 29   $ 121     $ 21   $ 39   $ —     $ 210  
                                       

2006 Restructuring Plan

  $ 14   $ 36     $ 7   $ 5   $ 6   $ 68  

2004 Restructuring Plan

    3     8       8     1     —       20  

2001 Restructuring Plan

    3     11       2     1     —       17  
                                       

Total special charges for the year ended December 31, 2006

  $ 20   $ 55     $ 17   $ 7   $ 6   $ 105  
                                       

Gain on Sales of Businesses and Assets

We did not have any material asset or business dispositions in 2008.

We recorded a gain on sales of businesses and assets of $31 in 2007, primarily due to the recognition of previously deferred gains of $21 related to the divestiture of our manufacturing operations to Flextronics, $10 related to the divestiture of the UMTS Access business and $12 related to the sale of a portion of our LG-Nortel wireline business. These gains were partially offset by a loss of $8 related to the disposals and write-offs of certain long-lived assets.

In 2006, gain on sale of businesses and assets was $206, primarily due to gains of $166 on the sale of certain assets and liabilities related to our UMTS Access business, $40 related to the sale of real estate assets in Canada and EMEA, and $23 on the sale of certain assets related to our blade server business. These gains were partially offset by write-offs of certain long-lived assets of $13 and charges related the divestiture of our manufacturing operations to Flextronics of $7.

 

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Other Operating Expense (Income)—Net

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

 

     For the Years Ended December 31,  
         2008             2007             2006      

Royalty license income—net

   $ (31 )   $ (29 )   $ (21 )

Litigation charges (recovery)

     11       (2 )     9  

Other—net

     43       (4 )     (1 )
                        

Other operating expense (income)—net(a)

   $ 23     $ (35 )   $ (13 )
                        

 

(a)

Includes items that were previously reported as non-operating and have been reclassified from “Other income—net” accordingly.

In 2008, other operating expense (income) – net was an expense of $23, primarily due to a $24 write-down of a tax credit, a charge related to an other than temporary impairment in the value of our investment of $14, litigation charges of $11 related to a patent infringement lawsuit settlement, partially offset by royalty income from cross patent license agreements of $31 and a net sales tax refund of $14.

In 2007, other operating expense (income)—net was income of $35, primarily due to $29 in royalties from patented technologies and $2 in litigation recovery primarily due to a third party bankruptcy claim settlement.

In 2006, other operating expense (income)—net was income of $13, primarily due to $21 related to royalty income from patented technology, partially offset by expenses of $9 related to various litigation and settlement costs.

Other Income (Expense)—Net

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

 

     For the Years Ended December 31,  
         2008             2007             2006      

Losses (gains) on sales and write downs of investments

   $ 1     $ (5 )   $ (6 )

Currency exchange gains (losses)—net

     (43 )     180       (18 )

Other—net

     (1,875 )     41       88  
                        

Other income (expense)—net

   $ (1,917 )   $ 216     $ 64  
                        

In 2008, other income (expense)—net was an expense of $1,917, primarily due to a provision of $1,836 against intercompany receivables due from our subsidiaries and NNC as a result of an assessment we undertook of the collectability of our receivable with NNC. See the note 20 of the 2008 Financial Statements for more information.

In 2007, other income (expense)—net was income of $216, primarily due to foreign exchange gains of $180 and sublease income of $18. The increase in currency exchange gains was primarily due to the strengthening of the Canadian Dollar against the U.S. Dollar.

In 2006, other income (expense) — net was income of $64, largely due to Other income of $88 primarily as a result of a gain of $26 related to the sale of a note receivable from Bookham, Inc., income of $22 from the sublease of certain facilities, and a gain of $24 related to changes in fair value of derivative financial instruments that did not meet the criteria for hedge accounting. These gains were partially offset by a net loss on the sales and write downs of investments of $6, expenses of $7 from the securitization of certain receivables, and net currency exchange losses of $18.

 

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Interest Expense

Interest expense of $281 in 2008 remained flat in comparison to 2007.

Interest expense increased by $72 in 2007 compared to 2006. The increase was primarily due to higher debt levels, interest rates and borrowing costs on our and NNC’s debt. NNL issued $2,000 aggregate principal amount of senior notes due 2011, 2013 and 2016 in July 2006 (July 2006 Notes).

Interest expense increased by $79 in 2006 compared to 2005. The increase was primarily due to higher debt levels, interest rates and borrowing costs on our debt as a result of the one-year credit facility in the aggregate principal amount of $1,300 and the July 2006 Notes offering.

Income Tax Expense

During the year ended December 31, 2008, we recorded a tax expense of $3,195 on a loss from operations before income taxes, minority interests and equity in net earnings of associated companies of $4,073. Included in the loss from operations before income taxes, minority interests and equity in net earnings of associated companies is an impairment related to goodwill in the amount of $2,202 that impacted our effective tax rate for the year ended December 31, 2008. The tax expense of $3,195 is largely comprised of several significant items including $3,020 relating to the establishment of a full valuation allowance against our net deferred tax asset in all tax jurisdictions other than joint ventures in Korea and Turkey, and certain deferred tax assets that are realizable through the reversal of existing taxable temporary differences. Also included in income tax expense is $98 of income taxes on historically profitable entities in Asia, CALA and Europe, $4 of income taxes relating to tax rate reductions enacted during 2008 in Korea, $40 of income taxes resulting from revisions to prior year tax estimates, $37 from increases in uncertain tax positions and other taxes of $25 primarily related to taxes on NNL preferred share dividends in Canada. This tax expense was partially offset by a $29 benefit derived from various tax credits and R&D-related incentives.

The expanding global economic downturn dramatically worsened in the fourth quarter of 2008 and in January 2009, the Debtors commenced the Creditor Protection Proceedings. In assessing the need for valuation allowances against our deferred tax assets, we considered the negative effect of these events on our revised modeled forecasts and the resulting increased uncertainty inherent in these forecasts. We determined that there was significant negative evidence against and insufficient positive evidence to support a conclusion that the tax benefits of our deferred tax assets were more likely than not to be realized in future tax years in all tax jurisdictions other than Korea and Turkey. Therefore, a full valuation allowance was necessary against our net deferred tax asset in all tax jurisdictions other than joint ventures in Korea and Turkey and certain deferred tax assets that are not realizable through the reversal of existing taxable temporary differences. For additional information, see “Application of Critical Accounting Policies and Estimates—Income Taxes—Tax Asset Valuation” in this section of this report.

During the year ended December 31, 2007, we recorded a tax expense of $1,114 on earnings from operations before income taxes, minority interests and equity in net earnings (loss) of associated companies of $387. The tax expense of $1,114 was largely comprised of several significant items including $1,036 of net valuation allowance increase including an increase of $1,064 in Canada, offset by releases in Europe and Asia, $74 of income taxes on profitable entities in Asia and Europe, including a reduction of our deferred tax assets in EMEA, $29 of income taxes relating to tax rate reductions enacted during 2007 in EMEA and Asia, and other taxes of $17 primarily related to taxes on NNL preferred share dividends in Canada. This tax expense was partially offset by a $25 benefit derived from various tax credits, primarily R&D-related incentives, and a $17 benefit resulting from true up of prior year tax estimates including a $14 benefit in EMEA as a result of transfer pricing adjustments.

 

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Segment Information

Carrier Networks

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

 

     For the Years Ended December 31,    2008 vs. 2007     2007 vs. 2006  
         2008            2007            2006        $ Change     % Change     $ Change     % Change  

Revenues

                 

CDMA solutions

   $ 2,190    $ 2,425    $ 2,311    $ (235 )   -10 %   $ 114     5 %

GSM and UMTS solutions

     1,578      1,373      2,021      205     15 %     (648 )   -32 %

Circuit and packet voice solutions

     544      695      825      (151 )   -22 %     (130 )   -16 %
                                                 

Total Revenues

   $ 4,312    $ 4,493    $ 5,157    $ (181 )   -4 %   $ (664 )   -13 %
                                                 

Management OM

   $ 871    $ 846    $ 480    $ 25     3 %   $ 366     76 %
                                                 

2008 vs. 2007

CN revenues decreased to $4,312 in 2008 from $4,493 in 2007, a decrease of $181 or 4%. The decrease was due to declines in the CDMA solutions and circuit and packet voice solutions businesses, partially offset by an increase in the GSM and UMTS solutions business. The decrease in the CDMA solutions business was primarily due to reduced spending by certain customers as a result of capital expenditure constraints resulting from the expanding economic downturn, while the decline in the circuit and packet voice solutions business was primarily due to certain customer contracts in 2007 not repeated in 2008 and a decline in demand for TDM products. The increase in the GSM and UMTS solutions business was primarily due to the completion of certain contract obligations for multiple customers in LG-Nortel resulting in the recognition of previously deferred revenues in 2008 and higher sales volumes.

CDMA solutions decreased by $235 primarily due to declines in the U.S. and Canada of $192 and $135, respectively, partially offset by an increase in Asia of $60. The decrease in the U.S. was primarily due to reduced spending by certain customers as a result of capital expenditure constraints resulting from the expanding economic downturn, certain customer contracts in 2007 not repeated in 2008 and a decline in sales volumes, partially offset by an increase due to the completion of a certain customer contract obligation resulting in the recognition of previously deferred revenues in 2008. The decrease in Canada was primarily due to reduced spending as a result of a change in technology migration plans by certain customers. The increase in Asia was primarily due to the recognition of deferred revenues and an adjustment to revenues, each of which resulted from the completion of obligations in connection with the termination of a customer contract in 2008 as well as higher sales volumes.

The decline in circuit and packet voice solutions of $151 was primarily due to declines in the U.S. and Canada of $95 and $37, respectively, which largely resulted from the completion of several VoIP buildouts in 2007 that were not repeated in 2008, as well as reduced customer spending as a result of the expanding economic downturn, and a decline in demand for TDM products.

GSM and UMTS solutions increased by $205 primarily due to an increase in Asia of $441, partially offset by declines in EMEA and CALA of $187 and $78, respectively. The increase in Asia was primarily due to the completion of certain contract obligations for multiple customers in LG-Nortel resulting in the recognition of previously deferred revenues, and higher sales volumes, partially offset by a decline in revenues outside of LG-Nortel due to reduced customer spending and price erosion. The decline in EMEA was primarily due to the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenue in 2007 not repeated in 2008 and a decline in sales volumes. The decrease in CALA was primarily due to the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenue in 2007 not repeated in 2008.

 

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CN Management OM increased to $871 in 2008 from $846 in 2007, an increase of $25 as a result of decreases in R&D and SG&A expenses of $82 and $73, respectively, partially offset by a decrease in gross profit of $130.

CN gross profit decreased to $2,091 from $2,221, and gross margin decreased to 48% from 49%. The decrease in gross profit was primarily due to lower sales volumes as a result of reduced spending by certain customers due to capital expenditure constraints resulting from the expanding economic downturn, and charges related to excess and obsolete inventory, partially offset by cost reduction initiatives, favorable product mix and lower warranty costs. The decrease in SG&A expense was mainly due to decreased investment in sales and marketing efforts in maturing technologies and cost containment efforts. The decrease in R&D expense was primarily due to reduced spending for maturing technologies, productivity gains enabled by consolidation of labs and resources, improved process and movement to low-cost countries, partially offset by an increase in spending on investments in potential growth areas.

2007 vs. 2006

CN revenues decreased to $4,493 in 2007 from $5,157 in 2006, a decrease of $664 or 13%. The decrease was primarily due to the UMTS Access divestiture, and declines in demand for GU Core products and our traditional technology such as TDM in the circuit and packet voice solutions business. These declines were partially offset by increased revenue from our CDMA solutions.

CDMA solutions increased $114 in 2007, primarily due to strong growth in sales in Asia of $153 primarily as a result of increased investments by certain of our customers in their infrastructure in order to enhance their service offerings within LG-Nortel, increased revenues in Canada of $41 associated with the continuing rollout of our EV-DO Rev A technology, and delays in spending by a major customer in 2006. EMEA and CALA declined in CDMA revenues by $74 and $9, respectively, due to the completion of projects in 2006 not repeated to the same extent as 2007 and the recognition of previously deferred revenues recorded in 2006 and not repeated in 2007. In the U.S. revenues remained unchanged, largely due to recognition of previously deferred revenue and increased spending by certain customers, entirely offset by lower spending by certain other customers in the fourth quarter of 2007.

The decline in GSM and UMTS solutions of $648 was primarily due to declines in EMEA of $457, the U.S. of $116 and Asia of $59. The decline in EMEA was primarily due to a $484 decrease in UMTS solutions as a result of the UMTS Access divestiture and a decline in demand for GU Core, partially offset by increased demand in GSM Access. The U.S. decline was due to customer investment in UMTS Access solutions rather than GSM Access or GU Core solutions and recognition of less deferred revenue compared to 2006. The decline in Asia was due to reduced customer spending and price erosion, partially offset by revenues from one-time support business resulting from sale of the UMTS Access business.

The decrease in circuit and packet voice solutions of $130 was primarily in the U.S. and Asia. U.S. revenues declined $122 as a result of reduced legacy TDM demand and one-time third quarter 2006 recognition of deferred revenues in 2006 not repeated in 2007 to the same extent. This decrease was partially offset by an increase in revenues in next-generation products. Asia revenues declined by $20 primarily due to the recognition of previously deferred revenues as a result of the completion of certain customer contract deliverables in 2006 that was not repeated to the same extent in 2007.

Management OM for CN increased to $846 in 2007 from $480 in 2006, an improvement of $366, or 76%. The increase in Management OM was the result of decreases in SG&A and R&D expenses of $87 and $320, respectively, partially offset by a decrease in gross profit of $41.

CN gross profit decreased from $2,262 to $2,221, due to reductions in volume, substantially offset by a gross margin increase from 43.9% to 49.4% as a result of favorable CDMA product mix, product cost reductions

 

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and improved GSM solutions margins. The decrease in SG&A of $87 was due to lower headcount costs as a result of the UMTS Access divestiture, partially offset by increased spending for new technologies. R&D expense decreased by $320 primarily due to the UMTS Access divestiture, and headcount reductions, lower-cost outsourcing and reduced investment in maturing technologies. The related cost reductions were partially offset by focused increases in R&D.

Enterprise Solutions

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

 

     For the Years Ended December 31,     2008 vs. 2007     2007 vs. 2006  
         2008             2007            2006         $ Change     % Change     $ Change    % Change  

Revenues

                

Circuit and packet voice solutions

   $ 1,640     $ 1,723    $ 1,618     $ (83 )   -5 %   $ 105    6 %

Data networking and security solutions

     762       897      674       (135 )   -15 %     223    33 %
                                                  

Total revenues

   $ 2,402     $ 2,620    $ 2,292       (218 )   -8 %   $ 328    14 %
                                                  

Management OM

   $ (64 )   $ 7    $ (22 )     (71 )   -1,014 %   $ 29    132 %
                                                  

2008 vs. 2007

ES revenues decreased to $2,402 in 2008 from $2,620 in 2007, a decrease of $218 or 8%, due to decreases in the data networking and security solutions and the circuit and packet voice solutions businesses primarily in the fourth quarter of 2008.

Data networking and security solutions decreased by $135 primarily due to decreases in the U.S. and Asia of $81 and $35, respectively. The decrease in the U.S. was primarily due to lower sales volumes related to a decline in demand for our Ethernet switch products as a result of a decline in the Ethernet switch market and competitive pressure, and the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenues in 2007 not repeated to the same extent in 2008, partially offset by higher sales volumes related to next generation products. The decrease in Asia was primarily due to the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenues in 2007 not repeated in 2008 and lower sales volumes, partially offset by the favorable impact of foreign exchange fluctuations.

Circuit and packet voice solutions decreased by $83 primarily due to decreases in EMEA and the U.S. of $76 and $42, respectively, partially offset by an increase in Canada of $23. The decrease in EMEA was primarily due to lower sales volumes. The decrease in the U.S. largely resulted from a decline in demand for TDM products and certain customer contracts in 2007 not repeated in 2008, partially offset by higher sales volumes across multiple customers. The increase in Canada largely resulted from higher sales volumes across several customers primarily in the first six months of 2008.

ES Management OM decreased by $71 to a loss of $64 in 2008 from earnings of $7 in 2007. The decrease was a result of a decrease in gross profit of $106, partially offset by declines in SG&A and R&D expenses of $23 and $12, respectively.

ES gross profit decreased to $1,093 in 2008 from $1,199 in 2007, while gross margin remained essentially flat in 2008 when compared to 2007. The decrease in gross profit was primarily a result of lower sales volumes and higher inventory provisions, partially offset cost improvements in the supply chain and lower warranty costs. SG&A expense decreased primarily due to headcount reductions and other cost reduction initiatives, partially offset by increased investment in sales and marketing efforts in expected growth areas. R&D expense decreased

 

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mainly due a reduced investment in maturing technologies. The related cost reductions were partially offset by focused increases in R&D related to potential growth areas.

2007 vs. 2006

ES revenues increased to $2,620 in 2007 from $2,292 in 2006, an increase of $328 or 14%. The increase in 2007 was primarily due to the recognition of previously deferred revenues as a result of the completion or elimination of customer deliverable obligations for certain products in our ES data networking and security solutions business and volume growth across both portfolios.

Revenues from ES circuit and packet voice solutions increased by $76 in EMEA, primarily due to supply chain delays resulting from difficulty in obtaining components required to meet RoHS standards in 2006 that were not present in 2007 and volume increases, $13 in CALA and $6 in the U.S. due to volume increases, partially offset by reduced demand for legacy products.

The increase in ES data networking and security solutions was primarily the result of increases of $83 in Asia, $79 in EMEA and $50 in the U.S. primarily due to the recognition of previously deferred revenues as a result of completion or elimination of customer deliverable obligations in 2006 for certain products and volume increases, partially offset by reduced demand for legacy products.

Management OM for ES increased to a gain of $7 in 2007 from a loss of $22 in 2006, an improvement of $29. This increase in Management OM was primarily due to an increase in gross profit of $183, partially offset by increases in SG&A and R&D expenses of $92 and $62, respectively.

Gross margin increased from 44.3% to 45.8% primarily due to favorable product mix and gross profit increased from $1,016 to $1,199 primarily due to the recognition of high margin deferred revenue, higher sales volumes and favorable product mix. The increase in SG&A expense of $92 was due to increased headcount investments across all regions to drive growth and also due to unfavorable foreign exchange impacts. Increased headcount investment in the development of our packet-based voice, data and security solutions portfolios and negative foreign exchange impact resulted in an increase in R&D expense of $62.

Global Services

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

 

     For the Years Ended December 31,    2008 vs. 2007     2007 vs. 2006  
         2008            2007            2006        $ Change     % Change     $ Change     % Change  

Revenues

   $ 2,089    $ 2,087    $ 2,132    $ 2     0 %   $ (45 )   -2 %
                                                 

Management OM

   $ 303    $ 386    $ 335    $ (83 )   -22 %   $ 51     15 %
                                                 

2008 vs. 2007

GS revenues remained essentially flat in 2008 when compared to 2007. A decrease in the network support services business was almost entirely offset by an increase in the network implementation services business.

Network support services revenues decreased $64 primarily due to decreases in EMEA and the U.S. of $63 and $17, respectively, partially offset by increases in Canada and CALA of $9 and $5, respectively. The decrease in EMEA was mainly due to lower sales volumes across multiple customers and the completion of certain customer contract obligations that resulted in the recognition of previously deferred revenues in 2007 not repeated in 2008, partially offset by the favorable impact of foreign exchange fluctuations. Revenues in the U.S. decreased primarily due to lower sales volumes across multiple customers as a result of capital expenditure

 

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constraints resulting from the expanding economic downturn. The increases in Canada and CALA were primarily due to higher sales volumes across multiple customers.

Revenues in network implementation services increased by $60 primarily as a result of an increase in Asia of $87, partially offset by declines in the U.S. and CALA of $14 and $11, respectively. The increase in Asia was primarily due to the recognition of deferred revenues and an adjustment to revenues, each of which resulted from the completion of obligations in connection with the termination of a customer contract in 2008, as well as the completion of a certain customer contract obligation in LG-Nortel resulting in the recognition of previously deferred revenue, and higher sales volumes across multiple customers. The decrease in the U.S. was primarily due to lower sales volumes across multiple customers as a result of capital expenditure constraints resulting from the expanding economic downturn, partially offset by higher revenues for services related to government business. The decrease in CALA was primarily due to the completion of certain customer contracts in 2007 that was not repeated in 2008.

GS Management OM decreased to $303 in 2008 from $386 in 2007, a decrease of $83. The decrease was primarily a result of a decrease in gross profit of $71 and an increase in R&D expense of $15.

GS gross profit decreased to $633 in 2008 from $704 in 2007, and gross margin decreased from 34% to 30%. The decrease in gross profit was primarily a result of reduced gross margin due to a specific customer contract and other high cost projects in 2008, partially offset by higher gross profit as a result of higher sales volumes. The increase in R&D expense was primarily due to increased investment in the development of new services as well as investments to improve our current service offerings.

2007 vs. 2006

GS revenues were $2,087 in 2007 compared to $2,132 in 2006, a decline of $45 or 2%. The decrease was primarily related to the UMTS Access divestiture, which resulted in a $176 decrease, partially offset by increased volumes.

The decrease in GS revenues was primarily due to a decrease in network implementation services primarily related to the UMTS Access divestiture, and lower sales volumes in EMEA. The decrease in GS revenues in EMEA of $142, of which the UMTS Access divestiture accounted for $176, was partially offset by an increase of $42 in Asia due to increased volumes and contracts where key milestones were met. The decrease in network implementation services was partially offset by growth of $47 in network support services across all regions (except CALA where we experienced significant price pressures and technology changes), and growth of $33 in network managed services, primarily in the U.S., Asia and EMEA. In 2007, the majority of GS revenue continued to be generated by network support services.

Management OM for GS increased to $386 in 2007 from $335 in 2006, an increase of $51, or 15%. This increase in Management OM was primarily due to improved gross profit of $112, partially offset by increases in SG&A and R&D expenses of $54 and $7, respectively.

Gross profit increased from $592 to $704 and gross margin increased from 27.8% to 33.7% due to the favorable impact of cost-reduction programs, the favorable impact of foreign exchange in EMEA, and certain one-time items. The increase in gross profit was partially offset by declines in volume primarily related to the UMTS Access divestiture. SG&A and R&D increased by $54 and $7, respectively, due to investments in resources and capabilities in the areas within the GS segment.

 

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Metro Ethernet Networks

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

 

         For the Years Ended December 31,        2008 vs. 2007     2007 vs. 2006  
         2008             2007             2006        $ Change     % Change     $ Change     % Change  

Revenues

               

Optical networking solutions

   $ 1,105     $ 1,185     $ 1,128    $ (80 )   -7 %   $ 57     5 %

Data networking and security solutions

     288       340       463      (52 )   -15 %     (123 )   -27 %
                                                   

Total Revenues

   $ 1,393     $ 1,525     $ 1,591    $ (132 )   -9 %   $ (66 )   -4 %
                                                   

Management OM

   $ (52 )   $ (18 )   $ 58    $ (34 )   -189 %   $ (76 )   -131 %
                                                   

2008 vs. 2007

Due to declines in both the optical networking solutions and data networking solutions businesses, MEN revenues decreased to $1,393 in 2008 from $1,525 in 2007, a decrease of $132 or 9%.

The decrease in the optical networking solutions business of $80 was primarily due to declines in the U.S. and Asia of $60 and $57, respectively, partially offset by increases in CALA and EMEA of $17 and $16, respectively. The decrease in the U.S. was mainly due to reduced demand for legacy products and significant revenues from a certain customer in 2007 that did not repeat to the same extent in 2008. The decrease in Asia was primarily due to lower sales volumes related to reduced demand for legacy products and significant revenues from certain customers in 2007 that did not repeat to the same extent in 2008. Revenues in CALA increased primarily due to higher sales volumes related to our next generation products. The increase in EMEA was largely due to the completion of certain customer contract obligations resulting in the recognition of previously deferred revenue, volume increases related to our next generation products for long-haul applications, and the favorable impact of foreign exchange fluctuations, partially offset by the completion of certain other customer contract obligations that resulted in the recognition of previously deferred revenue in 2007 that did not repeat in 2008.

Revenues in the data networking and security solutions business decreased $52 primarily due to declines in the U.S. and EMEA of $65 and $18, respectively, partially offset by an increase in Asia of $23. The decrease in the U.S. was primarily due to the completion of a certain customer contract deliverable that resulted from the termination of a supplier agreement resulting in the recognition of previously deferred revenue in 2007 not repeated in 2008. The decrease in EMEA was primarily due to the completion of a certain customer contract obligation that resulted in the recognition of previously deferred revenue in 2007 not repeated in 2008 and a decline in sales volumes across multiple customers related to the declining multi-server switch market, partially offset by an increase resulting from the completion of certain other customer contract obligations resulting in the recognition of previously deferred revenues. The increase in Asia was mainly due to higher sales volumes related to a specific customer in the first six months of 2008 and the completion of network deployments in 2008 for certain customers resulting in the recognition of previously deferred revenue.

MEN Management OM decreased to a loss of $52 in 2008 from a loss of $18 in 2007, a decrease of $34. The decrease was a result of decrease in gross profit of $92, partially offset by declines in R&D and SG&A expenses of $41 and $17, respectively.

MEN gross profit decreased to $425 in 2008 from $517 in 2007, and gross margin decreased from 34% to 31%. The decrease in gross profit was primarily due to lower sales volumes, higher inventory provisions, increased costs due to a settlement with one of our suppliers, price erosion and unfavorable product mix and higher warranty and royalty costs, partially offset by our cost reduction initiatives. R&D expense decreased

 

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primarily due to reduced spending in maturing technologies, partially offset by the unfavorable impact of foreign exchange fluctuations and increased investment in potential growth areas. SG&A expense decreased primarily as a result of cost containment efforts, partially offset by the unfavorable impact of foreign exchange fluctuations.

2007 vs. 2006

MEN revenues decreased to $1,525 in 2007 from $1,591 in 2006, a decrease of $66 or 4%. The decrease in the MEN segment was due to the recognition of less deferred revenues in 2007 than in 2006 and decreases in volumes for certain mature product portfolios, partially offset by increased optical volumes and a favorable foreign exchange impact.

Revenues from optical networking solutions increased by $93 in EMEA, primarily due to the recognition of previously deferred revenues as a result of the completion of certain customer contract deliverables in 2007, increased volume and favorable impact of foreign exchange due to fluctuations between the Euro and the U.S. Dollar. Revenues increased by $21 in Canada and $20 in CALA due to optical market growth. In the U.S., revenues increased by $22 due to an increase in volume, partially offset by deferred revenue recognized in 2006, which was not repeated in 2007. These increases were partially offset by a decrease of $99 in Asia, primarily due to the recognition of previously deferred revenues as a result of the completion of certain customer contract deliverables in 2006 that was not repeated in 2007, partially offset by increased volumes.

Revenues from data networking and security solutions decreased by $78 and $72 in EMEA and Asia, respectively, primarily due to the recognition of previously deferred revenues in 2006, which was not repeated in 2007. These decreases were partially offset by an increase of $31 in the U.S., primarily due to the recognition of previously deferred revenue in 2007 as a result of the completion of certain customer contract deliverables resulting from the termination of a supplier agreement. Further, all three regions had volume decreases due to a declining multi-service switch/services edge router market.

Management OM for MEN decreased to a loss of $18 in 2007 from earnings of $58 in 2006, a decrease of $76, or 131%. This decrease in Management OM was primarily due to a decrease in gross profit of $71 and an increase in R&D expenses of $29, partially offset by a decrease in SG&A expense of $24.

MEN gross profit decreased from $588 to $517 and gross margin decreased from 37.0% to 33.9% due to the recognition of deferred revenues at lower margins in the first quarter of 2007 and deferred revenue recognized at higher margins in 2006, combined with an unfavorable product and customer mix. These decreases were partially offset by volume increases primarily in optical networking solutions and cost reduction programs. The MEN segment also continues to experience pricing pressure resulting in lower margins. SG&A expense declined by $24 as a result of cost reductions in North America, legal expenses incurred in 2006 not repeated in 2007, and lower bad debt expenses in 2007. R&D expenses increased by $29 primarily due to the incremental investment in Carrier Ethernet and Optical OME products and the unfavorable impact of the strengthening of the Canadian Dollar, partially offset by the cancellation of certain R&D programs.

Other

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

 

         For the Years Ended December 31,         2008 vs. 2007     2007 vs. 2006  
         2008              2007              2006         $ Change    % Change     $ Change     % Change  

Revenues

   $ 225      $ 223      $ 246     2    1 %   $ (23 )   -9 %
                                                   

Management OM

   $ (525 )    $ (803 )    $ (852 )   278    35 %   $ 49     6 %
                                                   

 

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2008 vs. 2007

Other revenues increased to $225 in 2008 from $223 in 2007, an increase of $2 or 1%. The increase was due to increases in Canada and Asia of $7 and $2, respectively, partially offset by a decrease in the U.S. of $7.

Other Management OM improved to a loss of $525 in 2008 from a loss of $803 in 2007, a decrease in loss of $278. The decrease was primarily due to an increase in gross profit of $63 and decreases in SG&A and R&D expenses of $186 and $29 respectively. The decrease in SG&A expense was primarily due to cost savings from our previously announced restructuring activities, cost containment efforts, a decrease in charges related to our employee compensation plans, and savings due to lower expenses in relation to our internal control remediation plans and finance transformation activities. The increase in gross profit was primarily due to cost reduction initiatives.

2007 vs. 2006

Other revenues decreased to $223 in 2007 from $246 in 2006, a decrease of $23 or 9%. The decrease was due to declines in Nortel Government Solutions Incorporated (NGS) revenues as a result of delay in the issuance and, in some cases, cancellation of certain intended contract offerings by the U.S. Federal government.

Other Management OM includes corporate charges and improved to a loss of $803 in 2007 from a loss of $852 in 2006, a decrease in loss of $49. The improvement was primarily due to a decrease in SG&A expense of $40 and an increase in gross profit of $14, partially offset by an increase in R&D expense of $5. The decrease in SG&A expense was primarily due to lower costs related to our restatement-related activities and internal control remedial measures, partially offset by costs associated with our Business Transformation initiatives. The increase in R&D expense was primarily due to the continued momentum of our business transformation cost reduction initiatives and headcount reductions as a result of the UMTS Access divestiture.

 

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Liquidity and Capital Resources

Overview

As at December 31, 2008, our cash and cash equivalents balance was approximately $2,390, plus a balance of approximately $65 reflecting the remainder of The Reserve Primary Fund investment that has been classified as short term investments. On February 20, 2009, we received $24 from the Fund leaving a balance of $41 in short term investments.

Our consolidated cash is held globally in various Nortel consolidated entities and joint ventures as follows: approximately $200 in Canada, approximately $700 in the U.S., approximately $675 in EMEA, approximately $450 in joint ventures, approximately $200 in China, approximately $120 in Asia and, approximately $40 in CALA. 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 in the various jurisdictions and in the joint ventures is generally available to fund operations in the particular jurisdictions, but generally is not available to be freely transferred between jurisdictions, regions, or outside the joint ventures, other than for normal course intercompany trade and pursuant to specific court-approved agreements as highlighted 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. These agreements will currently expire on March 15, 2009 unless extended by agreement of the parties and in the case of the Canada-EMEA agreement, with the consent of the Canadian Monitor. Additional cash management provisions are in place 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.

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. The loan bears interest at 10% per annum, and is secured by a charge on Nortel’s Ottawa, Ontario facility, and subject to certain conditions, an intercompany charge, each as approved by the Canadian Court (see the Properties section of our 2008 Annual Report). NNL’s obligations under the loan are unconditionally guaranteed by NNTC. The agreement matures on December 31, 2009, subject to extension for a further year, and contains certain covenants, including mandatory prepayment of loans with the net cash proceeds from certain asset dispositions.

Under a current agreement with EDC, we have continued access under the EDC Support Facility up to May 1, 2009 for up to $30 of support. We and EDC continue to work together to see if a longer term arrangement, acceptable to both parties, can be reached. There is no assurance that this level of support will be sufficient during the period.

We have commenced 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 and reviews of our real estate and other property leases, IT equipment agreements, supplier and customer contracts and general discretionary spending. We have also commenced a process to assess the strategic and economic value of several of our subsidiaries.

Our current cash management system and cash on hand to fund our operations is subject to ongoing review and approval by the Canadian Monitor and 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

 

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system, (ii) the current support under the EDC Support Facility is sufficient for our business needs up to May 1, 2009 or that we will not have to provide cash collateral, or (iii) we generate sufficient cash to fund our operations during this process or that we will be able to access any alternative financing on acceptable terms or at all.

Cash Flow

Our total cash and cash equivalents excluding restricted cash decreased by $1,136 in 2008 to $2,390, due to cash used in operating and investing activities, and the unfavorable impact of foreign exchange fluctuations on cash and cash equivalents, partially offset by cash from financing activities.

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 as of December 31:

 

    

    For the Years Ended December 31,    

 
         2008         2007         2006      

Net loss

   $ (7,386 )   $ (798 )   $ (32 )

Non-cash items

     7,644       1,576       744  

Changes in operating assets and liabilities:

      

Accounts receivable—net

     (196 )     4       (496 )

Inventories—net

     (20 )     (66 )     (42 )

Accounts payable

     (200 )     94       (80 )
                        
     (416 )     32       (618 )

Deferred costs

     568       223       97  

Income taxes

     (17 )     18       (18 )

Payroll and benefit-related, other, accrued and contractual liabilities

     (404 )     (107 )     (252 )

Deferred revenue

     (345 )     (424 )     (229 )

Advanced billings in excess of revenues recognized to date on contracts

     (739 )     149       120  

Restructuring liabilities

     51       (7 )     (21 )

Other

     (199 )     (469 )     (74 )
                        

Changes in other operating assets and liabilities

     (1,085 )     (617 )     (377 )
                        

Net cash from (used in) operating activities

     (1,243 )     193       (283 )

Net cash from (used in) investing activities

     (310 )     (177 )     317  

Net cash from (used in) financing activities

     601       (81 )     483  

Effect of foreign exchange rate changes on cash and cash equivalents

     (184 )     104       94  
                        

Net increase (decrease) in cash and cash equivalents

     (1,136 )     39       611  

Cash and cash equivalents at beginning of year

     3,526       3,487       2,876  
                        

Cash and cash equivalents at end of year

   $ 2,390     $ 3,526     $ 3,487  
                        

Operating Activities

In 2008, our net cash used in operating activities of $1,243 resulted from a net loss of $7,386 plus adjustments for non-cash items of $7,644, net uses of cash of $1,085 due to changes in other operating assets and liabilities, and cash of $416 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 $739 primarily as a result of the completion of contracts in LG-Nortel, partially offset by the change in deferred costs of $568 due to the release of related revenues. The use of cash for payroll, accrued and contractual liabilities of $404 was primarily due to bonus payments and sales compensation accruals, SG&A and interest accruals. The change of $199 in the category of Other, under operating assets and liabilities, was primarily comprised of pension payments. The primary additions to our net loss for non-cash items were deferred income taxes of $3,053 primarily related to an increase in our deferred tax asset valuation allowance, goodwill impairment charge of $2,202 relating to all of our

 

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reportable segments, amortization and depreciation of $332, and minority interest of $121. For additional information with respect to the increase in our deferred tax asset valuation allowance and the goodwill impairment charge, see “Application of Critical Accounting Policies and Estimates—Income Taxes—Tax Asset Valuation” and “Application of Critical Accounting Policies and Estimates—Goodwill Valuation” sections, respectively, of this report.

In 2007, our net cash from operating activities of $193 was as a result of our net loss of $798 plus adjustments for non-cash items of $1,576, net cash from operating assets and liabilities of $32 and net cash used in other operating assets and liabilities of $617. The primary additions to our net income for non-cash items were deferred income taxes of $1,019, amortization and depreciation of $328, pension and other accruals of $276, share based compensation expense of $105 and minority interest of $73. These additions were partially offset by other non-cash changes of $210, primarily due to foreign exchange impacts on long-term assets and liabilities of $293.

Accounts Receivable

 

     December 31,
2008
   December 31,
2007
   $ Change     % Change  

Accounts Receivable

   $ 2,152    $ 2,578    $ (426 )   (17 )

Days sales outstanding in accounts receivable (DSO)(a)

     71      72     

 

(a)

DSO is the average number of days our receivables are outstanding based on a 90 day cycle. DSO is a metric that approximates the measure of the average number of days from when we recognize revenue until we collect cash from our customers. DSO for each quarter is calculated by dividing the quarter end accounts receivable-net balance by revenues for the quarter, in each case as determined in accordance with U.S. GAAP, and multiplying by 90 days.

Accounts receivable decreased to $2,152 as at December 31, 2008 from $2,578 as at December 31, 2007, a decrease of $426, or 17% primarily as a result of lower sales volumes in 2008 compared to 2007. The one day decrease in DSO was due to the proportionately higher decline in accounts receivable as compared to the revenue.

Inventory

 

     December 31,
2008
   December 31,
2007
   $ Change     % Change  

Inventory—net (excluding deferred costs)

   $ 493    $ 513    $ (20 )   (4 )

Net inventory days (NID)(a)

     30      26     

 

(a)

NID is the average number of days from procurement to sale of our product based on a 90 day cycle. NID for each quarter is calculated by dividing the average of the current quarter and prior quarter inventories—net (excluding deferred costs) by the cost of revenues for the quarter and multiplying by 90 days.

Inventory, excluding deferred costs, decreased to $493 as at December 31, 2008 from $513 as at December 31, 2007, a decrease of $20 or 4%. NID increased by 4 days compared to 2007 primarily due to a decrease in the cost of revenues and inventory build up related to the in-sourcing of certain distribution operations.

Accounts Payable

 

     December 31,
2008
   December 31,
2007
   $ Change     % Change  

Trade accounts payable

   $ 924    $ 1,145    $ (221 )   (19 )

Days of purchasing outstanding in accounts payable (DPO)(a)

     51      57     

 

(a)

DPO is the average number of days from when we receive purchased goods and services until we pay our suppliers based on a 90 day cycle. DPO for each quarter is calculated by dividing the quarter end trade and other accounts payable by the cost of revenues for the quarter, in each case as determined in accordance with U.S. GAAP, and multiplying by 90 days.

 

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Trade accounts payable decreased to $924 as at December 31, 2008 from $1,145 at December 31, 2007, a decrease of $221 or 19%. This decrease in the trade accounts payable balance and DPO is attributable to spending levels consistent with the current declining sales volumes.

Deferred Revenue

Billing terms and collections periods related to arrangements whereby we defer revenue are generally similar to other revenue arrangements. Similarly, payment terms and cash outlays related to products and services associated with delivering under these arrangements are also generally similar to other revenue arrangements. As a result, neither cash inflows nor outflows are unusually impacted under arrangements in which revenue is deferred, compared to arrangements in which revenue is not deferred, and the DSO and DPO include all these arrangements.

Investing Activities

In 2008, our net cash used in investing activities was $310, primarily due to expenditures for plant and equipment of $159, acquisition of investments and businesses, net of cash acquired of $113 and a net increase in short-term and long-term investments of $76 as described below.

In 2007, our net cash used in investing activities was $177 and was primarily due to expenditures for plant and equipment of $235 and a decrease in restricted cash & cash equivalents of $22, partially offset by proceeds of $90 primarily related to the sale of our facility located in Montreal, Quebec.

Money Market Funds

As part of our cash management strategy, we invest in institutional and government money market funds, which are considered highly liquid and which we generally account for as cash and cash equivalents. We had invested approximately $362 in the Reserve Primary Fund (the Fund), which was rated AAA by Standard & Poor’s (S&P) and Aaa (Moody’s). On September 16, 2008, the Fund announced that it was reducing to zero the value of its holdings of debt securities issued by Lehman Brothers Holdings, Inc. and, as a result, the net asset value (NAV) of the Fund was reduced from $1 to $0.97. On September 19, 2008, the Fund filed with the SEC an application to temporarily suspend rights of redemption and announced an intent to ensure an orderly liquidation of securities in the Fund. To account for these developments, we reclassified our investment in the Fund from cash and cash equivalents to short-term investments, and booked an impairment of $11 to reflect the decline in the Fund’s NAV. On October 31, 2008 and on December 3, 2008, the Fund distributed funds back to the investors of which our share was approximately $184 and $102, respectively. On February 20, 2009, we received $24 as a further redemption from the Fund. As a result, the current remaining carrying value in the Fund is $41, which we will re-assess the classification of as a short-term investment as further information is made available on timing of liquidation of the Fund.

Financing Activities

In 2008, our net cash from financing activities was $601, primarily due to the proceeds received from the issuance of the 2016 Fixed Rate Notes issued May 2008 of $668, and a $39 net increase in notes payable, partially offset by dividends of $35 paid by us related to our outstanding NNL preferred shares, a $22 decrease in net capital leases payable and debt issuance costs of $13.

In 2007, our net cash used in financing activities was $81, resulting primarily from dividends paid of $52, mainly related to our outstanding NNL preferred shares and a $24 net decrease in capital leases payable.

 

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Other Items

In 2008, our cash decreased by $184 due to the unfavorable effects of changes in foreign exchange rates, primarily of the Korean Won, the Euro, the British Pound and the Canadian Dollar against the U.S. Dollar.

In 2007, our cash increased by $104 due to favorable effects of changes in foreign exchange rates, primarily due to the strengthening of the Canadian Dollar, the British Pound and the Euro against the U.S. Dollar.

Fair Value Measurements

As discussed in Note 11 to the audited consolidated financial statements, effective January 1, 2008, we adopted the provisions of SFAS No. 157, “Fair Value Measurements” (SFAS 157). We utilize unobservable (Level 3) inputs in determining the fair value of auction rate securities and in some cases, derivative contracts, for which fair values totaled $19 and $20, respectively, as of December 31, 2008.

Our auction rate security instruments are classified as available-for-sale securities and reflected at fair value. In prior periods, due to the auction process which took place approximately every 30 days for most securities, quoted market prices were readily available, which would qualify as Level 1 under SFAS 157. However, due to events in credit markets during the year ended December 31, 2008, the auction events for most of these instruments failed. Therefore, we have determined the estimated fair values of these securities utilizing discounted expected cash flows (Level 3) as of December 31, 2008. We currently believe that there has been no decline in the fair value of the auction rate securities, because the underlying assets for these securities are almost entirely backed by the U.S. federal government. In addition, we entered into an agreement with the broker from whom we purchased these securities, whereby at anytime during the period from June 30, 2010 through July 2, 2012, we are entitled to sell the then remaining outstanding balance of these securities, if any, to such broker at par. Our holdings of auction rate securities represent less than one percent of our total cash and cash equivalents and short-term investments balance as of December 31, 2008. We believe that any difference between our estimate of fair value of our investments and an estimate that would be arrived at by another party would have no impact on earnings, since such difference would also be recorded to accumulated other comprehensive income. We will re-evaluate each of these factors as market conditions change in subsequent periods.

In October 2008, we entered into an agreement (the Agreement) with the investment firm that sold the Company a portion of its auction rate securities, which have a par value of approximately $19 as at December 31, 2008. By entering into the Agreement, we (1) received the right (Put Option) to sell these auction rate securities back to the investment firm at par, at our sole discretion, anytime during the period from June 30, 2010 through July 2, 2012, and (2) gave the investment firm the right to purchase these auction rate securities or sell them on our behalf at par anytime after the execution of the Agreement through July 2, 2012. We elected to measure the Put Option under the fair value option of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (SFAS 159), and recorded a pre-tax income of approximately $3, and recorded a corresponding long term investment. Simultaneously, we transferred these auction rate securities from available-for-sale to trading investment securities. As a result of this transfer, we recognized a pre-tax impairment loss of approximately $3. The recording of the Put Option and the recognition of the impairment loss resulted in no net impact to the Consolidated Statement of Earnings for the year ended December 31, 2008. We anticipate that any future changes in the fair value of the Put Option will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the Consolidated Statement of Earnings. The Put Option will continue to be measured at fair value utilizing Level 3 inputs until the earlier of its maturity or exercise.

We determine the value of the majority of derivatives we enter into utilizing standard valuation techniques. Depending on the type of derivative, the valuation could be calculated through either discounted cash flows or the Black-Scholes model. The key inputs depend upon the type of derivative, and include interest rate yield curves, foreign exchange spot and forward rates, and expected volatility. We have consistently applied these

 

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valuation techniques in all periods presented and believe we have obtained the most accurate information available for the types of derivative contracts we hold.

Senior Notes Offering

On May 28, 2008, we completed the offering of the 2016 Fixed Rate Notes issued May 2008 in the U.S. to qualified institutional buyers pursuant to Rule 144A under the Securities Act to persons outside the U.S. pursuant to Regulation S under the Securities Act and to accredited investors in Canada pursuant to applicable private placement exemptions.

The 2016 Fixed Rate Notes issued May 2008 were issued as additional notes under an existing indenture dated as of July 5, 2006 as supplemented (2006 Indenture), and are part of the same series as our currently outstanding $450 aggregate principal amount of 10.75% Senior Notes due 2016 that were issued on July 5, 2006 (2016 Fixed Rate Notes issued July 2006), under the 2006 Indenture. The 2016 Fixed Rate Notes issued May 2008 and the 2016 Fixed Rate Notes issued July 2006 have the same ranking, guarantee structure, interest rate, maturity date and other terms and are treated as a single class of securities under the indenture and holders will vote together as one class. The 2016 Fixed Rate Notes issued May 2008 and the related guarantees are initially not fungible for trading purposes with the 2016 Fixed Rate Notes issued July 2006.

The net proceeds received from the sale of the 2016 Fixed Rate Notes issued May 2008 were approximately $655, after deducting discount on issuance of $7 and commissions and other offering expenses of $13. On June 16, 2008, we used these net proceeds, together with available cash, to redeem, at par, $675 outstanding principal amount of NNC’s 4.25% Notes due 2008.

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 pension plan funding in 2009 and beyond is uncertain at this time.

Future Uses of Liquidity Our cash requirements for the 12 months commencing January 1, 2009 are primarily expected to consist of funding for operations, including our investments in R&D, and the following items:

 

 

 

cash contributions to our defined benefit pension plans and our post-retirement and post-employment benefit plans of approximately $148, assuming current funding rules and current plan design;

 

 

 

purchase of certain Flextronics inventory in the total amount of $120;

 

 

 

capital expenditures of approximately $60; and

 

 

 

costs related to workforce reductions and real estate actions in connection with our active workforce and other restructuring plans of approximately $160.

 

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Contractual cash obligations

The following table summarizes our contractual cash obligations as of December 31, 2008, for debt, operating leases, purchase obligations, outsourcing contracts, obligations under special charges, pension, post-retirement benefits and post-employment obligations, acquisitions and other liabilities. Our current contractual obligations are subject to re-evaluation in connection with our Creditor Protection Proceedings. As a result, obligations as currently quantified in the table below and in the text immediately following the footnotes to the table will continue to change. The table below does not include contracts that we have successfully rejected through our Creditor Protection Proceedings. The table also does not include commitments that are contingent on events or other factors that are uncertain or unknown at this time.

 

     Payments Due    Thereafter    Total
Obligations

Contractual Cash Obligations(a)

   2009    2010    2011    2012    2013      

Long-term debt(b)

   $ 24    $ 25    $ 1,027    $ 29    $ 696    $ 1,551    $ 3,352

Interest on Long-term debt(c)

     293      293      252      202      177      588      1,805

Operating leases(d)

     99      93      77      60      50      267      646

Purchase obligations

     17      9      3      —        —        —        29

Outsourcing contracts

     19      —        —        —        —        —        19

Obligations under special charges

     39      57      52      50      49      164      411

Pensions, post-retirement benefits and post-employment obligations(e)

     148      —        —        —        —        —        148

Acquisitions

     —        —        —        —        —        17      17

Other long-term liabilities reflected on the balance sheet(f)

     23      3      2      3      2      113      146
                                                

Total contractual cash obligations

   $ 662    $ 480    $ 1,413    $ 344    $ 974    $ 2,700    $ 6,573
                                                

 

(a)

Amounts represent our known, undiscounted, minimum contractual payment obligations under our long-term obligations and include amounts identified as contractual obligations in current liabilities of the 2008 Financial Statements as of December 31, 2008.

 

(b)

Includes principal payments due on long-term debt and $267 of capital lease obligations. For additional information, see note 12, “Long-term debt”, to the 2008 Financial Statements.

 

(c)

Amounts represent interest obligations on our long-term debt excluding capital leases as at December 31, 2008. As described in note 13, “Financial instruments and hedging activities”, to the 2008 Financial Statements, we have entered into certain interest rate swap contracts, which swap fixed rate payments for floating rate payments. For the purposes of estimating our future payment obligations with regards to floating rate payments, we have used the floating rate in effect as of December 31, 2008.

 

(d)

For additional information, see note 15, “Commitments”, to the 2008 Financial Statements.

 

(e)

Represents our 2009 estimate cash funding of our 2009 pension, post-retirement and post-employment plans. We will continue to have funding obligations in each future period; however, we are not currently able to estimate those amounts.

 

(f)

Includes asset retirement obligations, deferred compensation and tax liabilities under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. $15 has been classified as current and therefore reflected in 2008 and $92 in “Thereafter”, as we are unable to reasonably project the ultimate amount or timing of settlement of our reserves for income taxes. See note 8, “Income taxes” to the 2008 Financial Statements for further discussion.

As a result of the Creditor Protection Proceedings, we are not able to determine the amounts and timing of our contractual cash obligations. Accordingly, the preceding table reflects the scheduled maturities based on the original payment terms specified in the underlying agreement or contract. Future payment timing and amounts are expected to be modified as a result of the recognition under the Creditor Protection Proceedings.

Purchase obligations

Purchase obligation amounts in the above table represent the minimum obligation under our supply arrangements related to products and/or services entered into in the normal course of our business. Where the

 

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related contract specifies quantity, pricing and timing information, we have included that arrangement in the amounts presented above. In certain cases, these arrangements define an end date of the contract, but do not specify timing of payments between December 31, 2008 and such end date. In those cases, we have estimated the timing of the payments based on forecasted usage rates.

Outsourcing contracts

Outsourcing contract amounts in the table above represent our minimum contractual obligations for services provided to us for a portion of our information services function. The amounts payable under these outsourcing contracts is variable to the extent that our hardware volumes and workforce fluctuates from the baseline levels contained in the contracts, and our contractual obligations could increase above such baseline amount. If our hardware volumes or workforce were to fall below the baseline levels in the contracts, we nevertheless would be required to make the minimum payments noted above.

Obligations under special charges

Obligations under special charges in the above table reflect undiscounted amounts related to contract settlement and lease costs, and are expected to be substantially drawn down by the end of 2022. Balance sheet provisions of $117 for workforce reduction costs, included in restructuring in current liabilities in the accompanying audited consolidated financial statements, have not been reflected in the contractual cash obligations table above.

Pension and post-retirement obligations

During 2008, we made cash contributions to our defined benefit pension plans of $275 and to our post-retirement and post-employment benefit plans of $68. Assuming current funding rules and current plan design, estimated 2009 cash contributions to our defined benefit pension plans and our post-retirement and post-employment benefit plans are approximately $75 and $73, respectively. For further information, see “Application of Critical Accounting Policies and Estimates —Pension and Post-retirement Benefits”, below in this section of this report. The preceding table above does not include an intercompany guarantee agreement whereby NNL indemnifies the U.K. pension trust for any amounts due that Nortel Networks U.K. Limited (NNUK) does not pay under a Funding Agreement executed on November 21, 2006. As a result NNL guarantees NNUK’s performance under the November 21, 2006 Funding Agreement. The table also does not include an intercompany guarantee agreement whereby NNL indemnifies the trustees of the U.K. Fund on the insolvency of NNUK and consequent windup of the U.K. plan.

Acquisitions

As a result of the acquisitions made in 2008, we may be liable for future cash obligations of up to $17 based on the achievement of future business milestones. See “Other Significant Business Developments—Acquisitions and Divestitures” in this section of this report for additional information. This amount has been classified as “Thereafter” as we are unable to reasonably project the ultimate amount or timing of settlement of these contingent payments.

Other long-term liabilities reflected on the balance sheet

Other long-term liabilities reflected on the balance sheet relate to asset retirement obligations and deferred compensation accruals. Payment information related to our asset retirement obligations has been presented based on the termination date after the first renewal period of the associated lease contracts. Payment information related to our deferred compensation accruals has been presented based on the anticipated retirement dates of the employees participating in the programs.

 

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Future Sources of Liquidity

Available support facility

In 2003, we entered into the $750 EDC Support Facility with EDC. Our obligations under the EDC Support Facility are guaranteed by NNI. The EDC Support Facility’s termination date is December 31, 2011, subject to automatic annual renewal of the facility each following year, unless either party provides written notice to the other of its intent to terminate.

As of December 31, 2008, the EDC Support Facility provided for up to $750 in support including:

 

 

 

$300 of committed revolving support for performance bonds or similar instruments with individual amounts of up to $25, of which $125 was outstanding; and

 

 

 

$450 of uncommitted revolving support for performance bonds or similar instruments and/or receivables sales and/or securitizations, of which $63 was outstanding.

The EDC Support Facility provides that EDC may suspend its obligation to issue any additional support if events occur that could have a material adverse effect on our business, financial position or results of operation. In addition, the EDC Support Facility can be suspended or terminated if an event of default has occurred and is continuing under the EDC Support Facility or if our senior unsecured long-term corporate debt rating by Moody’s has been downgraded to less than B3 or if its debt rating by S&P has been downgraded to less than B-.

On December 15, 2008, following a downgrade by Moody’s of NNC’s corporate family rating to Caa2, we executed a standstill and waiver agreement with EDC.

Effective January 14, 2009, due to the Creditor Protection Proceedings, we entered into an agreement with EDC to permit continued access by us to the EDC Support Facility for an interim period to February 13, 2009, for up to $30 of support based on our then estimated requirements over the period. On February 10, 2009, EDC agreed to extend this interim period to May 1, 2009. This support is secured by a charge on the Canadian Debtors’ assets. See the Properties section of our 2008 Annual Report. In this agreement, EDC also agreed to waive certain conditions and temporarily refrain from acting with respect to certain events of default relating to the Creditor Protection Proceedings and certain credit rating events. We and EDC continue to work together to see if a longer term arrangement, acceptable to both parties, can be reached.

Credit Ratings

On November 10, 2008, S&P placed our Corporate Credit Rating on CreditWatch with negative implications and at the same time revised the ratings on our preferred shares to C from CCC-. On December 15, 2008 Moody’s downgraded NNC’s Ratings to Caa2 from B3 and the Rating on our preferred shares to Ca from Caa1. On January 14, 2009 S&P lowered our Corporate Credit Rating to D from B- and at the same time lowered the ratings on our preferred shares to D from C. On January 15, 2009 Moody’s downgraded NNC’s Ratings to Ca from Caa2 and the rating on our preferred shares to C from Ca and following these rating actions has withdrawn all ratings.

 

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Off-Balance Sheet Arrangements

Bid, Performance-Related and Other Bonds

During the normal course of business, we provide 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, and we do not anticipate that we will be required to make, material payments under these types of bonds.

The following table provides information related to these types of bonds as of:

 

    

    For the Years Ended December 31,    

         2008            2007    

Bid and performance-related bonds(a)

   $ 167    $ 155

Other bonds(b)

     57      54
             

Total bid, performance-related and other bonds

   $ 224    $ 209
             

 

(a)

Net of restricted cash and cash equivalents amounts of $4 and $5 as of December 31, 2008 and December 31, 2007, respectively.

 

(b)

Net of restricted cash and cash equivalents amounts of $7 and $27 as of December 31, 2008 and December 31, 2007, respectively.

The EDC Support Facility is used to support bid, performance-related and other bonds with varying terms. Any bid or performance-related bond will be supported under the EDC Support Facility with expiry dates of up to four years, assuming we and EDC are successful in implementing a long-term arrangement. See “Future Sources of Liquidity—Available support facility” in this section of this report.

Application of Critical Accounting Policies and Estimates

Our accompanying audited consolidated financial statements are based on the selection and application of accounting policies generally accepted in the U.S., 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, provisions for product warranties, income taxes, goodwill valuation, pension and post-retirement benefits, special charges and other contingencies.

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

 

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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. Various technologies within one of our reporting segments may also have different revenue recognition implications depending on, among other factors, the specific performance and acceptance criteria within the applicable contract. 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 regularly enter into multiple contractual agreements with the same customer. These agreements are reviewed to determine whether they should be evaluated as one arrangement in accordance with AICPA Technical Practice Aid 5100.39, “Software Revenue Recognition for Multiple-Element Arrangements”.

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.

If objective and reliable evidence of fair value exists for all units of accounting in the arrangement, revenue is allocated to each unit of accounting or element based on relative fair values. In situations where there is objective and reliable evidence of fair value for all undelivered elements, but not for delivered elements, the residual method is used to allocate the arrangement consideration. Under the residual method, the amount of revenue allocated to delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements. Each unit of accounting is then accounted for under the applicable revenue recognition guidance. 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. For instance, where post-contract customer support (“PCS”) is the last delivered element within the unit of accounting, the deferred revenue and costs are recognized ratably over the remaining PCS term once PCS is the only undelivered element.

Our assessment of which authoritative standard is applicable to an element also can involve significant judgment. For instance, the determination of whether software is more than incidental to a hardware element determines whether the hardware element is accounted for pursuant to AICPA Statement of Position (SOP) 97-2, “Software Revenue Recognition” (SOP 97-2), or based on general revenue recognition guidance as set out in SEC Staff Accounting Bulletin (SAB) 104, “Revenue Recognition” (SAB 104). This assessment could significantly impact the amount and timing of revenue recognition.

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

 

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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 change over time as our product offerings evolve. A change in this assessment, whereby software becomes more than incidental to the hardware product 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 in accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (SOP 81-1), 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. Profit estimates on these contracts are revised periodically based on changes in circumstances and any losses on contracts are recognized in the period that such losses become evident. Generally, the terms of SOP 81-1 contracts provide for progress billings based on completion of certain phases of work. Unbilled SOP 81-1 contract revenues recognized are accumulated in the contracts in progress account included in accounts receivable—net. Billings in excess of revenues recognized to date on these contracts are recorded as advance billings in excess of revenues recognized to date on contracts within other accrued liabilities until recognized as revenue. This classification also applies to billings in advance of revenue recognized on combined units of accounting under Emerging Issues Task Force (EITF) Issue No 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21), that contain both SOP 81-1 and non-SOP 81-1 elements. 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. The completed contract method is also applied to all SOP 81-1 units of accounting valued at under $0.5, as these are generally short-term in duration and our results of operations would not vary materially from those resulting if we applied the percentage-of-completion method of accounting.

Revenue for hardware that does not require significant customization, and where any software is considered incidental, is recognized under SAB 104. Under SAB 104, revenue 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 collectability 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 arrangements where the criteria for revenue recognition have not been met because legal title or risk of loss on products did not transfer to the buyer until final payment had been received or where delivery had not occurred, revenue is deferred to a later period when title or risk of loss passes either on delivery or on receipt of payment from the customer as applicable. For arrangements where the customer agrees to purchase products but we retain physical possession until the customer requests delivery, or “bill and hold” arrangements, revenue is not recognized until delivery to the customer has occurred and all other revenue recognition criteria have been met.

Revenue for software and software-related elements is recognized pursuant to SOP 97-2. Software-related elements within the scope of SOP 97-2 are defined in EITF 03-5, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software”, as those explicitly included within paragraph 9 of SOP 97-2 (e.g. software products, upgrades/enhancements, post-

 

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contract customer support, and services) as well as any non-software deliverable(s) for which a software deliverable is deemed essential to its functionality. For software arrangements involving multiple elements, we allocate revenue to each element based on the relative fair value or the residual method, as applicable, using vendor specific objective evidence to determine fair value, which is based on prices charged when the element is sold separately. Software revenue accounted for under SOP 97-2 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 collectability 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. For products sold through these distribution channels, revenue is recognized from product sales at the time of shipment to the distribution channel when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable. 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. We will defer revenue but recognize related costs if we are uncertain about whether we will be able to collect the receivable. As a result, our estimates and judgment regarding customer credit quality could significantly impact the timing and amount of revenue recognition. We generally do not sell under arrangements with extended payment terms.

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 complexities of our contractual arrangements result in the deferral of revenue for a number of reasons, the most significant of which are discussed below:

 

 

 

Complex arrangements that involve multiple deliverables such as future software deliverables and/or post-contract support which remain undelivered generally result in the deferral of revenue because, in most cases, we have not established fair value for the undelivered elements. We estimate that these arrangements account for approximately 64% of our deferred revenue balance and will be recognized upon delivery of the final undelivered elements and over time.

 

 

 

In many instances, our contractual billing arrangements do not match the timing of the recognition of revenue. Often this occurs in contracts accounted for under SOP 81-1 where we generally recognize the revenue based on a measure of the percentage of costs incurred to date relative to the estimated total expected contract costs. We estimate that approximately 8% of our deferred revenue balance relates to contractual arrangements where billing milestones preceded revenue recognition.

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 at December 31,    $ Change     % Change  
     2008    2007     

Deferred revenue

   $ 1,243    $ 1,619    $ (376 )   (23 )

Advance billings

     751      1,490      (739 )   (50 )
                            

Total deferred revenue

   $ 1,994    $ 3,109    $ (1,115 )   (36 )
                            

Total deferred revenue decreased by $1,115 in 2008 as a result of reductions related to the net release of approximately $936, other adjustments of $11 and foreign exchange fluctuations of $168. The release of deferred revenue to revenue is net of additional deferrals recorded during 2008.

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 collectability. 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 six 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 at December 31,    

 
         2008             2007      

Gross accounts receivable

   $ 2,188     $ 2,640  

Provision for doubtful accounts

     (36 )     (62 )
                

Accounts receivable—net

   $ 2,152     $ 2,578  
                

Accounts receivable provision as a percentage of gross accounts receivable

     2 %     2 %

Gross long-term receivables

   $ 80     $ 44  

Provision for doubtful accounts

     (37 )     (35 )
                

Net long-term receivables

   $ 43     $ 9  
                

Long-term receivables provision as a percentage of gross long-term receivables

     46 %     80 %

 

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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 our 365 day 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 at December 31,  
     2008     2007  

Gross inventory

   $ 2,104     $ 3,118  

Inventory provisions

     (481 )     (907 )
                

Inventories—net(a)

   $ 1,623     $ 2,211  
                

Inventory provisions as a percentage of gross inventory

     23 %     29 %

Inventory provisions as a percentage of gross inventory excluding deferred costs(b)

     49 %     64 %

 

(a)

Includes the long-term portion of inventory related to deferred costs of $146 and $209 as of December 31, 2008 and December 31, 2007, respectively, which is included in other assets.

 

(b)

Calculated excluding deferred costs of $1,130 and $1,698 as of December 31, 2008 and December 31, 2007, respectively.

Inventory provisions decreased by $426 primarily as a result of $441 of scrapped inventory, $63 of previously reserved inventory (including $38 of consigned inventory), and foreign exchange adjustments of $107, partially offset by $185 of additional inventory provisions. 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.

Provisions for Product Warranties

Provisions are recorded for estimated costs related to warranties given to customers on our products to cover defects. These provisions are calculated based on historical return rates as well as on estimates that take into consideration the historical material costs and the associated labor costs to correct the product defect. Known product defects are specifically provided for as we become aware of such defects. Revisions are made when actual experience differs materially from historical experience. These provisions for product warranties are part of the cost of revenues and are accrued when the product is delivered and recognized in the same period as the related revenue. They represent the best possible estimate, at the time the sale is made, of the expenses to be incurred under the warranty granted. Warranty terms generally range from one to six years from the date of sale depending upon the product. Warranty related costs incurred prior to revenue being recognized are capitalized and recognized as an expense when the related revenue is recognized.

 

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We accrue for warranty costs as part of our cost of revenues based on associated material costs and labor costs. Material cost is estimated based primarily upon historical trends in the volume of product returns within the warranty period and the cost to repair or replace the product. Labor cost is estimated based primarily upon historical trends in the rate of customer warranty claims and projected claims within the warranty period.

The following table summarizes the accrual for product warranties that was recorded as part of other accrued liabilities in the consolidated balance sheets:

 

    

    As at December 31,    

 
         2008             2007      

Balance at the beginning of the year

   $ 206     $ 214  

Payments

     (176 )     (181 )

Warranties issued

     209       261  

Revisions

     (59 )     (88 )
                

Balance at the end of the year

   $ 180     $ 206  
                

We engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers. Our estimated warranty obligation is based upon warranty terms, ongoing product failure rates, historical material costs and the associated labor costs to correct the product defect. If actual product failure rates, material replacement costs, service or labor costs differ from our estimates, revisions to the estimated warranty provision would be required. If we experience an increase in warranty claims compared with our historical experience, or if the cost of servicing warranty claims is greater than the expectations on which the accrual is based, our gross margin could be negatively affected.

Revisions to warranty provisions include releases and foreign currency exchange adjustments. The $59 of revisions relates to releases, consisting of $51 of warranty releases and $8 of known product defect releases. These releases reduced cost of revenues during 2008 by $59. The warranty releases were primarily due to declines in cost of sales for specific product portfolios to which our warranty estimates apply, as well as declines in various usage rates and warranty periods.

Income Taxes

Tax Asset Valuation

As of December 31, 2008, our deferred tax asset balance was $6,082, against which we have recorded a valuation allowance of $6,050 resulting in a net deferred tax asset of $32. As of December 31, 2007, our net deferred tax asset was $3,323. The reduction of $3,291 is primarily attributable to a write-down of the deferred tax assets in all tax jurisdictions (other than joint ventures in Korea and Turkey) through an increase in the valuation allowance, the effects of foreign exchange translation and the normal changes in deferred tax assets for profitable jurisdictions resulting from operations in the ordinary course of business. Prior to the December 31, 2008 write-down we had deferred tax assets resulting from net operating 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, the U.S., the U.K. and France). With the exception of deferred tax assets in Korea and Turkey, we have provided a full valuation allowance against the net deferred tax assets including the loss carryforwards.

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. Our expectations about future pre-tax income are based on detailed forecasts through 2011, which are based in part on assumptions about market growth rates and cost reduction initiatives. To estimate future pre-tax income beyond 2011, we use model forecasts based on market growth rates. The expanding global economic downturn and the commencement of the Creditor

 

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Protection Proceedings led us to conclude that the forecasts became less reliable as compared to prior periods. As a result, we are unable to rely on the forecasts as positive evidence to overcome the significant negative evidence and uncertainty. We determined that there was significant negative evidence supporting our conclusion that the tax benefit of our deferred tax asset was not more likely than not to be realized in future tax years in all tax jurisdictions other than Korea and Turkey. Therefore, a full valuation allowance was necessary against our net deferred tax asset in all tax jurisdictions other than joint ventures in Korea and Turkey and certain deferred tax assets that are realizable through the reversal of existing taxable temporary differences.

Prior to the fourth quarter of 2008, we assessed the expected realization of our deferred tax assets quarterly to determine whether an income tax valuation allowance is required. Based on available evidence, both positive and negative, we determine whether it is more likely than not that all or a portion of the remaining net deferred tax assets will be realized. The main factors that we believe provide evidence about the realizability of our net deferred tax asset are discussed in further detail below and include the following:

 

 

 

the amount of, and trends related to, cumulative earnings or losses realized over the most recent 12 quarters;

 

 

 

our current period net earnings (loss) and its impact on our history of earnings;

 

 

 

future earnings (loss) projections as determined through the use of internal forecasts, including the impact of sales backlog and existing contracts;

 

 

 

our ability to carryforward our tax losses and investment tax credits, including tax planning strategies to accelerate utilization of such assets; and

 

 

 

industry, business, or other circumstances that may adversely affect future operations, and the nature of the future income required to realize our deferred tax assets.

In evaluating the positive and negative evidence, the weight we assign each type of evidence is proportionate to the extent to which it can be objectively verified.

During the third quarter of 2008, the potential for an expanding global economic downturn had a negative effect on, and created uncertainty around our near-term modeled forecasts of taxable income. While our mid- to long-term financial outlook remained positive, significant uncertainty about the global economy during the third quarter of 2008 led us to revise downward our near-term modeled forecasts. To realize the deferred tax assets in our significant tax jurisdictions, these revisions resulted in a need to rely on an increased proportion of future taxable income generated by later years and an extended forecasting period. However, by their nature, modeled forecasted results become less objective and verifiable the further away they are from the current year. Accordingly, we concluded that we needed to shorten the timeframe on which we rely on these modeled forecasts and increased our valuation allowance by $2,069 as at September 30, 2008, as we no longer believed that we can meet the criteria to conclude that the related tax benefit was more likely than not to be realized.

Primarily as a result of cumulative losses arising from significant operating losses incurred during the severe downturn in the telecommunications industry in 2001 and 2002, we had maintained a partial valuation allowance against our deferred tax assets in certain major jurisdictions (namely Canada, the U.S. and France). An important aspect of establishing a valuation allowance against only a portion of our deferred tax assets was the weight assigned to our estimates of future profitability, including a significant sales backlog exceeding $5,000 as at December 31, 2007. In our judgment, estimates of near-, mid- and longer-term future profitability, our ability to

 

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carryforward tax losses and investment tax credits, and industry and business circumstances, were sufficient to overcome negative evidence, including cumulative losses, with regard to a portion of the deferred tax assets up to the fourth quarter of 2007. However, in the fourth quarter of 2007, there were a number of events that had a negative effect on the recoverability of our deferred tax assets in Canada and the time period over which we expected to realize the assets. As a result, in the fourth quarter of 2007, we adjusted our net deferred tax asset by recording an additional valuation allowance of approximately $1,064.

Revenue growth rates inherent in these forecasts are based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional trends in the telecommunications industry and product evolutions from a technological segment basis. Macro economic factors such as changes in economies, product evolutions, industry consolidation and other changes beyond our control could have a positive or negative impact on achieving our targets. There are certain risks to this long range forecast that we considered in our assessment of the valuation allowances. Significant management judgment is required in determining this valuation allowance. We have recorded a valuation allowance of $6,050 at December 31, 2008 as described earlier in this section. If we establish a strong pattern of earnings in the future and the uncertainty associated with our near-term modeled forecasts of earnings decline, we may conclude that it is more likely than not that we will realize all or a portion of the deferred tax assets currently reserved. This would result in a benefit to income tax expense from the release of all or a portion of the valuation allowance. Depending on the extent of any release of the valuation allowance, we may also be required to begin recording income tax expense based on the applicable jurisdictional tax rate in effect at that time.

The following table provides the breakdown of our net deferred tax assets by significant jurisdiction as of December 31, 2008:

 

     Tax
benefit of
losses
   Net
investment
tax credits
   Other
temporary
differences
   Gross
deferred
tax asset
   Valuation
allowance
    Net
deferred
tax asset

Canada

   $ 1,191    $ 869    $ 489    $ 2,549    $ (2,549 )   $ —  

United States

     563      376      903      1,842      (1,842 )     —  

United Kingdom

     348      —        264      612      (612 )     —  

France

     424      —        21      445      (445 )     —  

Other

     450      —        184      634      (602 )     32
                                          

Total

   $ 2,976    $ 1,245    $ 1,861    $ 6,082    $ (6,050 )   $ 32
                                          

During a review of our cumulative profits calculations during the fourth quarter of 2007, we identified and corrected certain errors arising from a failure to accurately take into account the impact of transfer pricing allocations as a result of our restatements of prior period financial results, which resulted in additional cumulative losses being applied to Canada of $43 and additional earnings being applied to the U.S. of approximately $300 as of December 31, 2006. We have updated our assessment of the deferred tax assets valuation allowance as at December 31, 2006 and concluded that the identified errors would not have impacted our ultimate conclusions as to the established valuation allowances at that time.

Transfer Pricing

We have considered the potential impact on our deferred tax assets that may result from settling our existing applications for an Advance Pricing Arrangements (APA). We have requested that the APA currently under negotiation with authorities in Canada, the U.S. and the U.K. apply to the 2001 through 2005 taxation years (2001-2005 APA). The 2001-2005 APA is currently being negotiated by the pertinent taxing authorities. We are in the process of negotiating new bilateral APA requests for tax years 2007 through at least 2010 (the 2007-2010 APA), with a request for rollback to 2006 in the U.S. and Canada, following methods generally similar to those under negotiation for 2001 through 2005.

 

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While preparing the 2007-2010 APA application for Canada, the U.S., U.K. and France we made some adjustments to the economics of our transfer pricing methodology (TPM). The adjustments resulted in decreases to deferred tax assets in the U.K. of $4 and $4 for 2006 and 2007, respectively. In other jurisdictions, changes resulting from adjustments to the new TPM impacted the level of deferred tax assets with an offset to valuation allowance and no impact to tax expense. With the exception of NNL, the original tax filings for 2007 in the U.S., the U.K., Ireland and France will include the adjustments to the TPM and the 2006 tax filings will be amended to reflect such adjustments. The 2006 and 2007 tax filings for NNL will be amended to reflect the adjustments to the new TPM.

In September 2008, with respect to the 2001-2005 APA under negotiation, the Canadian tax authorities provided the U.S. tax authorities with a supplemental position paper (Canadian Supplemental Position). We have evaluated the Canadian Supplemental Position and have adopted it under FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48) as the most likely of the possible outcomes. We believe that the Canadian Supplemental Position provides a reallocation of losses between the U.S. and Canada that moves toward a compromise of the reallocation provided in the U.S. position (U.S. Position) paper. The supplemental position resulted in a decrease as at September 30, 2008 of the deferred tax assets in the U.S. of $345, with a corresponding reduction in the valuation allowance, and an increase in deferred tax assets of $378 in Canada, with a corresponding increase in the valuation allowance. We received verbal communication from the Internal Revenue Service (IRS) in December 2008 stating that a tentative settlement on the 2001-2005 APA had been reached between the U.S. and Canadian taxing authorities. We have not received any written communication from the taxing authorities regarding the details of this tentative settlement. We expect the Canadian and U.S. tax authorities to meet to discuss the final settlement position in the next few quarters. We are unsure of the impact, if any, of the Creditor Protection Proceedings on the APA negotiations.

The U.K. and Canadian tax authorities are also parties to negotiations with respect to a bilateral APA for the 2001-2005 APA. We are uncertain if the U.K will adopt the Canadian Supplemental Position and therefore we have not recorded any adjustments to the deferred tax assets in the U.K. If adopted, the Canadian Supplemental Position would increase our deferred tax assets in the U.K. by $79. We expect the U.K. and Canadian tax authorities to advance negotiations regarding their 2001-2005 bilateral APA upon conclusion of the U.S. and Canadian 2001-2005 APA negotiations.

We are not a party to the government-to-government APA negotiations, but we do not believe the ultimate result of the negotiations will have an adverse impact on us or any further adverse impact on our deferred tax assets.

The impact of the ongoing government-to-government APA negotiations and ultimate settlement cannot be quantified by us at this time due to the uncertainties inherent in the negotiations between the tax authorities. As such, the ultimate settlement position could have a substantial impact on our transfer pricing methodology for future years. It is also uncertain whether the Creditor Protection Proceedings will have any impact on the ultimate resolution of the APAs. We continue to monitor the progress of the APA negotiations and will analyze the existence of new evidence, when available, as it relates to the APAs. We may make adjustments to the deferred tax and valuation allowance assessments, as appropriate, as additional evidence becomes available in future quarters.

Valuation Allowance

During the year ended December 31, 2008, our gross income tax valuation allowance increased to $6,050 compared to $3,149 as of December 31, 2007. The $2,901 increase was largely comprised of several significant items including $3,351 mainly relating to additional valuation allowances recorded against the tax benefit of current period losses and to the establishment of a full valuation allowance against our deferred tax assets in all

 

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major tax jurisdictions, other than deferred tax assets in joint venture operations in Korea and Turkey. In addition, $194 of additional valuation allowances were recorded against other comprehensive loss and $30 relating to operating losses acquired as part of the Novera acquisition. This is offset by net decreases to the valuation allowance of $674 as a result of decreases in the deferred tax assets in conjunction with FIN 48 and the impact of foreign currency translation of $688. In assessing the need for valuation allowances against our deferred tax assets, we considered the impact of the uncertainties surrounding the expanding global economic downturn and the Creditor Protection Proceedings, as well as the effect of these events on our revised modeled forecasts and the resulting increased uncertainty inherent in these forecasts. In light of these uncertainties, we determined that there was significant negative evidence against and insufficient positive evidence to support a conclusion that the tax benefit of our deferred tax asset was more likely than not to be realized in future tax years. Therefore, a full valuation allowance was necessary for all deferred tax assets that are not realizable through the reversal of existing taxable temporary differences or taxable income in carryback years.

Tax Contingencies

We adopted FIN 48 on January 1, 2007. 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 audited 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. 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. See note 8, “Income Taxes,” to the 2008 Financial Statements for additional information regarding FIN 48. Our liability for uncertain tax positions was $107 as of December 31, 2008.

Actual income tax expense, income tax assets and liabilities could vary from these FIN 48 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.

Specifically, the tax authorities in Brazil have completed an examination of prior taxable years and have issued assessments in the amount of $65 for the taxation years 1999 and 2000. We are currently in the process of appealing these assessments and believe that we have adequately provided for tax adjustments that are more likely than not to be realized as a result of the outcome of this ongoing appeals process.

Likewise, the tax authorities in Colombia have issued an assessment relating to the 2003 tax year proposing adjustments to increase taxable income. The result of the assessment is an additional tax liability of $15 inclusive of penalties and interest. As of December 31, 2008, we have recorded an income tax liability of $15 to fully reserve against this assessment. The tax liability associated with this assessment increased in 2008 by $6 as a result of adjustments made to reflect receipt of the final assessment and the unfavorable impact of foreign exchange.

In addition, tax authorities in France have issued notices of assessment in respect of the 2001, 2002 and 2003 taxation years. These assessments collectively propose adjustments to increase taxable income of approximately $1,327, additional income tax liabilities of $52, inclusive of interest, as well as certain

 

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adjustments to withholding and other taxes of approximately $106 plus applicable interest and penalties. Other than the withholding and other taxes, we have sufficient loss carryforwards to offset the majority of the proposed assessment. However, no amount has 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. 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 have entered into Mutual Agreement Procedures with the competent authority under the Canada-France tax treaty to settle the dispute and avoid double taxation. We believe we have adequately provided for tax adjustments that are more likely than not to be realized as a result of any ongoing or future examinations.

The ultimate outcome of the APA applications is uncertain and the ultimate reallocation of losses as they relate to the APA Applications cannot be determined at this time. There could be a further material shift in historical earnings between the above mentioned parties, particularly the U.S. and Canada. It is also uncertain what impact the Creditor Protection Proceedings will have on the ultimate resolution of the APAs. If these matters are resolved unfavorably, it could have a material adverse effect on our consolidated financial position, results of operations or cash flows. However, we believe it is more likely than not that the ultimate resolution of these negotiations will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

As discussed above, we have filed APA applications with the authorities in the U.S., Canada and the U.K. that applied to the taxation years 2001 through 2005. The APA requests are currently under consideration and the tax authorities are in the process of negotiating the terms of the arrangement. In September 2008, the Canadian tax authorities provided the U.S. tax authorities with the Canadian Supplemental Position paper regarding the 2001-2005 APA under negotiation, which suggests a material reallocation of losses from the U.S. to Canada and moves toward a compromise of the reallocation provided in the U.S. Position paper. Nortel received verbal communication from the U.S. tax authorities in December 2008 stating that a tentative settlement on the 2001-2005 APA had been reached between the U.S. and Canadian taxing authorities. We have not received any communication from the taxing authorities regarding the details of this tentative settlement. We expect the Canadian and U.S. tax authorities to meet to discuss the final settlement position in the next few quarters. We are unsure of the impact, if any, of the Creditor Protection Proceedings on these negotiations. We continue to monitor the progress of these negotiations; however, we are not a party to the government-to-government negotiations. It is possible that the ultimate resolution to the negotiations could be a further reallocation of losses from the U.S. to Canada. If an unexpected amount of tax losses are ultimately reallocated when the tax authorities reach agreement on the 2001-2005 APA, and/or if accounting estimates under FIN 48 regarding the 2007-2010 APA transfer pricing methodology result in a similar reallocation, we could have a further adjustment to our deferred tax assets.

In our ongoing assessment of the expected accounting impact of the settlement of the 2001-2005 APA, we continue to re-evaluate the level of the adjustment made during 2007 in accordance with FIN 48 to reduce the U.S. gross deferred tax assets and increase the Canadian gross deferred tax assets (with offsetting adjustments to the respective valuations allowances), to reflect our expectation that the more likely than not outcome of the negotiations between the U.S. and Canadian tax authorities related to our 2001-2005 APA would result in a reallocation of tax losses from the U.S. to Canada. We have made such adjustments during 2008 to reflect the reallocation of losses from the U.S. to Canada as suggested in Canadian Supplemental Position paper for the 2001-2005 APA. We believe that it provides a reallocation of losses between the U.S. and Canada that moves toward a compromise of the reallocation provided in the U.S. Position paper.

The U.K. and Canadian tax authorities are also parties to a bilateral APA for 2001-2005 that is currently under negotiation. We are uncertain if the U.K. tax authorities will adopt the Canadian Supplemental Position paper that was submitted in connection with the U.S and Canadian APA negotiations and therefore we have not

 

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recorded any adjustments to the deferred tax assets in the U.K. If adopted, the Canadian Supplemental Position would reallocate losses to the U.K. and increase our deferred tax assets in the U.K by $79. We expect the U.K and Canadian tax authorities to advance negotiations regarding their bilateral 2001-2005 APA upon conclusion of the U.S. and Canadian 2001-2005 APA negotiations.

Goodwill Valuation

We test goodwill for possible impairment on an annual basis as of October 1 of each year and at any other time if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Circumstances that could trigger an impairment test between annual tests include, but are not limited to:

 

 

 

a significant adverse change in the business climate or legal factors

 

 

 

an adverse action or assessment by a regulator

 

 

 

unanticipated competition

 

 

 

loss of key personnel

 

 

 

the likelihood that a reporting unit or a significant portion of a reporting unit will be sold or disposed of

 

 

 

a change in reportable segments

 

 

 

results of testing for recoverability of a significant asset group within a reporting unit and

 

 

 

recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.

The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to the reporting unit. Measurement of the fair value of a reporting unit is based on a fair value measure. We determine the fair value of our reporting units using an income approach; specifically, based on discounted cash flows (DCF Model). A market approach is used as a reasonableness test, but not given any weight in the final determination of fair value. These approaches involve significant management judgment and as a result are subject to change.

If the carrying amount of the reporting unit exceeds its fair value, step two requires the fair value of the reporting unit to be allocated to the underlying assets and liabilities of that reporting unit, whether or not previously recognized, resulting in an implied fair value of goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss equal to the excess is recorded in net earnings (loss).

The fair value of each reporting unit is determined using discounted cash flows. A multiple of earnings before interest, taxes, depreciation and amortization (EBITDA) of each reporting unit is calculated and compared to market participants to corroborate the results of the calculated fair value EBITDA Multiple Model. We also reconcile the sum of the calculated fair values to its enterprise value, being market capitalization plus the estimated value of debt based on interest rates that would be applicable to purchasers (that is, market participants), adjusted for other items as appropriate under U.S. GAAP. Such valuations involve significant assumptions regarding future operating performance. The following are the significant assumptions involved in each approach:

 

 

 

DCF Model: assumptions regarding revenue growth rates, gross margin percentages, projected working capital needs, SG&A expense, R&D expense, capital expenditure, discount rates and terminal growth rates. To determine fair value, we discount the expected cash flows of each reporting unit. The discount rate we use represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in our reporting unit operations and the rate of return an outside investor would expect to earn. To estimate cash flows beyond the final year of our model, we use a terminal value

 

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approach. Under this approach, we use the estimated cash flows in the final year of our model, apply a perpetuity growth assumption and discount by a perpetuity discount factor to determine the terminal value. We incorporate the present value of the resulting terminal value into our estimate of fair value.

 

 

 

EBITDA Multiple Model: assumptions regarding estimates of EBITDA growth and the selection of comparable companies to determine an appropriate multiple.

Interim Goodwill Assessment

At September 30, 2008, in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), we concluded that events had occurred and circumstances had changed that required us to perform an interim period goodwill impairment test for our ES, CN, MEN and GS reporting units. In September 2008, in response to significant pressure resulting from the expanding economic downturn and the unfavorable impact of foreign exchange fluctuations, we announced a revised full year 2008 outlook and estimated revenues to decline between two and four percent compared to 2007. Furthermore, during the quarter ended September 30, 2008, NNC experienced a material decline in its market capitalization due primarily to the continued challenging market conditions, particularly in the U.S. The average closing price of NNC common shares on the NYSE in the third quarter of 2008 was $5.77 compared to an average of $8.21 in the second quarter of 2008, a decline of approximately 30% and at September 30, 2008, NNC market capitalization was less than its book value.

As part of our interim goodwill impairment test we updated our forecasted cash flows for each of our reporting units. This update considered current economic conditions and trends, estimated future operating results, our view of growth rates and anticipated future economic conditions. Revenue growth rates inherent in this forecast were based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional trends in the telecommunications industry and product evolutions from a technological segment basis. Macro economic factors such as changes in economies, product evolutions, industry consolidations and other changes beyond our control could have a positive or negative impact on achieving our targets.

The results from step one of the two-step goodwill impairment test of each reporting unit indicated that the estimated fair values of the MEN and ES reporting units were less than the respective carrying values of their net assets and as such we performed step two of the impairment test for these reporting units.

In step two of the impairment test, we estimated the implied fair value of the goodwill of each of these reporting units and compared it to the carrying value of the goodwill for each of the MEN and ES reporting units. Specifically, we allocated the fair value of the MEN and ES reporting units as determined in the first step to their respective recognized and unrecognized net assets, including allocations to identified intangible assets. The allocations of the fair values of the MEN and ES reporting units also require us to make significant estimates and assumptions, including those in determining the fair values of the identified intangible assets. Such intangible assets had fair values substantially in excess of current book values. The resulting implied goodwill for each of these reporting units was nil; accordingly we reduced the goodwill recorded prior to the assessment by $1,142 to write down the goodwill related to MEN and ES to the implied goodwill amount as of September 30, 2008. The allocation discussed above is performed only for purposes of assessing goodwill for impairment; accordingly we did not adjust the net book value of the assets and liabilities on our condensed consolidated balance sheet other than goodwill as a result of this process.

Annual and December 31, 2008 Goodwill Assessment

The September 30, 2008 impairment analyses described above were used as a proxy for the annual impairment test performed as of October 1, 2008. Given the proximity of those testing dates, no additional impairment was recognized as a result of the annual test. However, during the fourth quarter of 2008, we

 

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observed further deterioration in industry conditions, global economic and credit conditions, and our market capitalization that required us to perform an additional interim period goodwill impairment test for the CN and GS reporting units as of December 31, 2008.

As part of the December 31, 2008 goodwill impairment test, we updated our forecasted cash flows for the CN and GS reporting units. This update considered management’s view of economic conditions and trends, estimated future operating results, sector growth rates, anticipated future economic conditions, and our strategic alternatives to respond to these conditions, including filing for creditor protection. Forecasts of revenues and profitability were developed to estimate the impact of creditor protection. Mid-to long-range forecasts were developed to reflect strategic alternatives under creditor protection. Revenue growth rates inherent in this forecast are based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional trends in the telecommunications industry and product evolution from a technological segment basis. Macro economic factors such as changes in economies, product evolutions, industry consolidations and other changes beyond our control could have a positive or negative impact on achieving our targets.

The results from step one of the two-step goodwill impairment test indicated that the estimated fair values of the CN and GS reporting units were less than the respective carrying values of their net assets and as such we performed step two of the impairment test for these reporting units.

In step two of the impairment test, we use the implied fair value calculated in step one as the purchase price in a hypothetical acquisition of the respective reporting unit. The implied fair value of goodwill calculated in step two is calculated as the residual amount of the purchase price after allocations made to the fair value of net assets, including working capital, plant and equipment and intangible assets, both pre-existing and those identified as part of the purchase price allocation process. Given the margin by which CN and GS failed step one, we concluded that the implied fair value of goodwill for both CN and GS was nil, after considering the value that would be allocated to existing tangible and intangible assets and the amounts that would be allocated to new intangible assets identified as part of the allocation process. As a result, we recorded a charge of $1,237 to reduce the value of goodwill accordingly. The allocation discussed above is performed only for purposes of assessing goodwill for impairment; accordingly we did not adjust the net book value of the assets and liabilities on our condensed consolidated balance sheet other than goodwill as a result of this process.

No impairment losses related to our goodwill were recorded during the years ended December 31, 2007 and 2006.

Related Analyses

In conjunction with our assessment of goodwill for impairment, we re-assessed the remaining useful lives of our long-lived assets and concluded they were appropriate. In addition, prior to the goodwill analysis discussed above, we performed a recoverability test of our long-lived assets in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”. We included cash flow projections from operations along with cash flows associated with the eventual disposition of the long-lived assets, where appropriate. The undiscounted future cash flows of the long-lived assets exceeded their net book value and, as a result, no impairment charge was recorded.

Pension and Post-retirement Benefits

We maintain various pension and post-retirement benefit plans for our employees globally. 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.

For 2008, the expected long-term rate of return on plan assets used to estimate pension expenses was 7.1% on a weighted average basis, which was the rate determined at September 30, 2007 and is unchanged from the

 

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rate used in 2007. The discount rates used to estimate the net pension obligations and expenses for 2008 were 6.4% and 5.8%, respectively, on a weighted average basis, compared to 5.8% and 5.1%, respectively, in 2007.

The key assumptions used to estimate the post-retirement benefit costs for 2008 were discount rates of 6.9% and 5.8% for the obligations and costs, respectively, both on a weighted average basis, compared to 5.8% and 5.4%, respectively, in 2007.

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. 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. The following table highlights the sensitivity of our pension and post-retirement benefit expense to changes in these assumptions, assuming all other assumptions remain constant:

 

Change in Assumption

   Effect on 2008 Pre-Tax Expense     Effect on 2008 Pre-Tax Post-Retirement
Benefit Expense
 
     Increase/(decrease)     Increase/(decrease)  

1 percentage point increase in the expected return on assets

   (69 )   N/A  

1 percentage point decrease in the expected return on assets

   68     N/A  

1 percentage point increase in discount rate

   (18 )   0  

1 percentage point decrease in discount rate

   10     (1 )

For 2009, we are maintaining our expected rate of return on plan assets at 7.1% for defined benefit pension plans. Also for 2009, our discount rate on a weighted-average basis for pension expenses will increase from 5.8% to 6.4% for the defined benefit pension plans and from 5.8% to 6.9% for post-retirement benefit plans. We will continue to evaluate our expected long-term rates of return on plan assets and discount rates at least annually and make adjustments as necessary, which could change the pension and post-retirement obligations and expenses in the future. There is no assurance that the pension plan assets will be able to earn the expected rate of return. Shortfalls in the expected return on plan assets would increase future funding requirements and expense.

For the 2008 year-end measurement, negative asset returns more than offset the favorable impact of increases in discount rates, foreign currency exchange gains driven by the strengthening of the U.S. Dollar against the British Pound and Canadian Dollar, our contributions made to the plans, decreased inflation rates, and other accounting assumptions. As a result, the unfunded status of our defined benefit plans and post-retirement plans increased from $1,937 as of the measurement date of September 30, 2007 to $2,119 as of the measurement date of December 31, 2008. The effect of the net actuarial loss adjustment and the related foreign currency translation adjustment was to increase accumulated other comprehensive loss including foreign currency translation adjustment (before tax) by $733 and increase pension and post-retirement liabilities by $733.

Plan assets were primarily comprised of debt and equity securities. Included in the equity securities of the defined benefit plans were NNC common shares, held directly or through pooled funds, with an aggregate market value of $0 (0.00% of total plan assets) as of December 31, 2008 and $2 (0.02% of total plan assets) as of December 31, 2007.

At December 31, 2008, we had net actuarial losses, before taxes, included in accumulated other comprehensive income/loss related to the defined benefit plans of $1,631, which 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 SFAS 87 and whether there is a change in the amortization period. The post-retirement benefit plans had actuarial gains, before taxes, of $103 included in accumulated other comprehensive loss at the end of 2008. 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

 

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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.

In the second quarter of 2006, we announced changes to our North American pension and post-retirement plans effective January 1, 2008. We moved employees currently enrolled in our defined benefit pension plans to defined contribution plans. In addition, we eliminated funding of post-retirement healthcare benefits for employees who were not age 50 with five years of service as of July 1, 2006. As a result of the U.K. Proceedings, all further service cost accruals to our U.K. defined benefit pension plan have ceased.

Effective for fiscal years ending after December 15, 2008, SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (SFAS 158) requires us to measure the funded status of our plans as of the date of our year end statement of financial position. SFAS 158 provides two approaches for an employer to transition to a fiscal year end measurement date. Nortel has adopted the second approach, whereby we continue to use the measurements determined for the December 31, 2007 fiscal year end reporting to estimate the effects of the transition. The adoption has resulted in an a increase in accumulated deficit of $33, net of taxes, and an increase in accumulated other comprehensive income of $5, net of taxes, as of January 1, 2008. For additional information, see “Accounting Changes and Recent Accounting Pronouncements” in this section of this report, and note 9, “Employee benefit plans”, to the 2008 Financial Statements.

During 2008, we made cash contributions to our defined benefit pension plans of $275 and to our post-retirement benefit plans of $39. Assuming current funding rules and current plan design, estimated 2009 cash contributions to our defined benefit pension plans and our post-retirement benefit plans are approximately $75 and $44, respectively. However, our 2009 cash contributions to these plans will be significantly impacted as a result of the Creditor Protection Proceedings. Currently, as a result of the U.K. Proceedings, following our latest contribution in January, all further contributions to our U.K. defined benefit pension plan have ceased pursuant to the direction of the U.K. Administrators, which is reflected in the numbers above. We continue to evaluate our pension and post-retirement benefit obligations in the context of the Creditor Protection Proceedings and as a result, these amounts may continue to change due to events or other factors that are uncertain or unknown at this time.

Special Charges

We record provisions for workforce reduction costs and exit costs when they are probable and estimable. Severance paid under ongoing benefit arrangements is recorded in accordance with SFAS No. 112, “Employers’ Accounting for Post-employment Benefits”. One-time termination benefits and contract settlement and lease costs are recorded in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”.

At each reporting date, we evaluate our accruals related to workforce reduction charges, contract settlement and lease costs and plant and equipment write downs to ensure that these accruals are still appropriate. As of December 31, 2008, we had $117 in accruals related to workforce reduction charges and $190 in accruals related to contract settlement and lease costs, which included significant estimates, primarily related to sublease income over the lease terms and other costs for vacated properties. In certain instances, we may determine that these accruals are no longer required because of efficiencies in carrying out our restructuring work plan. Adjustments to workforce reduction accruals may also be required when employees previously identified for separation do not receive severance payments because they are no longer employed by us or were redeployed due to circumstances not foreseen when the original plan was initiated. In these cases, we reverse any related accrual to earnings when it is determined it is no longer required. Alternatively, in certain circumstances, we may determine that certain accruals are insufficient as new events occur or as additional information is obtained. In these cases, we would increase the applicable existing accrual with the offset recorded against earnings. Increases or decreases to the accruals for changes in estimates are classified within special charges in the statement of operations.

 

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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, “Accounting changes” to the 2008 Financial Statements for a summary of the accounting changes that we have adopted on or after January 1, 2008. The following summarizes the accounting changes and pronouncements we have adopted in the first nine months of 2008:

 

 

 

The Fair Value Option for Financial Assets and Financial Liabilities: In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, which allows the irrevocable election of fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities and other items on an instrument-by-instrument basis. Changes in fair value would be reflected in earnings as they occur. The objective of SFAS 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. For us, SFAS 159 is effective as of January 1, 2008.

 

 

 

Fair Value Measurements: In September 2006, the FASB issued SFAS No. 157, which establishes a single definition of fair value and a framework for measuring fair value and requires expanded disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We partially adopted the provisions of SFAS 157 effective January 1, 2008. For disclosure related to SFAS 157, see note 11, “Fair Value”, to the 2008 Financial Statements.

 

 

 

Fair Value Measurements: In October 2008, the FASB issued FSP 157-3 “Determining Fair Value of a Financial Asset in a Market That Is Not Active” (FSP 157-3). FSP 157-3 clarified the application of SFAS No. 157 in an inactive market. It demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP 157-3 was effective upon issuance, including prior periods for which condensed consolidated financial statements had not been issued. We adopted the provisions of SFAS 157-3 effective September 30, 2008.

 

 

 

Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an Amendment of FASB Statements No. 87, 88, 106, and 132(R): In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an Amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS 158). Effective for fiscal years ending after December 15, 2006, SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit pension and post-retirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. We adopted these requirements in fiscal 2006. Effective for fiscal years ending after December 15, 2008, SFAS 158 requires us to measure the funded status of its plans as of the date of our year end statement of financial position, being December 31. We have historically measured the funded status of our significant plans on September 30. SFAS 158 provides two approaches for an employer to transition to a fiscal year end measurement date. We have adopted the second approach, whereby we continue to use the measurements determined for the December 31, 2007 fiscal year end reporting to estimate the effects of the transition. Under this approach, the net periodic benefit cost for the period between the earlier measurement date, being September 30, and the end of the fiscal year that the measurement date provisions are applied, being December 31, 2008 (exclusive of any curtailment or settlement gain or loss) shall be allocated proportionately between amounts to be recognized as an adjustment to opening accumulated deficit in 2008 and the net periodic benefit cost for the fiscal year ending December 31, 2008. The adoption has resulted in an increase in accumulated deficit of $33, net of taxes, and an increase in accumulated other comprehensive income of $5, net of taxes, as of January 1, 2008. For additional information on our pension and post-retirement plans, see note 9, “Employee benefit plans”, to the 2008 Financial Statements.

 

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Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, which establishes a single definition of fair value, a framework for measuring fair value under U.S. GAAP and requires expanded disclosures about fair value measurements. We partially adopted the provisions of SFAS 157 effective January 1, 2008. The effective date for SFAS 157 as it relates to fair value measurements for non-financial assets and liabilities that are not measured at fair value on a recurring basis has been deferred to fiscal years beginning after December 15, 2008 in accordance with FASB Staff Position (FSP), SFAS 157-2, “Effective Date of FASB Statement No. 157”. We plan to adopt the deferred portion of SFAS 157 on January 1, 2009. We do not currently expect the adoption of the deferred portion of SFAS 157 to have a material impact on our results of operations and financial condition, but will continue to assess the impact as the guidance evolves.

In September 2007, EITF reached a consensus on EITF Issue No. 07-1, “Collaborative Arrangements” (EITF 07-1). EITF 07-1 addresses the accounting for arrangements in which two companies work together to achieve a common commercial objective, without forming a separate legal entity. The nature and purpose of a company’s collaborative arrangements are required to be disclosed, along with the accounting policies applied and the classification and amounts for significant financial activities related to the arrangements. We plan to adopt the provisions of EITF 07-1 on January 1, 2009. The adoption of EITF 07-1 is not expected to have a material impact on our results of operations and financial condition.

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (SFAS 141R), replacing SFAS No. 141, “Business Combinations”. SFAS 141R revises existing accounting guidance for how an acquirer recognizes and measures in its financial statements the identifiable assets, liabilities, any noncontrolling interests and goodwill acquired on the acquisition of a business. SFAS 141R is effective for fiscal years beginning after December 15, 2008. We plan to adopt the provisions of SFAS 141R on January 1, 2009. The adoption of SFAS 141R will impact the accounting for business combinations completed by us on or after January 1, 2009.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB 51” (SFAS 160). SFAS 160 establishes accounting and reporting standards for the treatment of noncontrolling interests in a subsidiary. Noncontrolling interests in a subsidiary will be reported as a component of equity in the consolidated financial statements and any retained noncontrolling equity investment upon deconsolidation of a subsidiary will initially be measured at fair value. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We plan to adopt the provisions of SFAS 160 on January 1, 2009. The adoption of SFAS 160 will result in the reclassification of minority interests to shareholders’ equity.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—An Amendment of FASB Statement 133” (SFAS 161). SFAS 161 requires expanded and enhanced disclosure for derivative instruments, including those used in hedging activities. For instruments subject to SFAS 161, entities are required to disclose how and why such instruments are being used; where values, gains and losses are reported within financial statements; and the existence and nature of credit risk-related contingent features. Additionally, entities are required to provide more specific disclosures about the volume of their derivative activity. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. We plan to adopt the provisions of SFAS 161 on January 1, 2009. The adoption of SFAS 161 is expected to impact our disclosure for derivative instruments starting January 1, 2009.

In April 2008, the FASB issued FSP SFAS 142-3, “Determination of the Useful Life of Intangible Assets” (FSP SFAS 142-3). FSP SFAS 142-3 provides guidance with respect to estimating the useful lives of recognized intangible assets acquired on or after the effective date and requires additional disclosure related to the renewal or extension of the terms of recognized intangible assets. FSP SFAS 142-3 is effective for fiscal years and

 

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interim periods beginning after December 15, 2008. The adoption of FSP SFAS 142-3 is not expected to have a material impact on our results of operations and financial condition.

In June 2008, the EITF reached a consensus on EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (EITF 07-5). EITF 07-5 addresses the determination of whether an equity linked financial instrument (or embedded feature) that has all of the characteristics of a derivative under other authoritative U.S. GAAP accounting literature is indexed to an entity’s own stock and would thus meet the first part of a scope exception from classification and recognition as a derivative instrument. The adoption of EITF 07-5 is not expected to have a material impact on our results of operations and financial condition.

In September 2008, the FASB issued FSP 133-1 and FASB Interpretation Number (FIN) 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161” (FSP 133-1 and FIN 45-4). FSP 133-1 and FIN 45-4 amend and enhance disclosure requirements for sellers of credit derivatives and financial guarantees. They also clarify that the disclosure requirements of SFAS No. 161 are effective for quarterly periods beginning after November 15, 2008, and fiscal years that include those periods. FSP 133-1 and FIN 45-4 are effective for reporting periods (annual or interim) ending after November 15, 2008. The adoption of FSP 133-1 and FIN 45-4 has impacted our disclosure for financial guarantees.

In September 2008, the EITF ratified EITF Issue No. 08-5, “Issuer’s Accounting for Liabilities Measured at Fair Value With a Third-Party Credit Enhancement” (EITF 08-5). EITF 08-5 provides guidance for measuring liabilities issued with an attached third-party credit enhancement (such as a guarantee). It clarifies that the issuer of a liability with a third-party credit enhancement (such as a guarantee) should not include the effect of the credit enhancement in the fair value measurement of the liability. EITF 08-5 is effective for the first reporting period beginning after December 15, 2008. The adoption of EITF 08-5 is not expected to have a material impact on our results of operations and financial condition.

In November 2008, the FASB ratified EITF, Issue No. 08-6, “Equity-Method Investment Accounting” (EITF 08-6), concludes that the cost basis of a new equity-method investment would be determined using a cost-accumulation model, which would continue the practice of including transaction costs in the cost of investment and would exclude the value of contingent consideration. Equity-method investment should be subject to other-than-temporary impairment analysis. It also requires that a gain or loss be recognized on the portion of the investor’s ownership sold. EITF 08-6 is effective for fiscal years beginning after December 15, 2008. The adoption of EITF 08-6 is not expected to have a material impact on our results of operations and financial condition.

In November 2008, the EITF ratified EITF Issue No. 08-7 “Defensive Intangible Assets” (EITF 08-7). EITF 08-7 requires an acquiring entity to account defensive intangible assets as a separate unit of accounting. Defensive intangible assets should not be included as part of the cost of the acquirer’s existing intangible assets because the defensive intangible assets are separately identifiable. Defensive intangible assets must be recognized at fair value in accordance with SFAS 141R and SFAS 157. EITF 08-7 will be effective for the reporting period beginning after December 15, 2008. The adoption of EITF 08-7 is not expected to have a material impact on our results of operations and financial condition.

In November 2008, the FASB ratified EITF Issue No. 08-8, “For an Instrument (or an Embedded Feature) with a Settlement Amount that is based on the Stock of an Entity’s Consolidated Subsidiary” (EITF 08-8). EITF 08-8 clarifies whether a financial instrument whose payoff to the counterparty is based on the stock of the reporting entity’s consolidated subsidiary could be considered indexed to that reporting entity’s own stock in the consolidated financial statements. EITF 08-8 is effective for fiscal years beginning after December 15, 2008. The adoption of EITF 08-8 is not expected to have a material impact on our results of operations and financial condition.

 

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Outstanding Share Data

As of February 20, 2009, Nortel Networks Limited had 1,460,978,638 common shares outstanding.

Market Risk

Market risk represents the risk of loss that may impact our consolidated financial statements through adverse changes in financial market prices and rates. Our market risk exposure results primarily from fluctuations in interest rates and foreign exchange rates. Disclosure of market risk is contained in the Quantitative and Qualitative Disclosures About Market Risk section of our 2008 Annual Report.

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 December 31, 2008, the accruals on the consolidated balance sheet for environmental matters were $11. Based on information available as of December 31, 2008, 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 under way at 11sites that are either currently or previously owned or occupied facilities. 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.

We are also listed as a potentially responsible party under the U.S. Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) at four Superfund sites in the U.S. (At three of the Superfund sites, we are considered a de minimis potentially responsible party). A potentially responsible party within the meaning of CERCLA is generally considered to be a major contributor to the total hazardous waste at a Superfund site (typically 1% or more, depending on the circumstances). A de minimis potentially responsible party is generally considered to have contributed less than 1% (depending on the circumstances) of the total hazardous waste at a Superfund site. An estimate of our share of the anticipated remediation costs associated with such Superfund sites is expected to be de minimis and is included in the environmental accruals referred to above.

Liability under CERCLA may be imposed on a joint and several basis, without regard to the extent of our involvement. In addition, the accuracy of our estimate of environmental liability is affected by several uncertainties such as additional requirements which may be identified in connection with remedial activities, the complexity and evolution of environmental laws and regulations, and the identification of presently unknown remediation requirements. Consequently, our liability could be greater than its current estimate.

Legal Proceedings

For additional information related to our legal proceedings, see the Legal Proceedings section of our 2008 Annual Report.

Cautionary Notice Regarding Forward-Looking Information

Certain statements in this report may contain words such as “could”, “expects”, “may”, “anticipates”, “believes”, “intends”, “estimates”, “targets”, “envisions”, “seeks” and other similar language and are considered forward-looking statements or information under applicable securities laws. These statements are based on our

 

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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. We have made various assumptions in the preparation of any forward-looking statement in this report.

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 our Creditor Protection Proceedings including: (a) risks associated with our ability to: stabilize the business to maximize the chances of preserving all or a portion of the enterprise; develop, obtain required approvals for, and implement a comprehensive restructuring plan, and narrow our strategic focus in an effective and timely manner; resolve ongoing issues with creditors and other third parties whose interests may differ from ours; successfully implement a comprehensive restructuring plan; generate cash from operations and maintain adequate cash on hand; operate within the restrictions and limitations of the current EDC Support Facility or put in place a longer term solution; if necessary, arrange for sufficient debtor-in-possession or other financing; continue to maintain cash management arrangements and obtain any further approvals from the Canadian Monitor, the U.K. Administrators, the U.S. Creditors’ Committee, or other third parties, as necessary to continue such arrangements; raise capital to satisfy claims, including our ability to sell assets to satisfy claims against us; obtain sufficient exit financing to support a comprehensive restructuring plan; maintain R&D investments; realize full or fair value for any assets or business that may be divested as part of a comprehensive restructuring plan; utilize net operating loss carryforwards and certain other tax attributes in the future; avoid the substantial consolidation of NNI’s assets and liabilities with those of one or more other U.S. Debtors; attract and retain customers or avoid reduction in, or delay or suspension of, customer orders as a result of the uncertainty caused by the Creditor Protection Proceedings; maintain market share, as competitors move to capitalize on customer concerns; operate our business effectively in consultation with the Canadian Monitor, and work effectively with the U.K. Administrators in their administration of the business of the EMEA Debtors; 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 and attract new 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 Nortel 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 prescribed pursuant to any comprehensive restructuring plan to outstanding Nortel securities; the delisting of NNC common shares from the NYSE; and the potential delisting of NNC common shares and NNL preferred shares from the TSX; and (ii) risks and uncertainties relating to our business including: the sustained and expanding economic downturn and extraordinarily volatile market conditions and resulting negative impact on our business, results of operations and 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 our 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 current or planned 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; any material, adverse affects on our performance if our expectations regarding market demand for particular products prove to be wrong; potential higher operational and financial risks associated with our international operations; a failure to protect

 

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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; changes in regulation of the Internet or other regulatory changes; our potential inability to maintain an effective risk management strategy.

For additional information with respect to certain of these and other factors, see the “Risk Factors” section of our 2008 Annual Report and other securities filings with the SEC. 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 7A.

Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our consolidated financial statements through adverse changes in financial market prices and rates. Our market risk exposure results primarily from fluctuations in interest rates and foreign currency exchange rates. We maintain risk management control systems to monitor market risks and counterparty risks. These systems rely on analytical techniques including both sensitivity analysis and value-at-risk estimations. We do not hold or issue financial instruments or third party equity securities for trading purposes.

Termination of Derivative Hedging Instruments

To manage the risk from fluctuations in interest rates and foreign currency exchange rates, we had entered into various derivative hedging transactions in accordance with our policies and procedures. However, as a result of our Creditor Protection Proceedings, the financial institutions that were counterparties in respect of these transactions have terminated the related instruments. Consequently, we are now fully exposed to these risks and we are unable to mitigate them. We expect to remain so exposed at least until the conclusion of the Creditor Protection Proceedings.

Additional disclosure regarding our derivative hedging instruments is included in note 13, “Financial instruments and hedging activities” to the accompanying audited consolidated financial statements.

Foreign Currency Exchange Risk

Our most significant foreign currency exchange exposures for the year ended December 31, 2008 were in the Canadian Dollar, the British Pound, the Euro and the Korean Won. The net impact of foreign currency exchange fluctuations resulted in a loss of $38 in 2008, a gain of $176 in 2007, and a loss of $12 in 2006.

Given our exposure to international markets, it has been our practice to try to minimize the impact of such currency fluctuations through our ongoing commercial practices and, prior to the commencement of the Creditor Protection Proceedings, by attempting to hedge our major currency exposures. We regularly identify and monitor operations and transactions that may have material exposure based upon an excess or deficiency of foreign currency receipts over foreign currency expenditures. Prior to the initiation of our Creditor Protection Proceedings and termination of our derivative hedging instruments, we attempted to manage these exposures using forward and option contracts to hedge sale and purchase commitments. For example, we had entered into U.S. to Canadian Dollar forward and option contracts intended to hedge the U.S. to Canadian Dollar exposure on future revenues and expenditure streams. As noted above, we are no longer able to mitigate this risk through the use of derivative hedging instruments and are now fully exposed to this risk.

If an increasing proportion of our business is denominated in currencies other than U.S. Dollars, fluctuations in foreign currencies will increasingly affect us, although we cannot predict whether we will incur foreign currency exchange gains or losses. If significant losses are experienced, they could have a material adverse effect on our business, results of operations and financial condition.

In accordance with SFAS 133, we recognized gains and losses on the effective portion of the derivative hedging instruments previously held by us in earnings (loss) when the hedged transaction occurred. As of December 31, 2008, none of our cash flow hedges met the criteria for hedge accounting and therefore were considered non-designated hedging strategies in accordance with SFAS 133. As such, any gains and losses related to these contracts were recognized in results of operations at the end of each reporting period for the life of the contract.

We use sensitivity analysis to measure our foreign currency exchange risk. We compute the potential decrease in cash flows that may result from adverse changes in foreign exchange rates. The balances are segregated by source currency and a hypothetical unfavorable variance in foreign exchange rates of 10% is applied to each net source currency position, using year-end rates to determine the potential decrease in cash flows over the next year. The sensitivity analysis includes all foreign currency-denominated cash, short-term and long-term debt, and derivative hedging instruments that will impact cash flows over the next year that are held at December 31, 2008 and 2007. The underlying cash flows that relate to the hedged firm commitments are not included in the analysis. The analysis is performed at the reporting date and assumes no future changes in the balances or timing of cash flows from the year-end position. Further, the model assumes no correlation in the movement of foreign currency exchange rates. Based on a one-year time horizon, a 10% adverse change in exchange rates would have resulted in a potential decrease in fair market value of equity of $133 as of December 31, 2008, and a potential decrease in fair market value of equity of $134 as of December 31, 2007. This potential decrease would result primarily from our exposure to the Canadian Dollar, the British Pound, the Euro and the Korean Won. Because we do

 

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not have access to derivative hedging instruments at this time, we also performed the sensitivity analysis as of December 31, 2008 assuming no such instruments. Under that analysis, based on a one-year time horizon, a 10% adverse change in exchange rates would have resulted in a potential decrease in fair market value of equity of $96 as of December 31, 2008.

Interest Rate Risk

Our debt is subject to changes in fair value resulting from changes in market interest rates. Historically, and prior to the initiation of our Creditor Protection Proceedings and termination by the financial institutions of our derivative hedging instruments, we have managed interest rate exposures, as they relate to interest expense, using a diversified portfolio of fixed and floating rate derivative hedging instruments denominated in U.S. Dollars. For example, we had hedged a portion of this exposure using fixed for floating interest rate swaps on the $550 of senior fixed rate notes due 2013 issued by us in July 2006 (2013 Fixed Rate Notes). We are no longer able to mitigate this risk through the use of derivative hedging instruments and are now fully exposed to this risk. While operating as a debtor-in-possession, however, in accordance with SOP 90-7, we will record interest expense only to the extent that (i) interest will be paid during our Creditor Protection Proceedings, or (ii) it is probable that interest will be an allowed priority, secured or unsecured claim.

In 2008, because the swaps for the 2013 Fixed Rate Notes passed the hedge effectiveness designation criteria in accordance with SFAS 133, the change in fair value of the swaps was recognized in earnings (loss), with offsetting amounts related to the change in the fair value of the hedged debt attributable to interest rate changes also recognized in earnings (loss). Any ineffective portion of the swaps would be recognized in results of operations at the end of each reporting period for the life of the contract, without any offset.

We use sensitivity analysis to measure our interest rate risk. The sensitivity analysis includes cash, our outstanding floating rate long-term debt and any outstanding instruments that convert fixed rate long-term debt to floating rate. A 100 basis point adverse change in interest rates would have resulted in a potential decrease in fair market value of equity of $171 as of December 31, 2008 and a potential decrease in fair market value of equity of $61 as of December 31, 2007. Because we do not have access to such instruments at this time, we also performed the sensitivity analysis as of December 31, 2008 assuming no such instruments. Under that analysis, based on a one-year time horizon, a 100 basis point adverse change in interest rates would have resulted in a potential decrease in fair market value of equity of $165 as of December 31, 2008.

Equity Price Risk

The values of our equity investments in several third party publicly traded companies are subject to market price volatility. These investments are generally in companies in the technology industry sector and are classified as available for sale. We typically do not attempt to reduce or eliminate our market exposure on these securities. We also hold certain derivative instruments or warrants that are subject to market price volatility because their value is based on the common share price of a publicly traded company. These derivative instruments are generally acquired in connection with original equipment manufacturer arrangements with strategic partners, or acquired through business acquisitions or divestitures. As of December 31, 2008, a hypothetical 20% adverse change in the stock prices of publicly traded equity securities issued by third parties and held by Nortel, and the related underlying stock prices of publicly traded equity securities for certain of our derivative instruments, would result in a loss in their aggregate fair value of $0.

 

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ITEM 8.

Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Report of Independent Registered Public Accounting Firm

   104

Report of Independent Registered Chartered Accountants

   105

Consolidated Statement of Operations

   106

Consolidated Balance Sheets

   107

Consolidated Statements of Changes in Equity (Deficit) and Comprehensive Income (Loss)

   108

Consolidated Statements of Cash Flows

   109

Quarterly Financial Data (Unaudited)

   196

Report of Independent Registered Chartered Accountants

   197

Schedule II—Valuation and Qualifying Accounts and Reserves

   198

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

Nortel Networks Limited:

We have audited the accompanying consolidated balance sheets of Nortel Networks Limited and subsidiaries ( the Company) as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in equity (deficit) and comprehensive income (loss) and cash flows for the years then ended. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of Nortel Networks Limited’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nortel Networks Limited and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule II, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

The accompanying consolidated financial statements have been prepared assuming that Nortel Networks Limited and subsidiaries will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company and certain of its Canadian subsidiaries filed for creditor protection pursuant to the provisions of the Companies’ Creditors Arrangement Act; certain of the Company’s United States subsidiaries filed voluntary petitions seeking to reorganize under Chapter 11 of the United States Bankruptcy Code; certain of the Company’s subsidiaries in Europe, the Middle East and Africa made consequential filings under the Insolvency Act 1986 in the United Kingdom; and the Company’s Israeli subsidiaries made consequential filings under the Israeli Companies Law 1999. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As discussed in Note 3 to the consolidated financial statements, effective January 1, 2008, the Company adopted the provisions of Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”, Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115”; and Statement of Financial Accounting Standard No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an Amendment of FASB Statements No. 87, 88, 106, and 132(R)”. As discussed in Note 3 to the consolidated financial statements, effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109”.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Nortel Networks Limited’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 2, 2009, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Chartered Accountants, Licensed Public Accountants

Toronto, Canada

March 2, 2009

 

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REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS

To the Shareholders and Board of Directors of Nortel Networks Limited

We have audited the accompanying consolidated statements of operations, changes in equity (deficit) and comprehensive income (loss) and cash flows of Nortel Networks Limited and subsidiaries (“Nortel”) for the year ended December 31, 2006. These financial statements are the responsibility of Nortel’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the results of Nortel’s operations and its cash flows for the year ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

/s/  Deloitte & Touche LLP

Independent Registered Chartered Accountants

Licensed Public Accountants

Toronto, Canada

March 15, 2007, except as to notes 5, 6, 7 and 23, which are as of September 7, 2007 and the effect of the retrospective adjustments for a change in the segment performance measure as described in note 6, which is as of March 2, 2009

COMMENTS BY INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS ON

CANADA-UNITED STATES OF AMERICA REPORTING DIFFERENCE

The standards of the Public Company Accounting Oversight Board (United States) require the addition of an explanatory paragraph (following the opinion paragraph) when there are changes in accounting principles that have a material effect on the comparability of the company’s financial statements, such as the changes described in Note 3 to the financial statements. Our report to the Shareholders and Board of Directors of Nortel dated March 15, 2007 (except as to notes 5, 6, 7 and 23, which are as of September 7, 2007 and the effect of the retrospective adjustments for a change in the segment performance measure as described in note 6, which is as of March 2, 2009) with respect to the consolidated financial statements is expressed in accordance with Canadian reporting standards which do not require a reference to such changes in accounting principles in the auditors’ report when the change is properly accounted for and adequately disclosed in the financial statements.

/s/  Deloitte & Touche LLP

Independent Registered Chartered Accountants

Licensed Public Accountants

Toronto, Canada

March 15, 2007, except as to notes 5, 6, 7 and 23, which are as of September 7, 2007 and the effect of the retrospective adjustments for a change in the segment performance measure as described in note 6, which is as of March 2, 2009

 

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NORTEL NETWORKS LIMITED

Consolidated Statements of Operations for the years ended December 31

(Under Creditor Protection Proceedings as of January 14, 2009—note 1)

 

     2008     2007     2006  
     (Millions of U.S. Dollars)  

Revenues:

      

Products

   $ 9,189     $ 9,654     $ 10,158  

Services

     1,232       1,294       1,260  
                        

Total revenues

     10,421       10,948       11,418  
                        

Cost of revenues:

      

Products

     5,477       5,637       6,276