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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q/A
Amendment No. 1

x
    
    Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934For the Quarterly Period Ended March 31, 2003ORoTransition 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.)8200 Dixie Road, Suite 100Brampton, Ontario, Canada
    
    L6T 5P6(Address of principal executive offices)
    
    (Zip Code)


Registrants telephone number including area code (905) 863-0000

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 ü                No

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).  Yesü           No

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as at April 30, 2003

1,460,978,638 without nominal or par value



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EXPLANATORY NOTE

This Amendment No. 1 to our Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2003 initially filed with the Securities and Exchange
Commission (SEC) on May 9, 2003 (the Originally Filed 10-Q) is being filed
to reflect restatements of the following (unaudited) financial statements:
consolidated statements of operations and cash flows for the three month
periods ended March 31, 2003 and 2002; and consolidated balance sheets as at
March 31, 2003 and December 31, 2002. On October 23, 2003, we announced that
we would restate our consolidated financial statements for the years ended
December 31, 2002, 2001 and 2000 and for the quarters ended March 31, 2003 and
June 30, 2003 in connection with our previously announced comprehensive review
and analysis of our assets and liabilities and certain related reviews. For a
description of the restatements, see Restatements in note 2 to the
accompanying (unaudited) consolidated financial statements and Item 2.
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Recent developments  Restatements in this Amendment No. 1.

This Amendment No. 1 amends and restates Items 1, 2, 3 and 4 of Part I and Item
6 of Part II of the Originally Filed 10-Q and, except for such items and
Exhibit 31.1, 31.2 and 32, no other information in the Originally Filed 10-Q is
amended hereby. The explanatory caption at the beginning of each item of this
Amendment No. 1 sets forth the nature of the revisions to that item.

We did not amend our Annual Reports on Form 10-K or Quarterly Reports on Form
10-Q for periods affected by the restatements that ended prior to December 31,
2002, and the financial statements, auditors reports and related financial
information for the affected periods contained in such reports should no longer
be relied upon. We are concurrently filing Amendment No. 1 to our Annual
Report on Form 10-K for the year ended December 31, 2002, initially filed with
the SEC on March 10, 2003, which includes the following (audited) restated financial
statements: consolidated statements of operations, shareholders equity and
cash flows for the years ended December 31, 2002, 2001 and 2000; and
consolidated balance sheets as at December 31, 2002 and 2001.

For a discussion of events and developments subsequent to March 31, 2003, see:



| |  | our amended Quarterly Report on Form 10-Q/A for the quarterly period
ended June 30, 2003, which contained (unaudited) restated consolidated statements of
operations for the three and six month periods ended
June 30, 2003 and 2002, respectively, (unaudited) restated consolidated statements of
cash flows for the six month periods ended
June 30, 2003 and 2002 and (unaudited) restated consolidated balance
sheets as at June 30, 2003 and December 31, 2002 which is
being filed concurrently with this Amendment No. 1;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2003 filed with the SEC on November 19, 2003 and
subsequently amended on November 28, 2003, which contained (unaudited)
restated consolidated statements of operations for the
three and nine month periods ended September 30, 2002, (unaudited) restated consolidated statement of
cash flows for the nine month period ended
September 30, 2002 and (unaudited)
restated consolidated balance sheet as at December 31, 2002; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our other filings subsequent to March 31, 2003.
| | - | -----------------------------------------------

2



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|                             |                                                                                               |                                            |  |  |  |  |  | 
|---------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I FINANCIAL INFORMATION
|                             |                                                                                               | Consolidated Balance Sheets               
|                             |                                                                                               | Consolidated Statements of Cash Flows     
|                             |                                                                                               | Notes to Consolidated Financial Statements
|                             | ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                             | ITEM 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                             | ITEM 4. Controls and Procedures                                                              
|PART II                     
|                             | ITEM 6. Exhibits And Reports On Form 8-K                                                     
|SIGNATURES                  
|EX-31.1                     
|EX-31.2                     
|EX-32                       



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TABLE OF CONTENTS

PART I
 
FINANCIAL INFORMATION

PAGEITEM 1.
    
    Consolidated Financial Statements (unaudited)
    
    
    4ITEM 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    39ITEM 3.
    
    Quantitative and Qualitative Disclosures About
Market Risk
    
    
    77ITEM 4.
    
    Controls and Procedures
    
    
    78PART II
 OTHER INFORMATIONITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    
    80Signatures
    
    
    
    
    81Certifications
    


    
    
    82


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

NORTEL NETWORKS, NORTEL NETWORKS LOGO, NT and the GLOBEMARK are trademarks of
Nortel Networks.
MOODYS is a trademark of Moodys Investors Services,
Inc.
S&P 100, S&P 500 and STANDARD & POORS are trademarks of The McGraw-Hill
Companies, Inc.

3



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PART I
FINANCIAL INFORMATION

ITEM 1. Consolidated Financial Statements (unaudited)

The (unaudited) restated consolidated financial statements and supplementary data,
including the notes to the (unaudited) restated consolidated financial statements, set
forth in this Item 1 have been revised to reflect the restatements and, except
for these revisions, do not reflect events and developments subsequent to March
31, 2003.

Contents of Consolidated Financial StatementsPAGEConsolidated Statements of Operations
    
    
    5Consolidated Balance Sheets
    
    
    6Consolidated Statements of Cash Flows
    
    
    7Notes to Consolidated Financial Statements
    
    
    8


4



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NORTEL NETWORKS LIMITEDConsolidated Statements of Operations (unaudited) for the three months ended

March 31,
    
    
    March 31,(millions of U.S. dollars)
    
    2003
    
    
    2002As restated *
    
    
    As restated *Revenues
    
    $
    2,376
    
    
    $
    2,900Cost of revenues
    
    
    1,324
    
    
    
    2,161Gross profit
    
    
    1,052
    
    
    
    739Selling, general and administrative expense
    
    
    513
    
    
    
    701Research and development expense
    
    
    502
    
    
    
    565Amortization of acquired technology
    
    
    
    
    
    
    5Special charges
    
    
    111
    
    
    
    422Gain on sale of businesses
    
    
    (4
    )
    
    
    (6
    )Operating loss
    
    
    (70
    )
    
    
    (948
    )Other income (expense)  net
    
    
    13
    
    
    
    (10
    )Interest expenseLong-term debt
    
    
    (23
    )
    
    
    (38
    )Other
    
    
    (7
    )
    
    
    (13
    )Loss from continuing operations before income taxes
    
    
    (87
    )
    
    
    (1,009
    )Income tax benefit (provision)
    
    
    (6
    )
    
    
    315(93
    )
    
    
    (694
    )Equity in net loss of associated companies  net of tax
    
    
    (10
    )
    
    
    (8
    )Net loss from continuing operations
    
    
    (103
    )
    
    
    (702
    )Net earnings from discontinued operations  net of tax
    
    
    164
    
    
    
    16Net earnings (loss) before cumulative effect of accounting change  net of tax
    
    
    61
    
    
    
    (686
    )Cumulative effect of accounting change  net of tax
    
    
    (8
    )
    
    
    Net earnings (loss)
    
    
    53
    
    
    
    (686
    )Dividends on preferred shares
    
    
    (5
    )
    
    
    (5
    )Net earnings (loss) applicable to common shares
    
    $
    48
    
    
    $
    (691
    )


|* |  | See note 2
|- |  | ----------

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

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NORTEL NETWORKS LIMITEDConsolidated Balance Sheets (unaudited) as at

March 31,
    
    
    December 31,(millions of U.S. dollars)
    
    2003
    
    
    2002As restated *
    
    
    As restated *ASSETSCurrent assetsCash and cash equivalents
    
    $
    3,845
    
    
    $
    3,743Restricted cash and cash equivalents
    
    
    227
    
    
    
    249Accounts receivable (less provisions of $432 as at March 31, 2003, $516 as at December 31, 2002)
    
    
    2,131
    
    
    
    2,247Inventories  net
    
    
    885
    
    
    
    986Income taxes recoverable
    
    
    60
    
    
    
    58Deferred income taxes  net
    
    
    784
    
    
    
    793Other current assets
    
    
    421
    
    
    
    668Total current assets
    
    
    8,353
    
    
    
    8,744Investments at cost and associated companies at equity
    
    
    200
    
    
    
    248Plant and equipment  net
    
    
    1,435
    
    
    
    1,464Goodwill
    
    
    2,021
    
    
    
    2,021Deferred income taxes  net
    
    
    2,863
    
    
    
    2,653Other assets
    
    
    793
    
    
    
    766Total assets
    
    $
    15,665
    
    
    $
    15,896LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    12
    
    
    $
    30Trade and other accounts payable
    
    
    776
    
    
    
    899Payroll and benefit-related liabilities
    
    
    650
    
    
    
    499Contractual liabilities
    
    
    1,122
    
    
    
    1,213Restructuring
    
    
    433
    
    
    
    537Other accrued liabilities
    
    
    2,616
    
    
    
    2,894Long-term debt due within one year
    
    
    234
    
    
    
    233Total current liabilities
    
    
    5,843
    
    
    
    6,305Long-term debt
    
    
    1,894
    
    
    
    1,949Deferred income taxes  net
    
    
    431
    
    
    
    366Other liabilities
    
    
    2,397
    
    
    
    2,32110,565
    
    
    
    10,941Minority interest in subsidiary companies
    
    
    114
    
    
    
    129Guarantees, commitments and contingencies (notes 10 and 15)SHAREHOLDERS EQUITYPreferred
shares, without par value  Authorized shares: unlimited;
Issued and outstanding shares: 30,000,000 at March 31, 2003 and December 31, 2002
    
    
    536
    
    
    
    536Common
shares, without par value  Authorized shares: unlimited;
Issued and outstanding shares: 1,460,978,638 at March 31, 2003 and December 31, 2002
    
    
    1,211
    
    
    
    1,211Additional paid-in capital
    
    
    22,005
    
    
    
    22,004Deficit
    
    
    (17,559
    )
    
    
    (17,607
    )Accumulated other comprehensive loss
    
    
    (1,207
    )
    
    
    (1,318
    )Total shareholders equity
    
    
    4,986
    
    
    
    4,826Total liabilities and shareholders equity
    
    $
    15,665
    
    
    $
    15,896


|* |  | See note 2
|- |  | ----------

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

6



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NORTEL NETWORKS LIMITEDConsolidated Statements of Cash Flows (unaudited) for the three months ended

March 31,
    
    
    March 31,(millions of U.S. dollars)
    
    2003
    
    
    2002As restated *
    
    
    As restated *Cash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (103
    )
    
    $
    (702
    )Adjustments to reconcile net loss from continuing operations to net cash used
in operating activities, net of effects from acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    105
    
    
    
    158Non-cash portion of special charges and related asset write downs
    
    
    (11
    )
    
    
    75Equity in net loss of associated companies
    
    
    10
    
    
    
    8Current stock option compensation
    
    
    5
    
    
    
    Deferred income taxes
    
    
    21
    
    
    
    (326
    )Other liabilities
    
    
    26
    
    
    
    (37
    )Gain on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    (Gain) loss on sale or write down of investments and businesses
    
    
    24
    
    
    
    (11
    )Other  net
    
    
    27
    
    
    
    85Change in operating assets and liabilities:Accounts receivable
    
    
    108
    
    
    
    245Inventories
    
    
    127
    
    
    
    66Income taxes
    
    
    (6
    )
    
    
    519Restructuring
    
    
    (194
    )
    
    
    (354
    )Accounts payable and accrued liabilities
    
    
    (235
    )
    
    
    (79
    )Other operating assets and liabilities
    
    
    (16
    )
    
    
    (42
    )Net cash used in operating activities of continuing operations
    
    
    (116
    )
    
    
    (395
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (18
    )
    
    
    (103
    )Proceeds on disposals of plant and equipment
    
    
    6
    
    
    
    44Decrease in restricted cash and cash equivalents
    
    
    20
    
    
    
    Increase in long-term receivables
    
    
    (9
    )
    
    
    (107
    )Decrease in long-term receivables
    
    
    5
    
    
    
    89Acquisitions of investments and businesses  net of cash acquired
    
    
    (2
    )
    
    
    (19
    )Proceeds on sale of investments and businesses
    
    
    7
    
    
    
    24Net cash from (used in) investing activities of continuing operations
    
    
    9
    
    
    
    (72
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (5
    )
    
    
    (5
    )Decrease in notes payable  net
    
    
    (13
    )
    
    
    (11
    )Proceeds from long-term debt
    
    
    
    
    
    
    11Repayments of long-term debt
    
    
    (43
    )
    
    
    (2
    )Decrease in capital leases payable
    
    
    (1
    )
    
    
    (4
    )Net cash used in financing activities of continuing operations
    
    
    (62
    )
    
    
    (11
    )Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    18
    
    
    
    (6
    )Net cash used in continuing operations
    
    
    (151
    )
    
    
    (484
    )Net cash from discontinued operations
    
    
    253
    
    
    
    50Net increase (decrease) in cash and cash equivalents
    
    
    102
    
    
    
    (434
    )Cash and cash equivalents at beginning of period  net
    
    
    3,743
    
    
    
    3,404Cash and cash equivalents at end of period  net
    
    $
    3,845
    
    
    $
    2,970


|* |  | See note 2
|- |  | ----------

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

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NORTEL NETWORKS LIMITEDNotes to Consolidated Financial Statements (unaudited)
(millions of U.S. dollars, except per share amounts, unless otherwise stated)



|1. |  | Significant accounting policies
|-- |  | -------------------------------



| |  | Basis of presentation
| |  | ---------------------



| |  | The accompanying unaudited consolidated financial statements of Nortel
Networks Limited (Nortel Networks) include all majority owned subsidiaries
over which Nortel Networks exercises control and have been prepared in
accordance with the rules and regulations of the United States Securities and
Exchange Commission (the SEC) for the preparation of interim financial
information. They do not include all information and notes required by
accounting principles generally accepted in the United States (GAAP) in the
preparation of annual consolidated financial statements. The accounting
policies used in the preparation of the accompanying unaudited consolidated
financial statements are the same as those described in Nortel Networks
audited consolidated financial statements prepared in accordance with GAAP
for the three years ended December 31, 2002, except as described in note 3.
Although Nortel Networks is headquartered in Canada, the accompanying
unaudited consolidated financial statements are expressed in United States
dollars as the greater part of Nortel Networks financial results and net
assets are denominated in United States dollars.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As described in note 2, the consolidated statements of operations and cash
flows for the three month periods ended March 31, 2003 and 2002 and
consolidated balance sheets as at March 31, 2003 and December 31, 2002,
including the applicable notes, have been restated.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In the opinion of management, all adjustments necessary to effect a fair
statement of the results for the periods presented have been made and all
such adjustments are of a normal recurring nature. The financial results for
the three months ended March 31, 2003 are not necessarily indicative of
financial results for the full year. The accompanying unaudited consolidated
financial statements should be read in conjunction with Nortel Networks
Annual Report on Form 10-K for the year ended December 31, 2002 filed with
the SEC on March 10, 2003, as subsequently amended by Amendment No. 1 to
Nortel Networks Annual Report on Form 10-K/A for the year ended December 31,
2002 filed with the SEC on December 23, 2003 (Nortel Networks 2002 Annual
Report).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Recent accounting pronouncements
| |  | --------------------------------



| | (a) | In April 2003, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 149
Amendment of SFAS No. 133 on Derivative Instruments and Hedging
Activities (SFAS 149). SFAS 149 amends and clarifies accounting for
derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No.
133 Accounting for Derivative Instruments and Hedging Activities
(SFAS 133). In particular, it (1) clarifies under what circumstances
a contract with an initial net investment meets the characteristic of a
derivative as discussed in SFAS 133, (2) clarifies when a derivative
contains a financing component, (3) amends the definition of an
underlying to conform it to the language used in FASB Interpretation No.
(FIN) 45, Guarantor Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others
(FIN 45) and (4) amends certain other existing pronouncements.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | SFAS 149 is effective for contracts entered into or modified after June
30, 2003, except as stated below and for hedging relationships designated
after June 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The provisions of SFAS 149 that relate to SFAS 133 implementation issues
that have been effective for fiscal quarters that began prior to June 15,
2003, should continue to be applied in accordance with their respective
effective dates. In addition, certain provisions relating to forward
purchases or sales of when-issued securities or other securities that do
not yet exist, should be applied to existing contracts as well as new
contracts entered into after June 30, 2003. SFAS 149 should be applied
prospectively.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks will adopt the provisions of SFAS 149 for the quarter
ending June 30, 2003. Nortel Networks has not yet determined the impact
that the adoption of SFAS 149 will have on its business, results of
operations and financial position.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (b) | In January 2003, the FASB issued FIN 46  Consolidation of Variable
Interest Entities (FIN 46). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51  Consolidated Financial Statements
to those entities defined as Variable Interest Entities (more commonly
referred to as special purpose entities) in which equity investors do
not have the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other
parties. FIN 46 applies immediately to all Variable Interest Entities
created after January 31, 2003, and by the beginning of the first
interim or annual reporting period commencing after June 15, 2003 for
Variable Interest Entities created prior to February 1, 2003.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks currently conducts certain receivable sales and lease
financing transactions through special purpose entities and is in the
process of assessing the structure of these transactions against the
criteria set out in FIN 46. Receivable sales transactions are generally
conducted either directly with financial institutions or with multi-seller
conduits. It is not expected that Nortel Networks will be required to
consolidate any of these special purpose entities or provide any of the
additional disclosures set out in FIN 46.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Certain lease financing transactions are structured through single
transaction special purpose entities that currently do not have sufficient
equity at risk as defined in FIN 46. In addition, Nortel Networks retains
certain risks associated with guaranteeing recovery of the unamortized
principal balance of the debt which is expected to represent the majority
of the risks associated with the special purpose entities activities. The
amount of the guarantee will be adjusted over time as the underlying debt
matures. Therefore, it is expected that unless the existing arrangements
are modified prior to July 1, 2003, Nortel Networks will be required to
consolidate the assets, liabilities and any non-controlling interests of
these special purpose entities effective July 1, 2003. The total assets
and total liabilities held by these entities at March 31, 2003 were each
approximately $176 and these amounts represent the collateral and maximum
exposure to loss, respectively, as a result of our involvement with these
entities.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | In November 2002, the FASB Emerging Issues Task Force (EITF)
reached a consensus on Issue 00-21, Accounting for Revenue Arrangements
with Multiple Deliverables (EITF 00-21), which must be applied to all
revenue arrangements entered into after June 30, 2003. However, the
EITF is continuing discussion of the interaction of EITF 00-21 with
higher level accounting literature, including Statement of Position
81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts.  EITF 00-21 governs how to separately
account for goods or services or both that are to be delivered in a
bundled sales arrangement and allows for either prospective application
or a cumulative adjustment upon adoption. Nortel Networks is unable to
determine the impact of EITF 00-21 on its business, results of
operations and financial condition, until the EITF resolves
uncertainties regarding the scope of this pronouncement.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Comparative figures
| |  | -------------------



| |  | Certain 2002 figures in the accompanying unaudited consolidated financial
statements have been reclassified to conform to the 2003 presentation and
certain 2002 figures have been restated as set out in note 2.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|2. |  | Restatements
|-- |  | ------------



| |  | In 2001, Nortel Networks entered into an unprecedented period of business
realignment in response to a significant adjustment in the telecommunications
industry. Industry demand for networking equipment dramatically declined in
response to the industry adjustment, severe economic downturns in various
regions around the world and a tightening in global capital markets. Nortel
Networks implemented a company-wide restructuring plan to streamline its
operations and activities around core markets and operations, which included
significant workforce reductions, global real estate closures and
dispositions, substantial write-downs of its capital assets, goodwill and
other intangible assets and extensive contract settlements with customers and
suppliers around the world. As a result of these actions, Nortel Networks
workforce declined significantly from January 1, 2001 to March 31, 2003 and
over the same time period Nortel Networks significantly reduced its
facilities.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Subsequent to the issuance of its financial statements for the three months
ended March 31, 2003, Nortel Networks initiated, and disclosed in its
Quarterly Report on Form 10-Q for the period ended June 30, 2003, a
comprehensive review and analysis of its assets and liabilities. On October
23, 2003, Nortel Networks announced it would restate its
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9



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| |  | consolidated financial statements for the years ended December 31, 2002, 2001
and 2000 and for the quarters ended March 31, 2003 and June 30, 2003.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Based on the completion of the comprehensive review and certain related
reviews (collectively, the comprehensive review), Nortel Networks has
determined that approximately $909 and $924 of certain liabilities (primarily
accruals and provisions) carried on its previously reported consolidated
balance sheets as at March 31, 2003 and December 31, 2002, respectively,
needed to be released to income. These provisions were either initially
recorded incorrectly in prior periods or not properly released or adjusted
for changes in estimates in the appropriate periods. In certain cases, costs
were incorrectly charged to operations rather than to the appropriate
provisions. Following its determination to restate its consolidated
financial statements for the periods noted above, Nortel Networks also
determined that it would correct certain known errors that were previously
not recorded because the amount of the errors was not material to the
consolidated financial statements. Specifically, among other items, Nortel
Networks has made certain revenue adjustments to reflect revenue which should
have been deferred instead of recognized in a particular period. Also, as
part of the restatements, Nortel Networks made adjustments to correct errors
related to its deferred income tax assets and foreign currency translation
accounts. In addition, Nortel Networks made reclassification adjustments
within the consolidated balance sheets to better reflect the underlying
nature of certain items; these reclassifications did not impact the net
assets as at the end of any period. The net effect of all of these
adjustments was a reduction in accumulated deficit of $442 and $486 as at
March 31, 2003 and December 31, 2002, respectively.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following presents the impact on revenues and earnings (loss) of the
restatement adjustments for the three months ended March 31, 2003 and the
years ended December 31, 2002, 2001 and 2000:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Three months ended
    
    
    December 31,March 31, 2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    Prior years(a)RevenuesAs previously reported
    
    $
    2,397
    
    
    $
    10,546
    
    
    $
    17,375
    
    
    $
    27,853Adjustments
    
    
    (21
    )
    
    
    8
    
    
    
    (103
    )
    
    
    (17
    )
    
    $
    (1
    )As restated
    
    $
    2,376
    
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836Earnings (loss)Earnings (loss) from
continuing operationsAs previously reported
    
    $
    (67
    )
    
    $
    (3,039
    )
    
    $
    (11,555
    )
    
    $
    (871
    )Adjustments
    
    
    (36
    )
    
    
    294
    
    
    
    125
    
    
    
    28
    
    
    $
    4As restated
    
    $
    (103
    )
    
    $
    (2,745
    )
    
    $
    (11,430
    )
    
    $
    (843
    )Earnings (loss) from discontinued operations  net of taxAs previously reported
    
    $
    164
    
    
    $
    
    
    
    $
    (2,538
    )
    
    $
    (414
    )Adjustments
    
    
    
    
    
    
    21
    
    
    
    14
    
    
    
    
    
    
    $
    As restated
    
    $
    164
    
    
    $
    21
    
    
    $
    (2,524
    )
    
    $
    (414
    )Net earnings (loss) applicable to
common sharesAs previously reported
    
    $
    92
    
    
    $
    (3,061
    )
    
    $
    (14,105
    )
    
    $
    (1,316
    )Adjustments
    
    
    (44
    )
    
    
    315
    
    
    
    139
    
    
    
    28
    
    
    $
    4As restated
    
    $
    48
    
    
    $
    (2,746
    )
    
    $
    (13,966
    )
    
    $
    (1,288
    )
 (a)
    
    The amount in prior years relates to net adjustments in the years
1997 through 1999 which have been reflected as an adjustment to
accumulated deficit as of January 1, 2000.




| |  | Nortel Networks has also undertaken a series of physical counts and
reconciliations of plant and equipment. While Nortel Networks believes that
the portion of the work completed to date supports the carrying value of the
plant and equipment recorded in its consolidated balance sheet as at March
31, 2003, the conclusion of this work could result in adjustments to the
carrying value of certain assets.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following presents details by category, aggregating to the net decrease
in net earnings for the three months ended March 31, 2003 and the net
decrease in the net loss for the three months ended March 31, 2002, resulting
from the restatement adjustments:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

10



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##### Table of Contents





| |  | Net (decrease) in net earnings/Net decrease in net (loss)
| |  | ---------------------------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002Contract and customer-related accruals
    
    $
    30
    
    
    $
    59Special charges related to restructuring actions
    
    
    27
    
    
    
    26Other accruals and provisions
    
    
    (87
    )
    
    
    71Total accruals and provisions adjustments
    
    
    (30
    )
    
    
    156Income tax adjustments
    
    
    4
    
    
    
    (47
    )Revenue adjustments
    
    
    (21
    )
    
    
    (10
    )Foreign currency translation adjustments related to
Brazilian operations
    
    
    3
    
    
    
    Net (decrease) in net earnings/Net decrease in net (loss)
    
    $
    (44
    )
    
    $
    99




| |  | Descriptions of the categories of the restatement adjustments to Nortel
Networks net earnings for the three months ended March 31, 2003 and to the
net loss for the three months ended March 31, 2002 that were determined as a
result of its comprehensive review are set forth below.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contract and customer-related accruals
| |  | --------------------------------------



| |  | Adjustments related to certain contract and customer-related accruals were
approximately $30 and $59 for the three months ended March 31, 2003 and 2002,
respectively. These accruals were identified as having been accrued in error
and were reversed in the appropriate periods. Nortel Networks identified
situations in which additional accruals related to certain contracts were
recognized when circumstances did not justify such accruals. Certain of
these accruals were not supported by adequate documentation. In addition,
Nortel Networks identified situations where accruals had been released in
inappropriate periods. Therefore, certain adjustments have been made to
recognize these releases in the appropriate periods.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Special charges related to restructuring actions
| |  | ------------------------------------------------



| |  | During the period January 1, 2000 to March 31, 2003, Nortel Networks
recorded, prior to the restatement adjustments, $5,023 of special charges
related to workforce reductions, contract settlement and lease costs, plant
and equipment write-downs and other ancillary special charges in connection
with the implementation of specific restructuring actions to streamline its
operations and activities around core markets and operations. As part of the
restatements, Nortel Networks has reduced special charges by $27 and $26 for
the three months ended March 31, 2003 and 2002, respectively. The following
table provides details of the total adjustments related to these special
charges for each of the three months ended:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002Severance and fringe benefits calculations
    
    $
    14
    
    
    $
    16Plant and equipment and real estate related adjustments
    
    
    7
    
    
    
    4Contract settlements
    
    
    6
    
    
    
    6Total adjustments related to special charges (a)
    
    $
    27
    
    
    $
    26


| | (a) |  | The majority of the total adjustments related to special charges impacted
Special charges in the consolidated statements of operations. However, $5
of the above noted amounts for each of the three months ended March 31, 2003
and 2002 impacted other lines in the consolidated statements of operations.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Adjustments were made relating to special charges for costs associated with
severance and fringe benefits offered to terminated employees. These
adjustments were due to calculation errors that resulted in excess charges
being recorded at the time of initial recognition, or the failure to properly
release or adjust accruals for subsequent changes in estimates and
assumptions. In addition, Nortel Networks identified situations where
accruals had been released in inappropriate periods. Therefore, certain
adjustments have been made to recognize these releases in the appropriate
periods.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

11



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##### Table of Contents





| |  | Adjustments related to special charges for plant and equipment and certain
real estate facilities resulted from excess depreciation and amortization
charges taken on previously written-down assets, computational errors related
to foreign currency, incorrect recognition of proceeds received on the sale
of previously written-down assets and the need to recognize additional exit
costs for properties which had not previously been accrued to special
charges.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks also had appropriately accrued certain costs associated with
contract settlements with customers and suppliers related to exit activities.
However, the timely reassessment of the estimates and assumptions used to
establish these accruals was not carried out and accordingly the restatement
adjustments reflected the release of such accruals in the appropriate
periods.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other accruals and provisions
| |  | -----------------------------



| |  | Nortel Networks determined that certain accruals and provisions should not
have been recorded as the appropriate conditions and documentation supporting
the establishment of these accruals and provisions did not exist at the time
of such recognition. The restatement adjustments included the reversal of
these accruals and provisions in the periods in which they were originally
recorded. Nortel Networks also identified situations where accruals had been
released in inappropriate periods. Therefore, certain adjustments have been
made to recognize these releases in the appropriate periods.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The net impact of these adjustments was a $87 decrease in net earnings and a
$71 decrease in net loss for the three months ended March 31, 2003 and 2002,
respectively. The following table details the amounts related to each of
these adjustments for each of the three months ended March 31:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002Reverse previously released provisions related to inter-company balances
    
    $
    (35
    )
    
    $
    Release (reverse previously released) accruals related to finance system upgrades
    
    
    (15
    )
    
    
    10Reverse accruals related to discretionary bonuses
    
    
    
    
    
    
    12Other adjustments to modify accruals
    
    
    (37
    )
    
    
    49Total adjustments related to other accruals and provisions
    
    $
    (87
    )
    
    $
    71




| |  | These restatement adjustments included the reversal of the release of
provisions previously established to bring into balance certain inter-company
payables and receivables, the reversal of accruals for costs associated with
programs to upgrade certain financial information systems and the reversal of
accruals for discretionary bonuses in excess of amounts reasonably expected
to be paid. Other adjustments made in connection with the restatements
related to the need to make modifications to accruals in a number of specific
areas, including adjustments to accounts payable balances, warranty
provisions, and other accruals and provisions.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Income tax adjustments
| |  | ----------------------



| |  | The adjustment related to income taxes for the three months ended March 31,
2003 was a $4 decrease to the income tax provision which included $19 from
the reversal of a previously written-off withholding tax receivable partially
offset by the tax impacts of the restatement adjustments and a correction to
the income tax provision which was attributed to the utilization of a portion
of the current periods operating losses against the income earned in
discontinued operations. The write-off of the receivable had been recorded
in inappropriate periods and adjustments have been made to recognize the
write-off in the appropriate periods. The adjustment related to income taxes
for the three months ended March 31, 2002 was a $47 decrease in the income
tax benefit which resulted primarily from the tax impacts of the restatement
adjustments.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Revenue adjustments
| |  | -------------------



| |  | Nortel Networks recognized revenue in circumstances in which such revenue
should have been deferred to later periods. Adjustments primarily related to
the accounting treatment of certain contract related obligations with a
limited number of customers. In these cases, such obligations should not have
been recorded; rather, recognition of revenue should have been deferred.
Also, in the Caribbean and Latin America region, Nortel Networks determined
that there were revenue calculation errors. In the restatements, Nortel
Networks deferred the recognition of such revenues to the appropriate periods
and released associated accrued costs in the appropriate
periods. The net impact of these adjustments was a reduction to revenue of $21 and $10 for the
three months ended March 31, 2003 and 2002, respectively.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12



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##### Table of Contents





| |  | Foreign currency translation adjustments
| |  | ----------------------------------------



| |  | Nortel Networks had recorded net gains on the translation of foreign currency
denominated balances of its Brazilian entities in the currency translation
adjustment account included in accumulated other comprehensive loss on its
balance sheet. These net gains totaled $3 and nil for the three months ended
March 31, 2003 and 2002, respectively. In connection with the comprehensive
review, Nortel Networks determined that the appropriate accounting treatment
would have been to record the foreign exchange impact in its statement of
operations in the appropriate periods.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Impacts of the restatements on the accompanying (unaudited) consolidated
financial statements
| |  | ---------------------------------------------------------------------------------------------



| |  | The following presents a summary of the impact of the restatements for the
periods presented in the accompanying (unaudited) consolidated financial
statements.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated statement of operations for the three months ended March 31,
2003 as restated
| |  | ------------------------------------------------------------------------------------------



| |  | Net earnings applicable to common shares for the three months ended March 31,
2003 was reduced by $44 from $92 to $48. The major components of the
reduction included:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $14 improvement in gross profit which included a $21
reduction in revenues which resulted from revenue deferrals and a $35
improvement to cost of revenues which resulted primarily from
adjustments to contract and customer-related accruals;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $28 increase in selling, general and administrative expense
which resulted primarily from the reversal of previously recorded
releases of other accruals and provisions, including $15 of accruals
for costs associated with programs to upgrade certain financial
information systems;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $14 increase in research and development expense which
resulted primarily from the reversal of previously recorded releases
of other accruals and provisions, including $5 of accruals for
inter-company out of balance amounts;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $22 decrease in special charges which resulted primarily from
the release of accruals associated with severance and fringe benefits
for terminated employees; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $36 decrease in other income primarily from the reversal of
previously recorded releases of other accruals and provisions,
including $30 of accruals for inter-company out of balance amounts.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated statement of operations for the three months ended March 31,
2002 as restated
| |  | ------------------------------------------------------------------------------------------



| |  | Net loss applicable to common shares for the three months ended March 31,
2002 was reduced by $99 from $790 to $691. The major components of the
reduction included:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $58 improvement in gross profit which resulted primarily from
adjustments to contract and customer-related accruals;
| | - | ----------------------------------------------------------------------------------------------------------------------

| |  | a $39 decrease in selling, general and administrative expense
which resulted primarily from the release of $12 of accruals for
costs associated with discretionary bonuses in excess of amounts
reasonably expected to be paid and $10 of accruals for programs to
upgrade certain financial information systems;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $12 decrease in research and development expense which
resulted from adjustments related to other accruals and provisions;
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | a $21 decrease which resulted from the release of special
charges primarily related to costs associated with severance and
fringe benefits for terminated employees; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $16 adjustment to discontinued operations for items
previously recorded incorrectly as an expense in discontinued
operations.
| | - | -------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated balance sheets as at March 31, 2003 and December 31, 2002
| |  | ----------------------------------------------------------------------



| |  | Restatements
| |  | ------------



| |  | The consolidated balance sheets below present the cumulative impact of the
restatement adjustments described above classified by balance sheet line item
as at March 31, 2003 and December 31, 2002.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

13



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##### Table of Contents





| |  | Reclassification adjustments
| |  | ----------------------------



| |  | In addition to the restatement adjustments, reclassification adjustments were
made between line items which also impacted the consolidated balance sheets
as at March 31, 2003 and December 31, 2002. The principal reclassifications
are set forth below.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As at March 31, 2003
| |  | --------------------



| |  | a $66 reduction to cash and cash equivalents and notes payable to
reflect, upon consolidation, that a bank note payable by one subsidiary
was fully collateralized by, and could be offset against, a deposit in
the same bank by another subsidiary;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $117 increase in accounts receivable-net which included a $156
increase primarily to recognize advance billings in excess of revenues
as a liability partially offset by a $6 reclassification from other
accrued liabilities to properly offset amounts billed by Nortel Networks
as collection agent under receivable sales agreements against the
corresponding receivables and a $33 increase in allowance for doubtful
accounts for financed receivables which resulted from a reclassification
from other long-term assets;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $23 increase in net inventory with related reductions of $7 in
other current assets and of $16 in other long-term assets; and
| | - | -------------------------------------------------------------------------------------------------------------------------------

| |  | a $150 increase in other accrued liabilities including a $156
increase partially offset by a $6 decrease, both related to accounts
receivable-net (as noted above).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As at December 31, 2002
| |  | -----------------------



| |  | a $70 reduction to cash and cash equivalents and notes payable to
reflect, upon consolidation, that a bank note payable by one subsidiary
was fully collateralized by, and could be offset against, a deposit in
the same bank by another subsidiary;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $265 increase in accounts receivable-net which included a $370
increase primarily to recognize advance billings in excess of revenues
as a liability partially offset by a $64 reclassification from other
accrued liabilities to properly offset amounts billed by Nortel Networks
as collection agent under receivable sales agreements against the
corresponding receivables and a $41 increase in allowance for doubtful
accounts for financed receivables which resulted from a reclassification
from other long-term assets;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $90 increase in net inventory with related reductions of $52 in
other current assets and of $38 in other long-term assets; and
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | a $306 increase in other accrued liabilities including a $370
increase partially offset by a $64 decrease, both related to accounts
receivable-net (as noted above).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

14



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##### Table of Contents



Consolidated Statement of Operations (unaudited)

Three months ended March 31, 2003Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    2,397
    
    
    $
    (21
    )
    
    $
    2,376Cost of revenues
    
    
    1,359
    
    
    
    (35
    )
    
    
    1,324Gross profit
    
    
    1,038
    
    
    
    14
    
    
    
    1,052Selling, general and administrative expense
    
    
    485
    
    
    
    28
    
    
    
    513Research and development expense
    
    
    488
    
    
    
    14
    
    
    
    502Special charges
    
    
    133
    
    
    
    (22
    )
    
    
    111Gain on sale of businesses
    
    
    
    
    
    
    (4
    )
    
    
    (4
    )Operating earnings (loss)
    
    
    (68
    )
    
    
    (2
    )
    
    
    (70
    )Other income (expense)  net
    
    
    49
    
    
    
    (36
    )
    
    
    13Interest expenseLong-term debt
    
    
    (24
    )
    
    
    1
    
    
    
    (23
    )Other
    
    
    (7
    )
    
    
    
    
    
    
    (7
    )Loss from continuing operations
before income taxes and
equity in net loss of associated companies
    
    
    (50
    )
    
    
    (37
    )
    
    
    (87)Income tax benefit (expense)
    
    
    (10
    )
    
    
    4
    
    
    
    (6
    )(60
    )
    
    
    (33
    )
    
    
    (93
    )Equity in net loss of associated companies  net of tax
    
    
    (7
    )
    
    
    (3
    )
    
    
    (10
    )Net loss from continuing operations
    
    
    (67
    )
    
    
    (36
    )
    
    
    (103
    )Net earnings from discontinued operations  net of tax
    
    
    164
    
    
    
    
    
    
    
    164Net earnings (loss) before cumulative effect of accounting
change  net of tax
    
    
    97
    
    
    
    (36
    )
    
    
    61Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    (8
    )
    
    
    (8
    )Net earnings (loss)
    
    
    97
    
    
    
    (44
    )
    
    
    53Dividends on preferred shares
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Net earnings (loss) applicable to common shares
    
    $
    92
    
    
    $
    (44
    )
    
    $
    48


15



---



##### Table of Contents



Consolidated Statements of Operations (unaudited)

Three months ended March 31, 2002Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    2,910
    
    
    $
    (10
    )
    
    $
    2,900Cost of revenues
    
    
    2,229
    
    
    
    (68
    )
    
    
    2,161Gross profit
    
    
    681
    
    
    
    58
    
    
    
    739Selling, general and administrative expense
    
    
    740
    
    
    
    (39
    )
    
    
    701Research and development expense
    
    
    577
    
    
    
    (12
    )
    
    
    565Amortization of acquired technology
    
    
    5
    
    
    
    
    
    
    
    5Special charges
    
    
    443
    
    
    
    (21
    )
    
    
    422Gain on sale of businesses
    
    
    (3
    )
    
    
    (3
    )
    
    
    (6
    )Operating earnings (loss)
    
    
    (1,081
    )
    
    
    133
    
    
    
    (948
    )Other income (expense)  net
    
    
    (14
    )
    
    
    4
    
    
    
    (10
    )Interest expenseLong-term debt
    
    
    (36
    )
    
    
    (2
    )
    
    
    (38
    )Other
    
    
    (12
    )
    
    
    (1
    )
    
    
    (13
    )Loss from continuing operations
before income taxes and
equity in net loss of associated companies
    
    
    (1,143
    )
    
    
    134
    
    
    
    (1,009
    )Income tax benefit (expense)
    
    
    362
    
    
    
    (47
    )
    
    
    315(781
    )
    
    
    87
    
    
    
    (694
    )Equity in net loss of associated companies  net of tax
    
    
    (4
    )
    
    
    (4
    )
    
    
    (8
    )Net loss from continuing operations
    
    
    (785
    )
    
    
    83
    
    
    
    (702
    )Net earnings from discontinued operations  net of tax
    
    
    
    
    
    
    16
    
    
    
    16Net earnings (loss)
    
    
    (785
    )
    
    
    99
    
    
    
    (686
    )Dividends on preferred shares
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Net earnings (loss) applicable to common shares
    
    $
    (790
    )
    
    $
    99
    
    
    $
    (691
    )


16



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##### Table of Contents



Consolidated Balance Sheet (unaudited)

March 31, 2003Aspreviously
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    
    Restatement
    
    
    Reclassification
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    3,913
    
    
    $
    (2
    )
    
    $
    (66
    )
    
    $
    3,845Restricted cash and cash equivalents
    
    
    227
    
    
    
    
    
    
    
    
    
    
    
    227Accounts receivable  net
    
    
    2,028
    
    
    
    (14
    )
    
    
    117
    
    
    
    2,131Inventories  net
    
    
    846
    
    
    
    16
    
    
    
    23
    
    
    
    885Income taxes recoverable
    
    
    60
    
    
    
    
    
    
    
    
    
    
    
    60Deferred income taxes  net
    
    
    784
    
    
    
    
    
    
    
    
    
    
    
    784Other current assets
    
    
    419
    
    
    
    9
    
    
    
    (7
    )
    
    
    421Total current assets
    
    
    8,277
    
    
    
    9
    
    
    
    67
    
    
    
    8,353Investments at cost and associated companies at equity
    
    
    211
    
    
    
    (11
    )
    
    
    
    
    
    
    200Plant and equipment  net
    
    
    1,396
    
    
    
    39
    
    
    
    
    
    
    
    1,435Goodwill
    
    
    2,021
    
    
    
    
    
    
    
    
    
    
    
    2,021Deferred income taxes  net
    
    
    3,026
    
    
    
    (163
    )
    
    
    
    
    
    
    2,863Other assets
    
    
    749
    
    
    
    20
    
    
    
    24
    
    
    
    793Total assets
    
    $
    15,680
    
    
    $
    (106
    )
    
    $
    91
    
    
    $
    15,665LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    78
    
    
    $
    
    
    
    $
    (66
    )
    
    $
    12Trade and other accounts payable
    
    
    803
    
    
    
    (27
    )
    
    
    
    
    
    
    776Payroll and benefit-related liabilities
    
    
    664
    
    
    
    (14
    )
    
    
    
    
    
    
    650Contractual liabilities
    
    
    1,457
    
    
    
    (335
    )
    
    
    
    
    
    
    1,122Restructuring
    
    
    680
    
    
    
    (247
    )
    
    
    
    
    
    
    433Other accrued liabilities
    
    
    2,634
    
    
    
    (168
    )
    
    
    150
    
    
    
    2,616Long-term debt due within one year
    
    
    234
    
    
    
    
    
    
    
    
    
    
    
    234Total current liabilities
    
    
    6,550
    
    
    
    (791
    )
    
    
    84
    
    
    
    5,843Long-term debt
    
    
    1,864
    
    
    
    (1
    )
    
    
    31
    
    
    
    1,894Deferred income taxes  net
    
    
    431
    
    
    
    
    
    
    
    
    
    
    
    431Other liabilities
    
    
    2,408
    
    
    
    13
    
    
    
    (24
    )
    
    
    2,39711,253
    
    
    
    (779
    )
    
    
    91
    
    
    
    10,565Minority interests in subsidiary companies
    
    
    70
    
    
    
    44
    
    
    
    
    
    
    
    114SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited;
issued and outstanding shares: 30,000,000 at March 31, 2003
    
    
    536
    
    
    
    
    
    
    
    
    
    
    
    536Common shares, without par value  Authorized shares: unlimited;
issued and outstanding shares: 1,460,978,638 at March 31, 2003
    
    
    1,211
    
    
    
    
    
    
    
    
    
    
    
    1,211Additional paid-in capital
    
    
    21,991
    
    
    
    14
    
    
    
    
    
    
    
    22,005Deficit
    
    
    (18,000
    )
    
    
    441
    
    
    
    
    
    
    
    (17,559
    )Accumulated other comprehensive loss
    
    
    (1,381
    )
    
    
    174
    
    
    
    
    
    
    
    (1,207
    )Total shareholders equity
    
    
    4,357
    
    
    
    629
    
    
    
    
    
    
    
    4,986Total liabilities and shareholders equity
    
    $
    15,680
    
    
    $
    (106
    )
    
    $
    91
    
    
    $
    15,665


17



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Consolidated Balance Sheet (unaudited)

December 31, 2002Aspreviously
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    Reclassification
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    3,813
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    3,743Restricted cash and cash equivalents
    
    
    249
    
    
    
    
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    1,993
    
    
    
    (11
    )
    
    
    265
    
    
    
    2,247Inventories  net
    
    
    889
    
    
    
    7
    
    
    
    90
    
    
    
    986Income taxes recoverable
    
    
    58
    
    
    
    
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    793
    
    
    
    
    
    
    
    
    
    
    
    793Other current assets
    
    
    706
    
    
    
    14
    
    
    
    (52
    )
    
    
    668Total current assets
    
    
    8,501
    
    
    
    10
    
    
    
    233
    
    
    
    8,744Investments at cost and associated companies at equity
    
    
    246
    
    
    
    2
    
    
    
    
    
    
    
    248Plant and equipment  net
    
    
    1,441
    
    
    
    23
    
    
    
    
    
    
    
    1,464Goodwill
    
    
    2,021
    
    
    
    
    
    
    
    
    
    
    
    2,021Deferred income taxes  net
    
    
    2,797
    
    
    
    (144
    )
    
    
    
    
    
    
    2,653Other assets
    
    
    747
    
    
    
    9
    
    
    
    10
    
    
    
    766Total assets
    
    $
    15,753
    
    
    $
    (100
    )
    
    $
    243
    
    
    $
    15,896LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    100
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    30Trade and other accounts payable
    
    
    931
    
    
    
    (32
    )
    
    
    
    
    
    
    899Payroll and benefit-related liabilities
    
    
    513
    
    
    
    (14
    )
    
    
    
    
    
    
    499Contractual liabilities
    
    
    1,546
    
    
    
    (333
    )
    
    
    
    
    
    
    1,213Restructuring
    
    
    761
    
    
    
    (224
    )
    
    
    
    
    
    
    537Other accrued liabilities
    
    
    2,803
    
    
    
    (215
    )
    
    
    306
    
    
    
    2,894Long-term debt due within one year
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    6,887
    
    
    
    (818
    )
    
    
    236
    
    
    
    6,305Long-term debt
    
    
    1,919
    
    
    
    (1
    )
    
    
    31
    
    
    
    1,949Deferred income taxes  net
    
    
    366
    
    
    
    
    
    
    
    
    
    
    
    366Other liabilities
    
    
    2,351
    
    
    
    (6
    )
    
    
    (24
    )
    
    
    2,32111,523
    
    
    
    (825
    )
    
    
    243
    
    
    
    10,941Minority interests in subsidiary companies
    
    
    78
    
    
    
    51
    
    
    
    
    
    
    
    129SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited;
issued and outstanding shares: 30,000,000 at December 31, 2002
    
    
    536
    
    
    
    
    
    
    
    
    
    
    
    536Common shares, without par value
issued and outstanding shares: 1,460,978,638 at December 31, 2002
    
    
    1,211
    
    
    
    
    
    
    
    
    
    
    
    1,211Additional paid-in capital
    
    
    21,991
    
    
    
    13
    
    
    
    
    
    
    
    22,004Deficit
    
    
    (18,093
    )
    
    
    486
    
    
    
    
    
    
    
    (17,607
    )Accumulated other comprehensive loss
    
    
    (1,493
    )
    
    
    175
    
    
    
    
    
    
    
    (1,318
    )Total shareholders equity
    
    
    4,152
    
    
    
    674
    
    
    
    
    
    
    
    4,826Total liabilities and shareholders equity
    
    $
    15,753
    
    
    $
    (100
    )
    
    $
    243
    
    
    $
    15,896


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|3. |  | Accounting changes
|-- |  | ------------------



| | (a) | Stock-based compensation
| | --- | ------------------------



| |  | Prior to fiscal 2003, Nortel Networks, as permitted under SFAS No. 123,
Accounting for Stock-based Compensation (SFAS 123), applied Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees (APB 25), and related interpretations in accounting for
stock-based compensation plans. SFAS 123 required disclosure of pro forma
amounts to reflect the impact if Nortel Networks had elected to adopt the
optional recognition provisions of SFAS 123 for its stock option plans and
employee stock purchase plans.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure  an Amendment of
FASB Statement No. 123 (SFAS 148), which amended the transitional
provisions of SFAS 123 for entities choosing to recognize stock-based
compensation under the fair value based method of SFAS 123, rather than
electing to continue to follow the intrinsic value method of APB 25.
Under SFAS 148, Nortel Networks could have adopted the recommendations of
SFAS 123 either (1) prospectively to awards granted or modified after the
beginning of the year of adoption, (2) retroactively with restatement for
awards granted or modified since January 1, 1995, or (3) prospectively to
awards granted or modified since January 1, 1995. Effective January 1,
2003, Nortel Networks has elected to expense employee stock-based
compensation using the fair value based method prospectively for all
awards granted or modified after January 1, 2003. The effect of adoption
of SFAS 148 was a stock option expense of $5 for the three months ended
March 31, 2003.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Under various stock option programs of Nortel Networks parent, Nortel
Networks Corporation (NNC), options may be granted to various eligible
employees of Nortel Networks to purchase common shares of NNC.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Had Nortel Networks applied the fair value based method to all stock-based
awards, reported net earnings (loss) would have decreased (increased) to
the pro forma amounts indicated below for each of the three months ended:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002Net earnings (loss) applicable to common shares
    
    $
    48
    
    
    $
    (691
    )Stock-based
compensation  reported(a)
    
    
    15
    
    
    
    2Pro
forma stock-based compensation(b)
    
    
    (62
    )
    
    
    (238
    )Net earnings (loss) applicable to common shares  pro forma
    
    $
    1
    
    
    $
    (927
    )
 (a)
    
    Included in stock-based compensation  reported for the three
months ended March 31, 2003 was stock option expense of $5 (net of
tax of nil) and restricted stock units expense of $10 (net of tax of
nil).(b)
    
    Pro forma stock-based compensation was net of tax of $12 and
$69 for the three months ended March 31, 2003 and 2002, respectively.




| |  | The fair value of stock options used to compute pro forma net earnings
(loss) was the estimated fair value at grant date using the Black-Scholes
option-pricing model with the following weighted average assumptions for
each of the three months ended:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002Black-Scholes weighted-average assumptionsExpected dividend
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    92.48
    %
    
    
    71.17
    %Risk-free interest rate
    
    
    2.82
    %
    
    
    4.50
    %Expected option life in years
    
    
    4
    
    
    
    4Weighted average stock option fair value per option granted
    
    $
    1.56
    
    
    $
    3.63


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| | (b) | Guarantees
| | --- | ----------



| |  | Nortel Networks has entered into agreements that contain features which
meet the definition of a guarantee under FIN 45. FIN 45 defines a
guarantee to be a contract that contingently requires Nortel Networks to
make payments (either in cash, financial instruments, other assets, common
shares of NNC or through the provision of services) to a third party based
on changes in an underlying economic characteristic (such as interest
rates or market value) that is related to an asset, a liability or an
equity security of the other party. Effective January 1, 2003, Nortel
Networks adopted the initial recognition and measurement provisions of FIN
45, which apply on a prospective basis to certain guarantees issued or
modified after December 31, 2002. FIN 45 requires that a liability be
recognized for the estimated fair value of the guarantee at its inception.
The adoption of FIN 45 did not have a material impact on the business,
results of operations and financial condition of Nortel Networks. See
note 10 for additional disclosure on guarantees.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Accounting for costs
associated with exit or disposal activities
| | --- | ----------------------------------------------------------------



| |  | In June 2002, the FASB issued SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), which is
effective for exit or disposal activities initiated after December 31,
2002. SFAS 146 supercedes EITF Issue No. 94-3 Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in Restructuring) (EITF 94-3). SFAS
146 requires that costs associated with an exit or disposal activity be
recognized when the liability is incurred, whereas EITF 94-3 required
recognition of a liability when an entity committed to an exit plan. The
effect of SFAS 146 will be to change the timing of recognition of certain
liabilities and no material valuation differences are expected. Plans
initiated before December 31, 2002 continue to be accounted for under EITF
94-3. Nortel Networks adopted the requirements of SFAS 146 effective
January 1, 2003. See note 6 for additional disclosure and the effects of
adoption of SFAS 146.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | Asset retirement
obligations
| | --- | ----------------------------



| |  | In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS) which applies to certain obligations
associated with the retirement of tangible long-lived assets. SFAS 143
requires that a liability is initially recognized for the estimated fair
value of the obligation when it is incurred. The associated asset
retirement cost is capitalized as part of the carrying amount of the
long-lived asset and depreciated over the remaining life of the underlying
asset and the associated liability is accreted to the estimated fair value
of the obligation at the settlement date through periodic accretion
charges to net earnings (loss). When the obligation is settled, any
difference between the final cost and the recorded liability is recognized
as income or loss on settlement. Effective January 1, 2003, Nortel
Networks adopted the initial recognition and measurement provisions of
SFAS 143. The adoption of SFAS 143 resulted in a decrease to net earnings
of $8 (net of tax of nil) which has been reported as a cumulative effect
of an accounting change, the recording of a long-lived asset of $5 and an
asset retirement obligation liability of $13.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|4. |  | Consolidated financial statement details
|-- |  | ----------------------------------------



| |  | The following unaudited consolidated financial statement details are
presented as at March 31, 2003 and December 31, 2002 for the consolidated
balance sheet details, and for each of the three months ended March 31, 2003
and 2002 for the consolidated statement of cash flows:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated balance
sheets
| |  | ---------------------------



| |  | Inventories  net:
| |  | ------------------



March 31,
    
    
    December 31,2003
    
    
    2002Raw materials
    
    $
    302
    
    
    $
    343Work in process
    
    
    280
    
    
    
    308Finished goods
    
    
    303
    
    
    
    335Inventories
 net(a)
    
    $
    885
    
    
    $
    986
 (a)
    
    Net of inventory provisions of $959 and $1,070 as at March 31, 2003
and December 31, 2002, respectively. Included in Other accrued
liabilities were accruals of $156 and $167 at March 31, 2003 and
December 31, 2002, respectively for cancellation charges, inventory in
excess of future demand and the settlement of certain other claims
related to contract manufacturers or suppliers. Plant and equipment  net: March 31,
    
    
    December 31,2003
    
    
    2002Cost:Land
    
    $
    56
    
    
    $
    53Buildings
    
    
    1,216
    
    
    
    1,161Machinery and equipment
    
    
    3,348
    
    
    
    3,3894,620
    
    
    
    4,603Less accumulated depreciation:Buildings
    
    
    (488
    )
    
    
    (481
    )Machinery and equipment
    
    
    (2,697
    )
    
    
    (2,658
    )(3,185
    )
    
    
    (3,139
    )Plant and equipment  net
    
    $
    1,435
    
    
    $
    1,464


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Other accrued liabilities: March 31,
    
    
    December 31,2003
    
    
    2002Outsourcing and selling, general and administrative related
    
    $
    568
    
    
    $
    616Customer deposits
    
    
    84
    
    
    
    58Product related
    
    
    325
    
    
    
    343Warranty
    
    
    250
    
    
    
    253Deferred income
    
    
    588
    
    
    
    586Advance
billings in excess of revenues(a)
    
    
    194
    
    
    
    365Miscellaneous taxes
    
    
    99
    
    
    
    126Income taxes payable
    
    
    74
    
    
    
    98Current liabilities of discontinued operations
    
    
    64
    
    
    
    44Interest expense
    
    
    32
    
    
    
    52Other
    
    
    338
    
    
    
    353Other accrued liabilities
    
    $
    2,616
    
    
    $
    2,894
 (a)
    
    Amounts represent billings in excess of revenues recognized to date on long-term contracts. Consolidated statements of cash flows Interest and income taxes paid (recovered): March 31,
    
    
    March 31,2003
    
    
    2002Interest paid
    
    $
    43
    
    
    $
    70Income taxes paid (recovered)
    
    $
    21
    
    
    $
    (506
    )
 Goodwill Goodwill represents the excess of the purchase price of an acquired
enterprise over the fair values of the identifiable assets acquired and
liabilities assumed. Nortel Networks tests for impairment of goodwill on an
annual basis on October 1, and at any other time if events occur or
circumstances change that would more likely than not reduce the fair value of
the reporting unit below its carrying amount. Circumstances that could trigger an impairment test 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
significant portion of a reporting unit will be sold or otherwise disposed;
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 one or more of the following fair
value measures including: estimated amounts at which the unit as a whole
could be bought or sold in a current transaction between willing parties;
using present value techniques of estimated future cash flows; or using
valuation techniques based on multiples of earnings or revenue, or a similar
performance measure. Nortel Networks also considers the market
capitalization of NNC as of the date of the impairment test. If the carrying
amount of the reporting unit exceeds the 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, 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).


22



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|5. |  | Segmented information
|-- |  | ---------------------



| |  | General description
| |  | -------------------



| |  | Nortel Networks operations are organized around four reportable segments:
Wireless Networks; Enterprise Networks; Wireline Networks; and Optical
Networks. Wireless Networks includes network access and core networking
products for voice and data communications that span second and third
generation wireless technologies and most major global standards for mobile
networks. Enterprise Networks includes circuit and packet voice solutions,
data networking and security solutions and the related professional services
used by our enterprise customers. Wireline Networks includes circuit and
packet voice solutions, data networking and security solutions and the
related professional services used by our service provider customers.
Optical Networks includes metropolitan, regional and long-haul photonic dense
wavelength division multiplexing transmission systems, synchronous optical
transmission systems, optical switching solutions, network management
software and intelligence solutions and Optical Ethernet solutions for our
service provider and enterprise customers.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other represents miscellaneous business activities and corporate functions.
None of these activities meet the quantitative criteria to be disclosed as
reportable segments.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Segments
| |  | --------



| |  | The following tables set forth information by segment for each of the three
months ended:
| |  | -----------------------------------------------------------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002RevenuesWireless Networks
    
    $
    934
    
    
    $
    1,123Enterprise Networks
    
    
    611
    
    
    
    670Wireline Networks
    
    
    561
    
    
    
    686Optical Networks
    
    
    269
    
    
    
    406Other
    
    
    1
    
    
    
    15Total
    
    $
    2,376
    
    
    $
    2,900Contribution marginWireless Networks
    
    $
    317
    
    
    $
    260Enterprise Networks
    
    
    150
    
    
    
    85Wireline Networks
    
    
    158
    
    
    
    128Optical Networks
    
    
    12
    
    
    
    (383
    )Other
    
    
    (98
    )
    
    
    (52
    )Total
    
    
    539
    
    
    
    38Research and development expense
    
    
    (502
    )
    
    
    (565
    )Amortization of acquired technology
    
    
    
    
    
    
    (5
    )Special charges
    
    
    (111
    )
    
    
    (422
    )Gain on sale of businesses
    
    
    4
    
    
    
    6Other income (expense)  net
    
    
    13
    
    
    
    (10
    )Interest expense
    
    
    (30
    )
    
    
    (51
    )Loss from continuing operations before income taxes
    
    $
    (87
    )
    
    $
    (1,009
    )




| |  | For the three months ended March 31, 2003, one customer accounted for 10.3
percent of total revenues. No single customer accounted for greater than 10
percent of revenues for the three months ended March 31, 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|6. |  | Special charges
|-- |  | ---------------



| |  | During the three months ended March 31, 2003, Nortel Networks continued to
implement its restructuring work plan initiated in 2001. Changes in the
provision for special charges are shown below:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Contractsettlement
    
    
    Plant andWorkforce
    
    
    and lease
    
    
    equipmentreduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    TotalProvision
balance as at December 31, 2002(a)
    
    $
    233
    
    
    $
    629
    
    
    $
    
    
    
    $
    9
    
    
    $
    871Special charges
    
    
    45
    
    
    
    77
    
    
    
    (11
    )
    
    
    
    
    
    
    111Cash drawdowns
    
    
    (137
    )
    
    
    (50
    )
    
    
    
    
    
    
    (7
    )
    
    
    (194
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    11Provision
balance as at March 31, 2003(a)
    
    $
    141
    
    
    $
    656
    
    
    $
    
    
    
    $
    2
    
    
    $
    799
 (a)
    
    At March 31, 2003 and December 31, 2002, the short-term provision
balance was $433 and $537, respectively, and the long-term provision
balance was $366 and $334, respectively (included in Other liabilities). Regular full-time (RFT) employee notifications included in special charges
were as follows: Employees (approximate)Direct(a)
    
    
    Indirect(b)
    
    
    TotalRFT employee notifications for the three months ended
March 31, 2003
    
    
    200
    
    
    
    590
    
    
    
    790
 (a)
    
    Direct employees included employees performing manufacturing,
assembly, test and inspection activities associated with the production
of Nortel Networks products.(b)
    
    Indirect employees included employees performing manufacturing
management, sales, marketing, research and development and
administrative activities. Three months ended March 31, 2003 For the three months ended March 31, 2003, Nortel Networks recorded total
special charges of $111. Workforce reduction charges of $45 were related to severance and benefit
costs associated with approximately 790 employees notified of termination
during the three month period ended March 31, 2003 which extended across all
segments. These charges were net of $10 relating to provision amounts that
were no longer required. During the three month period ended March 31, 2003,
the workforce reduction provision balance was drawn down by cash payments of
$137. The remaining provision is expected to be substantially drawn down by
mid 2004. Contract settlement and lease costs of $77 consisted of net lease charges
related to a number of leased facilities (comprised of office, warehouse and
manufacturing space) and leased manufacturing equipment that were no longer
required, across all segments. Lease costs represented Nortel Networks
estimated future net contractual obligations under its operating leases for
those leases that Nortel Networks cannot terminate. Included in the $77 of
contract settlement and lease costs was $46 relating to changes in sublease
revenue assumptions associated with certain properties and $31 of net lease
charges related to newly identified leased facilities and equipment that were
no longer required which were valued using the estimated net present value
method as prescribed under SFAS 146. During the three months ended March 31,
2003, the provision balance for contract settlement and lease costs was drawn
down by cash payments of $50. The remaining provision, net of approximately
$345 in expected sublease revenue, is expected to be substantially drawn down
by the end of 2010. Plant and equipment  net write downs of $(11) were net of $(32) related primarily
to changes in the estimated net realizable value of leasehold improvements
and related assets. Current period write downs to net realizable value were
$21 for various leasehold improvements and excess equipment.


24



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##### Table of Contents





|7. |  | Income taxes
|-- |  | ------------



| |  | At March 31, 2003, Nortel Networks net deferred tax assets, excluding
discontinued operations, were $3,216, reflecting temporary differences
between financial reporting and tax treatment of certain assets and
liabilities, in addition to the tax benefit of net operating loss and tax
credit carryforwards. These carryforwards expire at various dates beginning
in 2003.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the three months ended March 31, 2003, Nortel Networks recorded a tax
expense of $6 on the pre-tax loss of $87 from continuing operations. The
valuation allowance was recorded in accordance with SFAS No. 109 Accounting
for Income taxes, which requires that tax valuation allowances be
established when it is more likely than not that some portion or all of a
companys deferred tax assets will not be realized. The valuation
allowances can be primarily attributed to continued uncertainty in the
telecommunications market.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|8. |  | Long-term debt, credit and support facilities
|-- |  | ---------------------------------------------



| |  | Long-term debt
| |  | --------------



| |  | During the three months ended March 31, 2003, Nortel Networks purchased a
portion of its 6.125 percent notes due February 15, 2006 with a face value of
$39. The transaction resulted in a gain of $4 which was included in the
consolidated statement of operations within Other income (expense)  net.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Credit facilities
| |  | -----------------



| |  | At March 31, 2003 and December 31, 2002, Nortel Networks had total unused
committed credit facilities of $750.
| |  | --------------------------------------------------------------------------------------------------------------



| |  | Support facilities
| |  | ------------------



| |  | On February 14, 2003, Nortel Networks entered into an agreement with Export
Development Canada (EDC) regarding arrangements to provide for support, on
a secured basis, of certain performance related obligations arising out of
normal course business activities for the benefit of Nortel Networks (the
EDC Support Facility). The agreement expires on June 30, 2004.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The EDC Support Facility provides for up to $750 in support including $300 of
committed revolving support for performance bonds or similar instruments, of
which $95 was utilized as at March 31, 2003. The remainder is uncommitted
support for performance bonds, receivables sales and/or securitizations, of
which $65 was utilized as at March 31, 2003. For additional information, see
Nortel Networks 2002 Annual Report and Nortel Networks Current Report on Form
8-K filed February 14, 2003 with the Securities and Exchange Commission.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks obligations under the EDC Support Facility are secured on an
equal basis under the existing security agreements entered into by Nortel
Networks and various of its subsidiaries that pledge substantially all of the
assets of Nortel Networks in favor of certain banks, including the banks
under Nortel Networks and Nortel Networks Inc. (NNI) $750 April 2000 five
year credit facilities and the holders of Nortel Networks and NNCs public
debt securities (see note 16).
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|9. |  | Financial instruments and hedging activities
|-- |  | --------------------------------------------



| |  | During the three months ended March 31, 2003, various cross currency coupon
swaps (notional amount of Canadian $350) were terminated. There was no
impact to net earnings (loss) on termination as these instruments were not
designated as hedges and were previously fair valued through net earnings
(loss).
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|10. |  | Guarantees and commitments
|--- |  | --------------------------



| |  | Guarantees
| |  | ----------



| |  | Nortel Networks has estimated the expected cash flow associated with certain
guarantees issued or modified after December 31, 2002 using a sum of
probability-weighted amounts in a range of possible estimated amounts. The
estimation resulted in an insignificant accrual for the three months ended
March 31, 2003.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Bid, performance related and
other bonds
| |  | ----------------------------------------



| |  | Nortel Networks has entered into bid, performance related and other bonds
associated with various contracts. Bid bonds generally have a term less than
twelve months. Performance related bonds generally have a term of twelve
months. Other bonds generally have a term of twenty-four months. The
various contracts to which these bonds apply generally have terms ranging
from two to five years. Potential payments due under these bonds are related
to Nortel Networks non-performance under the applicable contract. The
following table sets forth the maximum potential amount of future payments
under bid, performance related and other bonds, net of restricted cash and
cash equivalents, as at:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



March 31,
    
    
    December 31,2003
    
    
    2002Bid
and performance related bonds(a)
    
    $
    318
    
    
    $
    400Other
bonds(b)
    
    
    39
    
    
    
    35Total bid, performance related and other bonds
    
    $
    357
    
    
    $
    435
 (a)
    
    Net of restricted cash and cash equivalent amounts of $184 and $195
as at March 31, 2003 and December 31, 2002, respectively.(b)
    
    Net of restricted cash and cash equivalent amounts of $22 and $19 as
at March 31, 2003 and December 31, 2002, respectively. Customer financing Pursuant to certain financing agreements, Nortel Networks is committed to
provide future financing in connection with purchases of Nortel Networks
products and services. Commitments to extend future financing generally have
conditions for funding, fixed expiration or termination dates and specific
interest rates and purposes. Nortel Networks attempts to limit its financing
credit risk by utilizing an internal credit committee that actively monitors
the credit exposure of Nortel Networks. The following table sets forth
customer financing related information and commitments, excluding
discontinued operations, as at: March 31,
    
    
    December 31,2003
    
    
    2002Drawn
and outstanding  gross(a)
    
    $
    982
    
    
    $
    1,091Provisions for doubtful accounts
    
    
    (693
    )
    
    
    (799
    )Drawn and outstanding  net
    
    
    289
    
    
    
    292Undrawn commitments
    
    
    649
    
    
    
    801Total customer financing
    
    $
    938
    
    
    $
    1,093
 (a)
    
    Included short-term and long-term amounts.




|11. |  | Restricted cash and cash equivalents
|--- |  | ------------------------------------



| |  | As at March 31, 2003 and December 31, 2002, approximately $227 and $249 of
cash and cash equivalents, respectively, was restricted as collateral for
certain bid, performance related and other bonds. In addition to the payment
of fees, cash and cash equivalent collateral was also required in connection
with obtaining new bid, performance related and other bonds as a result of
the general economic and industry environment and Nortel Networks current
credit ratings.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|12. |  | Comprehensive income (loss)
|--- |  | ---------------------------



| |  | The following are the components of comprehensive income (loss), net of tax,
for each of the three months ended:
| |  | ----------------------------------------------------------------------------------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002Net earnings (loss)
    
    $
    53
    
    
    $
    (686
    )Other comprehensive income (loss) adjustments:Change
in foreign currency translation adjustment(a)
    
    
    97
    
    
    
    (51
    )Unrealized
gain on investments  net(b)
    
    
    3
    
    
    
    16Unrealized
derivative gain on cash flow hedges 
net(c)
    
    
    11
    
    
    
    1Comprehensive income (loss)
    
    $
    164
    
    
    $
    (720
    )
 (a)
    
    The changes in the foreign currency translation adjustments were not
adjusted for income taxes since they related to indefinite term
investments in non-United States subsidiaries.(b)
    
    Certain securities deemed available-for-sale by Nortel Networks are
measured at fair value. Unrealized holding gains and losses related to
these securities were excluded from net earnings (loss) and are included
in comprehensive income (loss) until realized. Unrealized gain on
investments was net of tax of $4 and $11 for the three months ended
March 31, 2003 and 2002, respectively.(c)
    
    During the three months ended March 31, 2003 and 2002, $1 and $(4),
respectively, of net derivative gains (losses) were reclassified to net
earnings (loss). Nortel Networks estimates that $9 of net derivative
gains included in other comprehensive income (loss) will be reclassified
into net earnings (loss) within the next 12 months.




|13. |  | Discontinued operations
|--- |  | -----------------------



| |  | During the three months ended March 31, 2003, Nortel Networks substantially
completed the wind-down of its access solutions operations. The initial
disposal strategy or intent to exit the business was approved by the Nortel
Networks Board of Directors on June 14, 2001. The continued deterioration in
industry and market conditions delayed certain disposal activities beyond the
original planned timeframe of one year. In particular, actions involving
negotiations with customers, who were also affected by industry conditions,
took longer than expected. Although disposal activities continued beyond a
one-year period, Nortel Networks has continued to present the access
solutions operations as discontinued operations in the accompanying unaudited
consolidated financial statements.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following unaudited consolidated financial results for discontinued
operations are presented as at March 31, 2003 and December 31, 2002 for the
consolidated balance sheets, and for each of the three month periods ended
March 31, 2003 and 2002, for the consolidated statements of operations and
consolidated statements of cash flows:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated statements of
operations:
| |  | --------------------------------------



March 31,
    
    
    March 31,2003
    
    
    2002Revenues
    
    $
    3
    
    
    $
    68Net
earnings from discontinued operations  net of tax(a)
    
    $
    164
    
    
    $
    16
 (a)
    
    Net earnings from discontinued operations were net of applicable
income tax of $8 and nil for the three months ended March 31, 2003 and
2002, respectively.


27



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Consolidated balance sheets: March 31,
    
    
    December 31,2003
    
    
    2002Accounts receivable  net
    
    $
    
    
    
    $
    20Inventories  net
    
    
    2
    
    
    
    Deferred income taxes
    
    
    66
    
    
    
    146Other
current assets(a)
    
    
    2
    
    
    
    45Total
current assets of discontinued operations(b)
    
    
    70
    
    
    
    211Other
long-term assets(a)(b)
    
    
    54
    
    
    
    48Total assets of discontinued operations
    
    $
    124
    
    
    $
    259Current
liabilities(b)(c)
    
    $
    64
    
    
    $
    44Long-term
liabilities(b)
    
    
    2
    
    
    
    2Total liabilities of discontinued operations
    
    $
    66
    
    
    $
    46
 (a)
    
    Included customer financing receivables of nil (net of provisions of
$96) and $56 (net of provisions of $486) as at March 31, 2003 and
December 31, 2002, respectively.(b)
    
    Current assets, Other long-term assets, Current liabilities and
Long-term liabilities of discontinued operations were included in Other
current assets, Other assets, Other accrued liabilities and Other
liabilities, respectively, of Nortel Networks consolidated balance
sheets.(c)
    
    Included accruals of $64 and $42 as at March 31, 2003 and December
31, 2002, respectively, related to the future contractual obligations
and estimated liabilities during the planned period of disposition.  Consolidated statements of cash flows: March 31,
    
    
    March 31,2003
    
    
    2002Cash flows from (used in) discontinued operationsOperating activities
    
    $
    12
    
    
    $
    74Investing activities
    
    
    241
    
    
    
    (24
    )Net cash from discontinued operations
    
    $
    253
    
    
    $
    50
  Three months ended March 31, 2003  On March 24, 2003, Nortel Networks sold 8 million common shares of Arris
Group Inc. (Arris) to Arris for cash consideration of $28 pursuant to a
March 11, 2003 agreement (the March 2003 Agreement). This resulted in a
gain of $12. Upon completion of this transaction, Nortel Networks owned 14
million Arris common shares or 18.8 percent of the Arris outstanding common
shares. Nortel Networks has classified its remaining ownership interest in
Arris as an available-for-sale investment. In addition, on March 18, 2003,
Nortel Networks assigned its membership interest in Arris Interactive LLC to
ANTEC Corporation, an Arris company, for cash consideration of $89. This
resulted in a gain for the full amount.  Under the terms of the March 2003 Agreement, Arris has the option to
purchase, from Nortel Networks, prior to the earlier of (1) June 30, 2003 and
(2) at Nortel Networks election, on the occurrence of a change of control,
or a material change in the business, of Arris, or the commencement of a
third party tender offer for the common shares of Arris, an additional 8
million shares of Arris. The purchase price of these shares will be equal to
the greater of $4.00 per share or 90 percent of the five trading day volume
weighted average market price prior to the exercise date. Nortel Networks
has also entered into various lock-up arrangements which restrict its rights
to dispose of its remaining common shares of Arris until June 11, 2003.  On March 20, 2003, Nortel Networks entered into a restructuring agreement
with a customer to restructure approximately $465 of trade and customer
financing receivables owed to Nortel Networks, the majority of which was
previously provisioned. As a result of the restructuring agreement, Nortel
Networks received consideration including cash of $125, notes and an
ownership interest which have been fully provided for and the mutual release
of all other claims between the parties. A gain of $95 was recorded as a
result of the transaction. In addition to the restructuring agreement,
a five year


28



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| |  | equipment and services supply agreement was entered into requiring
customer payment terms of either cash in advance or guarantee by letters of
credit in favor of Nortel Networks.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|14. |  | Related party transactions
|--- |  | --------------------------



| |  | In the ordinary course of business, Nortel Networks engages in transactions
with certain of its equity-owned investees that are under or are subject to
Nortel Networks significant influence and with NNC, joint ventures of NNC and
subsidiaries of NNC. These transactions include sales and purchases of
goods and services (under usual trade terms measured at their exchange
amounts), cash borrowings between the parties and funding activities pursuant
to reciprocal credit agreements.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As at March 31, 2003 and December 31, 2002, Nortel Networks had the following
related party amounts on its balance sheet related to NNC and owned
subsidiaries of NNC:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



March 31,
    
    
    December 31,2003
    
    
    2002Owing from (to) NNC
    
    $
    28
    
    
    $
    (47
    )Owing from NNC subsidiaries
    
    $
    119
    
    
    $
    99Stock option fair value increment (included in shareholders equity)
    
    $
    
    
    
    $
    525
 On August 29, 2002, a payment was made by a subsidiary of Nortel Networks to
NNC equal to $525 representing the difference between the market value of NNC
common shares issued on stock option exercises and the exercise price of NNC
stock options exercised by employees of the subsidiary. This payment was
referred to as stock option fair value increment.




|15. |  | Contingencies
|--- |  | -------------



| |  | Subsequent to the February 15, 2001 announcement in which NNC provided
revised guidance for financial performance for the 2001 fiscal year and the
first quarter of 2001, NNC and certain of its then current officers and
directors were named as defendants in more than twenty-five purported class
action lawsuits. These lawsuits in the United States District Courts for the
Eastern District of New York, for the Southern District of New York and for
the District of New Jersey, and the provinces of Ontario, Quebec and British
Columbia in Canada, on behalf of shareholders who acquired NNC securities as
early as October 24, 2000 and as late as February 15, 2001, allege, among
other things, violations of United States federal and Canadian provincial
securities laws. These matters also have been the subject of review by
Canadian and U.S. securities regulatory authorities. On May 11, 2001, NNC
filed motions to dismiss and/or stay in connection with the three proceedings
in Quebec primarily based on the factual allegations lacking substantial
connection to Quebec and the inclusion of shareholders resident in Quebec in
the class claimed in the Ontario lawsuit. The plaintiffs in two of these
proceedings in Quebec obtained court approval for discontinuances of their
proceedings on January 17, 2002. The motion to dismiss and/or stay the third
proceeding was heard on November 6, 2001 and the court deferred any
determination on the motion to the judge who will hear the application for
authorization to commence a class proceeding. On December 6, 2001, NNC filed
a motion seeking leave to appeal that decision. The motion for leave to
appeal was dismissed on March 11, 2002. On October 16, 2001, an order in the
Southern District of New York was filed consolidating twenty-five of the
related United States class action lawsuits into a single case, appointing
class plaintiffs and counsel for such plaintiffs. The plaintiffs served a
consolidated amended complaint on January 18, 2002. On December 17, 2001,
the defendants in the British Columbia action served notice of a motion
requesting the court to decline jurisdiction and to stay all proceedings on
the ground that British Columbia is an inappropriate forum. The motion has
been adjourned at the plaintiffs request to a future date to be set by the
parties.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A class action lawsuit against NNC was also filed in the United States
District Court for the Southern District of New York on behalf of
shareholders who acquired the securities of JDS Uniphase Corporation (JDS)
between January 18, 2001 and February 15, 2001, alleging violations of the
same United States federal securities laws as the above-noted lawsuits.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | On April 1, 2002, NNC filed a motion to dismiss both the above consolidated
United States shareholder class action and the above JDS shareholder class
action complaints on the grounds that they failed to state a cause of action
under United States federal securities laws. With respect to the JDS
shareholder class action complaint, NNC also moved to dismiss on the separate
basis that JDS shareholders lacked standing to sue NNC. On January 3, 2003,
the District Court granted the motion to dismiss the JDS shareholder class
action complaint and denied the motion to dismiss the consolidated United
States class action complaint. Plaintiffs are appealing the dismissal of the
JDS shareholder class action complaint.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On July 17, 2002, a new purported class action lawsuit (the Ontario Claim)
was filed in the Ontario Superior Court of Justice, Commercial List, naming
NNC, certain of its current and former officers and directors, and its
auditor as defendants. The factual allegations in the Ontario Claim are
substantially similar to the allegations in the consolidated amended
complaint filed in the United States District Court described above. The
Ontario Claim is on behalf of all Canadian residents who purchased NNC
securities (including options on NNC securities) between October 24, 2000 and
February 15, 2001. The plaintiffs claim damages of Canadian $5,000, plus
punitive damages in the amount of Canadian $1,000, prejudgment and
postjudgment interest, and costs of the action.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A purported class action lawsuit was filed in the United States District
Court for the Middle District of Tennessee on December 21, 2001, on behalf of
participants and beneficiaries of the Nortel Networks Long-Term Investment
Plan (the Plan) at any time during the period of March 7, 2000 through the
filing date and who made or maintained Plan investments in NNC common shares,
under the Employee Retirement Income Security Act for Plan-wide relief and
alleging, among other things, material misrepresentations and omissions to
induce Plan participants to continue to invest in and maintain investments in
NNC common shares in the Plan. A second purported class action lawsuit, on
behalf of the Plan and Plan participants for whose individual accounts the
Plan purchased NNC common shares during the period from October 27, 2000 to
February 15, 2001, and making similar allegations was filed in the same court
on March 12, 2002. A third purported class action lawsuit, on behalf of
persons who are or were Plan participants or beneficiaries at any time since
March 1, 1999 to the filing date, and making similar allegations, was filed
in the same court on March 21, 2002. The first and second purported class
action lawsuits were consolidated by a new purported class action complaint,
filed on May 15, 2002 in the same court and making similar allegations, on
behalf of Plan participants and beneficiaries who directed the Plan to
purchase or hold shares of certain funds, which held primarily NNC common
shares, during the period of March 7, 2000 through December 21, 2000. On
September 24, 2002, plaintiffs in the consolidated action filed a motion to
consolidate all the actions and to transfer them to the United States
District Court for the Southern District of New York. The plaintiffs then
filed a motion to withdraw the pending motion to consolidate and transfer.
The withdrawal was granted by the District Court on December 30, 2002. A
fourth purported class action lawsuit, on behalf of the Plan and Plan
participants for whose individual accounts the Plan held NNC common shares
during the period from March 7, 2000 through March 31, 2001, and making
similar allegations, was filed in the United States District Court for the
Southern District of New York on March 12, 2003. On March 18, 2003,
plaintiffs in the fourth purported class action filed a motion with the
Judicial Panel on Multidistrict Litigation to transfer all the actions to the
Southern District of New York for coordinated or consolidated proceedings
pursuant to 28 U.S.C. section 1407.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On February 12, 2001, NNI, a subsidiary of Nortel Networks, was served with a
consolidated amended class action complaint (the First Complaint) that
purported to add NNC as a defendant to a lawsuit commenced in July 2000
against Entrust, Inc. (formerly Entrust Technologies, Inc.) (Entrust) and
two of its then current officers in the United States District Court for the
Eastern District of Texas (Marshall Division) (the District Court). The
First Complaint alleges that Entrust, two officers of Entrust, and NNC
violated the Securities Exchange Act of 1934 with respect to certain
statements made by Entrust. NNC is alleged to be a controlling person of
Entrust. On April 6, 2001, NNC filed a motion to dismiss the First
Complaint. On July 31, 2001, the First Complaint was dismissed without
prejudice. On August 31, 2001, the plaintiffs filed a second amended class
action complaint (the Second Complaint) against the same defendants
asserting claims substantively similar to those in the First Complaint. On
September 21, 2001, NNC filed a motion to dismiss the Second Complaint. The
motion was granted by the District Court on September 30, 2002, and the
Second Complaint was dismissed without leave to amend. Plaintiffs have not
appealed the decision of the District Court and Nortel Networks considers
this matter closed.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On March 4, 1997, Bay Networks, Inc. (Bay Networks), a company acquired on
August 31, 1998, announced that shareholders had filed two separate lawsuits
in the United States District Court for the Northern District of California
(the Federal Court) and the California Superior Court, County of Santa
Clara (the California Court), against Bay Networks and ten of Bay Networks
then current and former officers and directors purportedly on behalf of a
class of shareholders who purchased Bay Networks common shares during the
period of May 1, 1995 through October 14, 1996. On August 17, 2000, the
Federal Court granted the defendants motion to dismiss the federal
complaint. On August 1,
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents





| |  | 2001, the United States Court of Appeals for the Ninth Circuit denied the
plaintiffs appeal of that decision. On April 18, 1997, a second lawsuit was
filed in the California Court, purportedly on behalf of a class of
shareholders who acquired Bay Networks common shares pursuant to the
registration statement and prospectus that became effective on November 15,
1995. The two actions in the California Court were consolidated in April
1998; however, the California Court denied the plaintiffs motion for class
certification. In January 2000, the California Court of Appeal rejected the
plaintiffs appeal of the decision. A petition for review was filed with the
California Supreme Court by the plaintiffs and was denied. In February 2000,
new plaintiffs who allege to have been shareholders of Bay Networks during
the relevant periods, filed a motion for intervention in the California Court
seeking to become the representatives of a class of shareholders. The motion
was granted on June 8, 2001 and the new plaintiffs filed their
complaint-in-intervention on an individual and purported class representative
basis alleging misrepresentations made in connection with the purchase and
sale of securities of Bay Networks in violation of California statutory and
common law. On March 11, 2002, the California Court granted the defendants
motion to strike the class allegations. The plaintiffs were permitted to
proceed on their individual claims. The intervenor-plaintiffs are appealing
the dismissal of their class allegations.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Except as otherwise described herein, in each of the matters described above,
plaintiffs are seeking an unspecified amount of monetary damages.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks is unable to ascertain the ultimate aggregate amount of
monetary liability or financial impact to Nortel Networks of the above
matters which, unless otherwise specified, seek damages from the defendants
of material or indeterminate amounts. Nortel Networks cannot determine
whether these actions, suits, claims and proceedings will, individually or
collectively, have a material adverse effect on the business, results of
operations and financial condition of Nortel Networks. Nortel Networks and
any named directors and officers of Nortel Networks intend to vigorously
defend these actions, suits, claims and proceedings.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|16. |  | Supplemental consolidating financial information
|--- |  | ------------------------------------------------



| |  | As a result of Nortel Networks current credit ratings, various liens, pledges
and guarantees are effective under certain credit and security agreements
entered into by Nortel Networks and various of its subsidiaries. In
addition, in accordance with the covenants in the trust indentures for all
Nortel Networks current consolidated public debt securities, which represent
primarily all of Nortel Networks consolidated long-term debt at March 31,
2003, all such public debt securities are also secured equally and ratably
with the obligations under Nortel Networks and NNIs credit facilities by
pledges of substantially all of the assets of Nortel Networks and those of
most of its United States and Canadian subsidiaries and by pledges of shares
in certain of Nortel Networks other subsidiaries. In addition, certain of
Nortel Networks wholly owned subsidiaries have guaranteed Nortel Networks
obligations under the credit and support facilities and outstanding public
debt securities (the Guarantor Subsidiaries). Non-guarantor subsidiaries
(the Non-Guarantor Subsidiaries) represent either wholly owned subsidiaries
of Nortel Networks whose shares have been pledged, or are the remaining
subsidiaries of Nortel Networks which are not providing liens, pledges or
guarantees. Nortel Networks obligations under the EDC Support Facility are
also secured on an equal and ratable basis under the security agreements.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The liens, pledges and guarantees described above also apply equally and
ratably to NNCs $1,800 4.25 percent senior notes due September 1, 2008 as
well as Nortel Networks obligations under the guarantee of the senior notes.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | If Nortel Networks senior long-term debt rating by Moodys returns to Baa2
(with a stable outlook) and its rating by Standard & Poors returns to BBB
(with a stable outlook), the security will be released in full. If both the
$750 April 2000 five year credit facilities and the EDC support facility are
terminated, or expire, the security will also be released in full. Nortel
Networks may provide EDC with cash collateral (or any other alternative
collateral acceptable to EDC), in an amount equal to the total amount of our
outstanding obligations and undrawn commitments and expenses under the EDC
Support Facility, in lieu of the security provided under the security
agreements (see note 8).
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following supplemental consolidating financial data illustrates, in
separate columns, the composition of Nortel Networks, the Guarantor
Subsidiaries, the Non-Guarantor Subsidiaries, eliminations and the
consolidated total as at March 31, 2003 and December 31, 2002, and for the
three months ended March 31, 2003 and 2002, respectively.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Investments in subsidiaries are accounted for by the equity method for
purposes of the supplemental consolidating financial data. Net earnings
(loss) of subsidiaries are therefore reflected in the investment account and
net loss. The principal elimination entries eliminate investments in
subsidiaries and intercompany balances and transactions. The financial data
may not necessarily be indicative of the results of operations or financial
position had the subsidiaries been operated as independent entities.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Supplemental Consolidating Statement of Operations for the three months ended March 31, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    873
    
    
    $
    1,708
    
    
    $
    666
    
    
    $
    (871
    )
    
    $
    2,376Cost of revenues
    
    
    441
    
    
    
    1,339
    
    
    
    415
    
    
    
    (871
    )
    
    
    1,324Gross profit
    
    
    432
    
    
    
    369
    
    
    
    251
    
    
    
    
    
    
    
    1,052Selling, general and administrative expense
    
    
    142
    
    
    
    318
    
    
    
    53
    
    
    
    
    
    
    
    513Research and development expense
    
    
    198
    
    
    
    234
    
    
    
    70
    
    
    
    
    
    
    
    502Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special charges
    
    
    36
    
    
    
    61
    
    
    
    14
    
    
    
    
    
    
    
    111Gain on sale of businesses
    
    
    (2
    )
    
    
    2
    
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )Operating earnings (loss)
    
    
    58
    
    
    
    (246
    )
    
    
    118
    
    
    
    
    
    
    
    (70
    )Other income (expense)  net
    
    
    42
    
    
    
    (25
    )
    
    
    (4
    )
    
    
    
    
    
    
    13Interest expenseLong-term debt
    
    
    (17
    )
    
    
    1
    
    
    
    (7
    )
    
    
    
    
    
    
    (23
    )Other
    
    
    (2
    )
    
    
    (14
    )
    
    
    9
    
    
    
    
    
    
    
    (7
    )Earnings (loss) from continuing operations before
income taxes
    
    
    81
    
    
    
    (284
    )
    
    
    116
    
    
    
    
    
    
    
    (87
    )Income tax benefit (provision)
    
    
    152
    
    
    
    (296
    )
    
    
    138
    
    
    
    
    
    
    
    (6
    )233
    
    
    
    (580
    )
    
    
    254
    
    
    
    
    
    
    
    (93
    )Equity in net loss
of associated companies  net of tax
    
    
    (344
    )
    
    
    805
    
    
    
    5
    
    
    
    (476
    )
    
    
    (10
    )Net earnings (loss) from continuing operations
    
    
    (111
    )
    
    
    225
    
    
    
    259
    
    
    
    (476
    )
    
    
    (103
    )Net earnings (loss) from discontinued operations
 net of tax
    
    
    164
    
    
    
    107
    
    
    
    
    
    
    
    (107
    )
    
    
    164Net earnings (loss) from continuing operations before
cumulative effect of accounting change  net of tax
    
    
    53
    
    
    
    332
    
    
    
    259
    
    
    
    (583
    )
    
    
    61Cumulative effect of accounting changes  net of tax
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    (8
    )Net earnings (loss)
    
    
    53
    
    
    
    324
    
    
    
    259
    
    
    
    (583
    )
    
    
    53Dividends on preferred shares
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Net earnings (loss) applicable to common shares
    
    $
    48
    
    
    $
    324
    
    
    $
    259
    
    
    $
    (583
    )
    
    $
    48


33



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##### Table of Contents



Supplemental Consolidating Statement of Operations for the three months ended
March 31, 2002:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    751
    
    
    $
    2,034
    
    
    $
    797
    
    
    $
    (682
    )
    
    $
    2,900Cost of revenues
    
    
    679
    
    
    
    1,514
    
    
    
    650
    
    
    
    (682
    )
    
    
    2,161Gross profit
    
    
    72
    
    
    
    520
    
    
    
    147
    
    
    
    
    
    
    
    739Selling, general and administrative expense
    
    
    131
    
    
    
    508
    
    
    
    62
    
    
    
    
    
    
    
    701Research and development expense
    
    
    197
    
    
    
    292
    
    
    
    76
    
    
    
    
    
    
    
    565Amortization of acquired technology
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    5Special charges
    
    
    70
    
    
    
    216
    
    
    
    136
    
    
    
    
    
    
    
    422Gain on sale of businesses
    
    
    (1
    )
    
    
    (4
    )
    
    
    (1
    )
    
    
    
    
    
    
    (6
    )Operating loss
    
    
    (325
    )
    
    
    (497
    )
    
    
    (126
    )
    
    
    
    
    
    
    (948
    )Other income (expense)  net
    
    
    (1
    )
    
    
    (11
    )
    
    
    2
    
    
    
    
    
    
    
    (10
    )Interest expenseLong-term debt
    
    
    (31
    )
    
    
    
    
    
    
    (7
    )
    
    
    
    
    
    
    (38
    )Other
    
    
    
    
    
    
    (13
    )
    
    
    
    
    
    
    
    
    
    
    (13
    )Loss from continuing operations before
income taxes
    
    
    (357
    )
    
    
    (521
    )
    
    
    (131
    )
    
    
    
    
    
    
    (1,009
    )Income tax benefit
    
    
    106
    
    
    
    119
    
    
    
    90
    
    
    
    
    
    
    
    315(251
    )
    
    
    (402
    )
    
    
    (41
    )
    
    
    
    
    
    
    (694
    )Equity in net loss
of associated companies  net of tax
    
    
    (451
    )
    
    
    (103
    )
    
    
    1
    
    
    
    545
    
    
    
    (8
    )Net loss from continuing operations
    
    
    (702
    )
    
    
    (505
    )
    
    
    (40
    )
    
    
    545
    
    
    
    (702
    )Net earnings (loss) from discontinued operations
 net of tax
    
    
    16
    
    
    
    10
    
    
    
    
    
    
    
    (10
    )
    
    
    16Net earnings (loss)
    
    
    (686
    )
    
    
    (495
    )
    
    
    (40
    )
    
    
    535
    
    
    
    (686
    )Dividends on preferred shares
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Net loss applicable to common shares
    
    $
    (691
    )
    
    $
    (495
    )
    
    $
    (40
    )
    
    $
    535
    
    
    $
    (691
    )


34



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##### Table of Contents



Supplemental Consolidating Balance Sheet as at March 31, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    (11
    )
    
    $
    2,818
    
    
    $
    1,038
    
    
    $
    
    
    
    $
    3,845Restricted cash and cash equivalents
    
    
    18
    
    
    
    170
    
    
    
    39
    
    
    
    
    
    
    
    227Accounts receivable  net
    
    
    243
    
    
    
    1,298
    
    
    
    416
    
    
    
    
    
    
    
    1,957Intercompany/related party accounts receivable
    
    
    4,629
    
    
    
    4,333
    
    
    
    2,833
    
    
    
    (11,621
    )
    
    
    174Inventories  net
    
    
    464
    
    
    
    230
    
    
    
    191
    
    
    
    
    
    
    
    885Income taxes recoverable
    
    
    2
    
    
    
    58
    
    
    
    
    
    
    
    
    
    
    
    60Deferred income taxes  net
    
    
    263
    
    
    
    520
    
    
    
    1
    
    
    
    
    
    
    
    784Other current assets
    
    
    56
    
    
    
    245
    
    
    
    120
    
    
    
    
    
    
    
    421Total current assets
    
    
    5,664
    
    
    
    9,672
    
    
    
    4,638
    
    
    
    (11,621
    )
    
    
    8,353Investments at cost and associated companies at equity
    
    
    1,066
    
    
    
    (7,137
    )
    
    
    111
    
    
    
    6,160
    
    
    
    200Plant and equipment  net
    
    
    431
    
    
    
    721
    
    
    
    283
    
    
    
    
    
    
    
    1,435Goodwill
    
    
    
    
    
    
    1,956
    
    
    
    65
    
    
    
    
    
    
    
    2,021Deferred income taxes  net
    
    
    1,289
    
    
    
    1,340
    
    
    
    234
    
    
    
    
    
    
    
    2,863Other assets
    
    
    731
    
    
    
    953
    
    
    
    1,912
    
    
    
    (2,803
    )
    
    
    793Total assets
    
    $
    9,181
    
    
    $
    7,505
    
    
    $
    7,243
    
    
    $
    (8,264
    )
    
    $
    15,665LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    3
    
    
    $
    7
    
    
    $
    
    
    
    $
    12Trade and other accounts payable
    
    
    295
    
    
    
    419
    
    
    
    33
    
    
    
    
    
    
    
    747Intercompany/related party accounts payable
    
    
    195
    
    
    
    6,883
    
    
    
    4,572
    
    
    
    (11,621
    )
    
    
    29Payroll and benefit-related liabilities
    
    
    59
    
    
    
    466
    
    
    
    125
    
    
    
    
    
    
    
    650Contractual liabilities
    
    
    73
    
    
    
    694
    
    
    
    355
    
    
    
    
    
    
    
    1,122Restructuring
    
    
    127
    
    
    
    181
    
    
    
    125
    
    
    
    
    
    
    
    433Other accrued liabilities
    
    
    598
    
    
    
    1,803
    
    
    
    215
    
    
    
    
    
    
    
    2,616Long-term debt due within one year
    
    
    174
    
    
    
    7
    
    
    
    53
    
    
    
    
    
    
    
    234Total current liabilities
    
    
    1,523
    
    
    
    10,456
    
    
    
    5,485
    
    
    
    (11,621
    )
    
    
    5,843Long-term debt
    
    
    1,559
    
    
    
    34
    
    
    
    301
    
    
    
    
    
    
    
    1,894Deferred income taxes  net
    
    
    265
    
    
    
    97
    
    
    
    69
    
    
    
    
    
    
    
    431Other liabilities
    
    
    848
    
    
    
    1,782
    
    
    
    2,570
    
    
    
    (2,803
    )
    
    
    2,3974,195
    
    
    
    12,369
    
    
    
    8,425
    
    
    
    (14,424
    )
    
    
    10,565Minority interest in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    114
    
    
    
    
    
    
    
    114SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    342
    
    
    
    
    
    
    
    (342
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    6,024
    
    
    
    703
    
    
    
    (6,727
    )
    
    
    1,211Additional paid-in capital
    
    
    22,005
    
    
    
    1,565
    
    
    
    4,064
    
    
    
    (5,629
    )
    
    
    22,005Deficit
    
    
    (17,559
    )
    
    
    (13,598
    )
    
    
    (5,977
    )
    
    
    19,575
    
    
    
    (17,559
    )Accumulated other comprehensive income (loss)
    
    
    (1,207
    )
    
    
    803
    
    
    
    (86
    )
    
    
    (717
    )
    
    
    (1,207
    )Total shareholders equity
    
    
    4,986
    
    
    
    (4,864
    )
    
    
    (1,296
    )
    
    
    6,160
    
    
    
    4,986Total liabilities and shareholders equity
    
    $
    9,181
    
    
    $
    7,505
    
    
    $
    7,243
    
    
    $
    (8,264
    )
    
    $
    15,665


35



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##### Table of Contents



Supplemental Consolidating Balance Sheet as at December 31, 2002:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    251
    
    
    $
    2,382
    
    
    $
    1,110
    
    
    $
    
    
    
    $
    3,743Restricted cash and cash equivalents
    
    
    6
    
    
    
    176
    
    
    
    67
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    270
    
    
    
    1,488
    
    
    
    406
    
    
    
    
    
    
    
    2,164Intercompany/related party accounts receivable
    
    
    4,200
    
    
    
    976
    
    
    
    459
    
    
    
    (5,552
    )
    
    
    83Inventories  net
    
    
    524
    
    
    
    246
    
    
    
    216
    
    
    
    
    
    
    
    986Income taxes recoverable
    
    
    3
    
    
    
    46
    
    
    
    9
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    178
    
    
    
    615
    
    
    
    
    
    
    
    
    
    
    
    793Other current assets
    
    
    182
    
    
    
    427
    
    
    
    59
    
    
    
    
    
    
    
    668Total current assets
    
    
    5,614
    
    
    
    6,356
    
    
    
    2,326
    
    
    
    (5,552
    )
    
    
    8,744Investments at cost and associated companies at equity
    
    
    1,338
    
    
    
    (8,037
    )
    
    
    118
    
    
    
    6,829
    
    
    
    248Plant and equipment  net
    
    
    409
    
    
    
    752
    
    
    
    303
    
    
    
    
    
    
    
    1,464Goodwill
    
    
    
    
    
    
    1,956
    
    
    
    65
    
    
    
    
    
    
    
    2,021Deferred income taxes  net
    
    
    1,062
    
    
    
    1,537
    
    
    
    54
    
    
    
    
    
    
    
    2,653Other assets
    
    
    627
    
    
    
    1,279
    
    
    
    754
    
    
    
    (1,894
    )
    
    
    766Total assets
    
    $
    9,050
    
    
    $
    3,843
    
    
    $
    3,620
    
    
    $
    (617
    )
    
    $
    15,896LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    3
    
    
    $
    25
    
    
    $
    
    
    
    $
    30Trade and other accounts payable
    
    
    356
    
    
    
    429
    
    
    
    85
    
    
    
    
    
    
    
    870Intercompany/related party accounts payable
    
    
    153
    
    
    
    3,288
    
    
    
    2,140
    
    
    
    (5,552
    )
    
    
    29Payroll and benefit-related liabilities
    
    
    32
    
    
    
    383
    
    
    
    84
    
    
    
    
    
    
    
    499Contractual liabilities
    
    
    78
    
    
    
    751
    
    
    
    384
    
    
    
    
    
    
    
    1,213Restructuring
    
    
    113
    
    
    
    308
    
    
    
    116
    
    
    
    
    
    
    
    537Other accrued liabilities
    
    
    637
    
    
    
    1,969
    
    
    
    288
    
    
    
    
    
    
    
    2,894Long-term debt due within one year
    
    
    174
    
    
    
    8
    
    
    
    51
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    1,545
    
    
    
    7,139
    
    
    
    3,173
    
    
    
    (5,552
    )
    
    
    6,305Long-term debt
    
    
    1,603
    
    
    
    34
    
    
    
    312
    
    
    
    
    
    
    
    1,949Deferred income taxes  net
    
    
    263
    
    
    
    95
    
    
    
    8
    
    
    
    
    
    
    
    366Other liabilities
    
    
    813
    
    
    
    1,734
    
    
    
    1,668
    
    
    
    (1,894
    )
    
    
    2,3214,224
    
    
    
    9,002
    
    
    
    5,161
    
    
    
    (7,446
    )
    
    
    10,941Minority interest in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    129
    
    
    
    
    
    
    
    129SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    342
    
    
    
    
    
    
    
    (342
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    6,061
    
    
    
    982
    
    
    
    (7,043
    )
    
    
    1,211Additional paid-in capital
    
    
    22,004
    
    
    
    1,563
    
    
    
    4,065
    
    
    
    (5,628
    )
    
    
    22,004Deficit
    
    
    (17,607
    )
    
    
    (13,897
    )
    
    
    (6,606
    )
    
    
    20,503
    
    
    
    (17,607
    )Accumulated other comprehensive income (loss)
    
    
    (1,318
    )
    
    
    772
    
    
    
    (111
    )
    
    
    (661
    )
    
    
    (1,318
    )Total shareholders equity
    
    
    4,826
    
    
    
    (5,159
    )
    
    
    (1,670
    )
    
    
    6,829
    
    
    
    4,826Total liabilities and shareholders equity
    
    $
    9,050
    
    
    $
    3,843
    
    
    $
    3,620
    
    
    $
    (617
    )
    
    $
    15,896


36



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##### Table of Contents



Supplemental Consolidating Statement of Cash Flow for the three months ended March 31, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    (111
    )
    
    $
    225
    
    
    $
    259
    
    
    $
    (476
    )
    
    $
    (103
    )Adjustments to reconcile net loss from
continuing operations to net cash from (used in) operating
activities, net of effects from acquisitions and
divestitures of businesses:Amortization and depreciation
    
    
    25
    
    
    
    51
    
    
    
    29
    
    
    
    
    
    
    
    105Non-cash portion of special charges
and related asset write downs
    
    
    (3
    )
    
    
    (5
    )
    
    
    (3
    )
    
    
    
    
    
    
    (11
    )Equity in net loss (earnings) of associated companies
    
    
    344
    
    
    
    (805
    )
    
    
    (5
    )
    
    
    476
    
    
    
    10Current stock option compensation
    
    
    1
    
    
    
    3
    
    
    
    1
    
    
    
    
    
    
    
    5Deferred income taxes
    
    
    10
    
    
    
    (1
    )
    
    
    12
    
    
    
    
    
    
    
    21Other liabilities
    
    
    16
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    26Gain on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )Loss on sale or write down of investments
and businesses
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    24Other  net
    
    
    103
    
    
    
    (67
    )
    
    
    (9
    )
    
    
    
    
    
    
    27Change in operating assets and liabilities:Accounts receivable
    
    
    (56
    )
    
    
    206
    
    
    
    (42
    )
    
    
    
    
    
    
    108Inventories
    
    
    60
    
    
    
    42
    
    
    
    25
    
    
    
    
    
    
    
    127Income taxes
    
    
    8
    
    
    
    (22
    )
    
    
    8
    
    
    
    
    
    
    
    (6
    )Restructuring
    
    
    (39
    )
    
    
    (127
    )
    
    
    (28
    )
    
    
    
    
    
    
    (194
    )Accounts payable and accrued liabilities
    
    
    (18
    )
    
    
    (185
    )
    
    
    (32
    )
    
    
    
    
    
    
    (235
    )Other operating assets and liabilities
    
    
    (262
    )
    
    
    132
    
    
    
    114
    
    
    
    
    
    
    
    (16
    )Intercompany/related party activity
    
    
    (377
    )
    
    
    773
    
    
    
    (396
    )
    
    
    
    
    
    
    Net cash from (used in) operating activities
    
    
    (303
    )
    
    
    254
    
    
    
    (67
    )
    
    
    
    
    
    
    (116
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (3
    )
    
    
    (10
    )
    
    
    (5
    )
    
    
    
    
    
    
    (18
    )Proceeds on disposals of plant and equipment
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    6Decrease in restricted cash and
cash equivalents
    
    
    (11
    )
    
    
    9
    
    
    
    22
    
    
    
    
    
    
    
    20Increase in long-term receivables
    
    
    
    
    
    
    (8
    )
    
    
    (1
    )
    
    
    
    
    
    
    (9
    )Decrease in long-term receivables
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5Acquisitions of investments and businesses
 net of cash acquired
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Proceeds on sale of investments and businesses
    
    
    1
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    7Net cash from (used in) investing activities
    
    
    (8
    )
    
    
    1
    
    
    
    16
    
    
    
    
    
    
    
    9Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Decrease in notes payable  net
    
    
    
    
    
    
    4
    
    
    
    (17
    )
    
    
    
    
    
    
    (13
    )Repayments of long-term debt
    
    
    (34
    )
    
    
    
    
    
    
    (9
    )
    
    
    
    
    
    
    (43
    )Decrease in capital leases payable
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    (1
    )Net cash from (used in) financing activities
    
    
    (39
    )
    
    
    3
    
    
    
    (26
    )
    
    
    
    
    
    
    (62
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    
    
    
    
    13
    
    
    
    5
    
    
    
    
    
    
    
    18Net cash from (used in) continuing operations
    
    
    (350
    )
    
    
    271
    
    
    
    (72
    )
    
    
    
    
    
    
    (151
    )Net cash from discontinued operations
    
    
    88
    
    
    
    165
    
    
    
    
    
    
    
    
    
    
    
    253Net increase (decrease) in cash and
cash equivalents
    
    
    (262
    )
    
    
    436
    
    
    
    (72
    )
    
    
    
    
    
    
    102Cash and cash equivalents at beginning of
period  net
    
    
    251
    
    
    
    2,382
    
    
    
    1,110
    
    
    
    
    
    
    
    3,743Cash and cash equivalents at end of period
 net
    
    $
    (11
    )
    
    $
    2,818
    
    
    $
    1,038
    
    
    $
    
    
    
    $
    3,845


37



---



##### Table of Contents



Supplemental Consolidating Statement of Cash Flow for the three months ended March 31, 2002:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (702
    )
    
    $
    (505
    )
    
    $
    (40
    )
    
    $
    545
    
    
    $
    (702
    )Adjustments to reconcile net loss from
continuing operations to net cash used in operating
activities, net of effects from acquisitions and
divestitures of businesses:Amortization and depreciation
    
    
    31
    
    
    
    110
    
    
    
    17
    
    
    
    
    
    
    
    158Non-cash portion of special charges
and related asset write downs
    
    
    26
    
    
    
    41
    
    
    
    8
    
    
    
    
    
    
    
    75Equity in net loss (earnings) of associated companies
    
    
    451
    
    
    
    103
    
    
    
    (1
    )
    
    
    (545
    )
    
    
    8Deferred income taxes
    
    
    (82
    )
    
    
    (236
    )
    
    
    (8
    )
    
    
    
    
    
    
    (326
    )Other liabilities
    
    
    8
    
    
    
    (31
    )
    
    
    (14
    )
    
    
    
    
    
    
    (37
    )(Gain) loss on sale of investments and businesses
    
    
    (6
    )
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    (11
    )Other  net
    
    
    18
    
    
    
    33
    
    
    
    34
    
    
    
    
    
    
    
    85Change in operating assets and liabilities:Accounts receivable
    
    
    (96
    )
    
    
    348
    
    
    
    (7
    )
    
    
    
    
    
    
    245Inventories
    
    
    14
    
    
    
    33
    
    
    
    19
    
    
    
    
    
    
    
    66Income taxes
    
    
    222
    
    
    
    327
    
    
    
    (30
    )
    
    
    
    
    
    
    519Restructuring
    
    
    (66
    )
    
    
    (279
    )
    
    
    (9
    )
    
    
    
    
    
    
    (354
    )Accounts payable and accrued liabilities
    
    
    (15
    )
    
    
    (77
    )
    
    
    13
    
    
    
    
    
    
    
    (79
    )Other operating assets and liabilities
    
    
    (40
    )
    
    
    (33
    )
    
    
    31
    
    
    
    
    
    
    
    (42
    )Intercompany/related party activity
    
    
    159
    
    
    
    (24
    )
    
    
    (135
    )
    
    
    
    
    
    
    Net cash used in operating activities
    
    
    (78
    )
    
    
    (195
    )
    
    
    (122
    )
    
    
    
    
    
    
    (395
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (15
    )
    
    
    (69
    )
    
    
    (19
    )
    
    
    
    
    
    
    (103
    )Proceeds on disposals of plant and equipment
    
    
    
    
    
    
    44
    
    
    
    
    
    
    
    
    
    
    
    44Increase in long-term receivables
    
    
    64
    
    
    
    (49
    )
    
    
    (122
    )
    
    
    
    
    
    
    (107
    )Decrease in long-term receivables
    
    
    17
    
    
    
    59
    
    
    
    13
    
    
    
    
    
    
    
    89Acquisitions of investments and businesses
 net of cash acquired
    
    
    
    
    
    
    (19
    )
    
    
    
    
    
    
    
    
    
    
    (19
    )Proceeds on sale of investments and businesses
    
    
    16
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    24Net cash from (used in) investing activities
    
    
    82
    
    
    
    (26
    )
    
    
    (128
    )
    
    
    
    
    
    
    (72
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Decrease (increase) in notes payable  net
    
    
    
    
    
    
    19
    
    
    
    (30
    )
    
    
    
    
    
    
    (11
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    11Repayments of long-term debt
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    (2
    )Decrease in capital leases payable
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    (4
    )Net cash from (used in) financing activities
    
    
    (5
    )
    
    
    15
    
    
    
    (21
    )
    
    
    
    
    
    
    (11
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    (5
    )
    
    
    (2
    )
    
    
    
    
    
    
    (6
    )Net cash used in continuing operations
    
    
    
    
    
    
    (211
    )
    
    
    (273
    )
    
    
    
    
    
    
    (484
    )Net cash from discontinued operations
    
    
    17
    
    
    
    33
    
    
    
    
    
    
    
    
    
    
    
    50Net increase (decrease) in cash and
cash equivalents
    
    
    17
    
    
    
    (178
    )
    
    
    (273
    )
    
    
    
    
    
    
    (434
    )Cash and cash equivalents at beginning of
period  net
    
    
    (41
    )
    
    
    2,285
    
    
    
    1,160
    
    
    
    
    
    
    
    3,404Cash and cash equivalents at end of period
 net
    
    $
    (24
    )
    
    $
    2,107
    
    
    $
    887
    
    
    $
    
    
    
    $
    2,970


38



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##### Table of Contents






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


This Managements Discussion and Analysis of Financial Condition and Results of
Operations, or MD&A, set forth in this Item 2 has been revised to reflect the
restatements and to update certain forward looking statements to reflect
current expectations, as well as to incorporate certain conforming changes.

You should read this section in combination with the accompanying unaudited
consolidated financial statements prepared in accordance with United States
generally accepted accounting principles. This section contains forward-looking
statements and should be read in conjunction with the risk factors described
below under Forward looking statements which risk factors have been updated
to reflect the restatements as well as for events and developments subsequent
to March 31, 2003. All dollar amounts in this Managements Discussion and
Analysis of Financial Condition and Results of Operations are in millions of
United States dollars unless otherwise stated.

Apart from the revisions described above, this MD&A does not reflect events and
developments subsequent to March 31, 2003.

Where we say we, us, our, or Nortel Networks, we mean Nortel Networks
Limited, or Nortel Networks Limited and its subsidiaries, as applicable. Where we refer to our 2002
Annual Report, we mean our Annual Report onForm 10-Kfor the year ended
December 31, 2002 filed with the Securities and Exchange Commission, or SEC, on
March 10, 2003, as subsequently amended by our Annual Report onForm 10-K/Afor
the year ended December 31, 2002 filed with the SEC on December 23, 2003. Where
we refer to the industry, we mean the telecommunications industry.

Business overview

Nortel Networks is an industry leader and innovator focused on transforming how
the world communicates and exchanges information. We supply products and
services that support the Internet and other public and private data, voice and
multimedia communications networks using wireline and wireless technologies,
which we refer to as networking solutions. A substantial portion of our
company has a technology focus and is dedicated to research and development.
This focus forms a core strength and a factor differentiating us from many of
our competitors. We envision an information society where people will be able
to connect and interact with information and with each other instantly, simply
and reliably, seamlessly accessing data, voice and multimedia communications
services and sharing experiences anywhere, anytime.

Our operations are organized in four reportable segments: Wireless Networks;
Enterprise Networks; Wireline Networks; and Optical Networks.

We are the principal direct operating subsidiary of Nortel Networks
Corporation. Nortel Networks Corporation holds all of our outstanding common
shares but none of our outstanding preferred shares. Nortel Networks
Corporations common shares are publicly traded on the New York and Toronto
stock exchanges under the symbol NT. Acquisitions involving any share
consideration are completed by Nortel Networks Corporation, while acquisitions
involving only cash consideration are generally completed by us.

Recent developments

Restatements

In 2001, we entered into an unprecedented period of business realignment in
response to a significant adjustment in the telecommunications industry.
Industry demand for networking equipment dramatically declined in response to
the industry adjustment, severe economic downturns in various regions around
the world and a tightening in global capital markets. We implemented a
company-wide restructuring plan to streamline our operations and activities
around core markets and operations, which included significant workforce
reductions, global real estate closures and dispositions, substantial
write-downs of our capital assets, goodwill and other intangible assets and
extensive contract settlements with customers and suppliers around the world.
As a result of these actions, our workforce declined significantly from January
1, 2001 to March 31, 2003 and over the same time period we significantly
reduced our facilities.

39



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##### Table of Contents



Subsequent to the issuance of our financial statements for the three months
ended March 31, 2003, we initiated, and disclosed in our Quarterly Report on
Form 10-Q for the period ended June 30, 2003, a comprehensive review and
analysis of our assets and liabilities. On October 23, 2003, we announced that
we would restate our consolidated financial statements for the years ended
December 31, 2002, 2001 and 2000 and for the quarters ended March 31, 2003 and
June 30, 2003.

Based on the completion of the comprehensive review and certain related reviews
(collectively, the comprehensive review), we determined that approximately
$909 and $924 of certain liabilities (primarily accruals and provisions)
carried on our previously reported consolidated balance sheets as at March 31,
2003 and December 31, 2002, respectively, needed to be released to income.
These provisions were either initially recorded incorrectly in prior periods or
not properly released or adjusted for changes in estimates in the appropriate
periods. In certain cases, costs were incorrectly charged to operations rather
than to the appropriate provisions. Following our determination to restate our
consolidated financial statements for the periods noted above, we also
determined that we would correct certain known errors that were previously not
recorded because the amount of the errors was not material to the consolidated
financial statements. Specifically, among other items, we made certain revenue
adjustments to reflect revenue which should have been deferred instead of
recognized in a particular period. Also, as part of the restatements, we made
adjustments to correct errors related to our deferred income tax assets and
foreign currency translation accounts. In addition, we made reclassification
adjustments within the consolidated balance sheets to better reflect the
underlying nature of certain items; these reclassifications did not impact the
net assets as at the end of any period. The net effect of all of these
adjustments was a reduction in accumulated deficit of $442 and $486 as at March
31, 2003 and December 31, 2002, respectively.

The following presents the impact on revenues and earnings (loss) of the
restatement adjustments for the three months ended March 31, 2003 and the years
ended December 31, 2002, 2001 and 2000:

Three months ended
    
    
    December 31,March 31, 2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    Prior
years (a)RevenuesAs previously reported
    
    $
    2,397
    
    
    $
    10,546
    
    
    $
    17,375
    
    
    $
    27,853Adjustments
    
    
    (21
    )
    
    
    8
    
    
    
    (103
    )
    
    
    (17
    )
    
    $
    (1
    )As restated
    
    $
    2,376
    
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836Earnings (loss)Earnings (loss) from
continuing operationsAs previously reported
    
    $
    (67
    )
    
    $
    (3,039
    )
    
    $
    (11,555
    )
    
    $
    (871
    )Adjustments
    
    
    (36
    )
    
    
    294
    
    
    
    125
    
    
    
    28
    
    
    $
    4As restated
    
    $
    (103
    )
    
    $
    (2,745
    )
    
    $
    (11,430
    )
    
    $
    (843
    )Earnings (loss) from discontinued
operations-net of taxAs previously reported
    
    $
    164
    
    
    $
    
    
    
    $
    (2,538
    )
    
    $
    (414
    )Adjustments
    
    
    
    
    
    
    21
    
    
    
    14
    
    
    
    
    
    
    $
    As restated
    
    $
    164
    
    
    $
    21
    
    
    $
    (2,524
    )
    
    $
    (414
    )Net earnings (loss) applicable to
common sharesAs previously reported
    
    $
    92
    
    
    $
    (3,061
    )
    
    $
    (14,105
    )
    
    $
    (1,316
    )Adjustments
    
    
    (44
    )
    
    
    315
    
    
    
    139
    
    
    
    28
    
    
    $
    4As restated
    
    $
    48
    
    
    $
    (2,746
    )
    
    $
    (13,966
    )
    
    $
    (1,288
    )


|(a) |  | The amount in prior years relates to net adjustments in the years 1997
through 1999 which have been reflected as an adjustment to accumulated
deficit as of January 1, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We have also undertaken a series of physical counts and reconciliations of plant
and equipment. While we believe that the portion of the work completed to date
supports the carrying value of the plant and equipment recorded in our
consolidated balance sheet as at March 31, 2003, the conclusion of this work
could result in adjustments to the carrying value of certain assets.

40



---



##### Table of Contents



The following presents details by category, aggregating to the net decrease in
net earnings for the three months ended March 31, 2003 and the net decrease in
the net loss for the three months ended March 31, 2002, resulting from the
restatement adjustments:

Net (decrease) in net earnings/Net decrease in net (loss)

March 31,
    
    
    March 31,2003
    
    
    2002Contract and customer-related accruals
    
    $
    30
    
    
    $
    59Special charges related to restructuring actions
    
    
    27
    
    
    
    26Other accruals and provisions
    
    
    (87
    )
    
    
    71Total accruals and provisions adjustments
    
    
    (30
    )
    
    
    156Income tax adjustments
    
    
    4
    
    
    
    (47
    )Revenue adjustments
    
    
    (21
    )
    
    
    (10
    )Foreign currency translation adjustments related to
Brazilian operations
    
    
    3
    
    
    
    Net (decrease) in net earnings/Net decrease in net (loss)
    
    $
    (44
    )
    
    $
    99


Impacts of the restatements on the accompanying (unaudited) consolidated
financial statements

The following presents a summary of the impact of the restatements for the
periods presented in the accompanying (unaudited) consolidated financial
statements.

Consolidated statement of operations for the three months ended March 31, 2003
as restated

Net earnings applicable to common shares for the three months ended March 31,
2003 was reduced by $44 from $92 to $48. The major components of the reduction
included:



| |  | a $14 improvement in gross profit which included a $21 reduction in
revenues which resulted from revenue deferrals and a $35 improvement to
cost of revenues which resulted primarily from adjustments to contract
and customer-related accruals;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $28 increase in selling, general and administrative expense which
resulted primarily from the reversal of previously recorded releases of
other accruals and provisions, including $15 of accruals for costs
associated with programs to upgrade certain financial information
systems
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $14 increase in research and development expense which resulted
primarily from the reversal of previously recorded releases of other
accruals and provisions, including $5 of accruals for inter-company out
of balance amounts;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $22 decrease in special charges which resulted primarily from the
release of accruals associated with severance and fringe benefits for
terminated employees; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $36 decrease in other income primarily from the reversal of
previously recorded releases of other accruals and provisions, including
$30 of accruals for inter-company out of balance amounts.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Consolidated statement of operations for the three months ended March 31, 2002
as restated

Net loss applicable to common shares for three months ended March 31, 2002 was
reduced by $99 from $790 to $691. The major components of the reduction
included:



| |  | a $58 improvement in gross profit which resulted primarily from
adjustments to contract and customer-related accruals;
| | - | ----------------------------------------------------------------------------------------------------------------------

| |  | a $39 decrease in selling, general and administrative expense which
resulted primarily from the release of $12 of accruals for costs
associated with discretionary bonuses in excess of amounts reasonably
expected to be paid and $10 of accruals for programs to upgrade certain
financial information systems;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $12 decrease in research and development expense which resulted
from adjustments related to other accruals and provisions;
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | a $21 decrease which resulted from the release of special charges
primarily related to costs associated with severance and fringe benefits
for terminated employees; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

41



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##### Table of Contents



| |  | a $16 adjustment to discontinued operations for items previously
recorded incorrectly as an expense in discontinued operations.
| | - | -------------------------------------------------------------------------------------------------------------------------------

Consolidated balance sheets as at March 31, 2003 and December 31, 2002

Restatements

The consolidated balance sheets included in Restatements in note 2 of the
accompanying (unaudited) consolidated financial statements present the
cumulative impact of the restatement adjustments classified by balance sheet
line item as at March 31, 2003 and December 31, 2002.

Reclassification adjustments

In addition to the restatement adjustments, reclassification adjustments were
made between line items which also impacted the consolidated balance sheets as
at March 31, 2003 and December 31, 2002. The principal reclassifications are
set forth below.

As at March 31, 2003

| |  | a $66 reduction to cash and cash equivalents and notes payable to
reflect, upon consolidation, that a bank note payable by one subsidiary
was fully collateralized by, and could be offset against, a deposit in
the same bank by another subsidiary;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $117 increase in accounts receivable-net which included a $156
increase primarily to recognize advance billings in excess of revenues
as a liability partially offset by a $6 reclassification from other
accrued liabilities to properly offset amounts billed by us as
collection agent under receivable sales agreements against the
corresponding receivables and a $33 increase in allowance for doubtful
accounts for financed receivables which resulted from a reclassification
from other long-term assets;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $23 increase in net inventory with related reductions of $7 in
other current assets and of $16 in other long-term assets; and
| | - | -------------------------------------------------------------------------------------------------------------------------------

| |  | a $150 increase in other accrued liabilities including a $156
increase partially offset by a $6 decrease, both related to accounts
receivable-net (as noted above).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

As at December 31, 2002

| |  | a $70 reduction to cash and cash equivalents and notes payable to
reflect, upon consolidation, that a bank note payable by one subsidiary
was fully collateralized by, and could be offset against, a deposit in
the same bank by another subsidiary;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $265 increase in accounts receivable-net which included a $370
increase primarily to recognize advance billings in excess of revenues
as a liability partially offset by a $64 reclassification from other
accrued liabilities to properly offset amounts billed by us as
collection agent under receivable sales agreements against the
corresponding receivables and a $41 increase in allowance for doubtful
accounts for financed receivables which resulted from a reclassification
from other long-term assets;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $90 increase in net inventory with related reductions of $52 in
other current assets and of $38 in other long-term assets; and
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | a $306 increase in other accrued liabilities including a $370
increase partially offset by a $64 decrease, both related to accounts
receivable-net (as noted above).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

An independent review is being conducted by the Audit Committee to examine the
facts and circumstances, leading to the need to restate our financial
statements for the relevant periods and to consider appropriate improvements to
our processes and procedures. The law firm of Wilmer, Cutler & Pickering has
been retained by and will report to our Audit Committee for such purposes.

NNCs financial statements have also been restated as a result of the
comprehensive review and other related reviews.

For further information on the restatements see Significant accounting
policies and Restatements in notes 1 and 2, respectively, of the
accompanying consolidated financial statements.

42



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##### Table of Contents



Discontinued operations

During the first quarter of 2003, we substantially completed the wind-down of
our access solutions operations. We closed a number of transactions in the
first quarter of 2003, including:



| | the sale of 8 million common shares of Arris Group Inc. for cash
consideration of $28 on March 24, 2003 which resulted in a gain of $12
and the assignment of our membership interest in Arris Interactive LLC
to ANTEC Corporation, an Arris company, on March 18, 2003 for cash
consideration of $89 which resulted in a gain for the full amount; and
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the restructuring of approximately $465 of trade and customer
financing receivables owed to us by a customer, the majority of which
was previously provisioned. As a result of the restructuring agreement,
we received consideration including cash of $125, notes and an ownership
interest which have been fully provided for, and the mutual release of
all other claims between the parties. The transaction closed on March
20, 2003 and resulted in a gain of $95.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

EDC support facility

On February 14, 2003, we entered into an agreement with Export Development
Canada, or EDC, regarding arrangements to provide for support, on a secured
basis, of certain of our performance related obligations arising out of normal
course business
activities. This facility provides for up to $750 in performance related
support for our operations and is expected to facilitate improved liquidity.
Currently, $300 is committed support for performance bonds. See Available
support facilities for additional information.

Stock options

We adopted fair value accounting for new grants or modifications of stock
options beginning January 1, 2003. As a result, all stock option grants or
modifications in 2003 and beyond will be expensed over the stock option vesting
period based on their fair value at the date the options are granted or
modified. The effect of the adoption of Statement of Financial Accounting
Standards No. 148, or SFAS 148, was a stock option expense of $5 in the first
quarter of 2003. If we continue to grant options in 2003 at a similar level to
2002, the expected impact on net earnings (loss) per share will be
approximately ($0.01) per common share for 2003. For additional information,
you should refer to Significant accounting policies in note 2(t) of our
financial statements in our 2002 Annual Report.

Results of operations  continuing operations

Segment revenues

For the 3 months ended March 31,2003
    
    
    2002
    
    
    $Change
    
    
    % ChangeWireless Networks
    
    $
    934
    
    
    $
    1,123
    
    
    $
    (189
    )
    
    
    (17
    )Enterprise Networks
    
    
    611
    
    
    
    670
    
    
    
    (59
    )
    
    
    (9
    )Wireline Networks
    
    
    561
    
    
    
    686
    
    
    
    (125
    )
    
    
    (18
    )Optical Networks
    
    
    269
    
    
    
    406
    
    
    
    (137
    )
    
    
    (34
    )Other(a)
    
    
    1
    
    
    
    15
    
    
    
    (14
    )
    
    
    (93
    )Consolidated
    
    $
    2,376
    
    
    $
    2,900
    
    
    $
    (524
    )
    
    
    (18
    )


|(a) |  | Other represented
miscellaneous business activities and corporate functions.
|--- |  | ------------------------------------------------------------------------------

43



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##### Table of Contents



Geographic revenues

For the 3 months ended March 31,2003
    
    
    2002
    
    
    $Change
    
    
    % ChangeUnited States
    
    $
    1,198
    
    
    $
    1,406
    
    
    $
    (208
    )
    
    
    (15
    )EMEA(a)
    
    
    640
    
    
    
    713
    
    
    
    (73
    )
    
    
    (10
    )Canada
    
    
    127
    
    
    
    218
    
    
    
    (91
    )
    
    
    (42
    )Other
regions(c)
    
    
    411
    
    
    
    563
    
    
    
    (152
    )
    
    
    (27
    )Consolidated(b)
    
    $
    2,376
    
    
    $
    2,900
    
    
    $
    (524
    )
    
    
    (18
    )


|(a) |  | The Europe, Middle East and Africa region                               
|--- |  | ------------------------------------------------------------------------
|(b) |  | Revenues by geographic region were based on the location of the customer
|(c) |  | Included the Asia Pacific and Caribbean and Latin America regions       

Consolidated revenues

First quarter 2003 compared to first quarter 2002

Our consolidated revenues declined 18% in the first quarter of 2003 compared to
the first quarter of 2002. The decline was primarily due to the continuing
industry adjustment and capital spending constraints experienced by our service
provider and enterprise customers. Many of our customers continued to realign
capital spending with their current levels of revenue and profits in order to
maximize their return on invested capital. Also, excess network capacity
continued to exist in the industry which has led to continued pricing pressures
on the sale of certain of our products. As a result, our customers continued
to change their focus from building new networks to conserving capital,
decreasing their debt levels, reducing costs and/or increasing the capacity
utilization rates and efficiency of existing networks.

From a geographic perspective, the 18% decline in revenues was primarily due to a:



| |  | 15% decline in revenues in the United States primarily due to
customer capital spending constraints by service provider and enterprise
customers;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 42% decline in revenues in Canada primarily related to continued
capital spending constraints experienced by our service provider and
enterprise customers;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 41% decline in revenues in the Caribbean and Latin America region, or
CALA, primarily related to continued capital spending constraints
experienced by our service provider customers;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 10% decline in revenues in EMEA primarily due to capital spending
constraints by service provider and enterprise customers; and
| | - | -------------------------------------------------------------------------------------------------------------------------------

| |  | 18% decline in revenues in the Asia Pacific region primarily due to
continued capital spending constraints by service provider customers and
maturing wireless technologies.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

First quarter 2003 compared to fourth quarter 2002

Our consolidated revenue declined $144 from $2,520 in the fourth quarter of
2002 to $2,376 in the first quarter of 2003. The decline was primarily due to
the seasonality more traditionally associated with the first quarter of our
fiscal year as well as a result of the continued capital spending constraints
experienced by our customers.

Geographic revenues for the first quarter of 2003 compared to fourth quarter of
2002:



| |  | decreased 27% in the Asia Pacific region;
| | - | -----------------------------------------

| |  | decreased 4% in the United States;
| | - | ----------------------------------

| |  | decreased 4% in Canada;
| | - | -----------------------

| |  | increased 9% in CALA; and
| | - | -------------------------

| |  | were relatively flat in EMEA.
| | - | -----------------------------

44



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Remainder of 2003

We expect overall spending in the telecommunications equipment market to be
down modestly in fiscal 2003 compared to fiscal 2002. We also expect that
capital spending levels in the second quarter will be similar to the first
quarter of 2003. Given the ongoing economic and geopolitical uncertainty,
customers continue to spend cautiously. We cannot predict the economic impact
of acts of war or terrorism on the global market or the transmission of
contagious diseases such as Severe Acute Respiratory Syndrome, or SARS, in the
Asia Pacific region. We expect to see continued constraints on capital
spending by customers due to:



| |  | our customers realigning their investment levels with their current
levels of revenue and returns, and focusing on maximizing their return
on invested capital;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the high debt levels of many service providers;
| | - | -----------------------------------------------

| |  | excess network assets;
| | - | ----------------------

| |  | the financial difficulties of certain service providers;
| | - | --------------------------------------------------------

| |  | a lack of available funding from the capital markets;
| | - | -----------------------------------------------------

| |  | a longer, more stringent spending approval process by enterprises when making capital investment decisions;
| | - | -----------------------------------------------------------------------------------------------------------

| |  | excess and shared bandwidth capacity; and
| | - | -----------------------------------------

| |  | the compounding impact of economic and geopolitical concerns.
| | - | -------------------------------------------------------------

Also, we expect that we will continue to experience pricing pressures on sales
of our products as a result of increased competition. It is difficult to
predict the duration of the current industry adjustment, as growth in industry
spending is not expected to occur until global geopolitical uncertainty and
economic and financial concerns have subsided. Market visibility remains
limited and we do not expect that our results of operations for any quarter
will necessarily be consistent with our historical quarterly profile or
indicative of our expected results in future quarters. See Forward looking
statements for factors that may affect our revenues.

Wireless Networks revenues

The following chart summarizes recent quarterly revenues for Wireless Networks:

(WIRELESS NETWORKS REVENUES BAR GRAPH)

First quarter 2003 compared to first quarter 2002

The 17% decline in Wireless Networks revenues in the first quarter of 2003
compared to the first quarter of 2002 was primarily due to an ongoing focus by
wireless service providers on capital and cash flow management, reflecting
slower subscriber growth and increased competition for customers by wireless
service providers. As a result of this focus, many customers continued to
delay capital expenditures.

Code Division Multiple Access, or CDMA, revenues declined significantly in the
first quarter of 2003 compared to the first quarter of 2002, primarily due to
customers, particularly in the United States, continuing to experience capital
spending constraints driven by their continued focus on capital and cash flow
management. Time Division Multiple Access, or TDMA, revenues declined
substantially in the first quarter of 2003 compared to the first quarter of
2002 primarily due to the continued transition to newer wireless technologies.
The substantial decline was primarily due to United States customers continuing
to migrate from the mature TDMA technology to CDMA and Global System for Mobile
communications, or GSM, technologies.

45



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##### Table of Contents



However, TDMA revenues continued to be a smaller portion of Wireless Networks
revenues in the first quarter of 2003 compared to the first quarter of 2002.

Overall GSM revenues, which includes General Packet Radio Standard, or GPRS,
and Enhanced Data Rates for Global Evolution, or EDGE, declined significantly
in the first quarter of 2003 compared to the first quarter of 2002 due to a
substantial decline in the Asia Pacific region and a significant decline in the
United States. The substantial decline in the Asia Pacific region was
primarily due to a decline in the overall growth rate of GSM technology
deployments by wireless service providers in the second half of 2002 and the
first quarter of 2003. As of the first quarter of 2003, many of our GSM
customers in the Asia Pacific region have completed their network deployments,
and as a result, have sufficient capacity to currently meet additional
subscriber demands. In the United States, the significant decline was
primarily due to continued slow subscriber growth and completion of some
networks by certain service providers. In EMEA and CALA, GSM revenues
increased substantially in the first quarter of 2003 primarily due to new
contracts won with certain service providers in the second half of 2002.

Universal Mobile Telecommunications Systems, or UMTS, revenues increased
significantly in the first quarter of 2003 compared to 2002. The significant
increase was primarily due to the resolution of contractual issues, including
collectibility, with a certain customer experienced in the second half of 2002.
However, larger network deployment delays continued in the first quarter of
2003 primarily due to the technology issues associated with third generation,
or 3G, handsets and network performance by certain vendors. In the first
quarter of 2003, UMTS revenues continued to be a small but growing portion of
our Wireless Networks revenues.

From a geographic perspective, the 17% decrease in Wireless Networks revenues
in the first quarter of 2003 compared to the same period in 2002 was primarily
due to a:



| |  | 15% decline in revenues in the United States primarily due to
customers focus on capital and cash flow management, technology
migration and a slower subscriber growth;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 51% decline in revenues in the Asia Pacific region primarily due to
capital spending constraints, network completion and a slower subscriber
growth; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 71% decline in revenues in Canada primarily due to customer capital
spending constraints; partially offset by
| | - | -------------------------------------------------------------------------------------------------------------

| |  | 28% increase in revenues in EMEA primarily due to the resolution of
contractual issues, including collectibility, with a certain customer
experienced in the second half of 2002 and the award of new GSM
contracts with certain service providers in the second half of 2002; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 25% increase in revenues in CALA primarily due to new GSM contracts
with certain service providers in the second half of 2002.
| | - | ------------------------------------------------------------------------------------------------------------------------------

First quarter 2003 compared to fourth quarter 2002

Compared to the fourth quarter of 2002, Wireless Networks revenues decreased
8%, primarily due to:



| |  | a significant decline in CDMA revenues primarily due to customer
capital spending constraints driven by their continued focus on capital
and cash flow management; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a significant decline in GSM revenues primarily due to continued slow
subscriber growth and delays in capital expenditures by service
providers; partially offset by
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a substantial increase in UMTS revenue primarily due to the
resolution of contractual issues, including collectibility, with a
certain customer experienced in the second half of 2002; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a substantial increase in TDMA revenues primarily due to a certain
customer continuing their network expansion.
| | - | ---------------------------------------------------------------------------------------------------------------

From a geographic perspective, Wireless Networks revenues decreased 8% in the
first quarter of 2003 compared to the fourth quarter of 2002 as a result of a
51% decline in the Asia Pacific region, a 9% decrease in the United States
which was partially offset by a 13% increase in EMEA and a 23% increase in
CALA.

46



---



##### Table of Contents



Remainder of 2003

In the first quarter of 2003, Wireless Networks revenues continued to be
primarily generated by sales of CDMA and GSM technologies. We continue to
expect that revenues associated with our TDMA technologies will decline in
2003. Overall GSM sales are also expected to decline as networks are built out
and subscriber growth slows. In 2003, our CDMA 3G and UMTS technology sales
are expected to grow, compared to 2002, and represent a larger proportion of
Wireless Networks revenues as 3G technologies are expected to gain a greater
foothold in the market due to increased wireless data traffic and requirements
for greater wireless spectrum efficiency. Also, we expect to experience
increased pricing pressures on sales of certain of our Wireless Networks
products as a result of increased competition.

As at December 23, 2003, we expect that
overall GSM sales in 2003 will increase compared to 2002 and that revenues from UMTS technologies will
remain a small portion of overall Wireless Networks revenue in 2003.

As with the rest of the industry, our wireless customers are experiencing
significant pressure and are adapting to a new, more stringent spending
environment due to the lack of available financing and a slower subscriber
growth in the overall wireless market. We anticipate a reduction in global
capital expenditures for wireless operators in 2003 and 2004, compared to 2002,
but cannot predict the complete impact. We also expect some consolidation in
this marketplace, including a reduction in the number of service providers in
certain regions due to competition and/or adjustments in deployment plans and
schedules. In addition, the timing of the anticipated change in revenue mix
from the different wireless technologies has become increasingly difficult to
predict as a result of the complexities and potential for delays in the
implementation of UMTS network deployments. All of these factors could
adversely affect our Wireless Networks revenues in the future.

Enterprise Networks revenues

The following chart summarizes recent quarterly revenues for Enterprise
Networks:

(ENTERPRISE NETWORKS REVENUES BAR GRAPH)

First quarter 2003 compared to first quarter 2002

The 9% reduction in Enterprise Networks revenues in the first quarter of 2003
compared to the first quarter of 2002 was primarily a result of our enterprise
customers continuing to delay their purchase decisions on certain products due
to the economic uncertainty in the industry.

Revenues from the circuit and packet voice portion of this segment were
essentially flat in the first quarter of 2003 compared to the first quarter of
2002. We experienced a reduction in revenue associated with our integrated
voice recognition products due to enterprises employing more stringent capital
spending approval processes resulting in purchase decision delays. This
decrease was partially offset by a substantial increase in revenues associated
with our internet protocol, or IP, telephony solutions as customers continued
to migrate towards packet voice solutions.

The data networking and security portion of this segment experienced
significant declines in the first quarter of 2003 compared to the first quarter
of 2002. The significant decrease in revenues was primarily due to continued
customer spending constraints and delayed purchasing decisions by customers.
Also, we experienced a reduction in the number of service contract renewals
associated with our legacy routing portfolio in the first quarter of 2003
compared to the first quarter of 2002.

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##### Table of Contents



From a geographic perspective, the 9% decline in Enterprise Networks revenues
in the first quarter of 2003 compared to the first quarter of 2002 was
primarily due to a:



| |  | 14% decline in revenues in the United States primarily due to
customer spending constraints and a reduction in the number of service
contract renewals;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 7% decline in revenues in EMEA primarily due to customer spending
constraints; and
| | - | ----------------------------------------------------------------------------------

| |  | 27% decline in revenues in CALA primarily due to the continued
deterioration of the socio-economic situation in Argentina and Venezuela
and the associated delays in certain government related contracts.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

First quarter 2003 compared to fourth quarter 2002

Enterprise Networks revenues decreased 5% in the first quarter of 2003 compared
to the fourth quarter of 2002. The decline was primarily due to:



| |  | a significant decline in the data network and security portion of
this segment primarily due to the more traditional seasonality
associated with the first quarter of our fiscal year and continuing
customer spending constraints; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a moderate decline in the circuit and packet voice portion of this
segment primarily due to the more traditional seasonality associated
with the first quarter of our fiscal year and a reduction in revenue
associated with our integrated voice recognition products due to
enterprises beginning to employ more stringent capital spending approval
processes.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, the 5% decline in the first quarter of 2003
compared to the fourth quarter of 2002 was primarily due to a 10% decline in
the United States and a 4% decline in EMEA which was partially offset by an 8%
increase in the Asia Pacific region.

Remainder of 2003

We anticipate that communications networks will continue to increase the use of
voice over packet technologies. We expect that data, voice and multimedia
communications technologies will continue to converge, and enterprises will
look for ways to maximize the effectiveness of their existing networks while
reducing ongoing capital expenditures and operating costs. However, the timing
of this progression is unclear. We also anticipate that demand will continue
for our traditional circuit switching products. Overall, we expect that the
continuing industry adjustment will have a negative impact on the level of
spending by our enterprise customers.

As at December 23, 2003, we no longer expect that the continuing industry
adjustment will have a negative impact on the level of spending by our
enterprise customers.

Wireline Networks revenues

The following chart summarizes recent quarterly revenues for Wireline Networks:

(WIRELINE NETWORKS REVENUES CHART)

48



---



##### Table of Contents



First quarter 2003 compared to first quarter 2002

The 18% decline in Wireline Networks revenues in the first quarter of 2003
compared to the first quarter of 2002 was primarily due to a substantial
reduction in capital spending by our service provider customers as a result of
the continuing industry adjustment.

Compared to the first quarter of 2002, revenues decreased in the circuit and
packet voice portion of this segment due to a substantial decrease in revenue
associated with our traditional circuit switching products. The substantial
decline in our traditional switching products was primarily due to the
tightened capital markets and continued capital spending constraints
experienced by our service provider customers. This substantial decline was
partially offset by a substantial increase in revenues in our packet based
technologies due to certain new service provider contracts awarded in the
second half of 2002 and the first quarter of 2003.

The significant decline in revenues in the data networking and security portion
of this segment was primarily due to a decline in demand for mature products,
compounded by the ongoing industry adjustment as our service provider
customers, in all regions, continued to reduce their capital expenditures.

From a geographic perspective, the 18% decline in Wireline Networks revenues in
the first quarter of 2003 compared to the first quarter of 2002 was primarily
due to a:



| |  | 83% decline in revenues in CALA primarily due to the completion of a
major contract in the first quarter of 2002 and continued capital
spending constraints experienced by our service provider customers; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 17% decline in revenues in EMEA primarily due to a reduction in
capital spending by our service provider customers.
| | - | -------------------------------------------------------------------------------------------------------------------

First quarter 2003 compared to fourth quarter 2002

Our Wireline Networks revenues increased 11% in the first quarter of 2003
compared to the fourth quarter of 2002, primarily due to:



| |  | a substantial increase in the circuit and packet voice portion of
this segment primarily due to a substantial increase in revenues in our
packet based technologies due to certain new service provider contracts
in the second half of 2002 and first quarter of 2003; partially offset
by
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a significant decline in the data networking and security portion of
this segment primarily due to the more traditional seasonality
associated with the first quarter of our fiscal year.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, Wireline Networks revenues increased 11% in the
first quarter of 2003 compared to the fourth quarter of 2002 primarily as a
result of a 24% increase in the United States and a 68% increase in Canada
which was partially offset by a 29% decline in the Asia Pacific region.

Remainder of 2003

In the future, we anticipate that service providers will continue to increase
the use of packet-based technologies in their communications networks as they
look for ways to optimize their existing networks and offer new revenue
generating services while controlling capital expenditures and operating costs.
Although we experienced an increase in revenues in our packet-based
technologies in the first quarter of 2003 compared to the same period in 2002,
the timing of when there will be continued and sustainable demand is unclear.
We expect that the continuing industry adjustment and reduction in capital
spending by our customers will have a negative impact on the level of spending
by our service provider customers and could adversely affect Wireline Networks
revenues in the future.

49



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##### Table of Contents



Optical Networks revenues

The following chart summarizes recent quarterly revenues for Optical Networks:

(OPTICAL NETWORKS REVENUES CHART)

First quarter 2003 compared to first quarter 2002

The 34% decline in Optical Networks revenues in the first quarter of 2003
compared to the first quarter of 2002 was primarily the result of the
continuing industry adjustment and substantial reductions in capital spending
by our United States and EMEA customers in the long-haul portion of this
segment.

Revenue in the long-haul portion of this segment declined substantially in the
first quarter of 2003 compared to the first quarter of 2002. The substantial
decline was primarily due to the continuing industry adjustment and continued
capital spending constraints in the United States and EMEA as customers
continued to focus on maximizing return on invested capital by increasing the
capacity utilization rates and efficiency of existing networks. In addition,
significant excess inventories continued to exist in this portion of the
segment which resulted in ongoing pricing pressures.

Also, in the fourth quarter of 2002, we sold certain optical components assets
to Bookham Technology plc, or Bookham. As a result, our first quarter results
in 2003 in the long-haul portion of this segment do not reflect revenues
generated from these assets. In the first quarter of 2002, revenues generated
from the optical components assets sold to Bookham were less than 5% of the
total revenue of $406. For additional information relating to the sale of
these assets to Bookham, you should refer to information contained in our 2002
Annual Report.

Revenue in the metro optical portion of this segment decreased significantly in
the first quarter of 2003 compared to the same period in 2002. The significant
decrease was primarily due to a substantial decline in revenues in the United
States and EMEA as customers in these regions continued to focus on maximizing
their return on invested capital by increasing the capacity utilization rates
and efficiency of existing networks. The substantial declines in these regions
were partially offset by a substantial increase in the Asia Pacific region due
to new customer contracts in 2003 compared to the insignificant revenues in the
first quarter of 2002.

From a geographic perspective, the 34% decline in Optical Networks revenues in
the first quarter of 2003 compared to the first quarter of 2002 was primarily
due to a:



| |  | 47% decline in revenues in EMEA primarily related to a substantial
reduction in capital spending as a result of the continuing industry
adjustment and customers continuing to focus on maximizing return on
invested capital;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 48% decline in revenues in the United States and a 42% decline in
Canada primarily related to a substantial reduction in capital spending;
and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------

| |  | 60% decline in revenues in CALA primarily related to a reduction in
capital spending and excess network capacity and assets; partially
offset by
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 41% increase in revenues in the Asia Pacific region primarily due to
new customer contracts.
| | - | --------------------------------------------------------------------------------------------

50



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##### Table of Contents



First quarter 2003 compared to fourth quarter 2002

Optical Networks revenues decreased 22% in the first quarter of 2003 compared
to the fourth quarter of 2002 primarily due to substantial declines in both the
optical long-haul and metro optical portions of this segment. The substantial
declines were primarily due to the more traditional seasonality associated with
the first quarter of our fiscal year and the continued capital spending
constraints in the United States and EMEA.

From a geographic perspective, Optical Networks revenues decreased 22% in the
first quarter of 2003 compared to the fourth quarter of 2002 primarily as a
result of a 35% decline in the United States, a 55% decline in Canada and a 9%
decline in EMEA.

Remainder of 2003

Our major customers in the optical long-haul portion of this segment remain
focused on maximizing return on their invested capital by increasing the
capacity utilization rates and efficiency of existing networks. We expect that
any additional capital spending by those customers will be increasingly
directed to opportunities that enhance customer performance, revenue generation
and cost reduction in the near term. We expect that customers in this portion
of the segment will continue to focus on route by route activities, adding
channels to existing networks, and interconnectivity and bandwidth as it is
required in the short term. Further, we believe that building out networks for
increased bandwidth will remain longer term projects. Revenues in the optical
long-haul portion of the segment are primarily based on network build-outs and,
consequently, generally include a number of long-haul products packaged
together in an end-to-end solution. As a result, almost all products within
this portion of the segment are generally affected in the same manner as
fluctuations in the needs of our customers typically result in corresponding
increases or decreases in overall optical long-haul revenue.

In the metro optical portion of this segment, we expect to see an increase in
demand for metro Dense Wavelength Division Multiplexing, or metro DWDM, as our
customers begin to deploy inter-office fiber infrastructure. As a result, we
expect that the metro optical portion of this segment will continue to become a
larger percentage of the overall Optical Networks revenues.

Due to the severe reduction, in number and size, of new optical long-haul
network build-outs and due to the nature of the relationship between the
products within the optical long-haul portion of this segment, we do not expect
a meaningful recovery in the optical long-haul market before early 2004. Also,
we anticipate that pricing pressures on optical system vendors will continue
due to intense competition, large inventories and a diminished market. As a
result, we expect that our Optical Networks revenues will decline in 2003
compared to 2002 and will be one of our last segments to recover from the
significant industry adjustment.

As at December 23, 2003, due to the severe reduction in the number and size of
new optical long-haul network build-outs and due to the nature of the
relationship between the products within the optical long-haul portion of this
segment, it is difficult to predict when a meaningful recovery in the optical
long-haul market will occur.

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##### Table of Contents



Gross profit and gross margin

For the 3 months ended March 31,2003
    
    
    2002
    
    
    Change
    
    
    % ChangeGross profit
    
    $
    1,052
    
    
    $
    739
    
    
    $
    313
    
    
    
    42Gross margin
    
    
    44.3
    %
    
    
    25.5
    %
    
    
    18.8
    
    
    
    74


Gross margin improved 18.8 percentage points in the first quarter of 2003
compared to the first quarter of 2002 primarily due to:



| |  | approximately $200 of increased provisions in the first quarter of
2002 related to incremental inventory provisions and contract and
customer settlement costs not repeated in the first quarter of 2003;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an increase of approximately 5 percentage points related to continued
improvements in our cost structure primarily as a result of more
favorable supplier pricing which was partially offset by continued
pricing pressures on the sale of our products;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an increase of approximately 2 percentage points related to
reductions in other operations related costs; and
| | - | -------------------------------------------------------------------------------------------------------------

| |  | an improvement of approximately 2 percentage points related to
favorable changes in product mix; partially offset by an accrual for the
employee return to profitability bonus plan.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

While we cannot predict the extent to which changes in product mix and pricing
pressures will impact our gross margin, we continue to see the effects of our
restructuring work plan which we began implementing in 2001 to create a cost
structure that is more reflective of the current industry and economic
environment. As a result, we expect that gross margin will continue to trend
in the low 40% range for the remainder of 2003. See Forward looking
statements for factors that may affect our gross margins.

As at December 23, 2003, we expect that gross margin will trend in the mid-40%
range in the near term.

Segment gross profit and gross margin

Wireless Networks

Wireless Networks gross margin improved by approximately 11 percentage points
in the first quarter of 2003 compared to the same period in 2002. The
improvement was primarily due to changes in our customer and product mix and
ongoing product cost improvements.

Enterprise Networks

Enterprise Networks gross margin improved by approximately 9 percentage points
in the first quarter of 2003 compared to the same period in 2002. The
improvement in gross margin was primarily due to:



| |  | improvements in our cost structure as a result of more favorable
supplier pricing; and
| | - | --------------------------------------------------------------------------------------

| |  | increased provisions recorded in the first quarter of 2002 related to
negotiations with our major suppliers which resulted in inventory
related provisions and contract and customer settlement costs not
repeated in the first quarter of 2003.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Wireline Networks

Wireline Networks gross margin decreased by approximately 6 percentage points
in the first quarter of 2003 compared to the same period in 2002. The decline
in gross margin was primarily due to:



| |  | changes in product mix; partially offset by
| | - | -------------------------------------------

| |  | increased provisions recorded in the first quarter of 2002 related to
negotiations with our major suppliers which resulted in inventory
related provisions and contract and customer settlement costs not
repeated in the first quarter of 2003.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Optical Networks

Optical Networks gross margin improved by approximately 80 percentage points in
the first quarter of 2003 compared to the same period in 2002. The improvement
in gross margin was primarily due to:



| |  | significant increased provisions recorded in the first quarter
of 2002 related to negotiations with our major suppliers which
resulted in inventory related provisions and contract and customer
settlement costs;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the sale of certain optical components assets to Bookham in the
fourth quarter of 2002 and, as a result, our gross margin in the
first quarter of 2003 in the optical long-haul portion of this
segment excluded the impact of excess capacity of those optical
components assets; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | improvements in our cost structure and favorable supplier
pricing.
| | - | ------------------------------------------------------------------

Operating expenses

Selling, general and administrative expense

For the 3 months ended March 31,2003
    
    
    2002
    
    
    Change
    
    
    % ChangeSG&A expense
    
    $
    513
    
    
    $
    701
    
    
    $
    (188
    )
    
    
    (27
    )As a percentage of revenues
    
    
    21.6
    %
    
    
    24.2
    %
    
    
    N/A
    
    
    
    N/A


Selling, general and administrative, or SG&A, expense declined $188 in the
first quarter of 2003 compared to the same period in 2002. The substantial
decline in the first quarter of 2003 compared to the first quarter of 2002 was
primarily due to:



| |  | the continued impact of our workforce reductions and associated
reductions in other related costs such as information services and real
estate; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |  | decreased provisioning for customer financing receivables; partially offset by
| | - | ------------------------------------------------------------------------------

| |  | an accrual for the employee return to profitability bonus plan.
| | - | ---------------------------------------------------------------

We will continue to manage SG&A expense according to the requirements of our
business, allocating resources and investment where customer demand dictates,
and reducing resources and investment where opportunities for improved
efficiencies present themselves. We expect that SG&A expense will continue to
trend lower in the second quarter of 2003 compared to the first quarter of
2003.

Segment selling, general and administrative expense

Wireless Networks

Wireless Networks SG&A expense decreased significantly in the first quarter of
2003 compared to the first quarter of 2002. The decrease was primarily due to
the continued impact of our workforce reductions across all regions and
associated reductions in other related costs such as information services and
real estate.

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Enterprise Networks

Enterprise Networks SG&A expense decreased significantly in the first quarter
of 2003 compared to the first quarter of 2002. The decrease was primarily due
to the continued impact of our workforce reductions, primarily in the United
States and Canada, and associated reductions in other related costs such as
information services and real estate.

Wireline Networks

Wireline Networks SG&A expense decreased substantially in the first quarter of
2003 compared to the first quarter of 2002. The decrease was primarily due to:



| |  | the continued impact of our workforce reductions, primarily in the
United States and Canada, and associated reductions in other related
costs such as information services and real estate; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a decrease in provisioning for customer financing receivables.
| | - | --------------------------------------------------------------

Optical Networks

Optical Networks SG&A expense decreased substantially in the first quarter of
2003 compared to the first quarter of 2002. The decrease in SG&A expense was
primarily due to:



| |  | the continued impact of our workforce reductions across all regions
and associated reductions in other related costs such as information
services and real estate; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a decrease in provisioning for customer financing receivables.
| | - | --------------------------------------------------------------

Segment contribution margin

For the 3 months ended March 31,2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    317
    
    
    $
    260
    
    
    $
    57
    
    
    
    22Enterprise Networks
    
    
    150
    
    
    
    85
    
    
    
    65
    
    
    
    76Wireline Networks
    
    
    158
    
    
    
    128
    
    
    
    30
    
    
    
    23Optical Networks
    
    
    12
    
    
    
    (383
    )
    
    
    395
    
    
    
    103Other
    
    
    (98
    )
    
    
    (52
    )
    
    
    (46
    )
    
    
    (88
    )Consolidated
    
    $
    539
    
    
    $
    38
    
    
    $
    501
    
    
    
    N/A


As a result of the gross margin and SG&A expense improvements mentioned above,
our consolidated contribution margin improved by $501 in the first quarter of
2003 compared to the same period in 2002. All of our four reportable segments
contributed positive contribution margin in the first quarter of 2003.

Research and development expense

For the 3 months ended March 31,2003
    
    
    2002
    
    
    Change
    
    
    % ChangeR&D expense
    
    $
    502
    
    
    $
    565
    
    
    $
    (63
    )
    
    
    (11
    )As a percentage of revenues
    
    
    21.1
    %
    
    
    19.5
    %
    
    
    N/A
    
    
    
    N/A


Research and development, or R&D, expense represents our planned investment in
our next generation core products across all businesses. R&D expense decreased
$63 in the first quarter of 2003 compared to the first quarter of 2002,
reflecting workforce reductions and focused investments to drive market
leadership across our product portfolios. Included in R&D expense in the first
quarter of 2003 was an accrual for the employee return to profitability bonus
plan.

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Our continuing strategic investments in R&D are aligned with technology
leadership in anticipated growth areas, while targeting a level of R&D expense
that is more representative of our overall cost structure. We will continue to
manage R&D expense according to the requirements of our business, allocating
resources and investment where customer demand dictates, and reducing resources
and investment where opportunities for improved efficiencies present
themselves. Our research and development efforts are currently focused on key
next generation networking solutions including wireless data, wireless LAN
(local area networks), packet voice solutions, broadband connectivity, internet
protocol, or IP, multimedia services and security. We expect that R&D expense
in the second quarter of 2003 will trend lower from the first quarter of 2003.

Special charges

In the first quarter of 2003, we recorded special charges of $111 related to
our continued restructuring work plan to streamline operations and activities
around core markets and leadership strategies. Net workforce reduction charges
of $45 related to the cost of severance and benefits associated with
approximately 800 employees notified of termination during the first quarter of
2003. Net contract settlement and lease costs of $77 related to the
cancellation of existing contracts across all segments. Also, we recorded a
net increase of $11 in the carrying value of plant and equipment for changes in
the estimated net realizable value of leasehold improvements and related
assets.

In the first quarter of 2002, we recorded special charges of $422 related to
our restructuring work plan. Workforce reduction charges of $298 were related
to the cost of severance and benefits associated with the approximately 4,000
employees notified of termination. Contract settlement and lease costs
included negotiated settlements of approximately $49 to either cancel contracts
or renegotiate existing contracts across all of our segments. Also, we
recorded $75 in plant and equipment write downs within global operations, a
function that supports all of our segments, and within our Optical Networks
reporting segment.

Currently, we expect that approximately $20 to $30 of special charges related
to our restructuring work plan will be incurred in the second quarter of 2003.

In the second quarter of 2003, we recorded a net reduction in special charges
of $1 associated with our continued restructuring work plan. Included in this
net reduction were total reductions of $62 related to revisions to prior
accruals.

For additional information related to our restructuring activities, see
Special charges in note 6 of the accompanying unaudited consolidated
financial statements.

Interest expense

The decrease in interest expense of $21 in the first quarter of 2003 compared
to the same period in 2002 was primarily related to the reduction in the
outstanding balances of our notes payable and long-term debt.

Income tax benefit (provision)

In the first quarter of 2003, we recorded a tax expense of $6 on the pre tax
loss from continuing operations of $87. The valuation allowance was recorded
in accordance with Statement of Financial Accounting Standards, or SFAS, No.
109, Accounting for Income taxes, which requires that tax valuation
allowances be established when it is more likely than not that some portion or
all of a companys deferred tax assets will not be realized. The valuation
allowances can be primarily attributed to continued uncertainty in the
industry. If market conditions improve and future results of operations exceed
our current expectations, our existing tax valuation allowances may be
adjusted, resulting in recognition of additional future tax benefits.
Alternatively, if market conditions deteriorate further or future results of
operations are less than expected, additional tax valuation allowances may be
required for all or a portion of our deferred tax assets.

Approved tax legislation in the first quarter of 2002 in the United States
extended the net operating loss carryback period from two years to five years.
As a result, we were able to carryback available United States losses from 2001
and utilize approximately $700 of deferred income tax assets previously
recognized, generating additional cash recoveries of approximately $700 in the
first quarter of 2002.

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Net loss from continuing operations

As a result of the items discussed under our results of operations, our
reported net loss from continuing operations improved by $599 in the first
quarter of 2003 compared to the first quarter of 2002.

Results of operations  discontinued operations

During the first quarter of 2003, we substantially completed the wind-down of
our access solutions operations and recorded net earnings of $164 (net of tax)
related to the sale of certain components of this business. The $164 in net
earnings was primarily related to a $101 gain from the disposition of certain
shares and a membership interest in certain Arris Group Inc. companies and a
gain of $95 from the settlement of certain trade and customer financing
receivables. Our intent to exit this business was originally approved by our
Board of Directors on June 14, 2001. The continued deterioration in industry
and market conditions delayed certain disposal activities beyond the original
planned timeframe of one year. In particular, actions involving negotiations
with customers, who have also been affected by industry conditions, took longer
than expected. Although disposal activities continued beyond the one-year
period, we have continued to present the access solutions operations as
discontinued operations in the accompanying unaudited consolidated financial
statements.

For additional information, see Discontinued operations in note 13 of the
accompanying unaudited consolidated financial statements.

Application of critical accounting policies

There have been no changes to our critical accounting policies since December
31, 2002. For a description of our critical accounting policies, see our 2002
Annual Report.

Liquidity and capital resources

Cash flows

The following table summarizes our cash flows by activity and cash on hand:

3 months ended March 31,2003
    
    
    2002Net cash used in operating activities of continuing operations
    
    $
    (116
    )
    
    $
    (395
    )Net cash from (used in) investing activities of continuing operations
    
    
    9
    
    
    
    (72
    )Net cash used in financing activities of continuing operations
    
    
    (62
    )
    
    
    (11
    )Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    18
    
    
    
    (6
    )Net cash used in continuing operations
    
    
    (151
    )
    
    
    (484
    )Net cash from discontinued operations
    
    
    253
    
    
    
    50Net increase (decrease) in cash and cash equivalents
    
    
    102
    
    
    
    (434
    )Cash and cash equivalents at beginning of period  net
    
    
    3,743
    
    
    
    3,404Cash and cash equivalents at end of period  net
    
    $
    3,845
    
    
    $
    2,970


As of March 31, 2003, our primary source of liquidity was our current cash and
cash equivalents, or cash. At March 31, 2003, we had cash of $3,845, excluding
$227 of restricted cash and cash equivalents. We believe this cash will be
sufficient to fund our current business model, manage our investments and meet
our customer commitments for at least the next 12 months. However, if capital
spending by service providers and other customers declines more significantly
than we currently expect, we may be required to adjust our current business
model. As a result, our revenues and cash flows may be materially lower than
we expect and we may be required to further reduce our investments or take
other measures in order to meet our cash requirements. We may seek additional
funds from liquidity generating transactions and other conventional sources of
external financing. We cannot provide any assurance that our net cash
requirements will be as we currently expect, that we will continue to have
access to our credit facilities when and as needed, or that liquidity
generating transactions or financings will be available to us on acceptable
terms or at all.

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Cash flows used in operating activities were $116 due to a net loss from
continuing operations of $103, less an adjustment of $203 for non-cash and
other items, plus a net cash outflow of $216 from operating assets and
liabilities. Cash inflows of $108 from accounts receivable were primarily due
to an increase in outstanding receivables with Nortel Networks Corporation in
the first quarter of 2003. Cash inflows of $127 from inventories were
primarily due to product shipments exceeding additions to inventories in the
first quarter 2003. The net cash outflows of $451 from the remaining operating
assets and liabilities were primarily due to:



| |  | $194 relating to restructuring payments; and
| | - | --------------------------------------------

| |  | the proportionate decrease in our assets and liabilities as a result
of the decline in sales volumes and the associated size of the business.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

Cash flows from investing activities were $9 and were primarily due to: a
decrease of $20 in restricted cash and cash equivalents held as cash collateral
for certain bid, performance related and other bonds; proceeds of $7 from the
sale of certain investments and businesses; and proceeds of $6 from the sale of
plant and equipment. These amounts were partially offset by $18 in plant and
equipment expenditures and a net increase in long-term receivables of $4.

Cash flows used in financing activities were $62 and were primarily due to $43
used to reduce our long-term debt, a net reduction of $13 used to reduce our
notes payable and dividend payments of $5 on our outstanding preferred shares.

Uses of liquidity

Our cash requirements for the next 12 months are primarily to fund:



| |  | operations;
| | - | -----------

| |  | research and development;
| | - | -------------------------

| |  | workforce reduction and other restructuring activities;
| | - | -------------------------------------------------------

| |  | pension and post retirement benefits;
| | - | -------------------------------------

| |  | debt service;
| | - | -------------

| |  | capital expenditures;
| | - | ---------------------

| |  | customer financings; and
| | - | ------------------------

| |  | committed investments.
| | - | ----------------------

Also, from time to time, we may purchase our outstanding debt securities and/or
convertible notes in privately negotiated or open market transactions, by
tender offer or otherwise, in compliance with applicable laws.

Obligations under special charges

The remaining cash payments of $141 relating to workforce reduction initiatives
are expected to be substantially completed by mid 2004. The remaining cash
payments of $656 related to contract settlement and lease costs are expected to
be substantially completed by the end of 2010. We expect to incur
approximately $600 to $700 in restructuring work plan related cash outflows
during the remainder of 2003.

As at September 30, 2003, the remaining balance sheet reserve of $93 related to
workforce reduction initiatives is expected to be substantially drawn down by
mid-2004. The remaining balance sheet reserve of $490, net of approximately
$353 in estimated sublease revenues, related to contract settlement and lease
costs is expected to be substantially drawn down by the end of 2010. As at
December 23, 2003, for the entire year 2003, we currently expect to incur
approximately $550 to $600 in restructuring work plan related cash outflows.

Contractual cash obligations

Our contractual cash obligations for long-term debt, outsourcing contracts,
operating leases and unconditional purchase obligations remained substantially
unchanged from the amounts disclosed as at December 31, 2002 in our 2002 Annual
Report.

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In the first quarter 2003, we purchased $39 of our 6.125% Notes due February
15, 2006. Also in 2003, we plan to repay the remaining $164 of our 6.00% Notes
due September 1, 2003.



|Commitments and guarantees
|--------------------------



|Bid, performance related and
other bonds
|----------------------------------------

We enter into bid, performance related and other bonds in connection with
various contracts. Bid bonds generally have a term less than twelve months,
depending on the length of the bid period for the applicable contract.
Performance related bonds generally have a term of twelve months and are
typically renewed, as required, over the term of the applicable contract.
Other bonds generally have a term of twenty four months. The various contracts
to which these bonds apply generally have terms ranging from two to five years.
Any potential payments that we would be required to make are related to our
performance under the applicable contract.

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

March 31,
    
    
    December 31,2003
    
    
    2002Bid
and performance related bonds (a)
    
    $
    318
    
    
    $
    400Other
bonds (b)
    
    
    39
    
    
    
    35Total bid, performance related and other bonds
    
    $
    357
    
    
    $
    435


|(a) |  | Net of restricted cash amounts of $184 as at March 31, 2003 and $195 as at December 31, 2002
|--- |  | --------------------------------------------------------------------------------------------
|(b) |  | Net of restricted cash amounts of $22 as at March 31, 2003 and $19 as at December 31, 2002  

Historically, we have not had to make material payments and we do not
anticipate that we will be required to make material payments under these types
of bonds.

The criteria under which bid, performance related and other bonds can be
obtained have changed due to declines in the economic and industry environment
and our current credit condition. In addition to the payment of fees, we have
experienced cash collateral requirements in connection with obtaining new bid,
performance related and other bonds. However, we do not expect that the
requirements and/or fees to obtain bid, performance related and other bonds
will have a material adverse effect on our ability to win contracts from
potential customers.

Our support facility with EDC provides support for certain of our obligations
under bid and performance related bonds and may reduce the requirement for us
to provide cash collateral to support these obligations. Although this
facility provides for up to $750 in support, only $300 is committed support for
these bonds. In addition, any bid or performance related bonds with terms that
extend beyond June 30, 2004, which is the expiry date of this facility, are
currently not eligible for the support provided by this facility. Unless EDC
agrees to an extension of the facility or agrees to provide support in respect
of any such bid or performance related bonds on a case-by-case basis outside
the scope of the facility, we may be required to provide cash collateral to
support these obligations. In addition to the support facility with EDC, our
existing security agreements permit us to secure additional obligations under
bid and performance related bonds with the assets pledged under the security
agreements and to provide cash collateral as security for these types of bonds.
See Available support facilities for additional information on
this support facility and the security agreements.



|Third party debt
agreements
|---------------------------

In the normal course of business, we have guaranteed the debt of certain
customers. These third party debt agreements require us to make debt payments
throughout the term of the related debt instrument if the customer fails to
make a scheduled payment. Historically, we have not had to make material
payments and currently we do not anticipate that we will be required to make
material payments under these debt instruments. Our third party debt
agreements remain substantially unchanged from the amounts disclosed as at
December 31, 2002 in our 2002 Annual Report.

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|Supply and network outsourcing contracts
|----------------------------------------

We enter into supply contracts with customers for products and services, which
in some cases involve new, undeveloped technologies or requirements for us to
build and operate networks. We also enter into network outsourcing contracts
with customers to operate their networks. Some of these supply and network
outsourcing contracts contain delivery and installation timetables, performance
criteria and other contractual obligations. If we do not meet these
requirements, it could result in:



| |  | our having to pay substantial penalties or liquidated damages;
| | - | --------------------------------------------------------------

| |  | the termination of the related supply or network outsourcing contract; and/or
| | - | -----------------------------------------------------------------------------

| |  | the reduction of shared revenues, in certain circumstances.
| | - | -----------------------------------------------------------

As is common in our industry, our supply and network outsourcing contracts are
highly customized to address each customers particular needs and concerns.
The nature of the triggering events and the amounts and timing of the penalties
associated with these contracts can vary significantly due to a variety of
complex, interrelated factors. We have not experienced material penalty
payments on our supply and network outsourcing contracts in any recent
reporting period.

Certain of our key supply arrangements were negotiated prior to the current
industry and economic downturn. As a result of the extent and duration of this
downturn, in respect of one of these arrangements, based on our current revenue
levels, we will not meet the minimum volume levels contained in the contract.
As a result, we may be obligated to compensate the supplier for certain direct
costs. The amount of such direct costs cannot be reasonably estimated at this
time. The amount of any such compensation would be based on a variety of
complex, interrelated factors (including applicable factors that could mitigate
such direct costs). An obligation to pay such compensation could have a
material adverse effect on our business, results of operations, financial
condition and/or supply relationships.

Customer financing

Generally, customer financing arrangements may include financing in connection
with the sale of our products and services, as well as funding for non-product
costs associated with network installation and integration of our products and
services. We may also provide funding for working capital purposes and equity
financing.

The following table provides information related to our customer financing
commitments, excluding our discontinued operations, as at:

March 31,
    
    
    December 31,2003
    
    
    2002Drawn
and outstanding  gross (a)
    
    $
    982
    
    
    $
    1,091Provisions for doubtful accounts
    
    
    (693
    )
    
    
    (799
    )Drawn and outstanding  net
    
    
    289
    
    
    
    292Undrawn commitments
    
    
    649
    
    
    
    801Total customer financing
    
    $
    938
    
    
    $
    1,093


|(a) |  | Included short-term and long-term amounts
|--- |  | -----------------------------------------

In the first quarter of 2003, our gross customer financing commitments and
related provisions each decreased by approximately $100 as a result of the
securitization of outstanding balances associated with two of our customers and
the write down of a third customer balance as a result of the customers
bankruptcy restructuring.

We currently have customer financing commitments and/or balances outstanding in
connection with the construction of new networks, including 3G wireless
networks. Although we may commit to provide customer financing to customers in
areas that are strategic to our core businesses, we remain focused on reducing
our overall customer financing exposures in accordance with any obligations
under our financing agreements. During the first quarter of 2003, we reduced
undrawn commitments by $152 reflecting commitment expiration, cancellations and
changing customer business plans. As of March 31, 2003, approximately $460 of
the $649 in undrawn commitments was not available for funding under the terms
of our financing agreements. In addition to being highly selective in
providing customer financing, we have programs in place to monitor and mitigate
customer credit risk, including performance milestones and other conditions of
funding. Management is focused on

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the strategic use of our customer financing
capacity and on reducing the amount of our existing and future customer
financing exposure.

We continue to regularly assess the levels of our customer financing provisions
based on a loan-by-loan review to evaluate whether they reflect current market
conditions. We review the ability of our customers to meet their repayment
obligations and determine our provisions accordingly. Any misinterpretation or
misunderstanding of these factors by us may result in losses in excess of our
provisions. These losses could have a material adverse effect on our business,
results of operations, financial condition and customer relationships.

Our ability to place customer financing with third party lenders has been
significantly reduced primarily due to:



| |  | reduced demand for telecommunications financings in capital and bank
markets as a result of network overcapacity, bankruptcies and financial
difficulties in the industry;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our current credit condition;
| | - | -----------------------------

| |  | adverse changes in the credit quality of our customers; and
| | - | -----------------------------------------------------------

| |  | economic downturns in various countries.
| | - | ----------------------------------------

As a result, we are currently directly supporting most commitments and
outstanding balances and expect this to continue in the future as well. While
we will continue to seek to arrange for third party lenders to assume our
customer financing obligations, we expect to fund most customer financings in
the normal course of our business from working capital and conventional sources
of external financing. Commitments to extend future financing generally have
conditions for funding, fixed expiration or termination dates and specific
interest rates and purposes. Based on the terms of the existing agreements, we
expect that a substantial amount of these undrawn commitments will not be
funded in 2003. However, we cannot predict with certainty the extent to which
our customers will satisfy the applicable conditions for funding, and
subsequently request funding, prior to the termination date of the commitments.

As at December 23, 2003, we expect to fund most customer financings in the
normal course of our business from working capital.

Joint ventures/minority interests

On October 19, 2002, we entered into a number of put option and call option
agreements as well as a share exchange agreement with our partner in three
European joint ventures. If the options and share exchange are exercised, we
would be required to deliver to our joint venture partner net consideration of
approximately $114, consisting of approximately $42 in cash, and an in-kind
component of approximately $72, representing the return of a loan note
currently owed to us by an affiliate of our joint venture partner. The option
agreements and the share exchange agreement can be exercised between July 1,
2003 and December 31, 2003 subject to certain terms and conditions. If the
transactions are completed, we will acquire the minority interests in two of
these joint ventures and dispose of our minority interest in the third joint
venture.

Discontinued operations

As of March 31, 2003, the remaining accruals of the discontinued access
solutions operations totaled $66 and were related to future contractual
obligations and estimated liabilities during the planned period of disposition.
The remaining accruals are expected to be substantially drawn down by cash
payments over the period of disposition. During the first quarter of 2003, we
generated cash of approximately $253 on the disposition of various assets from
the access solutions operations and associated wind-down activities.

For additional information related to our discontinued operations, see
Discontinued operations in note 13 of the accompanying unaudited consolidated
financial statements.

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Sources of liquidity

Available credit facilities

We currently have $750 in available and undrawn credit facilities which expire
in April 2005. These credit facilities were entered into on April 12, 2000 by
us and Nortel Networks Inc. and permit borrowings for general corporate
purposes. As of March 31, 2003, there were no balances drawn under our
available credit facilities.

The $750 April 2000 five year credit facilities contain a financial covenant
requiring that our consolidated tangible net worth at any time be not less than
$1,888. As of March 31, 2003, we were in compliance with this covenant. We
continue to monitor our financial position in light of this covenant and if we
incur net losses or record additional charges relating to our restructuring
work plan, the accounting of our registered pension plans, the valuation of
deferred income tax assets or for other events, our consolidated tangible net
worth may be reduced below the $1,888 threshold. If we are unable to comply
with the consolidated tangible net worth covenant, we will be unable to access
the $750 April 2000 five year credit facilities.

Available support facilities

On February 14, 2003, we entered into an agreement with EDC regarding
arrangements to provide support, on a secured basis, of certain of our
performance related obligations arising out of normal course business
activities. This facility, which expires on June 30, 2004, provides for up to
$750 in support including $300 of committed revolving support for performance
bonds or similar instruments of which $95 was utilized as at March 31, 2003.
The remainder is uncommitted support for performance bonds, receivables sales
and/or securitizations of which $65 was utilized as at March 31, 2003.

The support facility with EDC does not materially restrict our ability to sell
any of our assets (subject to certain maximum amounts) or to purchase or
pre-pay any of our currently outstanding debt. EDC is not obligated to make
any support available unless certain customary conditions are satisfied and our
senior long-term debt rating by Moodys has not been downgraded to less than B3
and our debt rating by Standard & Poors has not been downgraded to less than
B-. If we default on our obligations under the support facility with EDC and
EDC calls upon the security provided under the security agreements in an amount
exceeding $100, we would also, as a result, be in default under our $750 April
2000 five year credit facilities and our outstanding public debt.

Our obligations under the support facility with EDC are secured on an equal and
ratable basis under the existing security agreements entered into by us and
various of our subsidiaries that pledge substantially all of our assets in
favor of certain banks, including the banks under the $750 April 2000 five year
credit facilities and the holders of our public debt securities, the holders of
Nortel Networks Corporations 4.25% convertible senior notes. The security
provided under the security agreements is comprised of:



| |  | pledges of substantially all of our assets and those of most of our United States and Canadian subsidiaries;
| | - | ------------------------------------------------------------------------------------------------------------

| |  | share pledges in certain of our other subsidiaries; and
| | - | -------------------------------------------------------

| |  | guarantees by certain of our wholly owned subsidiaries.
| | - | -------------------------------------------------------

If our senior long-term debt rating by Moodys returns to Baa2 (with a stable
outlook) and our rating by Standard & Poors returns to BBB (with a stable
outlook), the security will be released in full. If both the $750 April 2000
five year credit facilities and the support facility with EDC are terminated,
or expire, the security will also be released in full. We may provide EDC with
cash collateral (or any other alternative collateral acceptable to EDC), in an
amount equal to the total amount of our outstanding obligations and undrawn
commitments and expenses under this facility, in lieu of the security provided
under the security agreements.

For additional information relating to our outstanding public debt, the $750
April 2000 five year credit facilities and the support facility with EDC, see
Long-term debt, credit and support facilities in note 8 of the accompanying
unaudited consolidated financial statements. For additional financial
information related to those subsidiaries providing guarantees, see
Supplemental consolidating financial information in note 16 of the
accompanying unaudited consolidated financial statements. For information
relating to our debt ratings, see Credit ratings below. See Forward looking
statements for factors that may affect our ability to comply with covenants
and conditions in our credit and support facilities in the future.

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Shelf registration statement and base shelf prospectus

In the second quarter of 2002, Nortel Networks Corporation and Nortel Networks
Limited filed a shelf registration statement with the United States Securities
and Exchange Commission and a base shelf prospectus with the applicable
securities regulatory authorities in Canada, to qualify for the potential sale
of up to $2,500 of various types of securities in the United States and/or
Canada. The qualifying securities include guaranteed debt securities of Nortel
Networks Limited. As of March 31, 2003, approximately $1,700 of the $2,500
available under the shelf registration statement and base shelf prospectus has
been utilized. Approximately $800 remains available for use.

Credit ratings

Rating on long-term debtissued or guaranteed by
    
    
    Rating on preferred sharesNortel Networks Limited/
    
    
    issued by Nortel NetworksRating agency
    
    Nortel Networks Corporation
    
    
    Limited
    
    
    Last updateStandard & Poors Ratings Service
    
    
    B
    
    CCC
    
    September 18, 2002Moodys Investors Services, Inc.
    
    
    B3
    
    Caa3
    
    November 1, 2002


The ratings remain on negative outlook by Moodys and Standard & Poors. There
can be no assurance that our credit ratings will not be lowered further or that
such ratings agencies will not issue adverse commentaries, potentially
resulting in higher financing costs and further reduced access to capital
markets or alternative financing arrangements. Our credit ratings may also
affect our ability, and the cost, to securitize receivables, obtain bid,
performance related and other bonds, access the support facility with EDC
and/or enter into normal course derivative or hedging transactions.

Off-balance sheet arrangements, contractual obligations and contingent
liabilities and commitments

Off-balance sheet arrangements

We currently conduct certain receivable sales and lease financing transactions
through special purpose entities and are in the process of assessing the
structure of these transactions against the criteria set out in the Financial
Accounting Standards Board Interpretation No. 46  Consolidation of Variable
Interest Entities, or FIN 46.

Our receivable sales transactions are generally conducted either directly with
financial institutions or with multi-seller conduits. We do not expect that we
will be required to consolidate any of these entities or provide any of the
additional disclosures set out in FIN 46.

Certain lease financing transactions are structured through single transaction
special purpose entities that currently do not have sufficient equity at risk
as defined in FIN 46. In addition, we retain certain risks associated with
guaranteeing recovery of the unamortized principal balance of debt which is
expected to represent the majority of the risks associated with the special
purpose entities activities. The amount of the guarantee will be adjusted
over time as the underlying debt matures. Therefore, we expect that unless the
existing arrangements are modified prior to July 1, 2003, we will be required
to consolidate the assets, liabilities and any non-controlling interests of
these special purpose entities effective July 1, 2003. The total assets and
total liabilities held by these entities at March 31, 2003 were each
approximately $176 and these amounts represent the collateral and maximum
exposure to loss, respectively, as a result of our involvement with these
entities.

Contractual obligations

Our contractual cash obligations for long-term debt, outsourcing contracts,
operating leases and unconditional purchase obligations remain substantially
unchanged from the amounts disclosed as at December 31, 2002 in our 2002 Annual
Report.

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In the first quarter of 2003, we purchased $39 of our 6.125% Notes due February
15, 2006. Also in 2003, we plan to repay the remaining $164 of our 6.00% Notes
due September 1, 2003. In the first quarter of 2003, we also reduced our
unconditional purchase obligations by $24 through normal business related
activity.

Contingent liabilities and commitments

Customer financing commitments

In certain instances, we are committed to provide future financing to certain
customers in connection with their purchases of our products and services. The
undrawn commitments were $649 at March 31, 2003 and $801 at December 31, 2002.
Commitments to extend future financing generally have conditions for funding,
fixed expiration or termination dates and specific interest rates and purposes.
Based on the terms of the existing agreements, we expect that a substantial
amount of these undrawn commitments will not be funded in 2003. However, we
cannot predict with certainty the extent to which our customers will satisfy
the applicable conditions for funding, and subsequently request funding, prior
to the termination date of the commitments.

Purchase commitments

Our purchase commitments remain substantially unchanged from the amounts
disclosed as at December 31, 2002 in our 2002 Annual Report.

Joint ventures/minority interests

On October 19, 2002, we entered into a number of put option and call option
agreements as well as a share exchange agreement with our partner in three
European joint ventures. If the options and share exchange are exercised, we
would be required to deliver to our joint venture partner net consideration of
approximately $114, consisting of approximately $42 in cash, and an in-kind
component of approximately $72, representing the return of a loan note
currently owed to us by an affiliate of our joint venture partner. The option
agreements and the share exchange agreement can be exercised between July 1,
2003 and December 31, 2003, subject to certain terms and conditions. If the
transactions are completed, we will acquire the minority interests in two of
these joint ventures and dispose of our minority interest in the third joint
venture.

Other contingent liabilities and commitments

Through our normal course of business, we have also entered into other
indemnifications or guarantees that arise in various types of arrangements
including:



| |  | business sale agreements;
| | - | -------------------------

| |  | intellectual property indemnification obligations;
| | - | --------------------------------------------------

| |  | lease agreements;
| | - | -----------------

| |  | third party debt agreements;
| | - | ----------------------------

| |  | indemnification of lenders and agents under credit facilities; and
| | - | ------------------------------------------------------------------

| |  | other indemnification agreements.
| | - | ---------------------------------

Historically, we have not made any significant payments under any of these
indemnifications or guarantees. In certain cases, due to the nature of the
agreement, we have not been able to estimate our maximum potential loss or the
maximum potential loss has not been specified. However, for those agreements
where we have been able to make an estimate, the maximum
amount that we would be obliged to pay remains substantially unchanged from the
amounts disclosed in our 2002 Annual Report.

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Legal proceedings

Nortel Networks Corporation and/or certain of its directors and officers have
been named as defendants in various class action lawsuits. We are unable to
determine the ultimate aggregate amount of monetary liability or financial
impact to us in these legal matters, which unless otherwise specified, seek
damages from the defendants of material or indeterminate amounts. We and
Nortel Networks Corporation are also defendants in various other suits, claims,
proceedings and investigations which are in the normal course of business. We
cannot determine whether these matters will, individually or collectively, have
a material adverse effect on our business, results of operations and financial
condition. We, and any of our named directors and officers intend to
vigorously defend these actions, suits, claims, proceedings and investigations.

For additional information related our legal proceedings, see Contingencies
in note 15 of the accompanying unaudited consolidated financial statements.

Forward looking statements

Certain statements in this Quarterly Report, contain words such as could,
expects, may, anticipates, believes, intends, estimates, plans,
envisions, 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
which are considered forward looking may be made by us or others on our behalf.
These statements are subject to important risks, uncertainties and
assumptions, which are difficult to predict and the actual outcome may be
materially different. Some of the factors which could cause results or events
to differ from current expectations include, but are not limited to, the risk
factors described below. Unless 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. The risk factors have been updated to reflect the restatements as
well as for events and developments subsequent to March 31, 2003.

We have restructured our business to respond to industry and market conditions.
The assumptions underlying our restructuring efforts may prove to be
inaccurate and we may have to restructure our business again in the future.

We have substantially completed our efforts to restructure our business to
realign resources and achieve desired cost savings. We have based our
restructuring efforts on certain assumptions regarding the cost structure of
our business and the nature, severity and duration of the industry downturn.
These assumptions may or may not be correct and as a result, we may determine
that further restructuring in the future will be needed. Our restructuring
efforts may not be sufficient for us to achieve sustained profitability and
meet the changes in industry and market conditions. We must manage the
potentially higher growth areas of our business, as well as the non-core areas,
in order for us to achieve sustained profitability.

While restructuring, we have made, and will continue to make, judgments as to
whether we should further reduce our workforce or exit, or dispose of, certain
businesses. These workforce reductions may impair our ability to achieve our
current or future business objectives. Costs incurred in connection with
restructuring efforts may be higher than estimated. Any decision by management
to further limit investment or exit, or dispose of, businesses may result in
the recording of additional charges. As a result, the costs actually incurred
in connection with the restructuring efforts may be higher than originally
planned and may not lead to the anticipated cost savings and/or sustained
profitability.

As part of our review of restructured businesses, we also look at the
recoverability of their tangible and intangible assets. Future market
conditions may trigger further write downs of these assets due to uncertainties
in:



| |  | the estimates and assumptions used in asset valuations, which are
based on our forecasts of future business performance; and
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | accounting estimates related to the useful life and recoverability of
the net book value of these assets, including goodwill, net deferred
taxes, pension assets and other intangible assets.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We will continue to review our restructuring work plan based on our ongoing
assessment of the industry adjustment and the business environment.

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We may be materially and adversely affected by continued reductions in spending
by our customers.

A continued slowdown in capital spending by service providers and other
customers may affect our revenues more than we currently expect. Moreover, the
significant slowdown in capital spending by our customers, coupled with
existing economic and geopolitical uncertainties and the potential impact on
customer demand, has created uncertainty as to market demand. As a result,
revenues and operating results for a particular period can be difficult to
predict. In addition, there can be no certainty as to the severity or duration
of the current industry adjustment. Our revenues and operating results have
been and may continue to be materially and adversely affected by the continued
reductions in capital spending by our customers. If the reduction of capital
spending continues longer than we expect and we incur net losses as a result or
if we are required to record additional charges related to our restructuring
work plan, the valuation of deferred income tax assets or for other events, we
may be unable to comply with the financial covenant under our current credit
facilities. As well, we have focused on the larger customers in certain
markets, which provide a substantial portion of our revenues. A reduction or
delay in business from one or more of these customers, or a failure to achieve
a significant market share with these customers, could have a material adverse
effect on our business, results of operations and financial condition.

Our operating results have historically been subject to yearly and quarterly
fluctuations and are expected to continue to fluctuate.

Our operating results have historically been and are expected to continue to be
subject to quarterly and yearly fluctuations as a result of a number of
factors. These factors include:



| |  | our ability to successfully implement programs to stimulate customer
spending by anticipating and offering the kinds of products and services
customers will require in the future to increase the efficiency and
profitability of their networks;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our ability to successfully complete programs on a timely basis to
reduce our cost structure, including fixed costs, to streamline our
operations and to reduce product costs;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our ability to focus our business on what we believe to be
potentially higher growth, higher margin businesses and to dispose of or
exit non-core businesses;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | increased price and product competition in the networking industry;
| | - | -------------------------------------------------------------------

| |  | the inherent uncertainties of using forecasts, estimates and
assumptions for asset valuations and in determining the amounts of
accrued liabilities, provisions and other items in our consolidated
financial statements;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the impact of changes in global capital markets and interest rates on
our pension plan assets and obligations;
| | - | --------------------------------------------------------------------------------------------------------------

| |  | our ability to complete our restructuring work plan without
negatively impacting our relationships with our customers, the delivery
of products based on new and developing technologies, the delivery of
high quality robust products at competitive prices, the maintenance of
technological leadership, the effectiveness of our internal processes
and organizations and the retention of qualified personnel;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | fluctuations in our gross margins;
| | - | ----------------------------------

| |  | the development, introduction and market acceptance of new
technologies, and integrated networking solutions, as well as the
adoption of new networking standards;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | variations in sales channels, product costs and the mix of products sold;
| | - | -------------------------------------------------------------------------

| |  | the size and timing of customer orders and shipments;
| | - | -----------------------------------------------------

| |  | our ability to continue to obtain customer performance bonds and contracts;
| | - | ---------------------------------------------------------------------------

| |  | our ability to maintain appropriate inventory levels;
| | - | -----------------------------------------------------

| |  | the impact of acquired businesses and technologies;
| | - | ---------------------------------------------------

| |  | the impact of our product development schedules, product quality
variances, manufacturing capacity and lead times required to produce our
products; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the impact of higher insurance premiums and deductibles and greater
limitations on insurance coverage.
| | - | ------------------------------------------------------------------------------------------------------

Our decision to adopt fair value accounting for employee stock options on a
prospective basis commencing January 1, 2003 will cause us to record an expense
over the stock option vesting period, based on the fair value at the date the
options are granted, and could have a significant negative effect on our
reported results.

Additionally, we are required to perform goodwill impairment tests on an annual
basis and between annual tests in certain circumstances, to value our deferred
tax assets and to accrue unfunded pension liabilities, each of which may result
in a

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negative effect on our reported results.

We enter into agreements that may require us to make certain indemnification
payments to third parties in the event of certain changes in an underlying
economic characteristic related to assets, liabilities or equity securities of
such third parties. We have historically not made any significant
indemnification payments under such agreements. The occurrence of events that
may cause us to become liable to make an indemnification payment is not within
our control and an obligation to make a significant indemnification payment
under such agreements could have a significant negative effect on our reported
results.

Global economic conditions affecting the industry, as well as other trends and
factors affecting the industry, are beyond our control and may result in
reduced demand and pricing pressure on our products.

There are trends and factors affecting the industry that are beyond our control
and may affect our operations. Such trends and factors include:



| |  | adverse changes in the public and private equity and debt markets and
our ability, as well as the ability of our customers and suppliers, to
obtain financing or to fund working capital and capital expenditures;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | adverse changes in our current credit condition or the credit quality of our customers and suppliers;
| | - | -----------------------------------------------------------------------------------------------------

| |  | adverse changes in the market conditions in our industry and the specific markets for our products;
| | - | ---------------------------------------------------------------------------------------------------

| |  | the trend towards the sale of integrated networking solutions;
| | - | --------------------------------------------------------------

| |  | visibility to, and the actual size and timing of, capital expenditures by our customers;
| | - | ----------------------------------------------------------------------------------------

| |  | inventory practices, including the timing of product and service deployment, of our customers;
| | - | ----------------------------------------------------------------------------------------------

| |  | the amount of network capacity and the network capacity utilization
rates of our customers, and the amount of sharing and/or acquisition of
new and/or existing network capacity by our customers;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | policies of our customers regarding utilization of single or multiple
vendors for the products they purchase;
| | - | -------------------------------------------------------------------------------------------------------------

| |  | the overall trend toward industry consolidation and rationalization
among our customers, competitors and suppliers;
| | - | -------------------------------------------------------------------------------------------------------------------

| |  | conditions in the broader market for communications products,
including data networking products and computerized information access
equipment and services;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | changes in legislation or accounting rules and governmental
regulation or intervention affecting communications or data networking;
| | - | -----------------------------------------------------------------------------------------------------------------------------------

| |  | computer viruses, break-ins and similar disruptions from unauthorized
tampering with our computer systems; and
| | - | --------------------------------------------------------------------------------------------------------------

| |  | acts of war or terrorism or transmission of contagious diseases that
could lead to disruptions in general global economic activity, changes
in logistics and security arrangements and reduced customer demand for
our products and services.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Reduced capital spending and negative economic conditions in our industry have
resulted in, and could continue to result in, reduced demand for, or increased
pricing pressures on, our products.

Our auditors have informed our Audit Committee of the existence of material
weaknesses in internal control.

As part of the communications by our independent auditors Deloitte & Touche
LLP, or D&T, to our Audit Committee with respect to D&Ts interim audit
procedures for the year ending December 31, 2003, D&T informed the Audit
Committee that they had identified the following reportable conditions each
of which constituted a material weakness (as each such term is defined under
standards established by the American Institute of Certified Public
Accountants, or the AICPA) in our internal control:



| |  | lack of compliance with our established procedures for monitoring and
adjusting balances relating to certain accruals and provisions,
including restructuring charges; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lack of compliance with our established procedures for appropriately
applying generally accepted accounting principles to the initial
recording of certain liabilities including those described in Financial
Accounting Standards Board Statement (SFAS) No. 5, Accounting for
Contingencies, and to foreign currency translation as described in SFAS
No. 52, Foreign Currency Translation.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

According to the AICPA, a reportable condition is a matter that comes to an
auditors attention that represents a significant deficiency in the design or
operation of internal control that could adversely affect an entitys ability
to initiate, record, process

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and report financial data consistent with the assertions of management in the
financial statements. A material weakness is a reportable condition in which
the design or operation of one or more of the internal control components does
not reduce to a relatively low level the risk that misstatements caused by
error or fraud in amounts that would be material in relation to the financial
statements being audited may occur and not be detected within a timely period
by employees in the normal course of performing their assigned functions.

The material weaknesses noted above, if not addressed, could result in
accounting errors such as those underlying the restatements of our consolidated
financial statements more fully discussed in note 2 of the accompanying
unaudited consolidated financial statements and Recent
developments 
Restatements in the MD&A. Our failure to fully address these material
weaknesses could have a material adverse effect on our business, results of
operations and financial condition. Please see Item 4. Controls and Procedures
below.

Our gross margins may be negatively affected, which in turn would negatively
affect our operating results.

Our gross margins may be negatively affected as a result of a number of
factors, including:



| |  | increased price competition;
| | - | ----------------------------

| |  | excess capacity or excess fixed assets;
| | - | ---------------------------------------

| |  | customer and contract settlement costs;
| | - | ---------------------------------------

| |  | higher product, material or labor costs;
| | - | ----------------------------------------

| |  | increased inventory provisions or contract and customer settlement costs;
| | - | -------------------------------------------------------------------------

| |  | warranty costs;
| | - | ---------------

| |  | obsolescence charges;
| | - | ---------------------

| |  | loss of cost savings on future inventory purchases as a result of high inventory levels;
| | - | ----------------------------------------------------------------------------------------

| |  | introduction of new products and costs of entering new markets;
| | - | ---------------------------------------------------------------

| |  | increased levels of customer services;
| | - | --------------------------------------

| |  | changes in distribution channels;
| | - | ---------------------------------

| |  | changes in product and geographic mix; and
| | - | ------------------------------------------

| |  | accruals for the employee return to profitability bonus plan or other incentive bonuses.
| | - | ----------------------------------------------------------------------------------------

Lower than expected gross margins would negatively affect our operating
results.

We may not be able to attract or retain the specialized technical and
managerial personnel necessary to achieve our business objectives.

Competition for certain key positions and specialized technical personnel in
the high-technology industry remains strong, despite current economic
conditions. We believe that 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 and in our key areas
of potential growth. An important factor in attracting and retaining qualified
employees is our ability to provide employees with the opportunity to
participate in the potential growth of our business through programs such as
stock option plans, restricted stock unit plans and employee investment plans.
The scope of these programs for employees and the value of these opportunities
have been adversely affected by the volatility or negative performance of the
market price for NNCs common shares. We may also find it more difficult to
attract or retain qualified employees because of our recent significant
workforce reductions and business performance which has negatively impacted our
level of incentive programs and incentive compensation plans. In addition, if
we have not properly sized our workforce and retained those employees with the
appropriate skills, our ability to compete effectively may be adversely
affected. We are also more dependent on those employees we have retained, as
many have taken on increased responsibilities due to the workforce reductions.
If we are not successful in attracting, recruiting or retaining qualified
employees, including members of senior management, we may not have the
necessary personnel to effectively compete in the highly dynamic, specialized
and volatile industry in which we operate or to achieve our business
objectives.

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Future cash flow fluctuations may affect our ability to fund our working
capital requirements or achieve our business objectives in a timely manner.

Our working capital requirements and cash flows historically have been, and are
expected to continue to be, subject to quarterly and yearly fluctuations,
depending on such factors as timing and size of capital expenditures, levels of
sales, timing of deliveries and collection of receivables, inventory levels,
customer payment terms, customer financing obligations and supplier terms and
conditions. In addition, due to the current general economic and industry
environment, and our current credit condition, an increased portion of our cash
and cash equivalents may be restricted as cash collateral for customer
performance bonds and contracts, notwithstanding our support facility with EDC.
Our $750 April 2000 five year credit facilities are our only remaining credit
facilities. We continue to have ongoing discussions with our banks and other
financial institutions to explore additional financing opportunities and credit
and support arrangements. As we continue to assess our overall liquidity and
business needs as well as our expected financial performance, we may elect or
it may be necessary to reduce or terminate our $750 April 2000 five year credit
facilities prior to their expiries. We believe our cash on hand will be
sufficient to fund our current business model, manage our investments and meet
our customer commitments for at least the next 12 months. However, a greater
than expected slow down in capital spending by service providers and other
customers may require us to adjust our current business model. As a result,
our revenues and cash flows may be materially lower than we expect and we may
be required to further reduce our capital expenditures and investments or take
other measures in order to meet our cash requirements. We may seek additional
funds from liquidity-generating transactions and other conventional sources of
external financing (which may include a variety of debt, convertible debt
and/or equity financings). We cannot provide any assurance that our net cash
requirements will be as we currently expect, that we will continue to have
access to our $750 April 2000 five year credit facilities or the support
facility with EDC when and as needed, or that liquidity-generating transactions
or financings will be available to us on acceptable terms or at all. Our
inability to manage cash flow fluctuations resulting from the above factors and
the potential reduction or termination of our $750 April 2000 five year credit
facilities or the support facility with EDC could have a material adverse
effect on our ability to fund our working capital requirements from operating
cash flows and other sources of liquidity or to achieve our business objectives
in a timely manner.

Our business may be materially and adversely affected by our high level of
debt.

In order to finance our business we have incurred, and have credit facilities
allowing for draw downs of, and have a shelf registration statement and a base
shelf prospectus for potential offerings of, significant levels of debt
compared to historical levels, and we may need to secure additional sources of
funding, which may include debt or convertible debt financing, in the future.
A high level of debt, arduous or restrictive terms and conditions related to
accessing certain sources of funding, failure to meet the financial and/or
other covenants in our credit and/or support facilities and any significant
reduction in, or access to, such facilities, poor business performance or lower
than expected cash inflows could have adverse consequences on our ability to
fund the operation of our business.

Other effects of a high level of debt include the following:



| |  | we may have difficulty borrowing money in the future or accessing
other sources of funding;
| | - | -------------------------------------------------------------------------------------------

| |  | we may need to use a large portion of our cash flow from operations
to pay principal and interest on our indebtedness, which would reduce
the amount of cash available to finance our operations and other
business activities;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a high debt level, arduous or restrictive terms and conditions, or
lower than expected cash flows would make us more vulnerable to economic
downturns and adverse developments in our business; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | if operating cash flows are not sufficient to meet our operating
expenses, capital expenditures and debt service requirements as they
become due, we may be required, in order to meet our debt service
obligations, to delay or reduce capital expenditures or the introduction
of new products, sell assets and/or forego business opportunities
including acquisitions, research and development projects or product
design enhancements.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our $750 April 2000 five year credit facilities contain a financial covenant.
If we are unable to comply with this covenant, it will adversely affect our
ability to access these credit facilities.

Our $750 April 2000 five year credit facilities include a financial covenant
which requires that our consolidated tangible net worth be not less than $1,888
at any time. We continue to monitor our financial position in light of this
covenant and we expect that if we incur net losses or record additional charges
related to our restructuring work plan, the accounting for our

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registered pension plans, the valuation of deferred income tax assets or for
other events, our consolidated tangible net worth may be reduced below the
$1,888 threshold. If we are unable to comply with this covenant, we will be
unable to access these credit facilities.

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

Our support facility with EDC may not provide all the support we require in
respect of certain of our obligations arising out of our normal course of
business activities. In particular, although this facility provides for up to
$750 in support, only $300 is committed support for performance bonds. In
addition, bid and performance related bonds with terms that extend beyond
December 31, 2005, which is the expiry date of this facility, are currently not
eligible for the support provided by this facility. Unless EDC agrees to an
extension of the facility or agrees to provide support outside the scope of the
facility, we may be required to provide cash collateral to support these
obligations. We cannot provide any assurance that we will reach an agreement
with EDC on these matters. We are also in discussions with banks and financial
institutions regarding arrangements, in addition to the support facility with
EDC, that would provide for additional support, possibly on a secured basis, of
these obligations, which include letters of credit, letters of guarantee,
indemnity arrangements, performance bonds, surety bonds, receivables purchases,
securitizations and similar instruments and arrangements. We cannot provide
any assurance that such discussions will result in satisfactory arrangements.
If we are unable to successfully conclude these arrangements and do not have
access to sufficient support for such obligations under the support facility
with EDC, an increased portion of our cash and cash equivalents may be
restricted as cash collateral provided as security for these obligations, which
could adversely affect our ability to support some of our normal course
business activities and our ability to borrow in the future.

Changes in respect of our public debt ratings or current credit condition may
materially and adversely affect the availability, the cost and the terms and
conditions of our debt and existing and alternative financing arrangements.

Certain of our outstanding debt instruments are publicly rated by independent
rating agencies, which ratings are below investment grade. These public debt
ratings and our current credit condition affect our ability to raise debt, our
access to the commercial paper market (which is currently closed to us), our
ability to engage in alternative financing arrangements, our ability to engage
in normal course derivative or hedging transactions and our ability to obtain
customer bid, performance related and other bonds and contracts. These public
debt ratings have also caused the security that we granted to certain banks and
holders of our outstanding public debt under our existing security agreements
to become effective. This security, which consists of pledges of substantially
all of our assets, will continue to apply to our obligations under the $750
April 2000 five year credit facilities, the support facility with EDC and our
outstanding public debt, unless such credit facilities are terminated or
expire, and such support facility expires or alternative collateral is
provided, or such public debt ratings return to investment grade (as specified
in the credit facilities) or higher. The continued existence of such security
arrangements may adversely affect our ability to incur additional debt or
obtain alternative financing arrangements. In addition, EDC is not obligated
to make any support available unless certain customary conditions are satisfied
and our senior long-term debt rating by Moodys has not been downgraded to less
than B3 and that our debt rating by S&P has not been downgraded to less than
B-.

Our current credit condition requires us, in addition to the payment of higher
fees, to also post cash collateral to secure certain bid, performance related
and other bonds and may also negatively affect the cost to us and terms and
conditions of debt and alternative financing arrangements. Additionally, any
negative developments regarding our cash flow, public debt ratings, current
credit condition and/or our incurring significant levels of debt, or our
failure to meet certain covenants under our credit and/or support facilities,
could cause us to lose access to and/or cause a default under such facilities
and/or adversely affect further the cost and terms and conditions of our debt
and alternative financing arrangements.

An inability of our subsidiaries to provide us with funding in sufficient
amounts could adversely affect our ability to meet our obligations.

We may at times depend primarily on loans, dividends or other forms of
financing from our subsidiaries to meet our obligations for payment of interest
and principal on outstanding public debt and corporate expenses. An inability
of our subsidiaries to pay dividends or provide loans or other forms of
financing in sufficient amounts could adversely affect our ability to meet
these obligations.

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We have risks related to our defined benefit plans.

We currently maintain various defined benefit plans in North America and the
United Kingdom which cover various categories of employees and retirees. 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 the actual operation of the plans differs from the
assumptions, additional contributions by us may be required. The equity
markets can be, and recently have been, very volatile, and therefore our
estimate of future contribution requirements can change significantly in a
short period of time. Similarly, changes in interest rates can impact our
contribution requirements. In a low interest rate environment, the likelihood
of required contributions in the future increases. If we are required to make
significant contributions to fund the defined benefit plans, our reported
results could be materially and adversely affected and our cash flow available
for other uses may be significantly reduced.

If market conditions deteriorate further or future results of operations are
less than expected, an additional valuation allowance may be required for all
or a portion of our deferred tax assets.

We currently have deferred tax assets, which may be used to reduce taxable
income in the future. We assess the realization of these deferred tax assets
quarterly, and if we determine that it is more likely than not that some
portion of these assets will not be realized, an income tax valuation allowance
is recorded. Our valuation allowance is primarily attributable to continued
uncertainty in the industry. If market conditions deteriorate further or
future results of operations are less than expected, future assessments may
result in a determination that it is more likely than not that some or all of
the net deferred tax assets are not realizable. As a result, we may need to
establish an additional valuation allowance for all or a portion of the net
deferred tax assets, which may have a material adverse effect on our business,
results of operations and financial condition.

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 the growth of data traffic and the use of the
Internet will significantly impact traditional voice networks, both wireline
and wireless. We believe that this will create market discontinuities. By
market discontinuities, we mean opportunities for new technologies,
applications, products and services that enable the secure, rapid and efficient
transport of large volumes of information over networks and allow service
providers and carriers to increase revenues and improve operating results.
Market discontinuities will also make traditional voice network products and
services less effective as they were not designed for data traffic. We believe
that these market discontinuities in turn will lead to the convergence of data
and voice through upgrades of traditional voice networks to transport large
volumes of data traffic or through the construction of new networks designed to
transport both voice and data traffic. Either approach would require
significant capital expenditures by service providers. We also believe that
such developments will give rise to the demand for IP optimized networking
solutions, and third generation, or 3G, wireless networks. IP is the
predominant method by which data is sent from one computer to another on the
Internet  a data message is divided into smaller packets which contain both
the senders unique IP address and the receivers unique IP address, and each
packet is sent, potentially by different routes and as independent units,
across the Internet. There is no continuing connection between the end points
which are communicating versus traditional telephone communications which
involve establishing a fixed circuit that is maintained for the duration of the
voice or data communications call. 3G wireless networks are an evolution of
communications networks from second generation wireless networks for voice and
low speed data communications that are based on circuit switching  when a call
is dialed, a circuit is established between the mobile handset and the third
party, and the connection lasts for the duration of the call. By comparison,
3G networks allow devices to be always on because the networks are
packet-based. We expect 3G wireless networks to include such features as
voice, high speed data communications and high bandwidth multimedia
capabilities, and usability on a variety of different communications devices,
such as cellular telephones and pagers, with the user having accessibility
anywhere and at any time to these features.

We cannot be sure what the rate of such convergence of voice and data networks
will be, due to the dynamic and rapidly evolving nature of the communications
business, the technology involved and the availability of capital.
Consequently, market discontinuities and the resulting demand for IP-optimized
networking solutions or 3G wireless networks may not materialize.
Alternatively, the pace of that development may be slower than currently
anticipated. It may also be the case that the market may develop in an
unforeseen direction. Certain events, including the commercial availability
and actual implementation of new technologies, including 3G networks, or the
evolution of other technologies, may occur which would affect the extent or
timing of anticipated market demand, or increase demand for products based on
other technologies, or

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reduce the demand for IP-optimized networking solutions or 3G wireless
networks, which in turn may reduce purchases of our networking solutions by our
customers, require increased expenditures to develop and market different
technologies, or provide market opportunities for our competitors. Our
performance may also be materially and adversely affected by a lack of growth
in the rate of data traffic, a reduction in the use of the Internet or a
reduction in the demand for IP-optimized networking solutions or 3G wireless
networks in the future.

We have made, and may continue to make, strategic acquisitions in order to
enhance our business. If we are not successful in operating or integrating
these acquisitions, our business, results of operations and financial condition
may be materially and adversely affected.

In the past, we acquired companies to enhance the expansion of our business and
products. We may consider selective opportunistic acquisitions of companies or
businesses with resources and product or service offerings capable of providing
us with additional product and/or market strengths to help fulfill our vision
of transforming how the world communicates and exchanges information.
Acquisitions involve significant risks and uncertainties. These risks and
uncertainties include:



| |  | the risk that the industry may develop in a different direction than
anticipated and that the technologies we acquire do not prove to be
those we need to be successful in the industry;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the risk that future valuations of acquired businesses may decrease
from the market price we paid for these acquisitions;
| | - | -------------------------------------------------------------------------------------------------------------------------

| |  | the generation of insufficient revenues by acquired businesses to
offset increased operating expenses associated with these acquisitions;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | the potential difficulties in completing in-process research and
development projects and delivering high quality products to our
customers;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

| |  | the potential difficulties in integrating new products, businesses
and operations in an efficient and effective manner;
| | - | -----------------------------------------------------------------------------------------------------------------------

| |  | the risk that our customers or customers of the acquired businesses
may defer purchase decisions as they evaluate the impact of the
acquisitions on our future product strategy;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the potential loss of key employees of the acquired businesses;
| | - | ---------------------------------------------------------------

| |  | the risk that acquired businesses will divert the attention of our
senior management from the operation of our business;
| | - | ------------------------------------------------------------------------------------------------------------------------

| |  | the risks of entering new markets in which we have limited experience
and where competitors may have a stronger market presence; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------

| |  | potential assumption of liabilities.
| | - | ------------------------------------

Our inability to successfully operate and integrate newly acquired businesses
appropriately, effectively and in a timely manner could have a material adverse
effect on our ability to take advantage of further growth in demand for
IP-optimized network solutions and other advances in technology, as well as on
our revenues, gross margins and expenses.

We operate in highly dynamic and volatile industries characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions and short product life cycles.

The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. We expect our success to depend, in substantial
part, on the timely and successful introduction of high quality, new products
and upgrades, 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 operate with products of other suppliers, to 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 development of new, technologically advanced
products, including IP-optimized networking solutions, software products and 3G
wireless networks, is a complex and uncertain process requiring high levels of
innovation, as well as the accurate anticipation of technological and market
trends. Investments in such development may result in expenses growing at a
faster rate than revenues, particularly since the initial investment to bring a
product to market may be high. 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.

The success of new or enhanced products, including IP-optimized networking
solutions and 3G wireless networks, depends on a number of other factors,
including the timely introduction of such products, market acceptance of new
technologies and

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industry standards, the quality and robustness of new or enhanced products,
competing product offerings, the pricing and marketing of such products and the
availability of funding for such networks. Products and technologies developed
by our competitors may render our products obsolete. Hackers may attempt to
disrupt or exploit our customers use of our technologies. 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, and our sales, market share and
customer relationships could be materially and adversely affected.

In addition, unanticipated changes in market demand for products based on a
specific technology, particularly lower than anticipated, or delays in, demand
for IP-optimized networking solutions, particularly long-haul and metro optical
networking solutions, or 3G wireless networks, could have a material adverse
effect on our business, results of operations and financial condition if we
fail to respond to such changes in a timely and effective manner.

We face significant competition and 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, vigorous competition for market share and
rapid technological development. Competition is heightened in periods of slow
overall market growth. These factors could result in aggressive pricing
practices and growing competition from smaller niche companies, established
competitors, as well as well-capitalized computer systems and communications
companies, which, in turn, could have a material adverse effect on our gross
margins.

Our major competitors in Wireless Networks have traditionally included
Telefonaktiebolagat LM Ericsson, Lucent Technologies Inc., Motorola, Inc.,
Siemens Aktiengesellschaft and Nokia Corporation. More recently, Samsung
Electronics Co., Ltd. and Huawei Technologies Co., Ltd. have emerged as
competitors. Our principal competitors in the sale of our Enterprise Networks
solutions to enterprises are Cisco Systems, Inc., Avaya Inc., Alcatel S.A., and
Siemens. We also compete with smaller companies that address specific niches,
such as Foundry Networks, Inc., Extreme Networks, Inc., Enteresys Networks,
Inc., 3Com Corporation and Genesys Telecommunications Laboratories, Inc. Our
principal competitors in the sale of our Wireline Networks products to service
providers are large communications companies such as Cisco, Lucent, Alcatel and
Siemens. In addition, we compete with smaller companies that address specific
niches within this market, such as Sonus Systems Limited, BroadSoft, Inc.,
Taqua Inc., Redback Networks Inc., Equipe Communications Corporation, Laurel
Networks, Inc. and WaveSmith Networks, Inc. Certain competitors are also
strong on a regional basis, such as ZTE Corporation and Huawei. Our major
competitors in Optical Networks include Alcatel, Lucent, Siemens, Marconi plc,
Cisco, Huawei, NEC Corporation, Ciena Corporation and ADVA International Inc.
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 become principal competitors in the future. We may
also face competition from the resale of used telecommunications equipment,
including our own on occasion, by failed, downsized or consolidated high
technology enterprises and telecommunications service providers. In addition,
one way to maximize market growth, enhance existing products and introduce new
products is through acquisitions of companies, where advisable. Certain of our
competitors may enter into additional business combinations, to accelerate
product development, or to engage in aggressive price reductions or other
competitive practices, creating even more powerful or aggressive competitors.
We expect that we will face additional competition from existing competitors
and from a number of companies that have entered or may enter our existing and
future markets. Some of our current and potential competitors have greater
marketing, technical and financial resources, including access to capital
markets and/or the ability to provide customer financing in connection with the
sale of products. Many of our current and potential competitors have also
established, or may in the future establish, relationships with our current and
potential customers. Other competitive factors include the ability to provide
new technologies and products, end-to-end networking solutions, and new product
features, such as security, as well as conformance to industry standards.
Increased competition could result in price reductions, negatively affecting
our operating results, reducing profit margins and potentially leading to a
loss of market share.

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We face certain barriers in our efforts to expand internationally.

We intend to continue to pursue international and emerging market growth
opportunities. In many international markets, long-standing relationships
between potential customers and their local suppliers and protective
regulations, including local content requirements and type approvals, create
barriers to entry. In addition, pursuing international opportunities may
require significant investments for an extended period before we realize
returns on such investments, if any, and such investments may result in
expenses growing at a faster rate than revenues. Furthermore, such projects
and investments could be adversely affected by:



| |  | reversals or delays in the opening of foreign markets to new competitors;
| | - | -------------------------------------------------------------------------

| |  | trade protection measures;
| | - | --------------------------

| |  | exchange controls;
| | - | ------------------

| |  | currency fluctuations;
| | - | ----------------------

| |  | investment policies;
| | - | --------------------

| |  | restrictions on repatriation of cash;
| | - | -------------------------------------

| |  | nationalization of local industry;
| | - | ----------------------------------

| |  | economic, social and political risks;
| | - | -------------------------------------

| |  | taxation;
| | - | ---------

| |  | interest rates;
| | - | ---------------

| |  | challenges in staffing and managing international opportunities;
| | - | ----------------------------------------------------------------

| |  | other factors, depending on the country involved; and
| | - | -----------------------------------------------------

| |  | acts of war or terrorism or the transmission of contagious diseases.
| | - | --------------------------------------------------------------------

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 or expand our business in international and emerging markets could
have a material adverse effect on our business, results of operations and
financial condition.

Fluctuating foreign currencies may negatively impact our business, results of
operations and financial condition.

As an increasing proportion of our business may be denominated in currencies
other than United States dollars, fluctuations in foreign currencies may have
an impact on our business, results of operations, and financial condition. Our
primary currency exposures are to Canadian dollars, United Kingdom pounds and
the euro. These exposures may change over time as we change the geographic mix
of our global business and as our business practices evolve. For instance, if
we increase our presence in emerging markets, we may see an increase in our
exposure to such emerging market currencies, such as, for example, the Chinese
Renminbi. These currencies may be affected by internal factors, and external
developments in other countries, all of which can have an adverse impact on a
countrys currency. Also, availability to enter into normal course derivative
or hedging transactions in the future may be impacted by our current credit
condition. We cannot predict whether foreign exchange losses will be incurred
in the future, and significant foreign exchange fluctuations may have a
material adverse effect on our results of operations.

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We may become involved in disputes regarding intellectual property rights that
could materially and adversely affect our business if we do not prevail.

Our industry is subject to uncertainty over adoption of industry standards and
protection of intellectual property rights. Our success is dependent on our
proprietary technology, for the protection of which we rely on patent,
copyright, trademark and trade secret laws. While our business is global in
nature, the level of protection of our proprietary technology provided by such
laws varies by country. Our issued patents may be challenged, invalidated or
circumvented, and our rights under issued patents may not provide us with
competitive advantages. Patents may not be issued from pending applications,
and claims in patents issued in the future may not be sufficiently broad to
protect our proprietary technology. In addition, claims of intellectual
property infringement or trade secret misappropriation may be asserted against
us or our customers in connection with their use of our products and the
outcome of any such claims are uncertain. A failure by us to react to changing
industry standards, the lack of broadly-accepted industry standards, successful
claims of intellectual property infringement or other intellectual property
claims against us or our customers, or a failure by us to protect our
proprietary technology, could have a material adverse effect on our business,
results of operations and financial condition. In addition, if others infringe
on our intellectual property rights, we may not be able to successfully contest
such challenges.

Rationalization and consolidation in the industry may cause us to experience a
loss of customers and increased competition.

The industry has experienced the consolidation and rationalization of industry
participants and this trend may continue. There have been adverse changes in
the public and private equity and debt markets for industry participants which
have affected their ability to obtain financing or to fund capital
expenditures. Some operators have experienced financial difficulty and have,
or may, file for bankruptcy protection or be acquired by other operators.
Other operators may merge and we and one or more of our competitors may each
supply products to the companies that have merged or will merge. This
rationalization and/or consolidation could result in our dependence on a
smaller number of customers, purchasing decision delays by the merged companies
and/or our playing a lesser role, or no longer playing a role, in the supply of
communications products to the merged companies. This rationalization and/or
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. A rationalization of
industry participants could also increase the supply of used communications
products for resale by affected industry participants, resulting in increased
competition and pressure on the pricing for our new products. In addition,
telecommunications equipment suppliers may enter into business combinations, or
may be acquired by or sell a substantial portion of their assets to other
competitors, resulting in accelerated product development, increased financial
strength, or a broader base of customers, creating even more powerful or
aggressive competitors. We may also see rationalization among
equipment/component suppliers. The business failures of operators, competitors
or suppliers may cause uncertainty among investors and in the industry
generally.

Changes in regulation of the Internet and/or other aspects of the industry may
affect the manner in which we conduct our business and may materially and
adversely affect our business, results of operations and financial condition.

Investment decisions of our customers could be affected by regulation of the
Internet in any country where we operate. We could also be materially and
adversely affected by an increase in competition among equipment suppliers or
by reduced capital spending by our customers, as a result of a change in the
regulation of the industry. On February 20, 2003, the United States Federal
Communications Commission, or the FCC, announced a decision in its triennial
review proceeding of the agencys rules regarding unbundled network elements,
or UNEs. The text of the FCCs order, including an explanation of the reasons
for the decision, was released on August 21, 2003. Certain parties have filed
petitions with the FCC for the decision to be reconsidered and have appealed
the decision to the United States federal courts. The uncertainty surrounding
the FCC decision is affecting, and may continue to affect, the decisions of our
United States based service provider customers regarding investment in
telecommunications infrastructure and the extent of the impact of the FCC
decision continues to be assessed. If a jurisdiction in which we operate
adopts measures which affect the regulation of the Internet and/or other
aspects of the industry, we could experience both decreased demand for our
products and increased costs of selling such products. Changes in laws or
regulations governing the Internet, Internet commerce and/or other aspects of
the industry could have a material adverse effect on our business, results of
operations and financial condition.

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The downturn in the economy could continue and increase our exposure to our
customers credit risk and the risk that our customers will not be able to
fulfill their payment obligations to us under customer financing arrangements.

The competitive environment in which we operate has required us in the past to
provide significant amounts of medium-term and long-term customer financing.
Customer financing arrangements may include financing in connection with the
sale of our products and services, funding for certain non-product and service
costs associated with network installation and integration of our products and
services, financing for working capital and equity financing. While we have
significantly reduced our customer financing exposure, we expect we may
continue in the future to provide customer financing to customers in areas that
are strategic to our core business activity.

We expect to continue to hold most current and future customer financing
obligations for longer periods prior to any possible placement with third-party
lenders, due to, among other factors, recent economic uncertainty in various
countries, adverse capital market conditions, our current credit condition,
adverse changes in the credit quality of our customers and reduced demand for
telecommunications financing in capital and bank markets. In addition, risks
generally associated with customer financing, including the risks associated
with new technologies, new network construction, market demand and competition,
customer business plan viability and funding risks, may require us to hold
certain customer financing obligations over a longer term. We may not be able
to place any of our current or future customer financing obligations with
third-party lenders on acceptable terms.

Certain customers have been experiencing financial difficulties and have failed
to meet their financial obligations. As a result, we have incurred charges for
increased provisions related to certain trade and customer financing
receivables. If there are further increases in the failure of our customers to
meet their customer financing and receivables obligations to us or if the
assumptions underlying the amount of provisions we have taken with respect to
customer financing and receivables obligations do not reflect actual future
financial conditions and customer payment levels, we could incur losses in
excess of our provisions, which could have a material adverse effect on our
cash flow and operating results.

Negative developments associated with our supply and network outsourcing
contracts and contract manufacturing agreements may materially and adversely
affect our business, results of operations, financial condition and supply
relationships.

We have entered into supply contracts with customers to provide products and
services, which in some cases involve new technologies currently being
developed, or which we have not yet commercially deployed, or which require us
to build and operate networks. We have also entered into network outsourcing
contracts with customers to operate their networks. Some of these supply and
network outsourcing contracts contain delivery and installation timetables,
performance criteria and other contractual obligations which, if not met, could
result in our having to pay substantial penalties or liquidated damages, the
termination of the related supply or network outsourcing contract, and/or the
reduction of shared revenues, in certain circumstances. Unexpected
developments in these supply and outsourcing contracts could have a material
adverse effect on our revenues, cash flows and relationships with our
customers.

Our ability to meet customer demand is, in part, dependent on us obtaining
timely and adequate component parts and products from suppliers, contract
manufacturers, and internal manufacturing capacity. As part of the
transformation of our supply chain from a vertically integrated manufacturing
model to a virtually integrated model, we have outsourced a substantial portion
of our manufacturing capacity to contract manufacturers. We work closely with
our suppliers and contract manufacturers to address quality issues and to meet
increases in customer demand, when needed, and we also manage our internal
manufacturing capacity, quality, and inventory levels as required. However, we
may encounter shortages of quality components and/or products in the future.
In addition, our component suppliers and contract manufacturers have
experienced, and may continue to experience, a consolidation in the industry
and financial difficulties, both of which may result in fewer sources of
components or products and greater exposure to the financial stability of our
suppliers. A reduction or interruption in component supply 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.

Our business may suffer if strategic alliances which we have entered into are
not successful.

We have entered into a number of strategic alliances with suppliers, developers
and members in our industry to facilitate product compatibility, encourage
adoption of industry standards or to offer complementary product or service
offerings to meet customer needs. In some cases, the companies with which we
have strategic alliances also compete against us in some of

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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.

The adverse resolution of litigation against us could negatively impact our
business. We are also subject to the risk of additional litigation and
regulatory proceedings or actions in connection with the restatement of prior
period financial statements.

We and/or NNC are currently defendants in numerous class actions and other
lawsuits, including lawsuits initiated against NNC and certain of its officers
and directors on behalf of holders of NNCs common shares, which seek damages
of material and indeterminate amounts, as well as lawsuits in the normal course
of business. We are and may in the future be subject to other litigation
arising in the normal course of our business.

We may in the future be subject to additional class actions, other securities
litigation or other proceedings or actions arising in relation to the
restatement of our and/or NNCs prior period financial statements. In
connection with the announcement of the restatements, we notified the
appropriate regulatory authorities, including the SEC, the Ontario Securities
Commission, the New York Stock Exchange and the Toronto Stock Exchange, of our
intent to restate previously reported results, and we are co-operating with
inquiries from certain of such regulatory authorities. An independent review
is being conducted by the Audit Committee to examine the facts and
circumstances leading to the need to restate our financial statements for the
relevant periods and to consider appropriate improvements to our processes and
procedures. The law firm of Wilmer, Cutler & Pickering has been retained by
and will report to our Audit Committee for such purposes. There can be no
assurance that the outcome of the independent review will not have a material
adverse effect on our business, results of operations and financial condition.

Litigation and any potential regulatory proceeding or action may be time
consuming, expensive and distracting from the conduct of our business, and the
outcome of litigation and any potential regulatory proceeding or action is
difficult to predict. The adverse resolution of any specific lawsuit or any
potential regulatory proceeding or action could have a material adverse effect
on our business, results of operations and financial condition. To the extent
expenses incurred in connection with litigation or any potential regulatory
proceeding or action (which may include substantial fees of attorneys and other
professional advisors and potential obligations to indemnify officers and
directors who may be parties to such actions) are not covered by available
insurance, such expenses could adversely affect our cash position.

Recent accounting pronouncements

For a discussion of recent pronouncements, see Significant accounting
policies in note 1 of the accompanying unaudited consolidated financial
statements.

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ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact the consolidated
financial statements of Nortel Networks due to adverse changes in financial
market prices and rates. Nortel Networks market risk exposure is primarily a
result of fluctuations in interest rates and foreign exchange rates. Disclosure
of market risk is contained in our 2002 Annual Report.

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ITEM 4.  Controls and Procedures

This Item 4 has been updated to reflect the restatements as well as for events
and developments subsequent to March 31, 2003.



|(a) Evaluation of Disclosure Controls and Procedures
|----------------------------------------------------

Subsequent to the evaluation referenced in Nortel Networks Quarterly Report on
Form 10-Q for the period ended March 31, 2003 filed with the Securities and
Exchange Commission (the SEC) on May 9, 2003, Nortel Networks has re-evaluated
the effectiveness of the design and operation of Nortel Networks disclosure
controls and procedures as of the end of the period covered by this report
under the supervision and with the participation of management, including the
President and Chief Executive Officer and the Chief Financial Officer, pursuant
to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the
Exchange Act), in light of the restatements and the identification of certain
material weaknesses discussed below.

In connection with the comprehensive and related reviews and work undertaken in
connection with the restatements of Nortel Networks financial statements for
the years ended December 31, 2002, 2001 and 2000 and the quarterly periods
ended March 31 and June 30, 2003 (as more fully described in note 2 to the
accompanying (unaudited) consolidated financial statements and Recent developments  Restatements in the MD&A), Nortel Networks identified a number of
deficiencies in Nortel Networks internal control over financial reporting. In
addition, as part of the communications by Nortel Networks independent auditors
Deloitte & Touche LLP (D&T) to the Nortel Networks Audit Committee with
respect to D&Ts interim audit procedures for the year ending December 31,
2003, D&T informed the Audit Committee that they had identified the following
reportable conditions each of which constituted a material weakness (as
each such term is defined under standards established by the American Institute
of Certified Public Accountants) in Nortel Networks internal control:



| |  | lack of compliance with established Nortel Networks procedures for
monitoring and adjusting balances relating to certain accruals and
provisions, including restructuring charges; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | lack of compliance with established Nortel Networks procedures for
appropriately applying generally accepted accounting principles to the
initial recording of certain liabilities including those described in
Financial Accounting Standards Board Statement (SFAS) No. 5,
Accounting for Contingencies, and to foreign currency translation as
described in SFAS No. 52, Foreign Currency Translation.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Please see Our auditors have informed our Audit Committee of the existence of
material weaknesses in internal control in Forward looking statements above.

Based on the re-evaluation described above and D&Ts communication to the Nortel
Networks Audit Committee, the President and Chief Executive Officer and the
Chief Financial Officer have concluded that these material weaknesses, if not
addressed, could result in accounting errors such as those underlying the
restatements of the Nortel Networks consolidated financial statements. In this
regard, and as noted in connection with this re-evaluation, Nortel Networks has already undertaken changes to its internal control
over financial reporting by initiating more thorough reviews of its balance
sheet accounts at appropriate levels within Nortel Networks finance
organization across all of its segments and major geographic regions. The
President and Chief Executive Officer and the Chief Financial Officer further
concluded, based on such re-evaluation, that the design and
operation of Nortel Networks disclosure controls and procedures were effective,
in all material respects, to ensure that information required to be disclosed
in the reports Nortel Networks files and submits under the Exchange Act is
recorded, processed, summarized and reported as and when required, except for
the material weaknesses identified above.



|(b) Changes in Internal Control
|-------------------------------

Nortel Networks initiated, and disclosed in its Quarterly Report on Form 10-Q
for the period ended June 30, 2003, a comprehensive review and analysis of its
assets and liabilities. On October 23, 2003, Nortel Networks announced it would
restate its consolidated financial statements for the years ended December 31,
2002, 2001 and 2000 and the fiscal quarters ended March 31, 2003 and June 30,
2003. The restatements primarily relate to the determination by Nortel
Networks that $909 and $924 of liabilities (primarily accruals and provisions)
carried on its previously reported balance sheet as at March 31,

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2003 and December 31, 2002, respectively, needed to be released to income.
These provisions were either initially recorded incorrectly in prior periods or
not properly released or adjusted for changes in estimates in the appropriate
periods. In certain cases, costs were incorrectly charged to operations rather
than to the appropriate provisions. Following its determination to restate its
financial statements, Nortel Networks also determined that it would correct
certain known errors that were previously not recorded because the amount of
the errors was not material to the consolidated financial statements.
Specifically, among other items, Nortel Networks has made certain revenue
adjustments to reflect revenue which should have been deferred instead of
recognized in a particular period. Also, as part of the restatements, Nortel
Networks made adjustments to correct errors relating to its deferred income tax
assets and foreign currency translation accounts. The net effect of the
restatement adjustments to Nortel Networks accumulated deficit as at March 31,
2003 was $442. Please see note 2 to the accompanying (unaudited) consolidated
financial statements and Recent developments  Restatements in the MD&A for
further information concerning the restatements and their impact on Nortel
Networks financials statements.

An independent review is being conducted by the Audit Committee to examine the
facts and circumstances, leading to the need to restate Nortel Networks financial
statements for the relevant periods and to consider appropriate improvements to
Nortel Networks processes and procedures. The law firm of Wilmer, Cutler & Pickering has
been retained by and will report to the Audit Committee for such purposes. In
addition to considering the implementation of such changes or improvements to
processes and procedures as may be recommended in connection with the
independent review, senior management intends to take steps to strengthen
Nortel Networks internal control over financial reporting and prevent a
recurrence of the circumstances that resulted in the need for the restatements.
As noted above, Nortel Networks has already undertaken changes to its internal
control over financial reporting by initiating more thorough reviews of its
balance sheet accounts at appropriate levels within Nortel Networks finance
organization across all of its segments and major geographic regions. In
addition, Nortel Networks plans to:



| |  | assess the organizational structure of the finance department, including to determine whether additional resources need to
be dedicated to it;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  | increase training of finance personnel including with respect to financial reporting responsibilities and enhanced
understanding of generally accepted accounting principles;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | modify the mandate of Nortel Networks internal audit function to place a greater emphasis on the adequacy of, and
compliance with, procedures relating to internal control over financial reporting;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | evaluate potential improvements to Nortel Networks accounting and information management systems; and
| | - | -----------------------------------------------------------------------------------------------------



| |  | modify the process by which journal entries are reviewed and posted on Nortel Networks general ledger.
| | - | ------------------------------------------------------------------------------------------------------

The Audit Committee and senior management plan to consider both prior to and
after receiving the results of the independent review whether additional
measures may be necessary to improve Nortel Networks internal control over
financial reporting.

There has been no change in Nortel
Networks internal control over financial reporting during the period covered by
this report or, with the exception of the items noted above, in the period ended September 30, 2003 covered by Nortel
Networks Quarterly Report on Form 10-Q filed with the SEC on
November 19, 2003, and subsequently amended on November 28,
2003,
that has materially affected or is reasonably likely to materially affect Nortel Networks
internal control over financial reporting.

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PART II




ITEM 6. Exhibits And Reports On Form 8-K

The information set forth in this Item 6 has not been revised to reflect events
and developments subsequent to March 31, 2003, except for Exhibits 31.1, 31.2
and 32.



|(a) |  | Exhibits:
|--- |  | ---------



|10.1 |  | Nortel Networks Limited Restricted Stock Unit Plan, as amended and restated effective January 23, 2003.*
|---- |  | --------------------------------------------------------------------------------------------------------



|10.2 |  | Nortel Networks Limited SUCCESS Plan, as amended and restated effective January 1, 2003.*
|---- |  | -----------------------------------------------------------------------------------------



|31.1 |  | Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



|31.2 |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



|32 |  | Certification of the President and Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) |  | Reports on Form 8-K:
|--- |  | --------------------



| |  | Nortel Networks Limited furnished a Current Report on Form 8-K dated January 23, 2003 related to its
financial results for the fourth quarter and year 2002.
Nortel Networks Limited filed a Current Report on Form 8-K dated January 24, 2003 related to its financial
results for the fourth quarter and year 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Limited filed a Current Report on Form 8-K dated February 14, 2003 related to the
announcement of a US$750 million support facility between Nortel Networks Limited and Export Development
Canada, and the announcement of special matters to be considered at the upcoming annual and special meeting
of shareholders of Nortel Networks Corporation, including a proposal for the shareholders to grant the Board
of Directors of Nortel Networks Corporation the authority to implement a consolidation of outstanding common
shares, in its sole discretion, and a proposal reconfirming and approving amendments to Nortel Networks
Corporations shareholder rights plan.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Limited filed a Current Report on Form 8-K dated April 24, 2003 related to its financial
results for the first quarter of 2003.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Limited furnished a Current Report on Form 8-K
dated April 24, 2003 related to its financial results for the first quarter of 2003.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |                                                                                                                                                   
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------
| |  | *    Previously filed as an exhibit to the Originally Filed 10-Q, which was filed with the Securities and Exchange
Commission on May 9,      2003.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

NORTEL NETWORKS LIMITED
(Registrant)

Chief Financial Officer
    
    Chief Accounting OfficerD.C. BEATTY
    
    M.J. GOLLOGLYD.C. BEATTY
Chief Financial Officer
    
    M.J. GOLLOGLY
Controller


Date: December 23, 2003

81