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

FORM 10-Q

|  |  |                                                                                                                                       | 
|- |  | ------------------------------------------------------------------------------------------------------------------------------------- | 
|x |  | Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934 
For the Quarterly Period Ended June 30, 2003

OR

|  |  |                                                                                          | 
|- |  | ---------------------------------------------------------------------------------------- | 
|o |  | Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934

For the Transition Period From _____________________ to _____________________

Commission file number 000-30758

Nortel Networks Limited(Exact name of registrant as specified in its charter)

|                                                                      |  |                                                 
|--------------------------------------------------------------------- |  | ------------------------------------------------
|Canada
(State or other jurisdiction of incorporation or organization) |  | 62-12-62580
(I.R.S. Employer Identification No.)

|                                                                                              |  |                   
|--------------------------------------------------------------------------------------------- |  | ------------------
|8200 Dixie Road, Suite 100
Brampton, Ontario, Canada
(Address of principal executive offices) |  | L6T 5P6
(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). Yes ü     
        No

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as at July 31, 2003

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



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TABLE OF CONTENTS



|                             |                                                                                               |                                       |  |  |  |  |  | 
|---------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------- |  |  |  |  |  | 
|PART I FINANCIAL INFORMATION
|                             | ITEM 1. Consolidated Financial Statements (unaudited)                                        
|                             | ITEM 1. Consolidated Financial Statements (unaudited)                                        
|                             |                                                                                               | Consolidated Statements of Operations
|                             |                                                                                               | Consolidated Balance Sheets          
|                             |                                                                                               | Consolidated Statements of Cash Flows
|                             | 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 OTHER INFORMATION   
|                             | ITEM 1. Legal Proceedings                                                                    
|                             | ITEM 4. Submissions Of Matters To A Vote Of Security Holders                                 
|                             | ITEM 6. Exhibits And Reports On Form 8-K                                                     
|SIGNATURES                  
|Exhibit 10.1                
|Exhibit 10.2                
|Exhibit 10.3                
|Exhibit 31.1                
|Exhibit 31.2                
|Exhibit 32                  



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TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

PAGEITEM 1.
    
    Consolidated Financial Statements (unaudited)
    
    
    3ITEM 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    32ITEM 3.
    
    Quantitative and Qualitative Disclosures About
Market Risk
    
    
    72ITEM 4.
    
    Controls and Procedures
    
    
    72PART II
OTHER INFORMATIONITEM 1.
    
    Legal Proceedings
    
    
    73ITEM 4.
    
    Submissions of Matters to a Vote of Security Holders
    
    
    73ITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    
    73Signatures
    
    
    
    
    75


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 Investor Services, Inc.
S&P 100, S&P 500 and STANDARD & POORS are trademarks of The McGraw-Hill Companies, Inc.

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PART I
FINANCIAL INFORMATION




ITEM 1.
    
    Consolidated Financial Statements (unaudited)PAGEConsolidated Statements of Operations
    
    
    4Consolidated Balance Sheets
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Notes to Consolidated Financial Statements
    
    
    7


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NORTEL NETWORKS LIMITED

Consolidated Statements of Operations (unaudited)

Three months ended June 30,
    
    
    Six months ended June 30,(millions of U.S. dollars)
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002Revenues
    
    $
    2,328
    
    
    $
    2,770
    
    
    $
    4,725
    
    
    $
    5,680Cost of revenues
    
    
    1,316
    
    
    
    1,870
    
    
    
    2,675
    
    
    
    4,099Gross profit
    
    
    1,012
    
    
    
    900
    
    
    
    2,050
    
    
    
    1,581Selling, general and administrative expense
    
    
    417
    
    
    
    764
    
    
    
    902
    
    
    
    1,504Research and development expense
    
    
    470
    
    
    
    567
    
    
    
    958
    
    
    
    1,144Amortization of acquired technology
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    11Special charges
    
    
    6
    
    
    
    307
    
    
    
    139
    
    
    
    750Gain on sale of businesses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3
    )Operating earnings (loss)
    
    
    119
    
    
    
    (744
    )
    
    
    51
    
    
    
    (1,825
    )Other income (expense)  net
    
    
    9
    
    
    
    (9
    )
    
    
    51
    
    
    
    (28
    )Interest expenseLong-term debt
    
    
    (23
    )
    
    
    (34
    )
    
    
    (47
    )
    
    
    (70
    )Other
    
    
    (2
    )
    
    
    (9
    )
    
    
    (9
    )
    
    
    (21
    )Earnings (loss) from continuing operations
before income taxes, minority interests
and equity in net loss of associated companies
    
    
    103
    
    
    
    (796
    )
    
    
    46
    
    
    
    (1,944
    )Income tax benefit (expense)
    
    
    (6
    )
    
    
    222
    
    
    
    (16
    )
    
    
    58497
    
    
    
    (574
    )
    
    
    30
    
    
    
    (1,360
    )Minority interests  net of tax
    
    
    (20
    )
    
    
    15
    
    
    
    (13
    )
    
    
    20Equity in net loss of associated
companies  net of tax
    
    
    (20
    )
    
    
    (10
    )
    
    
    (27
    )
    
    
    (14
    )Net earnings (loss) from continuing operations
    
    
    57
    
    
    
    (569
    )
    
    
    (10
    )
    
    
    (1,354
    )Net earnings from discontinued
operations  net of tax
    
    
    
    
    
    
    
    
    
    
    164
    
    
    
    Net earnings (loss)
    
    
    57
    
    
    
    (569
    )
    
    
    154
    
    
    
    (1,354
    )Dividends on preferred shares
    
    
    (7
    )
    
    
    (5
    )
    
    
    (12
    )
    
    
    (10
    )Net earnings (loss) applicable to common shares
    
    $
    50
    
    
    $
    (574
    )
    
    $
    142
    
    
    $
    (1,364
    )


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

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NORTEL NETWORKS LIMITEDConsolidated Balance Sheets (unaudited)

June 30,
    
    
    December 31,(millions of U.S. dollars)
    
    2003
    
    
    2002ASSETSCurrent assetsCash and cash equivalents
    
    $
    4,115
    
    
    $
    3,813Restricted cash and cash equivalents
    
    
    115
    
    
    
    249Accounts receivable (less provisions of $355 at June 30, 2003, $477 at December 31, 2002)
    
    
    1,899
    
    
    
    1,993Inventories  net
    
    
    830
    
    
    
    889Income taxes recoverable
    
    
    57
    
    
    
    58Deferred income taxes  net
    
    
    399
    
    
    
    793Other current assets
    
    
    438
    
    
    
    706Total current assets
    
    
    7,853
    
    
    
    8,501Investments
    
    
    209
    
    
    
    246Plant and equipment  net
    
    
    1,378
    
    
    
    1,441Goodwill
    
    
    2,022
    
    
    
    2,021Deferred income taxes  net
    
    
    3,585
    
    
    
    2,797Other assets
    
    
    631
    
    
    
    747Total assets
    
    $
    15,678
    
    
    $
    15,753LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    48
    
    
    $
    100Trade and other accounts payable
    
    
    832
    
    
    
    931Payroll and benefit-related liabilities
    
    
    633
    
    
    
    513Contractual liabilities
    
    
    1,354
    
    
    
    1,546Restructuring
    
    
    616
    
    
    
    761Other accrued liabilities
    
    
    2,510
    
    
    
    2,803Long-term debt due within one year
    
    
    184
    
    
    
    233Total current liabilities
    
    
    6,177
    
    
    
    6,887Long-term debt
    
    
    1,894
    
    
    
    1,919Deferred income taxes  net
    
    
    445
    
    
    
    366Other liabilities
    
    
    2,415
    
    
    
    2,35110,931
    
    
    
    11,523Minority interests in subsidiary companies
    
    
    86
    
    
    
    78Guarantees, commitments and contingencies (notes 9, 10 and 15)SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited; issued and outstanding shares:30,000,000 at June 30, 2003 and December 31, 2002
    
    
    536
    
    
    
    536Common shares, without par value  Authorized shares: unlimited; issued and outstanding shares:1,460,978,638 at June 30, 2003 and December 31, 2002
    
    
    1,211
    
    
    
    1,211Additional paid-in capital
    
    
    22,003
    
    
    
    21,991Accumulated deficit
    
    
    (17,951
    )
    
    
    (18,093
    )Accumulated other comprehensive loss
    
    
    (1,138
    )
    
    
    (1,493
    )Total shareholders equity
    
    
    4,661
    
    
    
    4,152Total liabilities and shareholders equity
    
    $
    15,678
    
    
    $
    15,753


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

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NORTEL NETWORKS LIMITEDConsolidated Statements of Cash Flows (unaudited)

Six months ended June 30,(millions of U.S. dollars)
    
    2003
    
    
    2002Cash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (10
    )
    
    $
    (1,354
    )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
    
    
    207
    
    
    
    304Non-cash portion of special charges and related asset write downs
    
    
    (26
    )
    
    
    264Equity in net loss of associated companies
    
    
    27
    
    
    
    14Stock
option compensation
    
    
    12
    
    
    
    Deferred income taxes
    
    
    19
    
    
    
    (595
    )Other liabilities
    
    
    65
    
    
    
    (47
    )Gain on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    (Gain) loss on sale or write down of investments and businesses
    
    
    42
    
    
    
    (15
    )Other  net
    
    
    (70
    )
    
    
    284Change in operating assets and liabilities:Accounts receivable
    
    
    87
    
    
    
    539Inventories
    
    
    117
    
    
    
    114Income taxes
    
    
    4
    
    
    
    1,268Restructuring
    
    
    (339
    )
    
    
    (643
    )Accounts payable and accrued liabilities
    
    
    (321
    )
    
    
    (82
    )Other operating assets and liabilities
    
    
    (34
    )
    
    
    (229
    )Net cash used in operating activities of continuing operations
    
    
    (224
    )
    
    
    (178
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (56
    )
    
    
    (208
    )Proceeds on disposals of plant and equipment
    
    
    21
    
    
    
    76Decrease in restricted cash and cash equivalents
    
    
    144
    
    
    
    Increase in long-term receivables
    
    
    (11
    )
    
    
    (210
    )Decrease in long-term receivables
    
    
    197
    
    
    
    105Acquisitions of investments and businesses  net of cash acquired
    
    
    (2
    )
    
    
    (25
    )Proceeds on sale of investments and businesses
    
    
    8
    
    
    
    38Net cash from (used in) investing activities of continuing operations
    
    
    301
    
    
    
    (224
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (12
    )
    
    
    (10
    )Decrease in notes payable  net
    
    
    (18
    )
    
    
    (77
    )Proceeds from long-term debt
    
    
    
    
    
    
    31Repayments of long-term debt
    
    
    (94
    )
    
    
    (6
    )Decrease in capital leases payable
    
    
    (2
    )
    
    
    (4
    )Issuance of common shares
    
    
    
    
    
    
    800Net cash from (used in) financing activities of continuing operations
    
    
    (126
    )
    
    
    734Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    78
    
    
    
    46Net cash from continuing operations
    
    
    29
    
    
    
    378Net cash from discontinued operations
    
    
    273
    
    
    
    287Net increase in cash and cash equivalents
    
    
    302
    
    
    
    665Cash and cash equivalents at beginning of period  net
    
    
    3,813
    
    
    

    3,457Cash and cash equivalents at end of period  net
    
    $
    4,115
    
    
    $
    4,122


The accompanying notes are an integral part of these unaudited 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 2.
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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 were of a normal recurring nature. The financial results
for the three months and six months ended June 30, 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.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| | (a) | In May 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150,
Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity (SFAS 150). SFAS 150 clarifies the
accounting for certain financial instruments with characteristics of
both liabilities and equity and requires that those instruments be
classified as liabilities in the balance sheets. Previously, many of
those financial instruments were classified as equity. SFAS 150 is
effective for financial instruments entered into or modified after May
31, 2003 and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. Nortel Networks expects
that this pronouncement will not have a material impact on its results
of operations and financial condition.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | In April 2003, the FASB issued 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 will be 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 guidance in SFAS 133
Implementation Issues that have been effective for fiscal quarters which
began prior to June 15, 2003, will 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, will be applied to both existing
contracts as well as new contracts entered into after June 30, 2003.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks will apply the provisions of SFAS 149 on a prospective
basis to contracts entered into or modified after June 30, 2003 and
expects that this pronouncement will not have a material impact on its
results of operations and financial condition.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | 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
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | 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 has conducted certain receivable sales and lease financing
transactions through special purpose entities. Receivable sales
transactions are generally conducted either directly with financial
institutions or with multi-seller conduits. As at June 30, 2003, Nortel
Networks did not expect to 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, Nortel Networks will be required to consolidate
the assets, liabilities and any non-controlling interests of these special
purpose entities in the next interim fiscal period. The total assets and
total liabilities held by these entities at June 30, 2003 were each
approximately $181 and these amounts represented both the collateral and
maximum exposure to loss, as a result of Nortel Networks involvement with
these entities.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | 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). In the absence of higher
level accounting literature, EITF 00-21 governs how to separate and
allocate revenue to goods or services or both that are to be delivered
in a bundled sales arrangement. EITF 00-21 applies to revenue
arrangements entered into after June 30, 2003 and allows for either
prospective application or cumulative adjustment upon adoption. Nortel
Networks will apply the guidance of EITF 00-21 on a prospective basis
and expects that this pronouncement will not have a
material impact on its results of operations and financial condition.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Certain 2002 figures in the accompanying unaudited consolidated financial
statements have been reclassified to conform to the 2003 presentation.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------



|2. |  | 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 and
providing disclosures for its stock-based compensation 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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Effective January 1, 2003, Nortel Networks 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 fair value
at grant date of stock options is estimated using the Black-Scholes
option-pricing model. Compensation expense is recognized over the stock
option vesting period. Nortel Networks has also adopted the amended
disclosure provisions of SFAS 148. Stock option expense (pre-tax)
recorded during the three months and six months ended June 30, 2003 was $7
and $12, respectively.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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) applicable to common shares would have
decreased (increased) to the pro forma amounts indicated below for the
following periods:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Three months ended June 30,
    
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Net earnings (loss) applicable to common shares  as reported
    
    $
    50
    
    
    $
    (574
    )
    
    $
    142
    
    
    $
    (1,364
    )Stock-based compensation  reported(a)
    
    
    26
    
    
    
    3
    
    
    
    42
    
    
    
    6Stock-based compensation  pro forma(b)
    
    
    (85
    )
    
    
    (236
    )
    
    
    (160
    )
    
    
    (472
    )Net earnings (loss) applicable to common shares  pro forma
    
    $
    (9
    )
    
    $
    (807
    )
    
    $
    24
    
    
    $
    (1,830
    )
 (a)
    
    Stock-based compensation  reported included stock option
expense, employer portion of stock purchase plan contributions and
restricted stock units expense. For the three months and six months
ended June 30, 2003, the amounts were net of tax of nil. For the
three months and six months ended June 30, 2002, the amounts were net
of tax of $2 and $3, respectively. (b)
    
    Stock-based compensation  pro forma included stock option
expense, pro forma stock option expense, employer portion of stock
purchase plan contributions, restricted stock units expense and
deferred stock option compensation. For the three months and six
months ended June 30, 2003, the amounts were net of tax of nil. For
the three months and six months ended June 30, 2002, the amounts were
net of tax of $74 and $147, respectively.


| |  | The following weighted average assumptions were used in computing the fair
value of stock options used to compute pro forma net earnings (loss)
applicable to common shares for the following periods:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Three months ended June 30,
    
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Black-Scholes weighted-average assumptionsExpected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    92.86
    %
    
    
    74.27
    %
    
    
    92.48
    %
    
    
    71.32
    %Risk-free interest rate
    
    
    2.48
    %
    
    
    4.26
    %
    
    
    2.81
    %
    
    
    4.49
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4
    
    
    
    4Weighted average stock option fair value
per option granted
    
    $
    1.91
    
    
    $
    1.45
    
    
    $
    1.57
    
    
    $
    3.51


| | (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 Nortel Networks 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 results of operations and
financial condition of Nortel Networks (see note 9).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Asset retirement obligations
| | --- | ----------------------------



| |  | Effective January 1, 2003,
Nortel Networks adopted the initial recognition and measurement
provisions of SFAS No. 143, Accounting for Asset Retirement
Obligations (SFAS 143), 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. The adoption of
SFAS 143 did not have a material impact on Nortel Networks
results of operations and financial condition.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | 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 requires
recognition of a liability when an entity committed to an exit plan. The
effect of SFAS 146 is to change the timing of recognition and basis for
measuring certain liabilities. No material valuation differences between
SFAS 146 and EITF 94-3 are expected. Exit and disposal 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. The adoption of SFAS 146 did not have a material impact on Nortel
Networks results of operations and financial condition.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9



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|3. |  | Consolidated financial statement details
|-- |  | ----------------------------------------



| |  | The following unaudited consolidated financial statement details are
presented as at June 30, 2003 and December 31, 2002 for the consolidated
balance sheets and for the six months ended June 30, 2003 and 2002 for the
consolidated statements of cash flows:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Consolidated balance sheets




Inventories  net:




June 30,
    
    
    December 31,2003
    
    
    2002Raw materials
    
    $
    332
    
    
    $
    343Work in process
    
    
    258
    
    
    
    308Finished goods
    
    
    240
    
    
    
    238Inventories  net(a)
    
    $
    830
    
    
    $
    889
 (a)
    
    Net of inventory provisions of $998 and $1,014 as at June 30, 2003
and December 31, 2002, respectively. Included in other accrued
liabilities were accruals of $147 and $168 at June 30, 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:




June 30,
    
    
    December 31,2003
    
    
    2002Cost:Land
    
    $
    57
    
    
    $
    54Buildings
    
    
    1,149
    
    
    
    1,169Machinery and equipment
    
    
    3,712
    
    
    
    3,7324,918
    
    
    
    4,955Less accumulated depreciation:Buildings
    
    
    (443
    )
    
    
    (463
    )Machinery and equipment
    
    
    (3,097
    )
    
    
    (3,051
    )(3,540
    )
    
    
    (3,514
    )Plant and equipment  net(a)
    
    $
    1,378
    
    
    $
    1,441
 (a)
    
    Included assets held for sale with a carrying value of $47 and $78 as
at June 30, 2003 and December 31, 2002, related to owned facilities that
were being actively marketed. These assets were written down to their
estimated fair values less costs to sell in previous periods. The write
down was included in special charges. We expect to dispose of
all of these facilities by mid-2005.


10



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##### Table of Contents



| |  | Other accrued liabilities:
| |  | --------------------------



June 30,
    
    
    December 31,2003
    
    
    2002Outsourcing and selling, general and administrative related
    
    $
    606
    
    
    $
    690Customer deposits
    
    
    345
    
    
    
    389Product related
    
    
    361
    
    
    
    372Warranty
    
    
    236
    
    
    
    238Deferred income
    
    
    244
    
    
    
    218Miscellaneous taxes
    
    
    107
    
    
    
    121Income taxes payable
    
    
    81
    
    
    
    98Current liabilities of discontinued operations
    
    
    84
    
    
    
    46Interest payable
    
    
    43
    
    
    
    52Other
    
    
    403
    
    
    
    579Other accrued liabilities
    
    $
    2,510
    
    
    $
    2,803


| |  | Consolidated statements of cash flows
| |  | -------------------------------------

| |  | Interest and income taxes paid (recovered):
| |  | -------------------------------------------



June 30,
    
    
    June 30,2003
    
    
    2002Interest paid
    
    $
    57
    
    
    $
    101Income taxes paid (recovered)
    
    $
    9
    
    
    $
    (1,237
    )




| |  | 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 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 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; present value
techniques of estimated future cash flows; and valuation techniques based on
multiples of earnings or revenue or a similar performance measure. Nortel
Networks also considers its market capitalization 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).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other
| |  | -----



| |  | During the three months ended March 31, 2003 and six months ended June 30,
2003, Nortel Networks net earnings (loss) included approximately $80 of
favorable impacts (of which $50 was included in other income (expense) 
net, $25 in selling, general and administrative expense and $5 in research
and development expense) associated with reductions in accruals principally
related to the wind-down of integration activities of previously acquired
companies, operations originally structured as joint ventures and
miscellaneous tax matters.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

11



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##### Table of Contents





|4. |  | Segment 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 both
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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks President and Chief Executive Officer (CEO) has been
identified as the chief operating decision maker in assessing the performance
of the segments and the allocation of resources to the segments. Each
reportable segment is managed separately with each segment manager reporting
directly to the CEO. The CEO relies on the information derived directly from
the Nortel Networks management reporting system. Contribution margin
represents the primary financial measure used by the CEO in assessing
performance and allocating resources and includes the cost of revenues and
selling, general and administrative expense for which the segment managers
are held accountable. Costs associated with shared services and other
corporate costs are allocated to the segments based on usage determined
generally by headcount. Costs not allocated to the segments are primarily
related to Nortel Networks corporate compliance and other non-operational
activities and are included in other. In addition, the CEO does not review
asset information on a segmented basis in order to assess performance and
allocate resources. Research and development expense represents planned
investment in next generation core products across all segments. The
accounting policies of the reportable segments are the same as those applied
to the consolidated financial statements.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12



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##### Table of Contents





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



The following table sets forth information by segment for the following
periods:




Three months ended June 30,
    
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002RevenuesWireless Networks
    
    $
    987
    
    
    $
    1,123
    
    
    $
    1,940
    
    
    $
    2,259Enterprise Networks
    
    
    549
    
    
    
    635
    
    
    
    1,160
    
    
    
    1,310Wireline Networks
    
    
    494
    
    
    
    588
    
    
    
    1,056
    
    
    
    1,270Optical Networks
    
    
    298
    
    
    
    404
    
    
    
    568
    
    
    
    809Other
    
    
    
    
    
    
    20
    
    
    
    1
    
    
    
    32Total
    
    $
    2,328
    
    
    $
    2,770
    
    
    $
    4,725
    
    
    $
    5,680Contribution marginWireless Networks
    
    
    333
    
    
    
    241
    
    
    
    649
    
    
    
    485Enterprise Networks
    
    
    97
    
    
    
    93
    
    
    
    242
    
    
    
    177Wireline Networks
    
    
    161
    
    
    
    83
    
    
    

    313
    
    
    
    179Optical Networks
    
    
    23
    
    
    
    (240
    )
    
    
    33
    
    
    
    (598
    )Other
    
    
    (19
    )
    
    
    (41
    )
    
    
    (89
    )
    
    
    (166
    )Total
    
    $
    595
    
    
    $
    136
    
    
    $
    1,148
    
    
    $
    77Research and development expense
    
    
    (470
    )
    
    
    (567
    )
    
    
    (958
    )
    
    
    (1,144
    )Amortization of acquired technology
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    (11
    )Special charges
    
    
    (6
    )
    
    
    (307
    )
    
    
    (139
    )
    
    
    (750
    )Gain on sale of businesses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3Other income (expense)  net
    
    
    9
    
    
    
    (9
    )
    
    
    51
    
    
    
    (28
    )Interest expense
    
    
    (25
    )
    
    
    (43
    )
    
    
    (56
    )
    
    
    (91
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in net loss of
associated companies
    
    $
    103
    
    
    $
    (796
    )
    
    $
    46
    
    
    $
    (1,944
    )




|5. |  | Special charges
|-- |  | ---------------



During the three months and six months ended June 30, 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)
    
    $
    416
    
    
    $
    668
    
    
    $
    
    
    
    $
    11
    
    
    $
    1,095Special charges:For the three months ended March 31, 2003
    
    
    70
    
    
    
    23
    
    
    
    21
    
    
    
    
    
    
    
    114For the three months ended June 30, 2003
    
    
    22
    
    
    
    14
    
    
    
    3
    
    
    
    
    
    
    
    39Revisions to prior accruals:For the three months ended March 31, 2003
    
    
    (10
    )
    
    
    55
    
    
    
    (26
    )
    
    
    
    
    
    
    19For the three months ended June 30, 2003
    
    
    (12
    )
    
    
    3
    
    
    
    (24
    )
    
    
    
    
    
    
    (33
    )Cumulative provision (drawdowns) adjustments in 2003:Cash drawdowns
    
    
    (213
    )
    
    
    (125
    )
    
    
    
    
    
    
    (2
    )
    
    
    (340
    )Non-cash (drawdowns) and adjustments
    
    
    
    
    
    
    
    
    
    
    26
    
    
    
    
    
    
    
    26Foreign exchange and other adjustments
    
    
    42
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    54Provision balance as at June 30, 2003(a)
    
    $
    315
    
    
    $
    650
    
    
    $
    
    
    
    $
    9
    
    
    $
    974
 (a)
    
    At June 30, 2003 and December 31, 2002, the short-term provision
balances were $616 and $761, respectively, and the long-term provision
balances were $358 and $334, respectively (included in other
liabilities).


13



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| |  | 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
    
    
    300
    
    
    
    500
    
    
    
    800June 30, 2003
    
    
    
    
    
    
    300
    
    
    
    300
 (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 and six months ended June 30, 2003
| |  | -----------------------------------------------



| |  | For the three months and six months ended June 30, 2003, Nortel Networks
recorded total special charges of $6 and $139, respectively, which were net
of revisions of $(33) and $(14), respectively, related to prior accruals.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of $92 for the six months ended June 30, 2003
were related to severance and benefit costs associated with approximately
1,100 employees notified of termination during the six months ended June 30,
2003 which extended across all segments. Offsetting these charges were net
revisions of $(22) which were primarily related to termination benefits where
actual costs were lower than the estimated amounts across all segments.
During the six months ended June 30, 2003, the workforce reduction provision
balance was drawn down by cash payments of $213. The remaining provision is
expected to be substantially drawn down by mid-2004.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contract settlement and lease costs of $37 for the six months ended June 30,
2003 consisted of net lease charges related to leased facilities (comprised
of office, warehouse and manufacturing space) and leased furniture that were
newly identified as no longer required and which were valued using the
estimated fair value method prescribed under SFAS 146. These costs extended
across all segments. In addition to these charges were revisions of $58
resulting from changes in sublease revenue and cost to vacate estimates
associated with certain properties which extended across all segments.
During the six months ended June 30, 2003, the provision balance for contract
settlement and lease costs was drawn down by cash payments of $125. The
remaining provision, net of approximately $294 in estimated sublease revenue,
is expected to be substantially drawn down by the end of 2010.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and equipment write downs of $24 for the six months ended June 30, 2003
were related to current period write downs to fair value less costs to sell
for various leasehold improvements and excess Optical Networks equipment.
Revisions of $(50) to prior write downs of assets held for sale resulted
primarily from adjustments to original plans or estimated amounts for certain
facility closures.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | Income taxes
|-- |  | ------------



| |  | At June 30, 2003, Nortel Networks net deferred tax assets, excluding
discontinued operations, were $3,539, reflecting temporary differences
between financial reporting and the 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For the six months ended June 30, 2003, Nortel Networks recorded a tax
expense on pre-tax income of $46 from continuing operations before minority
interests and equity in net loss of associated companies.
This tax expense was a result of various non-income related taxes partially
offset by a tax refund for a previously unrecognized loss carryback and a
tax benefit from the accounting for the tax expense on income generated from
discontinued operations.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks reviews the valuation allowance on a quarterly basis. As a
result of the latest review, Nortel Networks determined that the valuation
allowance as at June 30, 2003 was appropriate. 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.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

14



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|7. |  | 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 for the six months ended June 30, 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | At June 30, 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 (the EDC Support Facility). The
agreement was subsequently amended to extend its expiry date to December 31,
2005 from June 30, 2004 (see note 16).
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 $123 was utilized as at June 30, 2003. The remainder is uncommitted
support for performance bonds, receivables sales and/or securitizations, of
which $65 was utilized as at June 30, 2003. For additional information, see
Nortel Networks Annual Report on Form 10-K for the year ended December 31,
2002 and Nortel Networks Current Reports on Form 8-K filed on February 14,
2003 and July 10, 2003 with the SEC.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On February 14, 2003, Nortel Networks obligations under the EDC Support
Facility became secured on an equal and ratable 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 the banks under the 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. This security became effective in
favor of the banks and the public debt holders on April 4, 2002 (see note
17).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|8. |  | 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 changes in fair value were previously accounted for
in the statements of operations.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|9. |  | Guarantees
|-- |  | ----------



| |  | Nortel Networks has estimated the fair value relating to certain guarantees
issued or modified after December 31, 2002. The estimation resulted in an
immaterial accrual for the six months ended June 30, 2003. Unless specified
below, Nortel Networks is unable to make a reasonable estimate of the maximum
amount that could be payable under certain of its guarantee arrangements
since maximum amounts are generally not specified in the applicable contracts
and the amounts are dependent upon the outcome of future contingent events,
the nature and likelihood of which cannot be determined at this time. A
description of Nortel Networks guarantees as at June 30, 2003 is provided
below.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) | Business sale and business combination agreements
| | --- | -------------------------------------------------



| |  | In connection with agreements for the sale of portions of its business,
including certain discontinued operations, Nortel Networks has typically
retained the liabilities of a business which relate to events occurring
prior to its sale, such as tax, environmental, litigation and employment
matters. Nortel Networks generally indemnifies the purchaser of a Nortel
Networks business in the event that a third party asserts a claim against
the purchaser that relates to a liability retained by Nortel Networks.
These types of indemnification guarantees typically extend for a number of
years.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

15



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| |  | In the past, Nortel Networks has also entered into guarantees related to
the escrow of shares in business combinations. These types of agreements
generally include indemnities that require Nortel Networks to indemnify
counterparties for loss incurred from litigation that may be suffered by
counterparties arising under such agreements. These types of indemnities
apply over a specified period of time from the date of the business
combination and do not provide for any limit on the maximum potential
amount.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Intellectual property indemnification obligations
| | --- | -------------------------------------------------



| |  | Nortel Networks has entered periodically into agreements with customers
and suppliers that include limited intellectual property indemnification
obligations that are customary in the industry. These guarantees
generally require Nortel Networks to compensate the other party for
certain damages and costs incurred as a result of third party intellectual
property claims arising from these transactions.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Lease agreements
| | --- | ----------------



| |  | Nortel Networks has entered into agreements with its lessors that
guarantee the lease payments of certain sub-lessees of its facilities to
lessors. Generally, these lease agreements relate to facilities Nortel
Networks vacated prior to the end of the term of its lease. These lease
agreements require Nortel Networks to make lease payments throughout the
lease term if the sub-lessee fails to make scheduled payments. These
lease agreements have expiration dates through June 2012. The maximum
amount that Nortel Networks may be required to pay under these types of
agreements is $34 as at June 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has also entered into an agreement to indemnify a certain
lessor against certain additional costs, including financing costs, costs
incurred relating to construction problems with the building and costs
incurred if the transaction becomes invalid, through the term of a lease
which expires in May 2013. The maximum indemnification amount that Nortel
Networks may be required to pay under this lease agreement is $90 as at
June 30, 2003.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | Third party debt agreements
| | --- | ---------------------------



| |  | Nortel Networks has guaranteed the debt of certain customers. These third
party debt agreements require Nortel Networks to make debt payments
throughout the term of the related debt instrument if the customer fails
to make scheduled debt payments. These third party debt agreements have
expiration dates extending to May 2012. The maximum amount that Nortel
Networks may be required to pay under these types of debt agreements is $8
and has been provisioned.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is the full and unconditional guarantor of NNCs $1,800
4.25 percent convertible senior notes due September 1, 2008, in the event
that NNC does not make payments for the principal, interest, premium and
other amounts, if any, as they are due. The maximum amount that Nortel
Networks may be required to pay under this guarantee is $1,800 plus
interest and premium outstanding.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | Indemnification of banks and agents under credit facilities, EDC
Support Facility and security agreements
| | --- | ---------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has agreed to indemnify the banks and agents under its
credit facilities against costs or losses resulting from changes in laws
and regulations which would increase the banks costs and from any legal
action brought against the banks or agents related to the use of loan
proceeds. Nortel Networks has also agreed to indemnify EDC under the EDC
Support Facility against any legal action brought against EDC that relates
to the provision of support under the EDC Support Facility. Nortel
Networks has also agreed to indemnify the collateral agent under the
security agreements against any legal action brought against the
collateral agent in connection with the collateral pledged under the
security agreements. These indemnifications generally extend for the term
of the credit and support facilities, or for as long as the security
agreements remain in effect, and do not provide for any limit on the
maximum potential liability.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has agreed to indemnify its counterparties in receivables
securitization transactions. The indemnifications provided to
counterparties in these types of transactions may require Nortel Networks
to compensate counterparties for costs incurred as a result of changes in
laws and regulations (including tax legislation) or in the interpretations
of such laws and regulations, costs incurred by the counterparties as a
result of regulatory penalties that may be suffered by the counterparty as
a consequence of the transaction or the repurchase of the
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

16



---



##### Table of Contents





| |  | receivables if the particular transaction becomes invalid. The
indemnification provisions normally expire upon collection of the
receivable amount by the counterparty. As at June 30, 2003, Nortel
Networks had approximately $290 of securitized receivables which were
subject to repurchase if the securitization transaction becomes
invalid.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | Other indemnification agreements
| | --- | --------------------------------



| |  | Nortel Networks has also entered into other agreements that provide
indemnifications to counterparties in certain transactions including
investment banking agreements, guarantees related to the administration of
capital trust accounts, guarantees related to the administration of
employee benefit plans, indentures for its outstanding public debt and
sales of assets (other than the business sale agreements noted above).
These indemnification agreements generally require Nortel Networks to
indemnify the counterparties for costs incurred as a result of changes in
laws and regulations (including tax legislation) or in the interpretations
of such laws and regulations and/or as a result of losses from litigation
that may be suffered by the counterparties arising from the transactions.
These types of indemnification agreements normally extend over an
unspecified period of time from the date of the transaction and do not
provide for any limit on the maximum potential amount.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Product warranties
| |  | ------------------



As part of the normal sale of product, Nortel Networks has provided its
customers with product warranties that extend for periods generally ranging
from one to five years from the date of sale. A liability for the expected
cost of warranty-related claims is established when products are sold and the
related revenue is recognized. In estimating the warranty liability,
historical material replacement costs and associated labor to correct the
product failure are considered. Revisions are made when actual experience
differs materially from historical experience. Known product defects were
not included in the warranty reconciliation below and were included as an
element within other accrued liabilities  product related. The following
summarizes the accrual of product warranties that was recorded as part of
other accrued liabilities in the accompanying consolidated balance sheets as
at June 30, 2003:




Balance as at December 31, 2002
    
    $
    238Payments
    
    
    (45
    )Warranties issued
    
    
    51Other changes during the period
    
    
    (8
    )Balance as at June 30, 2003
    
    $
    236


|10. |  | Commitments
|--- |  | -----------



| |  | 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:




June 30,
    
    
    December 31,2003
    
    
    2002Bid and performance related bonds(a)
    
    $
    341
    
    
    $
    400Other bonds(b)
    
    
    38
    
    
    
    35Total bid, performance related and other bonds
    
    $
    379
    
    
    $
    435
 (a)
    
    Net of restricted cash and cash equivalent amounts of $63 and $195 as
at June 30, 2003 and December 31, 2002, respectively.(b)
    
    Net of restricted cash and cash equivalent amounts of $29 and $19 as
at June 30, 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
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17



---



##### Table of Contents





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:




June 30,
    
    
    December 31,2003
    
    
    2002Drawn and outstanding  gross(a)
    
    $
    455
    
    
    $
    1,091Provisions for doubtful accounts(a)
    
    
    (359
    )
    
    
    (799
    )Drawn and outstanding  net(a)
    
    
    96
    
    
    
    292Undrawn commitments (see note 16)
    
    
    667
    
    
    
    801Total customer financing
    
    $
    763
    
    
    $
    1,093
 (a)
    
    Included short-term and long-term amounts. Short-term and long-term
amounts were included in accounts receivable and other assets,
respectively, in the consolidated balance sheets.


| |  | During the three months ended June 30, 2003, Nortel Networks entered into
certain agreements to either sell or restructure various customer financing
and related receivables. As a result of these transactions, Nortel Networks
received cash consideration of approximately $199 to settle outstanding
receivables of approximately $503 (carrying value approximately $111).
Additional non-cash consideration received under one such restructuring
agreement included a five year equipment and services supply agreement and
the mutual release of all other claims between the parties.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the three months ended June 30, 2003, Nortel Networks recorded net
customer financing bad debt recoveries of $51 primarily as a result of the
favorable settlements described above and adjustments to other existing
provisions. The $51 recovery was included in the consolidated statements of
operations within selling, general and administrative expense.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | As at June 30, 2003 and December 31, 2002, approximately $115 and $249,
respectively, of cash and cash equivalents 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



The following are the components of comprehensive income (loss), net of tax,
for the following periods:




Three months ended June 30,
    
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Net earnings (loss)
    
    $
    57
    
    
    $
    (569
    )
    
    $
    154
    
    
    $
    (1,354
    )Other comprehensive income (loss) adjustments:Change in foreign currency translation adjustment(a)
    
    
    185
    
    
    
    140
    
    
    
    276
    
    
    
    91Unrealized gain (loss) on investments  net(b)
    
    
    48
    
    
    
    (19
    )
    
    
    58
    
    
    
    (3
    )Unrealized derivative gain on cash flow hedges  net(c)
    
    
    10
    
    
    
    14
    
    
    
    21
    
    
    
    15Comprehensive income (loss)
    
    $
    300
    
    
    $
    (434
    )
    
    $
    509
    
    
    $
    (1,251
    )
 (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 (losses) related to
these securities were excluded from net earnings (loss) and were
included in comprehensive income (loss) until realized. Unrealized gain
(loss) on investments was net of tax of $(5) and nil for the three
months and six months ended June 30, 2003, respectively, and net of tax
of $13 and $3 for the three months and six months ended June 30, 2002,
respectively.(c)
    
    During the three months and six months ended June 30, 2003, $9 and
$10, respectively, of net derivative gains were reclassified to net
earnings (loss). During the three months and six months ended June 30,
2002, $(6) and $(10) of net derivative losses were reclassified to net
earnings (loss), respectively. Nortel Networks estimates that $19 of
net derivative gains included in accumulated other comprehensive income
(loss) will be reclassified into net earnings (loss) within the next 12
months.


18



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



| |  | During the six months ended June 30, 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 for the three months and six months ended June 30,
2003 and 2002 for the consolidated statements of operations, as at June 30,
2003 and December 31, 2002 for the consolidated balance sheets, and for the
six months ended June 30, 2003 and 2002 for the consolidated statements of
cash flows:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Consolidated statements of operations:




Three months ended June 30,
    
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Revenues
    
    $
    4
    
    
    $
    70
    
    
    $
    7
    
    
    $
    138Net earnings from discontinued operations  net of tax(a)
    
    $
    
    
    
    $
    
    
    
    $
    164
    
    
    $
    
 (a)
    
    Net earnings from discontinued operations were net of applicable
income tax of nil and $8 for the three months and six months ended June
30, 2003, respectively, and net of applicable income tax of nil for the
three months and six months ended June 30, 2002.


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



June 30,
    
    
    December 31,2003
    
    
    2002Accounts receivable  net(a)
    
    $
    
    
    
    $
    20Inventories  net
    
    
    4
    
    
    
    Deferred income taxes
    
    
    62
    
    
    
    147Other current assets
    
    
    
    
    
    
    45Total current assets of discontinued operations(b)
    
    $
    66
    
    
    $
    212Other long-term assets(a) (b)
    
    
    75
    
    
    
    49Total assets of discontinued operations
    
    $
    141
    
    
    $
    261Current liabilities(b) (c)
    
    $
    84
    
    
    $
    46Long-term liabilities(b)
    
    
    2
    
    
    
    2Total liabilities of discontinued operations
    
    $
    86
    
    
    $
    48
 (a)
    
    Included customer financing receivables of nil (net of provisions of
$96) and $66 (net of provisions of $507) as at June 30, 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 the consolidated balance sheets.(c)
    
    Included accruals of $78 and $44 as at June 30, 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:
| |  | --------------------------------------



Six months ended June 30,2003
    
    
    2002Cash flows from discontinued operationsOperating activities
    
    $
    32
    
    
    $
    207Investing activities
    
    
    241
    
    
    
    80Net cash from discontinued operations
    
    $
    273
    
    
    $
    287


19



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##### Table of Contents





| |  | Six months ended June 30, 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. 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On March 20, 2003, Nortel Networks entered into an 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 receivable 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
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 June 30, 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:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



June 30,
    
    
    December 31,2003
    
    
    2002Owing from (to) NNC
    
    $
    65
    
    
    $
    (17
    )Owing from (to) NNC subsidiaries
    
    $
    118
    
    
    $
    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 Nortel Networks
provided revised guidance for financial performance for the 2001 fiscal year
and the first quarter of 2001, Nortel Networks 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 Nortel Networks 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, Nortel Networks 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, Nortel Networks 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
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

20



---



##### Table of Contents





| |  | 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 Nortel Networks 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.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On April 1, 2002, Nortel Networks 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, Nortel Networks also moved to
dismiss on the separate basis that JDS shareholders lacked standing to sue
Nortel Networks. 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.
With respect to the consolidated United States shareholder class action, the
plaintiffs served a motion for class certification on March 21, 2003. On May
30, 2003, the defendants served an opposition to the motion for class
certification. Plaintiffs reply was served on August 1, 2003 and the District
Court has scheduled oral arguments on class certification for September 3,
2003.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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
Nortel Networks, 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 Nortel
Networks securities (including options on Nortel Networks 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 Nortel Networks
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 Nortel Networks 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 Nortel
Networks 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 Nortel Networks 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 Nortel Networks
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 June 24, 2003, the Judicial Panel on
Multidistrict Litigation issued a transfer order transferring the Southern
District of New York action to the Middle District of Tennessee.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

21



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##### Table of Contents





| |  | 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, 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. On July 25, 2003, the California
Court of Appeal reversed the trial courts dismissal of the
intervenor-plaintiffs class allegations. The defendants intend to appeal
this decision to the California Supreme Court.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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. |  | Subsequent events
|--- |  | -----------------



| |  | On August 10, 2003, Nortel Networks essentially finalized the realignment of
Optical Networks with the sale of certain assets related to its
high speed module business to BreconRidge Manufacturing Solutions
Corporation. This transaction is not expected to have a material impact on Nortel Networks
business, results
of operations and financial condition.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On July 22, 2003, Nortel Networks renegotiated an agreement with a certain
customer and reduced undrawn customer financing commitments by approximately
$509, leaving approximately $158 in aggregate undrawn commitments.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On July 10, 2003, Nortel Networks and EDC amended the terms of the EDC
Support Facility by extending the termination date of the facility to
December 31, 2005 from June 30, 2004. All other material terms of the EDC
Support Facility remained unchanged.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On October 19, 2002, Nortel Networks, through various subsidiaries, entered
into a number of put option and call option agreements as well as a share
exchange agreement with European Aeronautic Defence and Space Company EADS
N.V. (EADS), its partner in three European joint ventures. On July 1,
2003, EADS exercised its put option to sell its minority interest of 45
percent in Nortel Networks France S.A.S. to Nortel Networks. On July 18,
2003, Nortel Networks exercised its call option and share exchange rights to
acquire the minority interest of EADS of 42 percent in Nortel Networks
Germany GmbH & Co. KG and dispose of Nortel Networks equity interest of 41
percent in EADS Telecom S.A.S. (formerly EADS Defence and Security Networks
S.A.S.). The closing of the transactions is subject to final regulatory
approval and involves net consideration payable by Nortel Networks of
approximately $130 (consisting of approximately $48 in cash and an in-kind
component of approximately $82, representing the return of a loan note
currently owed to Nortel Networks by EADS Telecom S.A.S., an affiliate of
EADS). The net consideration is payable by Nortel Networks in euro and the
approximation of net consideration is subject to fluctuations between the
euro and United States dollar. The acquisitions will be accounted for using
the purchase method of accounting. These transactions are expected to close
in the three months ending September 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

22



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##### Table of Contents





|17. |  | Supplemental consolidating financial information
|--- |  | ------------------------------------------------



| |  | As a result of Nortel Networks current credit ratings, various liens, pledges
and guarantees are effective under certain credit, support and security
agreements entered into by Nortel Networks and various of its subsidiaries.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The security agreements were originally entered into in connection with the
$1,510 December 2001 364-day credit facilities (which expired on December 13,
2002). The security became effective April 4, 2002 following Moodys
Investors Services Inc. (Moodys) downgrade of Nortel Networks senior
long-term debt rating to below investment grade, in respect of the then
existing credit facilities including the available $750 April 2000 five year
credit facilities. Consequently on April 4, 2002, and in accordance with the
negative pledge covenants in the indentures for all Nortel Networks and NNCs
outstanding public debt securities, all such public debt securities became,
under the terms of the security agreements, secured equally and ratably with
the obligations under Nortel Networks and NNIs then existing credit
facilities.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks obligations under the EDC Support Facility became secured on
an equal and ratable basis under the security agreements on February 14,
2003. As at June 30, 2003, the security agreements pledge substantially all
of the assets of Nortel Networks in favor of the banks under the $750 April
2000 five year credit facilities, EDC and the holders of Nortel Networks and
NNCs outstanding public debt securities, which debt securities represent
substantially all of NNCs consolidated long term debt.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The security provided under the security agreements is comprised of pledges
of substantially all of the assets of Nortel Networks and those of most of
its United States and Canadian subsidiaries and 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 Nortel Networks and
NNCs 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.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 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 and guarantees will be released in full
in respect of the banks, EDC, the public debt holders and any other parties
secured under the security agreements at that time. If both the $750 April
2000 five year credit facilities and the EDC Support Facility are terminated,
or expire, the security and guarantees will also be released in full in
respect of the banks, EDC, the public debt holders and any other parties
secured under the security agreements at that time. Nortel Networks may
provide EDC with cash collateral in an amount equal to the total amount of
its outstanding obligations and undrawn commitments and expenses under the
EDC Support Facility (or any other alternative collateral acceptable to EDC)
in lieu of the security provided under the security agreements (see note 7).
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following supplemental consolidating financial data illustrates, in
separate columns, the composition of Nortel Networks Limited, the Guarantor
Subsidiaries, the Non-Guarantor Subsidiaries, eliminations and the
consolidated total as at June 30, 2003 and December 31, 2002 and for the
three months and six months ended June 30, 2003 and 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

23



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##### Table of Contents



Supplemental Consolidating Statements of Operations for the three months ended
June 30, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    760
    
    
    $
    1,567
    
    
    $
    717
    
    
    $
    (716
    )
    
    $
    2,328Cost of revenues
    
    
    466
    
    
    
    1,096
    
    
    
    470
    
    
    
    (716
    )
    
    
    1,316Gross profit
    
    
    294
    
    
    
    471
    
    
    
    247
    
    
    
    
    
    
    
    1,012Selling, general and administrative expense
    
    
    81
    
    
    
    294
    
    
    
    42
    
    
    
    
    
    
    
    417Research and development expense
    
    
    201
    
    
    

    207
    
    
    
    62
    
    
    
    
    
    
    
    470Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special charges
    
    
    (14
    )
    
    
    31
    
    
    
    (11
    )
    
    
    
    
    
    
    6(Gain) loss on sale of businesses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating earnings (loss)
    
    
    26
    
    
    
    (61
    )
    
    
    154
    
    
    
    
    
    
    
    119Other income (expense)  net
    
    
    28
    
    
    
    84
    
    
    
    (103
    )
    
    
    
    
    
    
    9Interest expenseLong-term debt
    
    
    (17
    )
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    (23
    )Other
    
    
    
    
    
    
    (13
    )
    
    
    11
    
    
    
    
    
    
    
    (2
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in net
earnings (loss) from continuing operations
    
    
    37
    
    
    
    10
    
    
    
    56
    
    
    
    
    
    
    
    103Income tax benefit (provision)
    
    
    2
    
    
    
    13
    
    
    
    (21
    )
    
    
    
    
    
    
    (6
    )39
    
    
    
    23
    
    
    
    35
    
    
    
    
    
    
    
    97Minority interests  net
    
    
    
    
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    (20
    )Equity in net earnings (loss) of associated companies
 net of tax
    
    
    18
    
    
    
    189
    
    
    
    4
    
    
    
    (231
    )
    
    
    (20
    )Net earnings (loss) from continuing operations
    
    
    57
    
    
    
    212
    
    
    
    19
    
    
    
    (231
    )
    
    
    57Net earnings from discontinued operations
 net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss)
    
    $
    57
    
    
    $
    212
    
    
    $
    19
    
    
    $
    (231
    )
    
    $
    57Dividends
on preferred shares
    
    
    (7
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7
    )Net
earnings (loss) applicable to common shares
    
    $
    50
    
    
    $
    212
    
    
    $
    19
    
    
    $
    (231
    )
    
    $
    50


24



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##### Table of Contents



Supplemental Consolidating Statements of Operations for the three months ended
June 30, 2002:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    848
    
    
    $
    2,153
    
    
    $
    663
    
    
    $
    (894
    )
    
    $
    2,770Cost of revenues
    
    
    769
    
    
    
    1,396
    
    
    
    599
    
    
    
    (894
    )
    
    
    1,870Gross profit
    
    
    79
    
    
    
    757
    
    
    
    64
    
    
    
    
    
    
    
    900Selling, general and administrative expense
    
    
    101
    
    
    
    499
    
    
    
    164
    
    
    
    
    
    
    
    764Research and development expense
    
    
    241
    
    
    
    248
    
    
    
    78
    
    
    
    
    
    
    
    567Amortization of acquired technology
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    6Special charges
    
    
    185
    
    
    
    108
    
    
    
    14
    
    
    
    
    
    
    
    307Operating earnings (loss)
    
    
    (448
    )
    
    
    (104
    )
    
    
    (192
    )
    
    
    
    
    
    
    (744
    )Other income (expense)  net
    
    
    34
    
    
    
    (35
    )
    
    
    (8
    )
    
    
    
    
    
    
    (9
    )Interest expenseLong-term debt
    
    
    (27
    )
    
    
    
    
    
    
    (7
    )
    
    
    
    
    
    
    (34
    )Other
    
    
    (3
    )
    
    
    (4
    )
    
    
    (2
    )
    
    
    
    
    
    
    (9
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (444
    )
    
    
    (143
    )
    
    
    (209
    )
    
    
    
    
    
    
    (796
    )Income tax benefit (provision)
    
    
    230
    
    
    
    (16
    )
    
    
    8
    
    
    
    
    
    
    
    222(214
    )
    
    
    (159
    )
    
    
    (201
    )
    
    
    
    
    
    
    (574
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    15Equity
in net earnings (loss) of associated companies  net of tax
    
    
    (355
    )
    
    
    (134
    )
    
    
    (7
    )
    
    
    486
    
    
    
    (10)Net earnings (loss) from continuing operations
    
    
    (569
    )
    
    
    (293
    )
    
    
    (193
    )
    
    
    486
    
    
    
    (569
    )Net earnings from discontinued
operations  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    (569
    )
    
    
    (293
    )
    
    
    (193
    )
    
    
    486
    
    
    
    (569
    )Dividends on preferred shares
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Net loss applicable to common shares
    
    $
    (574
    )
    
    $
    (293
    )
    
    $
    (193
    )
    
    $
    486
    
    
    $
    (574
    )


25



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##### Table of Contents



Supplemental Consolidating Statements of Operations for the six months ended
June 30, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    1,640
    
    
    $
    3,279
    
    
    $
    1,393
    
    
    $
    (1,587
    )
    
    $
    4,725Cost of revenues
    
    
    906
    
    
    
    2,447
    
    
    
    909
    
    
    
    (1,587
    )
    
    
    2,675Gross profit
    
    
    734
    
    
    
    832
    
    
    
    484
    
    
    
    
    
    
    
    2,050Selling, general and administrative expense
    
    
    215
    
    
    
    591
    
    
    
    96
    
    
    
    
    
    
    
    902Research and development expense
    
    
    400
    
    
    
    441
    
    
    
    117
    
    
    
    
    
    
    
    958Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special charges
    
    
    21
    
    
    
    109
    
    
    
    9
    
    
    
    
    
    
    
    139(Gain) loss on sale of businesses
    
    
    (2
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    Operating earnings (loss)
    
    
    100
    
    
    
    (311
    )
    
    
    262
    
    
    
    
    
    
    
    51Other income (expense)  net
    
    
    74
    
    
    
    66
    
    
    
    (89
    )
    
    
    
    
    
    
    51Interest expenseLong-term debt
    
    
    (34
    )
    
    
    
    
    
    
    (13
    )
    
    
    
    
    
    
    (47
    )Other
    
    
    (2

    )
    
    
    (27
    )
    
    
    20
    
    
    
    
    
    
    
    (9
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in net earnings (loss) of associated companies
    
    
    138
    
    
    
    (272
    )
    
    
    180
    
    
    
    
    
    
    
    46Income tax benefit (provision)
    
    
    144
    
    
    
    (284
    )
    
    
    124
    
    
    
    
    
    
    
    (16
    )282
    
    
    
    (556
    )
    
    
    304
    
    
    
    
    
    
    
    30Minority interests  net
    
    
    
    
    
    
    
    
    
    
    (13
    )
    
    
    
    
    
    
    (13
    )Equity in net earnings (loss) of associated
companies  net of tax
    
    
    (292
    )
    
    
    579
    
    
    
    9
    
    
    
    (323
    )
    
    
    (27
    )Net earnings (loss) from continuing operations
    
    
    (10
    )
    
    
    23
    
    
    
    300
    
    
    
    (323
    )
    
    
    (10
    )Net earnings from discontinued
operations  net of tax
    
    
    164
    
    
    
    107
    
    
    
    
    
    
    
    (107
    )
    
    
    164Net earnings (loss)
    
    $
    154
    
    
    $
    130
    
    
    $
    300
    
    
    $
    (430
    )
    
    $
    154Dividends on preferred shares
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )Net earnings (loss)
    
    $
    142
    
    
    $
    130
    
    
    $
    300
    
    
    $
    (430
    )
    
    $
    142


26



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##### Table of Contents



Supplemental Consolidating Statements of Operations for the six months ended
June 30, 2002:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    1,604
    
    
    $
    4,191
    
    
    $
    1,461
    
    
    $
    (1,576
    )
    
    $
    5,680Cost of revenues
    
    
    1,462
    
    
    
    2,935
    
    
    
    1,278
    
    
    
    (1,576
    )
    
    
    4,099Gross profit
    
    
    142
    
    
    
    1,256
    
    
    
    183
    
    
    
    
    
    
    
    1,581Selling, general and administrative expense
    
    
    235
    
    
    
    1,042
    
    
    
    227
    
    
    
    
    
    
    
    1,504Research and development expense
    
    
    438
    
    
    
    551
    
    
    
    155
    
    
    
    
    
    
    
    1,144Amortization of acquired technology
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    11Special charges
    
    
    263
    
    
    
    334
    
    
    
    153
    
    
    
    
    
    
    
    750(Gain) loss on sale of businesses
    
    
    (1
    )
    
    
    (3
    )
    
    
    1
    
    
    
    
    
    
    
    (3
    )Operating earnings (loss)
    
    
    (793
    )
    
    
    (679
    )
    
    
    (353
    )
    
    
    
    
    
    
    (1,825
    )Other income (expense)  net
    
    
    34
    
    
    
    (57
    )
    
    
    (5
    )
    
    
    
    
    
    
    (28
    )Interest expenseLong-term debt
    
    
    (56
    )
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    (70
    )Other
    
    
    (3
    )
    
    
    (16
    )
    
    
    (2
    )
    
    
    
    
    
    
    (21
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in net earnings (loss) of
associated companies
    
    
    (818
    )
    
    
    (752
    )
    
    
    (374
    )
    
    
    
    
    
    
    (1,944
    )Income tax benefit (provision)
    
    
    351
    
    
    
    135
    
    
    
    98
    
    
    
    
    
    
    
    584(467
    )
    
    
    (617
    )
    
    
    (276
    )
    
    
    
    
    
    
    (1,360
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    20Equity in net earnings (loss) of associated
companies  net of tax
    
    
    (887
    )
    
    
    (248
    )
    
    
    (6
    )
    
    
    1,127
    
    
    
    (14
    )Net earnings (loss) from continuing operations
    
    
    (1,354
    )
    
    
    (865
    )
    
    
    (262
    )
    
    
    1,127
    
    
    
    (1,354
    )Net earnings from discontinued
operations  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    (1,354
    )
    
    
    (865
    )
    
    
    (262
    )
    
    
    1,127
    
    
    
    (1,354
    )Dividends on preferred shares
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )Net loss applicable to common shares
    
    $
    (1,364
    )
    
    $
    (865
    )
    
    $
    (262
    )
    
    $
    1,127
    
    
    $
    (1,364
    )


27



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##### Table of Contents



Supplemental Consolidating Balance Sheets as at June 30, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    27
    
    
    $
    3,284
    
    
    $
    804
    
    
    $
    
    
    
    $
    4,115Restricted cash and cash equivalents
    
    
    20
    
    
    
    57
    
    
    
    38
    
    
    
    
    
    
    
    115Accounts receivable  net
    
    
    283
    
    
    
    1,029
    
    
    
    402
    
    
    
    
    
    
    
    1,714Intercompany/related party accounts receivable
    
    
    4,808
    
    
    
    798
    
    
    
    685
    
    
    
    (6,106
    )
    
    
    185Inventories  net
    
    
    420
    
    
    
    243
    
    
    
    167
    
    
    
    
    
    
    
    830Income taxes recoverable
    
    
    8
    
    
    
    21
    
    
    
    28
    
    
    
    
    
    
    
    57Deferred income taxes  net
    
    
    130
    
    
    
    267
    
    
    
    2
    
    
    
    
    
    
    
    399Other current assets
    
    
    72
    
    
    
    254
    
    
    
    112
    
    
    
    
    
    
    
    438Total current assets
    
    
    5,768
    
    
    
    5,953
    
    
    
    2,238
    
    
    
    (6,106
    )
    
    
    7,853Investments
    
    
    630
    
    
    
    (7,322
    )
    
    
    133
    
    
    
    6,768
    
    
    
    209Plant and equipment  net
    
    
    449
    
    
    
    654
    
    
    
    275
    
    
    
    
    
    
    
    1,378Goodwill
    
    
    
    
    
    
    1,956
    
    
    
    66
    
    
    
    
    
    
    
    2,022Deferred income taxes  net
    
    
    1,664
    
    
    
    1,653
    
    
    
    268
    
    
    
    
    
    
    
    3,585Other assets
    
    
    341
    
    
    
    (198
    )
    
    
    1,890
    
    
    
    (1,402
    )
    
    
    631Total assets
    
    $
    8,852
    
    
    $
    2,696
    
    
    $
    4,870
    
    
    $
    (740
    )
    
    $
    15,678LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    3
    
    
    $
    43
    
    
    $
    
    
    
    $
    48Trade and other accounts payable
    
    
    298
    
    
    
    467
    
    
    
    67
    
    
    
    
    
    
    
    832Intercompany/related party accounts payable
    
    
    84
    
    
    
    2,210
    
    
    
    3,812
    
    
    
    (6,106
    )
    
    
    Payroll and benefit-related liabilities
    
    
    41
    
    
    
    467
    
    
    
    125
    
    
    
    
    
    
    
    633Contractual liabilities
    
    
    66
    
    
    
    829
    
    
    
    459
    
    
    
    
    
    
    
    1,354Restructuring
    
    
    195
    
    
    
    274
    
    
    
    147
    
    
    
    
    
    
    
    616Other accrued liabilities
    
    
    616
    
    
    
    1,598
    
    
    
    296
    
    
    
    
    
    
    
    2,510Long-term debt due within one year
    
    
    174
    
    
    
    7
    
    
    
    3
    
    
    
    
    
    
    
    184Total current liabilities
    
    
    1,476
    
    
    
    5,855
    
    
    
    4,952
    
    
    
    (6,106
    )
    
    
    6,177Long-term debt
    
    
    1,567
    
    
    
    3
    
    
    
    324
    
    
    
    
    
    
    
    1,894Deferred income taxes  net
    
    
    267
    
    
    
    109
    
    
    
    69
    
    
    
    
    
    
    
    445Other liabilities
    
    
    881
    
    
    
    1,778
    
    
    
    1,158
    
    
    
    (1,402
    )
    
    
    2,4154,191
    
    
    
    7,745
    
    
    
    6,503
    
    
    
    (7,508
    )
    
    
    10,931Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    86
    
    
    
    
    
    
    
    86SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    342
    
    
    
    
    
    
    
    (342
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    5,979
    
    
    
    600
    
    
    
    (6,579
    )
    
    
    1,211Additional paid-in capital
    
    
    22,003
    
    
    
    1,510
    
    
    
    3,832
    
    
    
    (5,342
    )
    
    
    22,003Accumulated deficit
    
    
    (17,951
    )
    
    
    (13,666
    )
    
    
    (6,080
    )
    
    
    19,746
    
    
    
    (17,951
    )Accumulated other comprehensive income (loss)
    
    
    (1,138
    )
    
    
    786
    
    
    
    (71
    )
    
    
    (715
    )
    
    
    (1,138
    )Total shareholders equity
    
    
    4,661
    
    
    
    (5,049
    )
    
    
    (1,719
    )
    
    
    6,768
    
    
    
    4,661Total liabilities and shareholders equity
    
    $
    8,852
    
    
    $
    2,696
    
    
    $
    4,870
    
    
    $
    (740)
    
    
    $
    15,678


28



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##### Table of Contents



Supplemental Consolidating Balance Sheets 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
    
    
    $
    2,452
    
    
    $
    1,110
    
    
    $
    
    
    
    $
    3,813Restricted cash and cash equivalents
    
    
    6
    
    
    
    176
    
    
    
    67
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    316
    
    
    
    1,189
    
    
    
    405
    
    
    
    
    
    
    
    1,910Intercompany/related party accounts
receivable
    
    
    4,200
    
    
    
    976
    
    
    
    459
    
    
    
    (5,552
    )
    
    
    83Inventories  net
    
    
    515
    
    
    
    211
    
    
    
    163
    
    
    
    
    
    
    
    889Income taxes recoverable
    
    
    3
    
    
    
    46
    
    
    
    9
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    178
    
    
    
    615
    
    
    
    
    
    
    
    
    
    
    
    793Other current assets
    
    
    182
    
    
    
    427
    
    
    
    97
    
    
    
    
    
    
    
    706Total current assets
    
    
    5,651
    
    
    
    6,092
    
    
    
    2,310
    
    
    
    (5,552
    )
    
    
    8,501Investments at cost and associated companies at equity
    
    
    707
    
    
    
    (7,679
    )
    
    
    118
    
    
    
    7,100
    
    
    
    246Plant and equipment  net
    
    
    399
    
    
    
    741
    
    
    
    301
    
    
    
    
    
    
    
    1,441Goodwill
    
    
    
    
    
    
    1,956

    
    
    
    65
    
    
    
    
    
    
    
    2,021Deferred income taxes  net
    
    
    1,143
    
    
    
    1,582
    
    
    
    72
    
    
    
    
    
    
    
    2,797Other assets
    
    
    472
    
    
    
    1,271
    
    
    
    916
    
    
    
    (1,912
    )
    
    
    747Total assets
    
    $
    8,372
    
    
    $
    3,963
    
    
    $
    3,782
    
    
    $
    (364
    )
    
    $
    15,753LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    3
    
    
    $
    95
    
    
    $
    
    
    
    $
    100Trade and other accounts payable
    
    
    400
    
    
    
    429
    
    
    
    102
    
    
    
    
    
    
    
    931Intercompany/related party accounts
payable
    
    
    
    
    
    
    3,336
    
    
    
    2,216
    
    
    
    (5,552
    )
    
    
    Payroll and benefit-related liabilities
    
    
    32
    
    
    
    397
    
    
    
    84
    
    
    
    
    
    
    
    513Contractual liabilities
    
    
    107
    
    
    
    932
    
    
    
    507
    
    
    
    
    
    
    
    1,546Restructuring
    
    
    183
    
    
    
    415
    
    
    
    163
    
    
    
    
    
    
    
    761Other accrued liabilities
    
    
    641
    
    
    
    1,768
    
    
    
    394
    
    
    
    
    
    
    
    2,803Long-term debt due within one year
    
    
    174
    
    
    
    8
    
    
    
    51
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    1,539
    
    
    
    7,288
    
    
    
    3,612
    
    
    
    (5,552
    )
    
    
    6,887Long-term debt
    
    
    1,603
    
    
    
    3
    
    
    
    313
    
    
    
    
    
    
    
    1,919Deferred income taxes  net
    
    
    263
    
    
    
    95
    
    
    
    8
    
    
    
    
    
    
    
    366Other liabilities
    
    
    815
    
    
    
    1,761
    
    
    
    1,688
    
    
    
    (1,913
    )
    
    
    2,3514,220
    
    
    
    9,147
    
    
    
    5,621
    
    
    
    (7,465
    )
    
    
    11,523Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    78
    
    
    
    
    
    
    
    78SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    342
    
    
    
    
    
    
    
    (342
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    6,061
    
    
    
    982
    
    
    
    (7,043
    )
    
    
    1,211Additional paid-in capital
    
    
    21,991
    
    
    
    1,551
    
    
    
    4,051
    
    
    
    (5,602
    )
    
    
    21,991Accumulated deficit
    
    
    (18,093
    )
    
    
    (13,753
    )
    
    
    (6,825
    )
    
    
    20,578
    
    
    
    (18,093
    )Accumulated other comprehensive income (loss)
    
    
    (1,493
    )
    
    
    615
    
    
    
    (125
    )
    
    
    (490
    )
    
    
    (1,493
    )Total shareholders equity
    
    
    4,152
    
    
    
    (5,184
    )
    
    
    (1,917
    )
    
    
    7,101
    
    
    
    4,152Total liabilities and shareholders equity
    
    $
    8,372
    
    
    $
    3,963
    
    
    $
    3,782
    
    
    $
    (364
    )
    
    $
    15,753


29



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##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the six months ended
June 30, 2003:

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
    
    $
    (10
    )
    
    $
    23
    
    
    $
    300
    
    
    $
    (323
    )
    
    $
    (10
    )Adjustments to reconcile net loss from (used in)
continuing operations to net cash from operating
activities, net of effects from acquisitions and
divestitures of businesses:Amortization and depreciation
    
    
    44
    
    
    
    121
    
    
    
    42
    
    
    
    
    
    
    
    207Non-cash portion of special charges
and related asset write downs
    
    
    (14
    )
    
    
    (4
    )
    
    
    (8
    )
    
    
    
    
    
    
    (26
    )Equity in net earnings (loss) of associated
companies
    
    
    292
    
    
    
    (579
    )
    
    
    (9
    )
    
    
    323
    
    
    
    27Stock option compensation
    
    
    2
    
    
    
    8
    
    
    
    2
    
    
    
    
    
    
    
    12Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    19Other liabilities
    
    
    45
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    65Gain on repurchases of outstanding debt
securities
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )(Gain) loss on sale of investments and
businesses
    
    
    
    
    
    
    42
    
    
    
    
    
    
    
    
    
    
    
    42Other  net
    
    
    149
    
    
    
    (158
    )
    
    
    (61
    )
    
    
    
    
    
    
    (70
    )Change in operating assets and liabilities:Accounts receivable
    
    
    403
    
    
    
    (102
    )
    
    
    (214
    )
    
    
    
    
    
    
    87Inventories
    
    
    90
    
    
    
    (15
    )
    
    
    42
    
    
    
    
    
    
    
    117Income taxes
    
    
    
    
    
    
    (10
    )
    
    
    14
    
    
    
    
    
    
    
    4Restructuring
    
    
    (81
    )
    
    
    (206
    )
    
    
    (52
    )
    
    
    
    
    
    
    (339
    )Accounts payable and accrued liabilities
    
    
    (98
    )
    
    
    (121
    )
    
    
    (102
    )
    
    
    
    
    
    
    (321
    )Other operating assets and liabilities
    
    
    (313
    )
    
    
    148
    
    
    
    131
    
    
    
    
    
    
    
    (34
    )Intercompany/related party activity
    
    
    (955
    )
    
    
    1,317
    
    
    
    (362
    )
    
    
    
    
    
    
    Net cash from (used in) operating activities
    
    
    (450
    )
    
    
    484
    
    
    
    (258
    )
    
    
    
    
    
    
    (224
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (15
    )
    
    
    (28
    )
    
    
    (13
    )
    
    
    
    
    
    
    (56
    )Proceeds on disposals of plant and equipment
    
    
    6
    
    
    
    12
    
    
    
    3
    
    
    
    
    
    
    
    21Decrease (increase) in restricted cash and
cash equivalents
    
    
    (12
    )
    
    
    131
    
    
    
    25
    
    
    
    
    
    
    
    144Increase in long-term receivables
    
    
    
    
    
    
    (10
    )
    
    
    (1
    )
    
    
    
    
    
    
    (11
    )Decrease in long-term receivables
    
    
    195
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    197Acquisitions of investments and businesses
 net of cash acquired
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Proceeds on sale of investments and businesses
    
    
    1
    
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    8Net cash from (used in) investing activities
    
    
    175
    
    
    
    112
    
    
    
    14
    
    
    
    
    
    
    
    301Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )Increase (decrease) in notes payable  net
    
    
    
    
    
    
    
    
    
    
    (18
    )
    
    
    
    
    
    
    (18
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Repayments of long-term debt
    
    
    (34
    )
    
    
    
    
    
    
    (60
    )
    
    
    
    
    
    
    (94
    )Decrease in capital leases payable
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    (2
    )Net cash from (used in) financing activities
    
    
    (46
    )
    
    
    (1
    )
    
    
    (79
    )
    
    
    
    
    
    
    (126
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    60
    
    
    
    17
    
    
    
    
    
    
    
    78Net cash from (used in) continuing operations
    
    
    (320
    )
    
    
    655
    
    
    
    (306
    )
    
    
    
    
    
    
    29Net cash from (used in) discontinued operations
    
    
    96
    
    
    
    177
    
    
    
    
    
    
    
    
    
    
    
    273Net increase (decrease) in cash and
cash equivalents
    
    
    (224
    )
    
    
    832
    
    
    
    (306
    )
    
    
    
    
    
    
    302Cash and cash equivalents at beginning of
period  net
    
    
    251
    
    
    
    2,452
    
    
    
    1,110
    
    
    
    
    
    
    
    3,813Cash and cash equivalents at end of period
 net
    
    $
    27
    
    
    $
    3,284
    
    
    $
    804
    
    
    $
    
    
    
    $
    4,115


30



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##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the six months ended
June 30, 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
    
    $
    (1,354
    )
    
    $
    (865
    )
    
    $
    (262
    )
    
    $
    1,127
    
    
    $
    (1,354
    )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
    
    
    47
    
    
    
    238
    
    
    
    19
    
    
    
    
    
    
    
    304Non-cash portion of special charges
and related asset write downs
    
    
    155
    
    
    
    101
    
    
    
    8
    
    
    
    
    
    
    
    264Equity in net loss of associated companies
    
    
    887
    
    
    
    248
    
    
    
    6
    
    
    
    (1,127
    )
    
    
    14Deferred income taxes
    
    
    (163
    )
    
    
    (418
    )
    
    
    (14
    )
    
    
    
    
    
    
    (595
    )Other liabilities
    
    
    (14
    )
    
    
    (33
    )
    
    
    
    
    
    
    
    
    
    
    (47
    )Gain on repurchase of outstanding debt
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gain on sale of investments and businesses
    
    
    (10
    )
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    (15
    )Other  net
    
    
    25
    
    
    
    153
    
    
    
    106
    
    
    
    
    
    
    
    284Change in operating assets and liabilities:Accounts receivable
    
    
    (65
    )
    
    
    606
    
    
    
    (2
    )
    
    
    
    
    
    
    539Inventories
    
    
    68
    
    
    
    62
    
    
    
    (16
    )
    
    
    
    
    
    
    114Income taxes
    
    
    220
    
    
    
    1,079
    
    
    
    (31
    )
    
    
    
    
    
    
    1,268Restructuring
    
    
    (422
    )
    
    
    (114
    )
    
    
    (107
    )
    
    
    
    
    
    
    (643
    )Accounts payable and accrued
liabilities
    
    
    224
    
    
    
    (448
    )
    
    
    142
    
    
    
    
    
    
    
    (82
    )Other operating assets and liabilities
    
    
    (361
    )
    
    
    262
    
    
    
    (130
    )
    
    
    
    
    
    
    (229
    )Intercompany/related party activity
    
    
    504
    
    
    
    (731
    )
    
    
    227
    
    
    
    
    
    
    
    Net cash from (used in) operating activities
    
    
    (259
    )
    
    
    135
    
    
    
    (54
    )
    
    
    
    
    
    
    (178
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (15
    )
    
    
    (174
    )
    
    
    (19
    )
    
    
    
    
    
    
    (208
    )Proceeds on disposals of plant and equipment
    
    
    
    
    
    
    76
    
    
    
    
    
    
    
    
    
    
    
    76Increase in long-term receivables
    
    
    64
    
    
    
    (152
    )
    
    
    (122
    )
    
    
    
    
    
    
    (210
    )Decrease in long-term receivables
    
    
    18
    
    
    
    83
    
    
    
    4
    
    
    
    
    
    
    
    105Acquisitions of investments and businesses
 net of cash acquired
    
    
    (3
    )
    
    
    (22
    )
    
    
    
    
    
    
    
    
    
    
    (25
    )Proceeds on sale of investments and businesses
    
    
    20
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    38Net cash used in investing activities
    
    
    84
    
    
    
    (171
    )
    
    
    (137
    )
    
    
    
    
    
    
    (224
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )Increase (decrease) in notes payable  net
    
    
    
    
    
    
    1
    
    
    
    (78
    )
    
    
    
    
    
    
    (77
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    31
    
    
    
    
    
    
    
    31Repayments of long-term debt
    
    
    
    
    
    
    (3
    )
    
    
    (3
    )
    
    
    
    
    
    
    (6
    )Decrease in capital leases payable
    
    
    (1
    )
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    (4
    )Issuance of common shares
    
    
    800
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800Net cash from (used in) financing activities
    
    
    789
    
    
    
    (5
    )
    
    
    (50
    )
    
    
    
    
    
    
    734Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    8
    
    
    
    28
    
    
    
    10
    
    
    
    
    
    
    
    46Net cash from (used in) continuing operations
    
    
    622
    
    
    
    (13
    )
    
    
    (231
    )
    
    
    
    
    
    
    378Net cash used in discontinued operations
    
    
    100
    
    
    
    187
    
    
    
    
    
    
    
    
    
    
    
    287Net increase (decrease) in cash and
cash equivalents
    
    
    722
    
    
    
    174
    
    
    
    (231
    )
    
    
    
    
    
    
    665Cash and cash equivalents at beginning of
period  net
    
    
    (41
    )
    
    
    2,340
    
    
    
    1,158
    
    
    
    
    
    
    
    3,457Cash and cash equivalents at end of period
 net
    
    $
    681
    
    
    $
    2,514
    
    
    $
    927
    
    
    $
    
    
    
    $
    4,122


31



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##### Table of Contents






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

You should read this section in combination with the accompanying unaudited
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States. This section contains
forward looking statements and should be read in conjunction with the factors
described below under Forward looking statements. 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.

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 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 into 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

Asset and liability review and
analysis

In light of a period of unprecedented industry
adjustment and subsequent restructuring actions, including workforce
reductions and asset write-downs, in the second quarter of 2003 we
initiated a comprehensive review and analysis of identifiable
categories of our assets and liabilities, or the comprehensive review.
The amounts under review were recorded when our balance sheet and
income statement were much larger. Specifically, what would have been
relatively minor amounts in prior periods may be considered to be
material to current periods. The comprehensive review is in addition
to reviews normally performed by us in connection with the recording
of our current period financial results.The outcome of the
comprehensive review may result in the elimination of certain assets
and liabilities (including accruals and provisions). As part of the
comprehensive review, we are currently assessing the support for
certain of our liabilities which were initially recorded, along with
corresponding charges to income, in prior periods. These liabilities
represented less than 2% of our total liabilities as at June 30,
2003. The outcome of the comprehensive review is currently not
expected to have a negative impact on our net assets. Reported
results in one or more prior periods may be affected, potentially
resulting in the non-material reduction of prior period losses. No
amounts relating to the elimination of any such assets and
liabilities have been included in our results for the second quarter
of 2003. The comprehensive review is ongoing, and we expect to
substantially conclude it in the third quarter of 2003.

Customer financing commitments

During the first half of 2003, we reduced undrawn
customer financing commitments by $134
reflecting commitment expirations, cancellations and changing customer business
plans. As of June 30, 2003, approximately $100 of the $667 in undrawn
commitments was not available for funding under the terms of our financing
agreements. Subsequent to June 30, 2003, we renegotiated an agreement
with a certain customer and reduced our undrawn commitments by approximately
$509, leaving approximately $158 in aggregate undrawn commitments.

Ownership adjustment in our French and German operations

On July 18, 2003, we announced that we will realign our business activities in
France and Germany. As a result, we will increase our ownership in our core
businesses in these countries, consistent with our overall global business
strategy. Subject to final regulatory approval, we will acquire the 42%
ownership interest in Nortel Networks Germany GmbH & Co. KG and the 45%
ownership interest in Nortel Networks France S.A.S., currently held by European
Aeronautic Defence and Space Company EADS N.V., or EADS, our partner in three
European joint ventures. When completed, these transactions will bring our
ownership in each company to 100%. These companies are responsible for the
sales and marketing of our products in France and Germany. At the same time,
EADS will increase its ownership in EADS Telecom S.A.S. (formerly EADS Defence
and Security Networks S.A.S.) from 59% to 100% as a result of acquiring our
equity ownership in that company.

For additional information, see Joint ventures/minority interests.

32



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##### Table of Contents



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 has reduced our need to
utilize restricted cash as collateral for our performance related obligations.
Currently, $300 is committed support for performance bonds. On July 10, 2003,
we announced an amendment to the EDC support facility which extended the
termination date to December 31, 2005 from June 30, 2004. See Available
support facility for additional information.

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 receivable 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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, or SFAS, No. 148 was a stock option expense of $7 in the second
quarter of 2003 and $12 in the first half 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 Annual Report on Form 10-K for
the year ended December 31, 2002 filed with the SEC.

Results of operations  continuing operations

Segment revenues

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    987
    
    
    $
    1,123
    
    
    $
    (136
    )
    
    
    (12
    )
    
    $
    1,940
    
    
    $
    2,259
    
    
    $
    (319
    )
    
    
    (14
    )Enterprise Networks
    
    
    549
    
    
    
    635
    
    
    
    (86
    )
    
    
    (14
    )
    
    
    1,160
    
    
    
    1,310
    
    
    
    (150
    )
    
    
    (11
    )Wireline Networks
    
    
    494
    
    
    
    588
    
    
    
    (94
    )
    
    
    (16
    )
    
    
    1,056
    
    
    
    1,270
    
    
    
    (214
    )
    
    
    (17
    )Optical Networks
    
    
    298
    
    
    
    404
    
    
    
    (106
    )
    
    
    (26
    )
    
    
    568
    
    
    
    809
    
    
    
    (241
    )
    
    
    (30
    )Other (a)
    
    
    
    
    
    
    20
    
    
    
    (20
    )
    
    
    (100
    )
    
    
    1
    
    
    
    32
    
    
    
    (31
    )
    
    
    (97
    )Consolidated
    
    $
    2,328
    
    
    $
    2,770
    
    
    $
    (442
    )
    
    
    (16
    )
    
    $
    4,725
    
    
    $
    5,680
    
    
    $
    (955
    )
    
    
    (17
    )


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

33



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##### Table of Contents



Geographic revenues

The following table summarizes our geographic revenues based on the location of
the customer:

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeUnited States
    
    $
    1,140
    
    
    $
    1,485
    
    
    $
    (345
    )
    
    
    (23
    )
    
    $
    2,342
    
    
    $
    2,890
    
    
    $
    (548
    )
    
    
    (19
    )EMEA (a)
    
    
    583
    
    
    
    632
    
    
    
    (49
    )
    
    
    (8
    )
    
    
    1,224
    
    
    
    1,356
    
    
    
    (132
    )
    
    
    (10
    )Canada
    
    
    138
    
    
    
    203
    
    
    
    (65
    )
    
    
    (32
    )
    
    
    268
    
    
    
    421
    
    
    
    (153
    )
    
    
    (36
    )Other regions (b)
    
    
    467
    
    
    
    450
    
    
    
    17
    
    
    
    4
    
    
    
    891
    
    
    
    1,013
    
    
    
    (122
    )
    
    
    (12
    )Consolidated
    
    $
    2,328
    
    
    $
    2,770
    
    
    $
    (442
    )
    
    
    (16
    )
    
    $
    4,725
    
    
    $
    5,680
    
    
    $
    (955
    )
    
    
    (17
    )


|(a) |  | The Europe, Middle East and Africa region.                        
|--- |  | ------------------------------------------------------------------
|(b) |  | Included the Asia Pacific and Caribbean and Latin America regions.

Consolidated revenues



| |  | Q2 2003 vs. Q2 2002 and first half of 2003 vs. first half of 2002
| |  | -----------------------------------------------------------------

Our consolidated revenues declined 16% in the second quarter of 2003 compared
to the second quarter of 2002 and declined 17% in the first half of 2003
compared to the first half of 2002. These declines were across all segments
and were primarily due to the continuing industry adjustment, tightened capital
markets and/or capital spending restrictions experienced by our service provider
and enterprise customers. Customer spending remained cautious, with many of
our customers realigning capital spending with their current levels of revenues
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 focus on 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 16% decline in revenues in the second
quarter of 2003 compared to the same period in 2002 was primarily due to a:



| |  | 23% decline in revenues in the United States primarily due to
tightened capital markets and/or capital spending restrictions by our
service provider and enterprise customers and their focus on capital and
cash flow management and a one time shipment to a certain enterprise
customer in the second quarter of 2002 which was not repeated in the
second quarter of 2003;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 32% decline in revenues in Canada primarily due to tightened capital
markets, capital spending restrictions experienced by our service
provider customers and their focus on capital and cash flow management;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 8% decline in revenues in the Europe, Middle East and Africa region,
or EMEA, primarily due a substantial reduction in capital spending as a
result of the continuing industry adjustment, tightened capital markets
and/or customers continuing to focus on maximizing return on invested
capital; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 22% decline in revenues in the Caribbean and Latin America region, or
CALA, primarily due to continued capital spending restrictions by service
provider and enterprise customers; partially offset by
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 15% increase in revenues in the Asia Pacific region, or Asia Pacific,
primarily due to new contracts with certain customers and continuing
network expansions.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, the 17% decline in revenues in the first half of
2003 compared to the same period in 2002 was primarily due to a:



| |  | 19% decline in revenues in the United States primarily due to
tightened capital markets and/or capital spending restrictions by our
service provider and enterprise customers and their focus on capital and
cash flow management;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 36% decline in revenues in Canada primarily due to tightened capital
markets, capital spending restrictions experienced by our service
provider customers and their focus on capital and cash flow management;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 10% decline in revenues in EMEA primarily due to tightened capital
markets and/or capital spending restrictions by service provider and
enterprise customers which were partially offset by increases in revenue
related to new Global System for Mobile communications, or GSM,
contracts with certain service providers; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

34



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##### Table of Contents





| |  | 30% decline in revenues in CALA primarily due to the completion of a
major contract in the first quarter of 2002 and continued capital
spending restrictions experienced by our service provider customers.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q2 2003 vs. Q1 2003
| |  | -------------------

Our consolidated revenues declined $69 from $2,397 in the first quarter of 2003
to $2,328 in the second quarter of 2003. The decline was primarily due to
continuing capital spending restrictions experienced by our service provider
and enterprise customers. Also contributing to the decline in revenues were
some incremental one time shipments on new contracts in the first quarter of
2003 in the United States that were not repeated in the second quarter of 2003.

Geographic revenues for the second quarter of 2003 compared to the first
quarter of 2003 decreased 5% in the United States, decreased 9% in EMEA,
decreased 23% in CALA, increased 27% in Asia Pacific and increased 6% in
Canada.



| |  | Remainder of 2003
| |  | -----------------

Given the ongoing economic and geopolitical uncertainty, customers continue to
spend cautiously. We expect to see continued restrictions on capital spending
by customers due to:



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



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



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



| |  | 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 certain of our products as a result of increased competition. Further,
customer spending is expected to remain cautious while customers assess the
impact of the recent Federal Communications Commission, or FCC, decision
regarding unbundled network elements, or UNEs. It is difficult to predict the
duration of the current industry adjustment, as growth in industry spending is
not expected to occur until the economic and financial concerns and the
geopolitical uncertainty 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:

(QUARTERLY REVENUES FOR WIRELESS NETWORKS)

35



---



##### Table of Contents





| |  | Q2 2003 vs. Q2 2002
| |  | -------------------

Wireless Networks revenues declined 12% in the second quarter of 2003 compared
to the second quarter of 2002 primarily due to an ongoing focus by wireless
service providers on capital and cash flow management and increased competition
for customers by wireless service providers. Many customers continued to
heavily scrutinize capital expenditure requirements and postponed or reduced
their capital spending.

Code Division Multiple Access, or CDMA, revenues declined in the second quarter
of 2003 compared to the second quarter of 2002 primarily due to customers,
particularly in the United States, continuing to implement capital spending
restrictions driven by their continued focus on capital and cash flow
management. CDMA revenues also declined substantially in CALA primarily due to
many of our customers completing their initial network deployments in 2002 and,
as a result, having sufficient capacity to currently meet additional subscriber
demand. CDMA revenues in Asia Pacific increased substantially in the second
quarter of 2003 compared to the second quarter of 2002 and partially offset the
declines in the United States and CALA. This substantial increase was
primarily due to new contracts with certain service providers and other
customers expanding their existing networks to meet increased subscriber
demand.

Time Division Multiple Access, or TDMA, revenues declined substantially in the
second quarter of 2003 compared to the second 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 GSM and CDMA technologies. TDMA revenues
continued to be a smaller portion of Wireless Networks revenues in the second
quarter of 2003 compared to the second quarter of 2002.

Overall GSM revenues, which includes General Packet Radio Standard, or GPRS,
and Enhanced Data Rates for Global Evolution, or EDGE, declined slightly in the
second quarter of 2003 compared to the second quarter of 2002 due to a
significant decline in the United States and a substantial decline in Asia
Pacific. The significant decrease in revenues in the United States was
primarily due to a continued decline in the overall growth rate of GSM
technology deployments by wireless service providers as a result of sufficient
network capacity. In Asia Pacific, the substantial decline in GSM revenues was
primarily due to the completion of network deployments by many of our customers
as of the beginning of the first quarter of 2003 and as a result, they have
sufficient capacity to currently meet additional subscriber demand. GSM
revenues increased substantially in EMEA and CALA in the second quarter of 2003
compared to the same period in 2002 and partially offset the declines in the
United States and Asia Pacific. The substantial increases were primarily due
to new contracts with certain service providers.

Universal Mobile Telecommunications Systems, or UMTS, revenues decreased
substantially in the second quarter of 2003 compared to the same period in 2002
as operators continued to scrutinize and delay deployment plans. However, in
both the second quarter of 2003 and the second quarter of 2002, UMTS revenues
accounted for an insignificant amount of total Wireless Networks revenues.

From a geographic perspective, the 12% decrease in Wireless Networks revenues
in the second quarter of 2003 compared to the same period in 2002 was primarily
due to a:



| |  | 25% decline in revenues in the United States and a 45% decline in
Canada primarily due to customers focus on capital and cash flow
management; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 9% decline in revenues in CALA primarily due to many customers
completing their initial network deployments in 2002, and as a result,
having sufficient capacity to currently meet additional subscriber
demand; partially offset by a
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 49% increase in revenues in Asia Pacific primarily due to new CDMA
contracts with certain customers and continuing CDMA network expansion;
and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  | 17% increase in revenues in EMEA primarily due to new GSM contracts
with certain service provider customers.
| | - | ------------------------------------------------------------------------------------------------------------



| |  | First half 2003 vs. first half 2002
| |  | -----------------------------------

In the first half of 2003, Wireless Networks revenues declined 14% compared to
the same period in 2002 primarily due to the ongoing focus by wireless service
providers on capital and cash flow management, and increased competition for
customers by wireless service providers. As a result, many of our customers
continued to heavily scrutinize their capital expenditure requirements and
postponed or reduced their capital spending.

CDMA revenues decreased in the first half of 2003 compared to the first half of
2002 primarily due to a substantial decline in the United States and Canada as
customers continued to experience capital spending restrictions driven by their
continued focus on capital and cash flow management. In Asia Pacific, CDMA
revenues increased substantially in the first half of 2003

36



---



##### Table of Contents



compared to the same period in 2002 primarily due to new contracts with certain
service provider customers and other customers expanding their existing
networks to meet increased subscriber demand.

TDMA revenues declined substantially in the first half of 2003 compared to the
first half of 2002 primarily due to the continued transition to newer wireless
technologies. The substantial decline was primarily due to United States and
Canada customers continuing to migrate from the mature TDMA technology to GSM
and CDMA technologies. In the first half of 2003, TDMA revenues accounted for
less than 10% of total Wireless Networks revenues.

GSM revenues decreased in the first half of 2003 compared to the first half of
2002 due to a substantial decline in Asia Pacific and a significant decline in
the United States. The substantial decline in Asia Pacific 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 half of
2003. As of the beginning of the first quarter of 2003, many of our GSM
customers in Asia Pacific have completed their current network deployments, and
as a result, they have sufficient capacity to currently meet additional
subscriber demand. In the United States, the significant decline was primarily
due to the completion of some network deployments by certain service providers.
In EMEA and CALA, GSM revenues increased substantially in the first half of
2003 primarily due to new contracts with certain service providers.

UMTS revenues were essentially flat in the first half of 2003 compared to the
first half of 2002. In the first half of 2003, operators continued to
scrutinize and delay deployment plans.

From a geographic perspective, the 14% decrease in Wireless Networks revenues
in the first half of 2003 compared to the first half of 2002 was primarily due
to a:



| |  | 21% decline in revenues in the United States and a 58% decline in
Canada primarily due to customers focus on capital and cash flow
management, technology migration and a slower subscriber growth; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 11% decline in revenues in Asia Pacific primarily due to capital
spending restrictions, network completion and a slower subscriber
growth; partially offset by
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 21% increase in revenues in EMEA and a 13% increase in CALA primarily
due to new GSM contracts with certain service providers.
| | - | ------------------------------------------------------------------------------------------------------------------------------



| |  | Q2 2003 vs. Q1 2003
| |  | -------------------

Compared to the first quarter of 2003, Wireless Networks revenues increased 4%
in the second quarter of 2003, primarily due to a:



| |  | substantial increase in GSM revenues primarily due to increases in
the United States, Canada, EMEA and Asia Pacific as a result of new
contracts and network expansions; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | increase in CDMA revenues, primarily in Asia Pacific, as a result of
existing network expansions to meet increased subscriber demand;
partially offset by
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | substantial decline in UMTS revenues in EMEA primarily due to the
resolution of contractual issues, including collectibility, with a
certain customer in the first quarter of 2003 not repeated in the second
quarter of 2003; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | substantial decline in TDMA revenues, primarily in the United States
and Canada, as a result of customers continuing to migrate to CDMA and
GSM technologies.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, Wireless Networks revenues increased 4% in the
second quarter of 2003 compared to the first quarter of 2003 as a result of an
87% increase in revenues in Asia Pacific and a 51% increase in revenues in
Canada. These increases were partially offset by a 28% decline in revenues in
CALA and an 11% decline in revenues in EMEA. United States revenues were
essentially flat in the second quarter of 2003 compared to the first quarter of
2003.



| |  | Remainder of 2003
| |  | -----------------

In the first half 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 compared to
2002. In 2003, our 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.

37



---



##### Table of Contents



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 overall slower economic conditions. We anticipate a
reduction in global capital expenditures for wireless operators in 2003
compared to 2002. 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:

(QUARTERLY REVENUES FOR ENTERPRISE NETWORKS)



| |  | Q2 2003 vs. Q2 2002
| |  | -------------------

Enterprise Networks revenues declined 14% in the second quarter of 2003
compared to the second quarter of 2002 and was primarily a result of:



| |  | a decline in the data networking and security portion of this segment
due to pricing pressures driven by increased competition, a decline in
our legacy routing portfolio and a corresponding reduction in the number
of service contract renewals;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a decline in demand in our traditional circuit switching products as
a result of delays with the establishment of new channel relationships
to address demand from small and medium sized enterprise customers and
the redirection of sales efforts by existing channel partners towards
larger enterprise customers; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | enterprise customers having implemented a longer, more stringent
spending approval process when making capital expenditure decisions
which resulted in continued capital spending delays.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues from the circuit and packet voice portion of this segment decreased in
the second quarter of 2003 compared to the second quarter of 2002 primarily due
to a decrease in the United States and a significant decline in EMEA. The
decline in the United States was primarily due to a decrease in demand for our
traditional circuit switching products as our enterprise customers networks
had sufficient capacity to meet demand. In EMEA, the significant decline was
primarily due to the transition of certain service contracts to our channel
partners during the first half of 2003. These declines were partially offset
by a substantial increase in revenues associated with our packet voice
solutions in the second quarter of 2003 compared to the same period in 2002 as
a result of the continuing evolution of traditional circuit switching
technology towards converged internet protocol, or IP, telephony solutions.

Revenues in the data networking and security portion of this segment declined
substantially in the second quarter of 2003 compared to the second quarter of
2002. This substantial decline was primarily due to a reduction in the number
of service contract renewals associated with our legacy routing portfolio,
primarily in the United States. Further, revenues associated with certain of
our Layer 2 products declined as a result of pricing pressures driven by
increased competition for enterprise customers. In Asia Pacific, revenues
decreased substantially primarily due to one time incremental shipments of
certain products in the second quarter of 2002 which were not repeated in the
second quarter of 2003.

From a geographic perspective, the 14% decline in Enterprise Networks revenues
in the second quarter of 2003 compared to the second quarter of 2002 was
primarily due to a:



| |  | 17% decline in revenues in the United States primarily due to our
enterprise customers traditional circuit switching networks having
sufficient capacity to meet current demand and a reduction in service
contract renewals;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

38



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| |  | 13% decline in revenues in Asia Pacific primarily due to one time
incremental shipments of certain products in the second quarter of 2002
which were not repeated in the second quarter of 2003;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 35% decline in revenues in CALA primarily due to the deterioration of
the economic situation in certain countries and associated spending
restrictions implemented by certain of our distributors; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 5% decline in revenues in EMEA primarily due to continuing economic
uncertainty in the region, a delay associated with the transition of a
portion of our business from direct to indirect channels and the
transition of certain service contracts to our channel partners during
the first half of 2003.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | First half 2003 vs. first half 2002
| |  | -----------------------------------

Enterprise Networks revenues declined 11% in the first half of 2003 compared to
the first half of 2002 and was primarily due to:



| |  | a decline in our traditional circuit switching products as a result
of delays associated with the establishment of new channel relationships
to address demand from small and medium sized enterprise customers and
the redirection of sales efforts by existing channel partners towards
larger enterprise customers;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a decline in our legacy routing portfolio and an associated decline
in services related to this portfolio as the number of service contract
renewals decreased; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | enterprise customers having implemented a longer, more stringent
spending approval process when making capital investment decisions which
resulted in continued capital spending delays.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues from the circuit and packet voice portion of this segment decreased in
the first half of 2003 compared to the first half of 2002. We experienced a
substantial reduction in revenues associated with our traditional circuit
switching and interactive voice response products primarily due to continuing
capital spending restrictions as a result of the economic uncertainty in the
industry. These declines were partially offset by a substantial increase in
revenues associated with our IP telephony solutions as customers continued to
migrate towards converged packet voice solutions.

Revenues associated with the data networking and security portion of this
segment decreased significantly in the first half of 2003 compared to the first
half of 2002. The significant decrease in revenues was primarily due to a
decline in revenues associated with our legacy routing portfolio and a
reduction in the number of service contract renewals associated with these
products. Also, we experienced a decline in revenue in certain of our other
data networking and security products primarily due to pricing pressures driven
by increased competition.

From a geographic perspective, the 11% decline in Enterprise Networks revenues
in the first half of 2003 compared to the first half of 2002 was primarily due
to a:



| |  | 15% decline in revenues in the United States primarily due to
customer spending restrictions, a reduction in revenues associated with
our legacy routing portfolio and a corresponding reduction in the number
of service contract renewals;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 7% decline in revenues in EMEA primarily due to continuing economic
uncertainty in the region, a delay associated with the transition of a
portion of our business from direct to indirect channels and the
transition of certain service contracts to our channel partners during
the first half of 2003;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 30% decline in revenues in CALA primarily due to the continued
deterioration of the economic situation in certain countries and
associated spending restrictions implemented by certain of our
distributors; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 6% decline in Asia Pacific primarily due to one time incremental
shipments of certain products in the second quarter of 2002 which were
not repeated in the first half of 2003.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q2 2003 vs. Q1 2003
| |  | -------------------

Enterprise Networks revenues decreased 10% in the second quarter of 2003
compared to the first quarter of 2003 primarily due to:



| |  | a significant decline in revenues associated with our traditional
circuit switching products primarily due to incentive programs and other
pricing discounts offered to certain enterprise customers during the
first quarter of 2003 and not repeated in the second quarter of 2003;
and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

39



---



##### Table of Contents





| |  | a decrease in the data network and security portion of this segment
primarily due to enterprise customers having implemented a longer, more
stringent spending approval process when making capital investment
decisions which resulted in continued capital spending delays and
increased competition for enterprise customers.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, the 10% decline in the second quarter of 2003
compared to the first quarter of 2003 was primarily due to a 14% decline in
revenues in EMEA, a 7% decline in revenues in the United States, a 21% decline
in revenues in Canada and a 32% decline in CALA.



| |  | Remainder of 2003
| |  | -----------------

We anticipate that enterprise customers will continue to increase the use of
voice over packet technologies in their communications networks. 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. Although
we anticipate that demand will continue for our traditional circuit switching
products, it is difficult to determine the extent to which the decline in these
revenues will continue as a result of the migration to voice over packet
technologies. We are also working to complete the realignment of our channel
strategy to address the demand of the small and medium sized enterprise
customers. Overall, we 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:

(QUARTERLY REVENUES FOR WIRELINE NETWORKS)



| |  | Q2 2003 vs. Q2 2002
| |  | -------------------

Wireline Networks revenues declined 16% in the second quarter of 2003 compared
to the second quarter of 2002 primarily due to a substantial reduction in
capital spending by our service provider customers as a result of the
continuing industry adjustment and continued cautious customer spending.

Revenues from the circuit and packet voice portion of this segment decreased
significantly in the second quarter of 2003 compared to the second quarter of
2002 primarily due to a substantial decrease in our traditional circuit
switching product revenues in the United States and also uncertainty regarding
the recent FCC decision regarding UNEs. The decline in our circuit switching
product revenues was primarily due to the continuing impact of tightened
capital markets and capital spending restrictions experienced by our service
provider customers. Revenues from our packet voice solutions increased
substantially in the United States and Canada in the second quarter of 2003
compared to the second quarter of 2002 and continued to represent a small, but
growing, portion of overall Wireline Networks revenues. The increase was
primarily due to new service provider contracts.

Revenues from the data networking and security portion of this segment
decreased in the second quarter of 2003 compared to the second quarter of 2002
and was primarily due to substantial declines in Asia Pacific and CALA. In
these regions, we experienced a decline in demand for our mature products
compounded by the ongoing industry adjustment as service providers continued to
reduce their capital expenditures.

From a geographic perspective, the 16% decline in Wireline Networks revenues in
the second quarter of 2003 compared to the second quarter of 2002 was primarily
due to a:

40



---



##### Table of Contents





| |  | 21% decline in revenues in the United States primarily due to the
continuing impact of tightened capital markets and capital spending
restrictions experienced by our service provider customers and also
uncertainty regarding the recent FCC decision regarding UNEs;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 34% decline in revenues in Asia Pacific primarily due to service
provider capital spending restrictions; and
| | - | ------------------------------------------------------------------------------------------------------------



| |  | 50% decline in revenues in CALA primarily due to service provider
capital spending restrictions and tightened capital markets; partially
offset by
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 21% increase in revenues in Canada primarily due to an increase in
packet voice revenues as certain customers upgraded their existing
networks.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | First half 2003 vs. first half 2002
| |  | -----------------------------------

Wireline Networks revenues declined 17% in the first half of 2003 compared to
the first half of 2002. These declines were primarily due to a substantial
reduction in capital spending by our service provider customers as a result of
the continuing industry adjustment.

Revenues from the circuit and packet voice portion of this segment decreased
significantly in the first half of 2003 compared to the first half of 2002
primarily due to a substantial decrease in our traditional circuit switching
product revenues and also uncertainty regarding the recent FCC
decision with respect to UNEs. The decline in our circuit switching revenues was primarily due to
the continuing impact of tightened capital markets and capital spending
restrictions experienced by our service provider customers. Revenues from our packet
voice solutions increased substantially in the United States and Canada in the
first half of 2003 compared to the first half of 2002 primarily due to some
incremental one time shipments in the first quarter of 2003 relating to new
contracts awarded in the second half of 2002 and the first quarter of 2003.

Revenues from the data networking and security portion of this segment
decreased significantly in the first half of 2003 compared to the first half of
2002 primarily due to substantial declines in Asia Pacific and CALA regions and
a significant decline in the United States. In these regions, we experienced a
decline in demand for our mature products primarily due to the ongoing industry
adjustment as service providers continued to reduce their capital expenditures.

From a geographic perspective, the 17% decline in Wireline Networks revenues in
the first half of 2003 compared to the first half of 2002 was primarily due to
a:



| |  | 76% decline in revenues in CALA primarily due to the completion of a
major contract in the first quarter of 2002 and continued capital
spending restrictions experienced by our service provider customers;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 10% decline in revenues in the United States primarily due to the
continuing impact of tightened capital markets, capital spending
restrictions experienced by our service provider customers and also
uncertainty regarding the recent FCC decision regarding UNEs;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 9% decline in revenues in EMEA primarily due to a reduction in
capital spending by service provider customers and tightened capital
markets; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 21% decline in revenues in Asia Pacific primarily due to service
provider capital spending restrictions.
| | - | --------------------------------------------------------------------------------------------------------



| |  | Q2 2003 vs. Q1 2003
| |  | -------------------

Our Wireline Networks revenues decreased 12% in the second quarter of 2003
compared to the first quarter of 2003 primarily due to:



| |  | a significant decline in the circuit and packet voice portion of this
segment, primarily in the United States, due to a substantial decrease
in revenues associated with our packet-based technologies caused by
incremental one time shipments on new contracts in the first quarter of
2003 that were not repeated in the second quarter of 2003; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a decrease in the data networking and security portion of this
segment primarily due to continued customer spending restrictions in
EMEA associated with our more mature products.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, Wireline Networks revenues decreased 12% in the
second quarter of 2003 compared to the first quarter of 2003 primarily as a
result of a 26% decrease in the United States partially offset by a 10%
increase in EMEA. The remaining geographic regions were essentially flat
compared to the first quarter of 2003.

41



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##### Table of Contents





| |  | Remainder of 2003
| |  | -----------------

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 half of 2003 compared to the same period in 2002, the timing of when
service providers will deploy packet-based technologies on a wider scale is
unclear. Further, it is difficult to determine the effect the recent FCC
ruling regarding UNEs will have on our business as our customers assess its
impact. 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.

Optical Networks revenues

The following chart summarizes recent quarterly revenues for Optical Networks:

(QUARTERLY REVENUES FOR OPTICAL NETWORKS)



| |  | Q2 2003 vs. Q2 2002
| |  | -------------------

Optical Networks revenues declined 26% in the second quarter of 2003 compared
to the second quarter of 2002. This decline was primarily due to the
continuing industry adjustment, tightened capital markets and substantial
reductions in capital spending by our United States, Canada and EMEA customers
in both the long-haul and metro optical portions of this segment. These
declines were partially offset by a substantial increase in Asia Pacific due to
new contracts with customers in the second quarter of 2003.

Revenues in the long-haul portion of this segment decreased substantially in
the second quarter of 2003 compared to the second quarter of 2002. The
substantial decline was primarily due to the continuing industry adjustment,
tightened capital markets and continued capital spending restrictions in the
United States, Canada and EMEA as our service provider customers continued to
focus on maximizing return on invested capital by increasing the capacity
utilization rates and efficiency of existing networks. Also contributing to
the decline in the United States were revenues associated with a one time
shipment to a certain enterprise customer in the second quarter of 2002 which
was not repeated in the second quarter of 2003. In addition, significant
excess inventories continued to exist in this portion of the segment which
resulted in ongoing pricing pressures.

In the fourth quarter of 2002, we sold certain optical components assets to
Bookham Technology plc, or Bookham. As a result, our second quarter results in
2003 in the long-haul portion of this segment do not reflect revenues generated
from these assets. In the second quarter of 2002, revenues generated from the
optical components assets sold to Bookham were approximately 5% of the total
revenues of $404. For additional information relating to the sale of these
assets to Bookham, you should refer to information contained in our Annual
Report on Form 10-K for the year ended December 31, 2002 filed with the SEC.

Revenues in the metro optical portion of this segment decreased significantly
in the second quarter of 2003 compared to the second quarter of 2002. The
significant decrease was primarily due to a substantial decrease in EMEA as a
result of the continuing industry adjustment, tightened capital markets and
capital spending restrictions by customers.

From a geographic perspective, the 26% decline in Optical Networks revenues in
the second quarter of 2003 compared to the second quarter of 2002 was primarily
due to a:



| |  | 44% decline in revenues in EMEA primarily related to a substantial
reduction in capital spending as a result of the
| | - | -------------------------------------------------------------------------------------------------------------------

42



---



##### Table of Contents





| |  | continuing industry adjustment, tightened capital markets and customers
continuing to focus on maximizing return on invested capital;
| |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  | 28% decline in revenues in the United States primarily related to a
substantial reduction in capital spending as a result of the continuing
industry adjustment, tightened capital markets and customers continuing
to focus on maximizing return on invested capital and a one time
shipment to a certain enterprise customer in the second quarter of 2002
which was not repeated in the second quarter of 2003; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 64% decrease in revenues in Canada primarily related to a substantial
reduction in capital spending as a result of the continuing industry
adjustment, tightened capital markets and customers continuing to focus
on maximizing return on invested capital; partially offset by
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 32% increase in revenues in Asia Pacific primarily due to new
customer contracts for expansions of existing networks to meet increased
customer demand.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | First half 2003 vs. first half 2002
| |  | -----------------------------------

Optical Networks revenues declined 30% in the first half of 2003 compared to
the first half of 2002. These declines were primarily the result of the
continuing industry adjustment, tightened capital markets and substantial
reductions in capital spending by our United States, Canada and EMEA customers
in the long-haul portion of this segment.

Revenues in the long-haul portion of this segment declined substantially in the
first half of 2003 compared to the first half of 2002. The substantial decline
was primarily due to the continuing industry adjustment, tightened capital
markets and continued capital spending restrictions in the United States,
Canada 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.

As mentioned above, our long-haul revenues in the first half of 2003 do not
reflect revenues generated from the optical component assets sold to Bookham.
In the first half of 2002, revenues associated with these assets were
approximately 5% of the total Optical Networks revenues of $809.

Revenues in the metro optical portion of this segment decreased significantly
in the first half of 2003 compared to the first half of 2002. The significant
decrease was primarily due to a substantial decrease in revenues in EMEA and
the United States and was partially offset by a substantial increase in
revenues in Asia Pacific. The declines in EMEA and the United States were
primarily the result of the continuing industry adjustment, tightened capital
markets and customer spending restrictions. The substantial increase in
revenues in Asia Pacific was primarily due to new customer contracts in 2003
for expansions of existing networks to meet increased customer demand.

From a geographic perspective, the 30% decline in Optical Networks revenues in
the first half of 2003 compared to the first half of 2002 was primarily due to
a:



| |  | 46% decline in revenues in EMEA, 36% decline in the United States and
a 55% decline in Canada primarily related to a substantial reduction in
capital spending as a result of the continuing industry adjustment,
tightened capital markets and customers continuing to focus on
maximizing return on invested capital; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 33% decline in revenues in CALA primarily related to a reduction in
capital spending and excess network capacity and assets; partially
offset by
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 35% increase in revenues in Asia Pacific primarily due to new
customer contracts for expansions of existing networks to meet increased
customer demand.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q2 2003 vs. Q1 2003
| |  | -------------------

Optical Networks revenues increased 10% in the second quarter of 2003 compared
to the first quarter of 2003 primarily due to increased customer spending in
the United States on both our long-haul and metro optical products. The
increased spending in the United States was mainly due to customers expanding
existing networks and the resolution of contractual issues with certain
customers in the first quarter of 2003. The substantial increase in revenues
in the United States was partially offset by a substantial decline in revenues
in EMEA which was mainly due to some incremental one time shipments of products
in the first quarter of 2003 which were not repeated in the second quarter of
2003.

From a geographic perspective, Optical Networks revenues increased 10% in the
second quarter of 2003 compared to the first

43



---



##### Table of Contents



quarter of 2003 primarily as a result of a 77% increase in revenues in the
United States partially offset by a 26% decrease in revenues in EMEA. The
remaining geographic regions were essentially flat.



| |  | Remainder of 2003
| |  | -----------------

On August 10, 2003, we essentially finalized the realignment of Optical Networks
with the sale of certain assets of our high speed module business. We do not expect
that the sale of this business will have a material impact on our business,
results of operations and financial condition. Going forward, our efforts will
focus on providing next generation optical networking systems, including the
evolution of next generation SONET/SDH systems, metro Dense Wavelength Division
Multiplexing, or metro DWDM, systems and optical long-haul line and terminal
solutions. Also, we will continue to invest in core technologies, such as
efficient service adaptation, aggregation, switching and management that will
enable our customers to deploy optical networking services which we believe
will lead the networking transformation towards packet-based networks.

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, revenues
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, interconnectivity and
bandwidth as it is required in the short term. Further, we believe that
building out networks for increased bandwidth will remain long term projects.

In the metro optical portion of this segment, we expect to see an increase in
demand for 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, it is difficult
to predict when a meaningful recovery in the optical long-haul market will
occur. 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.

Gross profit and gross margin

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    Change
    
    
    % ChangeGross profit
    
    $
    1,012
    
    
    $
    900
    
    
    $
    112
    
    
    
    12
    
    
    $
    2,050
    
    
    $
    1,581
    
    
    $
    469
    
    
    
    30Gross margin
    
    
    43.5
    %
    
    
    32.5
    %
    
    
    11.0
    
    
    
    34
    
    
    
    43.4
    %
    
    
    27.8
    %
    
    
    15.6
    
    
    
    56


Gross margin improved 11 percentage points in the second quarter of 2003
compared to the second quarter of 2002 primarily due to:



| |  | 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 certain of our products; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of approximately 6 percentage points related to
reductions in inventory provisioning and other operations related costs,
primarily in the United States and EMEA.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Gross margin also improved 15.6 percentage points in the first half of 2003
compared to the first half of 2002 primarily due to:



| |  | an increase of approximately 6 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 certain of our products; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of approximately 9 percentage points related to a decline
in inventory provisioning, contract and customer
| | - | ----------------------------------------------------------------------------------------------------------------------

44



---



##### Table of Contents





| |  | settlement costs and other operations related costs; partially offset by
| |  | ------------------------------------------------------------------------



| |  | an accrual in the first quarter of 2003 for the employee return to
profitability bonus plan for which no similar accrual was made in the
first half of 2002.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------

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.



| |  | Segment gross profit and gross margin
| |  | -------------------------------------



| |  | Wireless Networks
| |  | -----------------

Wireless Networks gross margin improved by approximately 8 percentage points in
the second quarter of 2003 compared to the second quarter of 2002. The
improvement was primarily due to changes in product mix and ongoing product
cost improvements.

Wireless Networks gross margin improved by approximately 9 percentage points in
the first half of 2003 compared to the first half of 2002. The improvement was
primarily due to changes in product mix and ongoing product cost improvements.



| |  | Enterprise Networks
| |  | -------------------

Enterprise Networks gross margin improved by approximately 3 percentage points
in the second quarter of 2003 compared to the second quarter of 2002. The
improvement in gross margin was primarily due to:



| |  | improvements in our cost structure as a result of more favorable
supplier pricing which was partially offset by reductions in the selling
price of certain of our products as a result of increased competition
for enterprise customers;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | reductions in other operations related costs including product defects, customer service and warranty costs; and
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | changes in customer and product mix.
| | - | ------------------------------------

Enterprise Networks gross margin improved by approximately 6 percentage points
in the first half 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 which was partially offset by reductions in the selling
price of certain of our products as a result of increased competition
for enterprise customers;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | reductions in other operations related costs including product
defects, customer service and warranty costs; and
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | a decrease in inventory provisioning and contract and customer
settlement costs in the first half of 2003 compared to the first half of
2002.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  | Wireline Networks
| |  | -----------------

Wireline Networks gross margin increased by approximately 8 percentage points
in the second quarter of 2003 compared to the second quarter of 2002. The
increase in gross margin was primarily due to:



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



| |  | a decrease in inventory provisioning; and
| | - | -----------------------------------------



| |  | reductions in other operations related costs including customer service and warranty costs.
| | - | -------------------------------------------------------------------------------------------

Wireline Networks gross margin increased by approximately 8 percentage points
in the first half of 2003 compared to the same period in 2002. The increase in
gross margin was primarily due to:



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



| |  | a decrease in inventory provisioning and contract and customer
settlement costs in the first half of 2003 compared to the first half of
2002; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  | reductions in other operations related costs including customer
service and warranty costs.
| | - | -------------------------------------------------------------------------------------------

45



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##### Table of Contents





| |  | Optical Networks
| |  | ----------------

Optical Networks gross margin improved by approximately 39 percentage points in
the second quarter of 2003 compared to the second quarter of 2002. The
improvement in gross margin was primarily due to:



| |  | reductions in operations related costs, primarily in the United States and EMEA;
| | - | --------------------------------------------------------------------------------



| |  | a decrease in inventory provisioning in the first half of 2003 compared to the first half of 2002;
| | - | --------------------------------------------------------------------------------------------------



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



| |  | 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 certain products.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Optical Networks gross margin improved by approximately 55 percentage points in
the first half of 2003 compared to the same period in 2002. The improvement in
gross margin was primarily due to:



| |  | a decrease in inventory provisioning and contract and customer
settlement costs in the first half of 2003 compared to the first half of
2002;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  | reductions in operations related costs, primarily in the United
States and EMEA;
| | - | --------------------------------------------------------------------------------



| |  | the sale of certain optical components assets to Bookham and, as a
result, our gross margin in the first half of 2003 excluded the impact
of excess capacity of those optical components assets; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | improvements in our cost structure primarily as a result of more
favorable supplier pricing which were partially offset by continued
pricing pressures on the sale of certain products.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Operating expenses



| |  | Selling, general and administrative expense
| |  | -------------------------------------------

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeSG&A expense
    
    $
    417
    
    
    $
    764
    
    
    $
    (347
    )
    
    
    (45
    )
    
    $
    902
    
    
    $
    1,504
    
    
    $
    (602
    )
    
    
    (40
    )As % of revenues
    
    
    17.9
    %
    
    
    27.6
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    19.1
    %
    
    
    26.5
    %
    
    
    N/A
    
    
    
    N/A


Selling, general and administrative, or SG&A, expense declined $347 in the
second quarter of 2003 compared to the second quarter of 2002 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
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  | net customer financing bad debt recoveries of $51 primarily as a
result of favorable settlements related to our customer financing
activities and adjustments to other existing provisions.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In the first half of 2003, SG&A expense declined $602 compared to the first
half of 2002. These declines were primarily due to:



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



| |  | net customer financing bad debt recoveries of $51 primarily as a
result of favorable settlements related to our customer financing
activities and adjustments to other existing provisions; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | accruals in the first half of 2003 for the employee return to
profitability bonus plan for which no similar accrual was made in the
first half of 2002.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

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

46



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efficiencies present themselves. For the year 2003, we expect that our annual
SG&A expense will continue to decline compared to 2002 although not to the same
extent as was experienced in 2002 compared to 2001.



| |  | Segment selling, general and administrative expense
| |  | ---------------------------------------------------



| |  | Wireless Networks
| |  | -----------------

Wireless Networks SG&A expense decreased substantially in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the first half of 2002. These declines were primarily due to:



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



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



| |  | Enterprise Networks
| |  | -------------------

Enterprise Networks SG&A expense decreased significantly in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the same period in 2002. These decreases were 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 trade receivables.
| | - | -------------------------------------------------



| |  | Wireline Networks
| |  | -----------------

Wireline Networks SG&A expense decreased substantially in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the same period in 2002. These decreases were 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 trade and customer financing
receivables.
| | - | ------------------------------------------------------------------------



| |  | Optical Networks
| |  | ----------------

Optical Networks SG&A expense decreased substantially in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the same period in 2002. These reductions were 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 trade and customer financing
receivables.
| | - | ------------------------------------------------------------------------



| |  | Segment contribution margin
| |  | ---------------------------

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    333
    
    
    $
    241
    
    
    $
    92
    
    
    
    38
    
    
    $
    649
    
    
    $
    485
    
    
    $
    164
    
    
    
    34Enterprise Networks
    
    
    97
    
    
    
    93
    
    
    
    4
    
    
    
    4
    
    
    
    242
    
    
    
    177
    
    
    
    65
    
    
    
    37Wireline Networks
    
    
    161
    
    
    
    83
    
    
    
    78
    
    
    
    94
    
    
    
    313
    
    
    
    179
    
    
    
    134
    
    
    
    75Optical Networks
    
    
    23
    
    
    
    (240
    )
    
    
    263
    
    
    
    110
    
    
    
    33
    
    
    
    (598
    )
    
    
    631
    
    
    
    106Other
    
    
    (19
    )
    
    
    (41
    )
    
    
    22
    
    
    
    54
    
    
    
    (89
    )
    
    
    (166
    )
    
    
    77
    
    
    
    46Consolidated
    
    $
    595
    
    
    $
    136
    
    
    $
    459
    
    
    
    338
    
    
    $
    1,148
    
    
    $
    77
    
    
    $
    1,071
    
    
    
    1,391


As a result of the gross margin and SG&A expense changes discussed above, our
consolidated contribution margin improved by $459 in the second quarter of 2003
compared to the second quarter of 2002 and by $1,071 in the first half of 2003

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compared to the first half of 2002. All of our four reportable segments
contributed positive contribution margin in the second quarter and first half
of 2003.



| |  | Research and development expense
| |  | --------------------------------

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeR&D expense
    
    $
    470
    
    
    $
    567
    
    
    $
    (97
    )
    
    
    (17
    )
    
    $
    958
    
    
    $
    1,144
    
    
    $
    (186
    )
    
    
    (16
    )As % of revenues
    
    
    20.2
    %
    
    
    20.5
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    20.3
    %
    
    
    20.1
    %
    
    
    N/A
    
    
    
    N/A


Research and development, or R&D, expense represents our planned investment in
our next generation core products across all segments. R&D expense decreased
$97 in the second quarter of 2003 compared to the second quarter of 2002. The
decline was primarily due to workforce reductions and focused investment
decisions to drive market leadership across our product portfolios.

R&D expense also decreased $186 in the first half of 2003 compared to the first
half of 2002 primarily due to our workforce reductions and focused investments
to drive market leadership across our product portfolios. The decline was
partially offset by an accrual in the first quarter of 2003 for the employee
return to profitability bonus plan for which no similar accrual was made in the
first half of 2002.

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:



| |  | key areas of wireless networking solutions;
| | - | -------------------------------------------



| |  | voice over packet solutions to drive operating efficiencies, cost
savings and in some cases new revenues for our customers;
| | - | ---------------------------------------------------------------------------------------------------------------------------



| |  | multimedia services and applications to drive business and revenue
growth; and
| | - | ------------------------------------------------------------------------------



| |  | broadband networking solutions including optical networking solutions
to support storage area network connectivity services and business
continuity.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------

For the year 2003, we expect that our annual R&D expense will continue to
decline compared to 2002 although not to the same extent as was experienced in
2002 compared to 2001.



| |  | Special charges
| |  | ---------------

In the second quarter of 2003, we recorded special charges of $6 related to our
continued restructuring work plan. Included in this charge was a reduction of
$33 related to revisions to prior accruals. Workforce reduction charges of $22
related to the cost of severance and benefits across all segments associated with approximately 300
employees notified of termination during the second quarter of 2003. Net
revisions of $12 to reduce prior accruals primarily related to termination
benefits where actual costs were lower than our original estimates
across all segments. Contract
settlement and lease costs were $14 and related to leased facilities and
furniture that were no longer being used across all segments. Net revisions of $3 increased prior
accruals and related to changes in estimates associated with the cost of
vacating previously identified properties and changes in sublease revenue
assumptions which extended across all segments. Also, we recorded a charge of $3 related to current period write
downs for various leasehold improvements and excess equipment. Net revisions
of $24 to reduce prior accruals related to adjustments in our original plans or
estimates for the closure of certain facilities.

In the first half of 2003, we recorded special charges of $139 related to our
continued restructuring work plan. Included in this charge was a reduction of
$14 related to revisions to prior accruals. Workforce reduction charges of $92
related to the cost of severance and benefits associated with approximately
1,100 employees notified of termination during the first half of 2003 which extended across all segments. Net
revisions of $22 to reduce prior accruals primarily related to termination
benefits where actual costs were lower than our original estimates across all segments. Contract
settlement and lease costs were $37 and related to newly identified leased
facilities and furniture that we determined were no longer being used across all segments. Net
revisions of $58 increased prior accruals and related to changes in estimates
associated with the cost of vacating previously identified properties and
changes in sublease revenues which extended across all segments. Also, we recorded charges of $24 related to
current period write downs for various leasehold improvements and excess Optical Networks
equipment. Net

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revisions of $50 to reduce prior accruals related to adjustments in our
original plans or estimates for the closure of certain facilities.

In the second quarter of 2002, we recorded special charges of $307 related to
our restructuring work plan. Workforce reduction charges of $117 related to
the cost of severance and benefits associated with approximately 1,900
employees notified of termination. Contract settlement and lease costs
included negotiated settlements of approximately $1 to either cancel contracts
or renegotiate existing contracts across all of our segments. We recorded
approximately $189 in plant and equipment write downs within Optical Networks.

In the first half of 2002, we recorded special charges of $750 related to our
restructuring work plan. Workforce reduction charges of $429 were related to
the cost of severance and benefits associated with the approximately 5,900
employees notified of termination. Contract settlement and lease costs
included negotiated settlements of approximately $57 to either cancel contracts
or renegotiate existing contracts across all of our segments. Also, we
recorded approximately $264 in plant and equipment write downs within global
operations, a function that supports all of our segments, and within Optical
Networks.

Currently, we expect that approximately $30 to $40 of special charges related
to our restructuring work plan will be incurred in the second half of 2003.

For additional information related to our restructuring activities, see
Special charges in note 5 of the accompanying unaudited consolidated
financial statements.

Other income (expense)  net

In the first half of 2003, other income  net
was $51, which primarily
included:



| |  | $50 primarily associated with reductions in accruals principally
related to the wind-down of integration activities of previously
acquired companies, operations originally structured as joint ventures
and miscellaneous tax matters;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | interest income on our short term investments; and
| | - | --------------------------------------------------



| |  | a payment received from a settlement related to intellectual property use; partially offset by
| | - | ----------------------------------------------------------------------------------------------



| |  | foreign exchange losses; and
| | - | ----------------------------



| |  | losses on the sale or write down of certain of our investments.
| | - | ---------------------------------------------------------------

Interest expense

Interest expense decreased $18 in the second quarter of 2003 compared to the
second quarter of 2002 and declined $35 in the first half of 2003 compared to
the first half of 2002. These declines were primarily due to a reduction in
the outstanding balances of our notes payable and long-term debt.

In the third quarter of 2003, we expect that our quarterly interest expense
will remain at a level similar to that of the second quarter of 2003.

Income tax expense

In the first half of 2003, we recorded a tax
expense on the pre-tax income of $45
from continuing operations before minority interests and equity earnings in net
loss of associated companies. This tax expense was a result of
various non-income related taxes partially offset by a tax refund
from a previously unrecognized loss carryback and a tax benefit from
the accounting for the tax expense on income generated from
discontinued operations.

We will continue to record a full valuation allowance on the tax benefit of
losses generated from continuing operations to the extent that such benefits
exceed the tax effect of income generated from similar transactions discussed
above. These valuation allowances are 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. Our valuation allowances are primarily attributed
to continued uncertainty in the industry. 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. For additional information, see Tax asset valuation.

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Other

In the first quarter of 2003, our SG&A, R&D and Other income  net included
approximately $80 of favorable impacts ($50 in other income (expense)  net,
$25 in SG&A expense and $5 in R&D expense) associated with reductions in
accruals principally related to the wind-down of integration activities of
previously acquired companies, operations originally structured as joint
ventures and miscellaneous tax matters. During the first quarter of 2003, we
reviewed the matters related to the wind-down and settlement of balances
associated with the integration activities of previously acquired companies and
operations originally structured as joint ventures and determined
that, based on
decreases in transactional activity and magnitude of their net
position, it
was appropriate to reduce certain accruals. Such amounts and matters included
foreign exchange, transfer pricing and other statutory assessments, charges in
transit and acquisition and divestiture and disposal activities. These
balances were considered to be in dispute, erroneous and/or for amounts which
could not be resolved. These items were more than offset by costs related to
the return to profitability employee bonus plan and stock-based compensation
expense.

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 $624 and
$1,506 in the
second quarter and first half of 2003, respectively, compared to the same
periods in 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 $190 (net of tax)
related to the sale of certain components of this business. The $190 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 originally
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

Our unaudited consolidated financial statements are based on the selection and
application of accounting policies, generally accepted in the United States,
which require us to make significant estimates and assumptions. We believe that
the following accounting policies may involve a higher degree of judgment and
complexity in their application and represent our critical accounting policies.
The application of these policies requires us to make subjective and objective
judgments. These accounting policies include estimates and assumptions
associated with revenue recognition, provisions for receivables, provisions for
inventory, tax asset valuation, goodwill valuation, pension and post retirement
benefits and other contingencies.

There have been no changes to our critical accounting policies since December
31, 2002, other than the material changes in the recorded balances and other
updates noted below. For further information relating to our critical
accounting policies, see our Annual Report on Form 10-K for the year ended
December 31, 2002 filed with the SEC.

Revenue recognition

In November 2002, the Financial Accounting Standards Board, or FASB, Emerging
Issues Task Force reached a consensus on Issue 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. We will be applying this guidance
prospectively for all revenue arrangements entered into after June 30, 2003 and
expect that the adoption of this pronouncement will not have a material impact
on our business, results of operations and financial condition. For additional
information, see Significant accounting policies in note 1(d) of the
accompanying unaudited consolidated financial statements.

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Provisions for receivables

We recorded receivable (recoveries) provisions, relating to continuing
operations, of $(41) in the first half of 2003 compared to $121 in the first
half of 2002. The receivable recoveries in the first half of 2003 primarily
related to net customer financing bad debt recoveries of $51 primarily as a
result of favorable settlements related to our sale or restructuring of various
customer financing related receivables and adjustments to other existing
provisions. The following table summarizes our accounts receivable and
long-term receivable balances and related reserves of our continuing
operations, as at:

June 30,
    
    
    December 31,2003
    
    
    2002Gross accounts receivable
    
    $
    2,254
    
    
    $
    2,470Related reserves
    
    
    (355
    )
    
    
    (477
    )Net accounts receivable
    
    $
    1,899
    
    
    $
    1,993Accounts receivable reserves as a percentage of gross accounts receivables
    
    
    16
    %
    
    
    19
    %Gross long-term receivables
    
    $
    394
    
    
    $
    822Related reserves
    
    
    (324
    )
    
    
    (781
    )Net long-term receivables
    
    $
    70
    
    
    $
    41Long-term receivable reserves as a percentage of long-term receivables
    
    
    82
    %
    
    
    95
    %


Throughout 2002, we recorded significant provisions related to receivables from
our continuing operations. In the first half of 2003, we recorded net
recoveries primarily due to our subsequent collections of certain customer
financing receivables for amounts exceeding our original estimates of net
recovery. Given the current market conditions and creditworthiness of some of
our customers, it is difficult to determine the extent to which this trend will
continue in the future.

Provisions for inventory

We recorded inventory provisions and other provisions related to our contract
manufacturers and suppliers, relating to continuing operations, of $110 in the
first half of 2003 compared to $347 in the first half of 2002. The following
table summarizes our inventory balances and related reserves of our continuing
operations, as at:

June 30,
    
    
    December 31,2003
    
    
    2002Gross inventory
    
    $
    1,828
    
    
    $
    1,903Related reserves
    
    
    (998
    )
    
    
    (1,014
    )Net inventory
    
    $
    830
    
    
    $
    889Inventory reserves as a percentage of gross inventory
    
    
    55
    %
    
    
    53
    %Other reserves for claims related to our contract manufacturers and suppliers (a)
    
    
    (147
    )
    
    
    (168
    )


|(a) |  | Included in other accrued liabilities and relating to cancellation
charges, inventory in excess of future demand, and for the settlement of
certain other claims.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

During the remainder of 2003, we believe that we will continue to see
restrictions on capital expenditures by our customers. As a result, we will
continue to closely monitor our inventory reserves to ensure that our
provisions appropriately reflect the current market conditions. However, the
inventory provisions we have recorded in the past may not be reflective of
those in future quarters.

Tax asset valuation

We currently have deferred tax assets resulting from net operating loss
carryforwards, tax credit carryforwards, and deductible temporary differences,
all of which will reduce taxable income in the future. We assess the
realization of these deferred tax assets quarterly to determine whether an
income tax valuation allowance is required. Based on available evidence, both
positive and negative, we determine whether it is more likely than not that all
or a portion of the remaining net deferred tax

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assets will be realized. In evaluating the positive and negative evidence, the
weight given to each type of evidence must be proportionate to the extent to
which it can be objectively verified.

If market conditions deteriorate further or future results of operations are
less than expected, future assessments may result in a determination that some
or all of the net deferred tax assets are not realizable. As a result, we may
need to establish additional tax valuation allowances 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.

Liquidity and capital resources

Cash flows

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

6 months ended June 30,2003
    
    
    2002Net cash used in operating activities of continuing operations
    
    $
    (224
    )
    
    $
    (178
    )Net cash from (used in) investing activities of continuing operations
    
    
    301
    
    
    
    (224
    )Net cash from (used in) financing activities of continuing operations
    
    
    (126
    )
    
    
    734Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    78
    
    
    
    46Net cash from continuing operations
    
    
    29
    
    
    
    378Net cash from discontinued operations
    
    
    273
    
    
    
    287Net increase in cash and cash equivalents
    
    
    302
    
    
    
    665Cash and cash equivalents at beginning of period  net
    
    
    3,813
    
    
    
    3,457Cash and cash equivalents at end of period  net
    
    $
    4,115
    
    
    $
    4,122


As of June 30, 2003, our primary source of liquidity was our current cash and
cash equivalents, or cash. At June 30, 2003, we had cash of $4,115 excluding
$115 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 and support facility when and as needed or that
liquidity generating transactions or financings will be available to us on
acceptable terms or at all.

Cash flows used in operating activities were $224 due to a net loss from
continuing operations of $10, less an adjustment of $272 for non-cash related
items, plus a net cash outflow of $486 from operating assets and liabilities.
We generated cash inflows of $87 from accounts receivables due to increased
cash collections. Cash inflows of $117 from inventories were primarily due to
product shipments exceeding additions to inventories during the first half of
2003. Net cash inflows from income taxes were $4. As a result of previously
incurred tax losses, we do not expect that we will have to make significant
cash income tax payments for the foreseeable future. The net cash outflows of
$695 from the remaining operating assets and liabilities were primarily due to:



| |  | $339 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 $301 and were primarily due to a net
decrease of $186 in long-term receivables primarily due to cash inflows of
outstanding customer financing amounts associated with two customers, a
decrease of $144 in restricted cash and cash equivalents held as cash
collateral for certain bid, performance related and other bonds, proceeds of
$21 from the sale of plant and equipment and proceeds of $8 from the sale of
certain investments and businesses. These amounts were partially offset by $56
in plant and equipment expenditures. For the year 2003, we now expect that our
plant and equipment purchases will decline substantially from the $335 in
purchases we made in 2002.

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Cash flows used in financing activities were $126 and were primarily due to $94
used to reduce our long-term debt, $18 used to reduce our notes payable and $12
in preferred share dividends.

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;
| | - | -------------------------------------------------------



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



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



| |  | 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
| |  | ---------------------------------

We expect to incur approximately $300 to $400 in restructuring work plan
related cash outflows during the remainder of 2003. For the entire year 2003,
we currently expect to incur approximately $650 to $750 in restructuring work
plan related cash outflows.

The remaining balance sheet reserve of $315 relating to workforce reduction
initiatives is expected to be substantially drawn down by mid-2004. The
remaining balance sheet reserve of $650 related to contract settlement and
lease costs is expected to be substantially drawn down by the end of 2010.



| |  | 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 Annual
Report on Form 10-K filed with the SEC.

In the second quarter of 2003, we repaid $51 related to an outstanding loan.
In the first quarter of 2003, we purchased $39 of our 6.125% Notes due February
15, 2006. Also, we plan to repay the remaining $164 of our 6.00% Notes due
September 1, 2003 in the third quarter of 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 of 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.

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

June 30,
    
    
    December 31,2003
    
    
    2002Bid and performance related bonds(a)
    
    $
    341
    
    
    $
    400Other bonds(b)
    
    
    38
    
    
    
    35Total bid, performance related and other bonds
    
    $
    379
    
    
    $
    435


|(a) |  | Net of restricted cash and cash equivalents of $63 as at June 30, 2003
and $195 as at December 31, 2002.
|--- |  | --------------------------------------------------------------------------------------------------------
|(b) |  | Net of restricted cash and cash equivalents of $29 as at June 30, 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 obligations under
bid and performance related bonds and may reduce the requirement to provide
cash collateral to support these obligations. On July 10, 2003, we entered
into an amendment to the support facility with EDC which extended the
termination date to December 31, 2005 from June 30, 2004. All other material
terms of the support facility remained unchanged. This facility provides for
up to $750 in support, of which, $300 is committed support for these bonds. In
addition, any bid or performance related bonds with terms that extend beyond
December 31, 2005 are currently not eligible for the support provided by this
facility. 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 facility 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 Annual Report on Form 10-K for the year ended December
31, 2002 filed with the SEC.



| |  | 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

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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:

June 30,
    
    
    December 31,2003
    
    
    2002Drawn and outstanding  gross(a)
    
    $
    455
    
    
    $
    1,091Provisions for doubtful accounts(a)
    
    
    (359
    )
    
    
    (799
    )Drawn and outstanding  net(a)
    
    
    96
    
    
    
    292Undrawn commitments
    
    
    667
    
    
    
    801Total customer financing
    
    $
    763
    
    
    $
    1,093


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

In the second quarter of 2003, we entered into certain agreements to either
sell or restructure various customer financing and related receivables. As a
result of these transactions, we received cash consideration of approximately
$199 to settle outstanding receivables of approximately $503 with a carrying
value of approximately $111. Additional non-cash consideration received under one
such restructuring agreement included a five year equipment and services supply
agreement and the mutual release of all other claims between the parties.

Also in the second quarter of 2003, we recorded net customer financing bad debt
recoveries of $51 primarily as a result of the favorable settlements described
above and adjustments to other existing provisions.

In the first quarter of 2003, our gross customer financing receivables 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 half of 2003, we reduced
undrawn commitments by $134 reflecting commitment expiration, cancellations and
changing customer business plans. As of June 30, 2003, approximately $100 of
the $667 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 the strategic use of our customer financing
capacity and on reducing the amount of our existing and future customer
financing exposure.

Subsequent to June 30, 2003, we renegotiated an agreement with a certain
customer and reduced our undrawn commitments by approximately $509, leaving
approximately $158 in aggregate undrawn commitments.

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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.



| |  | Joint ventures/minority interests
| |  | ---------------------------------

As was previously discussed in our Recent developments, on October 19, 2002
we entered into a number of put option and call option agreements as well as a
share exchange agreement with EADS, our partner in three European joint
ventures. During July 2003, the options and share exchange were exercised
which will require us to deliver, subject to final regulatory approval, net
consideration of approximately $130 consisting of approximately $48 in cash
and an in-kind component of approximately $82 representing the return of a loan
note currently owed to us by an affiliate of EADS. The net consideration is
payable in euro and is subject to fluctuations between the euro and United
States dollar. These transactions are expected to close prior to the end of
the third quarter of 2003 and are not expected to have a material impact on our
business, results of operations and financial condition.

Discontinued operations

As of June 30, 2003, accruals relating to our discontinued access solutions
operations totaled $84 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 half of 2003, we generated cash of
approximately $278 on the disposition of various assets from the access
solutions operations.

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

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
Nortel Networks Limited and Nortel Networks Inc. and permit borrowings for
general corporate purposes. As of June 30, 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 June 30, 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

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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 facility
| |  | --------------------------

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, following an amendment on July 10, 2003,
expires on December 31, 2005, provides for up to $750 in support including $300
of committed revolving support for performance bonds or similar instruments of
which $123 was utilized as at June 30, 2003. The remainder is uncommitted
support for performance bonds, receivables sales and/or securitizations of
which $65 was utilized as at June 30, 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 Investor Services, Inc., or 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, Nortel
Networks Limited and Nortel Networks Inc. would also, as a result, be in
default under the $750 April 2000 five year credit facilities and we and
Nortel Networks Corporation would be in default under 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 the banks under the $750 April 2000 five year credit facilities, the
holders of our public debt securities and the holders of Nortel Networks
Corporation 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 and guarantees will be released in full in respect of
the banks, EDC, the public debtholders and any other party secured under the
security agreements at that time. If both the $750 April
2000 five year credit facilities and the support facility with EDC are
terminated, or expire, the security and guarantees will also be released in
full in respect of the banks, EDC, the public debtholders and any other party
secured under the security agreements at that time. We may
provide EDC with cash collateral in an amount equal to the total amount of our
outstanding obligations and undrawn commitments and expenses under this
facility (or any other alternative collateral acceptable to EDC) 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 and Supplemental consolidating
financial information in notes 7 and 17, respectively, of the accompanying
unaudited consolidated financial statements. For additional financial
information related to those subsidiaries providing guarantees, see
Supplemental consolidating financial information in note 17 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.



| |  | 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 SEC 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 June 30, 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.

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Credit ratings

Rating on long-termdebt issued orguaranteed by
    
    
    Rating on preferredNortel Networks Limited/
    
    
    shares issued byRating agency
    
    Nortel Networks Corporation
    
    
    Nortel Networks Limited
    
    
    Last updateStandard & Poors Ratings Service
    
    
    B
    
    CCC
    
    
    September 18, 2002Moodys Investor 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 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 have conducted certain receivable sales and lease financing transactions
through special purpose entities.

Our receivable sales transactions are generally conducted either directly with
financial institutions or with multi-seller conduits. Under the criteria set
out in FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, or FIN 46, 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 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 June 30, 2003 were each approximately
$181 and represented the collateral and maximum exposure to loss, respectively,
as a result of our involvement with these entities.

For additional information, see Significant accounting policies in note 1(c)
of the accompanying unaudited consolidated financial statements.

Contractual 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 Annual
Report on Form 10-K for the year ended December 31, 2002 filed with the SEC.
See Contractual cash obligations for additional information.

Contingent liabilities and commitments



| |  | Customer financing commitments
| |  | ------------------------------

See Customer financing for additional information on our outstanding customer
financing commitments.

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| |  | Purchase commitments
| |  | --------------------

Our purchase commitments remain substantially unchanged from the amounts
disclosed as at December 31, 2002 in our Annual Report on Form 10-K filed with
the SEC.



| |  | Commitment relating to joint ventures/minority interests
| |  | --------------------------------------------------------

See Joint ventures/minority interests for additional information relating to
the acquisition of the minority interest in two of our joint ventures and the
disposition of our equity interest in a 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. For additional information,
see Guarantees in note 9 of the accompanying unaudited consolidated financial statements.

Market risk

Market risk represents the risk of loss that may impact our consolidated
financial statements through adverse changes in financial market prices and
rates. Our market risk exposure results primarily from fluctuations in
interest rates and foreign exchange rates. To manage the risk from these
fluctuations, we enter into various derivative-hedging transactions that we
have authorized under our policies and procedures. We maintain risk management
control systems to monitor market risks and counter-party risks. These systems
rely on analytical techniques including both sensitivity analysis and
value-at-risk estimations. We do not hold or issue financial instruments for
trading purposes.

For additional information relating to our derivative financial instruments,
you should refer to Significant accounting policies in note 2(s) and
Financial instruments and hedging activities in note 11 of the consolidated
financial statements contained in our Annual Report on Form 10-K for the year
ended December 31, 2002 filed with the SEC.

We manage foreign exchange exposures using forward and option contracts to
hedge firm sale and purchase commitments. Our most significant foreign
exchange exposures are in the Canadian dollar, the United Kingdom pound and the
euro. We enter into United States to Canadian dollar forward and option
contracts intended to hedge the United States to Canadian dollar exposure on
future revenues and expenditure streams. In accordance with SFAS 133,
Accounting for Derivative Instruments and Hedging Activities, we recognize
the gains and losses on the effective portion of these contracts in income when
the hedged transaction occurs. Any ineffective portion of these contracts is
recognized in income immediately.

We expect to continue to expand our business globally and, as such, expect that
an increasing proportion of our business will be denominated in currencies
other than United States dollars. As a result, fluctuations in foreign
currencies may have a material impact on our business, results of operations
and financial condition. We try to minimize the impact of such currency
fluctuations through our ongoing commercial practices and by attempting to
hedge our exposures to major currencies. In attempting to manage this foreign
exchange risk, we identify operations and transactions that may have exposure
based upon the excess or deficiency of foreign currency receipts over foreign
currency expenditures. Given our exposure to international markets, we
regularly monitor all of our foreign currency exposures. We cannot predict
whether we will incur foreign exchange losses in the future. However, if
significant foreign exchange losses are experienced, they could have a material
adverse effect on our business, results of operations and financial condition.

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We manage interest rate exposures using a diversified portfolio of fixed and
floating rate instruments denominated in several major currencies. We manage
these exposures using interest rate swaps which reduce interest expense
fluctuations. We record net settlements on these swap instruments as
adjustments to interest expense.

For additional information on our exposure to foreign currency and interest
rate risk, you should refer to our Market Risk discussion in our Annual
Report on Form 10-K for the year ended December 31, 2002 filed with the SEC.

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 to 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
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.

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 relating 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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 relating 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.

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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 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 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, such
as Severe Acute Respiratory Syndrome, or SARS, in the Asia Pacific
region, 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 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
| | - | ------------------------------------------

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| |  |  | 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 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 Nortel
Networks Corporation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.

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 the $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 our 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.

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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 drawdowns 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 relating 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 at any time be not less
than $1,888. 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
relating to our restructuring work plan, the accounting for 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 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.

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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
secure 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 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.

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, additional valuation allowances 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. 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
additional tax valuation allowances 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.

The outcome of our comprehensive review and
analysis of identifiable categories of assets and liabilities may
impact prior periods.

The outcome of the comprehensive review and
analysis of identifiable categories of assets and liabilities as more
fully described under Recent developments above (the
comprehensive review) may result in the elimination of
certain assets and liabilities (including accruals and provisions).
As part of the comprehensive review, we are currently assessing the
support for liabilities which were initially recorded, along with
corresponding charges to income, in prior periods. These liabilities
represented less than 2% of our total liabilities as at June 30,
2003. The outcome of the comprehensive review is currently not
expected to have a negative impact on our net assets. Reported
results in one or more prior periods may be affected, potentially
resulting in the non-material reduction of prior period losses. No
amounts relating to the elimination of any such assets and
liabilities have been included in our results for the second quarter
of 2003. The comprehensive review is ongoing, and we expect to
substantially conclude it in the third quarter of 2003.

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

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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 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.
| | - |  | ------------------------------------

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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 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 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

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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.

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 transmission of contagious diseases, such as SARS in the Asia Pacific region.
| | - |  | ---------------------------------------------------------------------------------------------------------

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 has not yet been released. Although the decision may affect
the decisions of our United States based service provider customers regarding
investment in
telecommunications infrastructure, the extent of the impact has not been
determined. 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.

The current downturn in the economy has increased, and could continue to
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 are
seeking to reduce 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. If we do, we may be required to
directly hold a significantly greater amount of such

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financings than in the
past, when we were able to place a large amount of our customer financing
obligations with third party lenders.

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.

Further, 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 level contained in the
contract. As a result, we may be obligated to compensate the supplier for
certain direct costs. The amount of 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.

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 our business areas.
If a member of a strategic alliance fails to perform its obligations, if the
relationship fails to develop as

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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 and/or Nortel Networks Corporation are currently a defendant in numerous
class actions and other lawsuits, including lawsuits initiated against Nortel
Networks Corporation and certain of its officers and directors on behalf of
holders of Nortel Networks Corporation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. Litigation may be time consuming,
expensive and distracting from the conduct of our business and the outcome of
litigation is difficult to predict. The adverse resolution of any specific
lawsuit could have a material adverse effect on our business, results of
operations and financial condition.

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 Market Risk in Managements
Discussion and Analysis of Financial Condition and Results of Operations and in
our Annual Report on Form 10-K for the year ended December 31, 2002 filed with
the SEC on March 10, 2003.






|ITEM 4. |  | Controls And Procedures
|------- |  | -----------------------

(a) Evaluation of Disclosure Controls and Procedures

As at the end of the period covered by this report, Nortel Networks
carried out an evaluation under the supervision and with the
participation of management, including the President and Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation
of Nortel Networks disclosure controls and procedures. Based upon that
evaluation, the President and Chief Executive Officer and Chief
Financial Officer concluded that the design and operation of these
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 to the extent noted in (b) below.

(b) Changes in Internal Control

In light of a period of unprecedented industry
adjustment and subsequent restructuring actions, including workforce
reductions and asset write-downs, in the second quarter of 2003
Nortel Networks initiated a comprehensive review and analysis of
identifiable categories of its assets and liabilities (the
comprehensive review). The amounts under review were
recorded when Nortel Networks balance sheet and income statement were
much larger. Specifically, what would have been relatively minor
amounts in prior periods may be considered to be material to current
periods. The comprehensive review is in addition to reviews normally
performed by Nortel Networks in connection with the recording of
current period financial results.

The outcome of the comprehensive review may result
in the elimination of certain assets and liabilities (including
accruals and provisions). As part of the comprehensive review, Nortel
Networks is currently assessing the support for certain of its
liabilities which were initially recorded, along with corresponding
charges to income, in prior periods. These liabilities represented
less than 2% of Nortel Networks total liabilities as at June 30,
2003. The outcome of the comprehensive review is currently not
expected to have a negative impact on Nortel Networks net assets.
Reported results in one or more prior periods may be affected,
potentially resulting in the non-material reduction of prior period
losses. No amounts relating to the elimination of any such assets and
liabilities have been included in Nortel Networks results for the
second quarter of 2003. The comprehensive review is ongoing, and we
expect to substantially conclude it in the third quarter of 2003.

In connection with the assessment of the
liabilities (including accruals and provisions) identified above,
Nortel Networks has noted certain deficiencies in documentary
support. Nortel Networks continues to address this matter as part of
the comprehensive review.

As part of the required communications by
Deloitte & Touche LLP (D&T), Nortel Networks
independent auditors, to the Nortel Networks Audit Committee, D&T
informed the Audit Committee that this deficiency constituted a
reportable condition, but not a material
weakness, as those terms are defined under standards
established by the American Institute of Certified Public
Accountants. D&T noted that its assessment was based on such
information as was available at the date of its communication to the
Audit Committee and the materiality of the underlying amounts in the
context of 2003 reported results. Further to discussions between and
among Nortel Networks management, the Audit Committee and D&T, D&T's
assessment is being taken into account in connection with the ongoing
comprehensive review. While Nortel Networks is currently assessing
whether any changes to Nortel Networks internal control over
financial reporting are necessary, Nortel Networks expects that any
such changes would be minor.

There has been no change in Nortel Networks
internal control over financial reporting during the quarter ended
June 30, 2003 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.

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PART II
OTHER INFORMATION






|ITEM 1. |  | Legal Proceedings
|------- |  | -----------------

For a discussion of our material legal proceedings, see Contingencies in note
15 of the accompanying unaudited consolidated financial statements.






|ITEM 4. |  | Submissions Of Matters To A Vote Of Security Holders
|------- |  | ----------------------------------------------------

Pursuant to a unanimous decision dated April 24, 2003 by Nortel Networks
Corporation, the sole holder of the common shares of Nortel Networks Limited,
the following items of business were passed:



|(a) |  | Election of Directors
|--- |  | ---------------------

The following individuals were elected as directors of Nortel Networks Limited
to hold office in accordance with By-law No. 1 of Nortel Networks Limited:

DirectorHonourable J.J. Blanchard
R.E. Brown
J.E. Cleghorn
F.A. Dunn
L.Y. Fortier
R.A. Ingram
W.A. Owens
G. Saucier
S.H. Smith, Jr.
L.R. Wilson




|(b) |  | Appointment of Auditors
|--- |  | -----------------------

The appointment of Deloitte & Touche LLP as independent auditors was approved.






|ITEM 6. |  | Exhibits And Reports On Form 8-K
|------- |  | --------------------------------



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



|10.1 |  | Amended general description of
special cash bonus for employees and executives of
Nortel Networks Corporation and Nortel Networks Limited.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------



|10.2 |  | Nortel Networks Limited Directors Deferred Share Compensation Plan as
amended and restated, effective May 29, 2003.
|---- |  | --------------------------------------------------------------------------------------------------------------------



|10.3 |  | Letter dated June 23, 2003 from Frank A. Dunn, President and Chief
Executive Officer of Nortel Networks, to the Joint Leadership
Resources Committee of the Board of Directors of Nortel Networks
Corporation and Nortel Networks Limited regarding the voluntary return for
cancellation of certain stock options to purchase common shares of Nortel
Networks Corporation granted to and held by Frank A. Dunn.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|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 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.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Limited filed a Current Report on Form 8-K dated July 10,
2003 related to Amending Agreement No. 1 dated as of July 10, 2003 to the
Master Facility Agreement dated as of February 14, 2003 between Nortel
Networks Limited and Export Development Canada.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Limited filed a Current Report on Form 8-K dated July 25,
2003 related to its financial results for the second quarter of 2003.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Limited furnished a Current Report on Form 8-K dated July
25, 2003 related to its financial results for the second quarter of 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 
D.C.
BEATTY
D.C. BEATTY
Chief Financial Officer
    
    Chief Accounting Officer 
M.J. GOLLOGLY
M.J. GOLLOGLY
Controller


Date: August 11, 2003

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