##### Table of Contents



---

---

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

FORM 10-Q

x        Quarterly Report Pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934For the Quarterly Period Ended September 30, 2003ORo        Transition Report Pursuant to Section 13 or 15(d) ofthe 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.

Yesü                 No

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

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

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



---

---





---

TABLE OF CONTENTS



|                                                       |                                                                                               |  |  |  |  |  |  | 
|------------------------------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|ITEM 1. Consolidated Financial Statements (unaudited) 
|Notes to Consolidated Financial Statements (unaudited)
|Consolidated Balance Sheet                            
|                                                       | ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                       | ITEM 3. Quantitative And Qualitative Disclosures About Market Risk                           
|                                                       | ITEM 4. Controls And Procedures                                                              
|PART II                                               
|                                                       | ITEM 1. Legal Proceedings                                                                    
|                                                       | ITEM 6. Exhibits And Reports On Form 8-K                                                     
|SIGNATURES                                            
|EX-10.1                                               
|EX-31.1                                               
|EX-31.2                                               
|EX-32                                                 



---



##### Table of Contents



EXPLANATORY NOTE

Nortel Networks Limited previously announced it would restate its consolidated
financial statements for the years ended December 31, 2000, 2001 and 2002 and
the quarters ended March 31, 2003 and June 30, 2003. The consolidated
statements of operations for the three and nine months ended September 30,
2002, the consolidated balance sheet as at December 31, 2002 and the
consolidated statement of cash flows for the nine months ended September 30,
2002, including the applicable notes, contained in this Quarterly Report on
Form 10-Q have been restated. For a description of the restatements, see
Restatements in note 2 to the accompanying unaudited consolidated financial
statements and Developments in 2003  Restatements in Managements Discussion
and Analysis of Financial Condition and Results of Operations contained in this
Quarterly Report on Form 10-Q. In addition, at the earliest possible time in
the fourth quarter of 2003, Nortel Networks Limited expects to file an amended
Annual Report on Form 10-K/A for the year ended December 31, 2002 and amended
Quarterly Reports on Form 10-Q/A for the quarters ended March 31, 2003 and June
30, 2003 containing restated financial statements for the other relevant
periods.

2



---



##### Table of Contents



TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

PAGEITEM 1.
    
    Consolidated Financial Statements (unaudited)
    
    
    4ITEM 2.
    

Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    46ITEM 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    91ITEM 4.
    
    Controls and Procedures
    
    
    91


PART II
OTHER INFORMATION

ITEM
1.
    
    Legal Proceedings
    
    
    93ITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    
    93Signatures
    
    
    
    
    94


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

3



---



##### Table of Contents






PART I
FINANCIAL INFORMATION

ITEM 1. Consolidated Financial Statements (unaudited)

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


4



---



##### Table of Contents



NORTEL NETWORKS LIMITED

Consolidated Statements of Operations (unaudited)


Three months ended September 30,
    
    
    Nine months ended September 30,(millions of U.S. dollars)
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002As Restated *
    
    
    
    
    
    As Restated *Revenues
    
    $
    2,266
    
    
    $
    2,349
    
    
    $
    6,982
    
    
    $
    8,034Cost of revenues
    
    
    1,089
    
    
    
    1,500
    
    
    
    3,730
    
    
    
    5,491Gross profit
    
    
    1,177
    
    
    
    849
    
    
    
    3,252
    
    
    
    2,543Selling, general and administrative expense
    
    
    482
    
    
    
    695
    
    
    
    1,408
    
    
    
    2,150Research and development expense
    
    
    480
    
    
    
    544
    
    
    
    1,454
    
    
    
    1,667Amortization of acquired technology
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    17Special chargesGoodwill impairment
    
    
    
    
    
    
    264
    
    
    
    
    
    
    
    264Other special charges
    
    
    70
    
    
    
    563
    
    
    
    180
    
    
    
    1,251Gain on sale of businesses
    
    
    (20
    )
    
    
    (3
    )
    
    
    (28
    )
    
    
    (11
    )Operating earnings (loss)
    
    
    165
    
    
    
    (1,220
    )
    
    
    238
    
    
    
    (2,795
    )Other income (expense)  net
    
    
    100
    
    
    
    (18
    )
    
    
    130
    
    
    
    (43
    )Interest expenseLong-term debt
    
    
    (25
    )
    
    
    (37
    )
    
    
    (71
    )
    
    
    (110
    )Other
    
    
    
    
    
    
    (13
    )
    
    
    (9
    )
    
    
    (35
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    240
    
    
    
    (1,288
    )
    
    
    288
    
    
    
    (2,983
    )Income tax benefit (expense)
    
    
    (35
    )
    
    
    (75
    )
    
    
    (43
    )
    
    
    430205
    
    
    
    (1,363
    )
    
    
    245
    
    
    
    (2,553
    )Minority interests  net of tax
    
    
    (14
    )
    
    
    (1
    )
    
    
    (18
    )
    
    
    6Equity in net loss of associated companies  net of tax
    
    
    (5
    )
    
    
    (7
    )
    
    
    (35
    )
    
    
    (26
    )Net earnings (loss) from continuing operations
    
    
    186
    
    
    
    (1,371
    )
    
    
    192
    
    
    
    (2,573
    )Net earnings from discontinued operations  net of tax
    
    
    44
    
    
    
    2
    
    
    
    206
    
    
    
    21Net earnings (loss) before cumulative effect of accounting
change  net of tax
    
    
    230
    
    
    
    (1,369
    )
    
    
    398
    
    
    
    (2,552
    )Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    Net earnings (loss)
    
    
    230
    
    
    
    (1,369
    )
    
    
    390
    
    
    
    (2,552
    )Dividends on preferred shares
    
    
    (6
    )
    
    
    (6
    )
    
    
    (18
    )
    
    
    (16
    )Net earnings (loss) applicable to common shares
    
    $
    224
    
    
    $
    (1,375
    )
    
    $
    372
    
    
    $
    (2,568
    )


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

5



---



##### Table of Contents



NORTEL NETWORKS LIMITED

Consolidated Balance Sheets (unaudited)


September 30,
    
    
    December 31,(millions of U.S. dollars)
    
    2003
    
    
    2002As Restated *ASSETSCurrent assetsCash and cash equivalents
    
    $
    3,493
    
    
    $
    3,743Restricted cash and cash equivalents
    
    
    113
    
    
    
    249Accounts receivable  net
    
    
    2,250
    
    
    
    2,247Inventories  net
    
    
    928
    
    
    
    986Income taxes recoverable
    
    
    59
    
    
    
    58Deferred income taxes  net
    
    
    415
    
    
    
    793Other current assets
    
    
    418
    
    
    
    668Total current assets
    
    
    7,676
    
    
    
    8,744Investments
    
    
    183
    
    
    
    248Plant and equipment  net
    
    
    1,468
    
    
    
    1,464Goodwill
    
    
    2,053
    
    
    
    2,021Deferred income taxes  net
    
    
    3,224
    
    
    
    2,653Other assets
    
    
    565
    
    
    
    766Total assets
    
    $
    15,169
    
    
    $
    15,896LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    23
    
    
    $
    30Trade and other accounts payable
    
    
    766
    
    
    
    899Payroll and benefit-related liabilities
    
    
    705
    
    
    
    499Contractual liabilities
    
    
    768
    
    
    
    1,213Restructuring
    
    
    269
    
    
    
    537Other accrued liabilities
    
    
    2,293
    
    
    
    2,894Long-term debt due within one year
    
    
    112
    
    
    
    233Total current liabilities
    
    
    4,936
    
    
    
    6,305Long-term debt
    
    
    1,958
    
    
    
    1,949Deferred income taxes  net
    
    
    280
    
    
    
    366Other liabilities
    
    
    2,288
    
    
    
    2,321Total liabilities
    
    
    9,462
    
    
    
    10,941Minority interests in subsidiary companies
    
    
    77
    
    
    
    129Guarantees, commitments and contingencies (notes 11, 12 and 17)SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited; issued and outstanding shares:30,000,000 at September 30, 2003 and December 31, 2002
    
    
    536
    
    
    
    536Common shares, without par value  Authorized shares: unlimited; issued and outstanding shares:1,460,978,638 at September 30, 2003 and December 31, 2002
    
    
    1,211
    
    
    
    1,211Additional paid-in capital
    
    
    22,024
    
    
    
    22,004Accumulated deficit
    
    
    (17,235
    )
    
    
    (17,607
    )Accumulated other comprehensive loss
    
    
    (906
    )
    
    
    (1,318
    )Total shareholders equity
    
    
    5,630
    
    
    
    4,826Total liabilities and shareholders equity
    
    $
    15,169
    
    
    $
    15,896


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

6



---



##### Table of Contents



NORTEL NETWORKS LIMITED

Consolidated Statements of Cash Flows (unaudited)


Nine months ended September 30,(millions of U.S. dollars)
    
    2003
    
    
    2002As Restated *Cash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    192
    
    
    $
    (2,573
    )Adjustments
to reconcile net earnings (loss) from continuing operations to net cash used
in operating activities,
net of effects from acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    326
    
    
    
    415Non-cash portion of special charges and related asset write downs
    
    
    8
    
    
    
    840Equity in net loss of associated companies
    
    
    35
    
    
    
    25Stock option compensation
    
    
    19
    
    
    
    Deferred income taxes
    
    
    44
    
    
    
    (438
    )Other liabilities
    
    
    119
    
    
    
    (29
    )Gain on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    Gain on sale of investments and businesses
    
    
    (67
    )
    
    
    (17
    )Other  net
    
    
    38
    
    
    
    595Change in operating assets and liabilities
    
    
    (1,315
    )
    
    
    623Net cash used in operating activities of continuing operations
    
    
    (605
    )
    
    
    (559
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (94
    )
    
    
    (289
    )Proceeds on disposals of plant and equipment
    
    
    22
    
    
    
    356Decrease (increase) in restricted cash and cash equivalents
    
    
    147
    
    
    
    (420
    )Increase in long-term receivables
    
    
    (12
    )
    
    
    (249
    )Decrease in long-term receivables
    
    
    207
    
    
    
    253Acquisitions of investments and businesses  net of cash acquired
    
    
    (54
    )
    
    
    (29
    )Proceeds on sale of investments and businesses
    
    
    51
    
    
    
    44Net cash from (used in) investing activities of continuing operations
    
    
    267
    
    
    
    (334
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (18
    )
    
    
    (16
    )Decrease in notes payable  net
    
    
    (39
    )
    
    
    (314
    )Proceeds from long-term debt
    
    
    
    
    
    
    32Repayments of long-term debt
    
    
    (267
    )
    
    
    (22
    )(Increase) decrease in capital leases payable
    
    
    (3
    )
    
    
    (7
    )Issuance of common shares
    
    
    
    
    
    
    1,997Stock option fair value increment
    
    
    
    
    
    
    (525
    )Net cash (used in) from financing activities of continuing operations
    
    
    (327
    )
    
    
    1,145Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    97
    
    
    
    16Net cash from continuing operations
    
    
    (568
    )
    
    
    268Net cash from discontinued operations
    
    
    318
    
    
    
    337Net (decrease) increase in cash and cash equivalents
    
    
    (250
    )
    
    
    605Cash and cash equivalents at beginning of period
    
    
    3,743
    
    
    
    3,404Cash and cash equivalents at end of period
    
    $
    3,493
    
    
    $
    4,009


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

7



---



##### Table of Contents






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) have been prepared in accordance with
accounting principles generally accepted in the United States (GAAP) and
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 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 year ended December 31, 2002, except as described in note 3.
Although Nortel Networks is headquartered in Canada, the accompanying
unaudited consolidated financial statements are expressed in United States
dollars as the greater part of Nortel Networks financial results and net
assets are denominated in United States dollars.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As described in note 2, the consolidated statements of operations for the
three months and nine months ended September 30, 2002, the consolidated
balance sheet as at December 31, 2002 and the consolidated statement of cash
flows for the nine months ended September 30, 2002, including the applicable
notes, were restated. At the earliest possible time in the fourth quarter of
2003, Nortel Networks expects to file with the SEC an amended Annual Report
on Form 10-K/A for the year ended December 31, 2002 (Nortel Networks Form
10-K/A). In addition, the results of operations and cash flows for the six
months ended June 30, 2003, as reflected in the consolidated statements of
operations and cash flows for the nine months ended September 30, 2003, were
restated. At the earliest possible time in the fourth quarter of 2003,
Nortel Networks also expects to file with the SEC amended Quarterly Reports
on Form 10-Q/A for the quarterly periods ended March 31, 2003 and June 30,
2003.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In the opinion of management, all adjustments necessary for a fair statement
of the results for the periods presented have been made and all such
adjustments were of a normal recurring nature. The financial results for the
three months and nine months ended September 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 and, when filed with the SEC,
the Nortel Networks Form 10-K/A (collectively, Nortel Networks Annual
Report), subject to the restated financial information described above.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



| |  | In 2001, Nortel Networks entered into an unprecedented period of business
realignment in response to a significant adjustment in the telecommunications
industry. Industry demand for networking equipment dramatically declined in
response to the industry adjustment, severe economic downturns in various
regions around the world and a tightening in global capital markets. Nortel
Networks implemented a company-wide restructuring plan to streamline its
operations and activities around core markets and operations, which included
significant workforce reductions, global real estate closures and
dispositions, substantial write-downs of its capital assets, goodwill and
other intangible assets and extensive contract settlements with customers and
suppliers around the world. As a result of these actions, Nortel Networks
workforce declined significantly from January 1, 2001 to September 30, 2003
and over the same time period Nortel Networks significantly reduced its
facilities.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks initiated, and disclosed in its Quarterly Report on Form 10-Q
for the period ended June 30, 2003, a comprehensive review and analysis of
its assets and liabilities. On October 23, 2003, Nortel Networks announced
it would restate its consolidated financial statements for the years ended
December 31, 2000, 2001 and 2002 and for the quarters ended March 31, 2003
and June 30, 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

8



---



##### Table of Contents





| |  | Based on the completion of the comprehensive review and certain related
reviews (collectively, the comprehensive review), Nortel Networks has
determined that approximately $948 of certain liabilities (primarily accruals
and provisions) carried on its previously reported consolidated balance sheet as at June
30, 2003 needed to be released to income in prior periods as part of the
restatements. These provisions were either initially recorded incorrectly in
prior periods or not properly released or adjusted for changes in estimates
in the appropriate periods. In certain cases, costs were incorrectly charged
to operations rather than to the appropriate provisions. Following its
determination to restate certain consolidated financial statements, Nortel
Networks also determined that it would correct certain known errors that were
previously not recorded because the amount of the errors was not material to
the consolidated financial statements. Specifically, among other items,
Nortel Networks has made certain revenue adjustments to reflect revenue which
should have been deferred instead of recognized in a particular period.
Also, as part of the restatements, Nortel Networks made adjustments to
correct errors related to its deferred income tax assets and foreign currency
translation accounts. In addition, Nortel Networks made reclassification
adjustments within the consolidated balance sheet to better reflect the underlying nature
of certain items; these reclassifications did not impact the net assets as at
the end of any period. The net effect of all of these adjustments was a
reduction in accumulated deficit as at June 30, 2003 of $492.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has also undertaken a series of physical counts and
reconciliations of plant and equipment. While Nortel Networks believes that
the portion of the work completed to date supports the carrying value of the
plant and equipment recorded in its consolidated balance sheet as at September 30, 2003,
the conclusion of this work could result in adjustments to the carrying value
of certain assets.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following presents Nortel Networks accumulated deficit as previously
reported and after giving effect to the restatement adjustments as at June
30, 2003, March 31, 2003, December 31, 2002, December 31, 2001 and December
31, 2000:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Accumulated deficit
| |  | -------------------



December 31,June 30,
    
    
    March 31,
    
    
    
    
    
    Prior(a)2003
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    yearsAccumulated deficitAs previously reported
    
    $
    17,951
    
    
    $
    18,001
    
    
    $
    18,093
    
    
    $
    14,507
    
    
    $
    402As restated
    
    
    17,459
    
    
    
    17,559
    
    
    
    17,607
    
    
    
    14,336
    
    
    
    370Cumulative adjustment
    
    $
    (492
    )
    
    $
    (442
    )
    
    $
    (486
    )
    
    $
    (171
    )
    
    $
    (32
    )
    
    $
    (4
    )
 (a)
    
    The amount in prior years relates to net adjustments in the years
1997 through 1999 which have been reflected as an adjustment to
accumulated deficit as of January 1, 2000.




| |  | The following presents the impact on revenues and earnings (loss) of the
restatement adjustments for the quarterly periods ended June 30, 2003 and
March 31, 2003 and the years ended December 31, 2002, 2001 and 2000:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9



---



##### Table of Contents





| |  | Restated revenues and earnings (loss)
| |  | -------------------------------------



Three months endedDecember 31,June 30,
    
    
    March 31,
    
    
    
    
    
    Prior(a)
    
    
    Total2003
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    years
    
    
    adjustmentsRevenuesAs previously reported
    
    $
    2,328
    
    
    $
    2,397
    
    
    $
    10,546
    
    
    $
    17,375
    
    
    $
    27,853Adjustments
    
    
    12
    
    
    
    (21
    )
    
    
    8
    
    
    
    (103
    )
    
    
    (17
    )
    
    $
    (1
    )
    
    $
    (122
    )As restated
    
    $
    2,340
    
    
    $
    2,376
    
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836Earnings (loss)Earnings (loss) from
continuing operationsAs previously reported
    
    $
    57
    
    
    $
    (67
    )
    
    $
    (3,039
    )
    
    $
    (11,555
    )
    
    $
    (871
    )Adjustments
    
    
    52
    
    
    
    (36
    )
    
    
    294
    
    
    
    125
    
    
    
    28
    
    
    $
    4
    
    
    $
    467As restated
    
    $
    109
    
    
    $
    (103
    )
    
    $
    (2,745
    )
    
    $
    (11,430
    )
    
    $
    (843
    )Earnings
(loss) from discontinued
operations-net of taxAs previously reported
    
    $
    
    
    
    $
    164
    
    
    $
    
    
    
    $
    (2,538
    )
    
    $
    (414
    )Adjustments
    
    
    (2
    )
    
    
    
    
    
    
    21
    
    
    
    14
    
    
    
    
    
    
    $
    
    
    
    $
    33As restated
    
    $
    (2
    )
    
    $
    164
    
    
    $
    21
    
    
    $
    (2,524
    )
    
    $
    (414
    )Net
earnings (loss) applicable
to common sharesAs previously reported
    
    $
    50
    
    
    $
    92
    
    
    $
    (3,061
    )
    
    $
    (14,105
    )
    
    $
    (1,316
    )Adjustments
    
    
    50
    
    
    
    (44
    )
    
    
    315
    
    
    
    139
    
    
    
    28
    
    
    $
    4
    
    
    $
    492As restated
    
    $
    100
    
    
    $
    48
    
    
    $
    (2,746
    )
    
    $
    (13,966
    )
    
    $
    (1,288
    )
 (a)
    
    The amount in prior years relates to net adjustments in the years
1997 through 1999 which have been reflected as an adjustment to
accumulated deficit as of January 1, 2000.




| |  | The following presents details by category, aggregating to the net decrease
in accumulated deficit of $492 as at June 30, 2003, resulting from the
restatement adjustments:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Net decrease in accumulated deficit by category
| |  | -----------------------------------------------



Contract and customer-related accruals
    
    $
    424Special charges related to restructuring actions
    
    
    328Other accruals and provisions
    
    
    196Total accruals and provisions adjustments
    
    $
    948Income tax adjustments
    
    
    (168
    )Revenue adjustments
    
    
    (122
    )Foreign currency translation adjustments related to Brazilian operations
    
    
    (107
    )Foreign currency translation adjustments  other
    
    
    (59
    )Decrease in accumulated deficit as at June 30, 2003
    
    $
    492




| |  | Descriptions of the categories of the restatement adjustments to Nortel
Networks accumulated deficit as at June 30, 2003 that were determined as a
result of its comprehensive review are set forth below.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Approximately $424 of adjustments related to certain contract and
customer-related accruals. These accruals were identified as having been
accrued in error and were reversed in the appropriate periods. Nortel
Networks identified situations in which additional accruals related to
certain contracts were recognized when circumstances did not justify such
accruals. Certain of these accruals were not supported by adequate
documentation.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

10



---



##### Table of Contents





| |  | In addition, Nortel Networks identified situations where accruals were not
released in the appropriate period. While these errors did not impact the
cumulative reduction of the contract and customer-related accruals in the
$424 of adjustments noted above, certain periods reflect adjustments to these
accruals to recognize them in the appropriate periods.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | During the period January 1, 2000 to June 30, 2003, Nortel Networks recorded
prior to the restatement adjustments $5,029 of special charges related to workforce reductions, contract
settlement and lease costs, plant and equipment write-downs, and other
ancillary special charges in connection with the implementation of specific
restructuring actions to streamline its operations and activities around core
markets and operations. As part of the restatements, Nortel Networks has
reduced, on a cumulative basis, $328 of special charges. The following table
provides details of the total adjustments related to these special charges:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Severance and fringe benefits calculations
    
    $
    222Plant and equipment and real estate related adjustments
    
    
    62Contract settlements
    
    
    44Total special charges related to restructuring actions
    
    $
    328




| |  | Approximately $222 of adjustments were made relating to special charges for
costs associated with severance and fringe benefits offered to terminated
employees due to calculation errors that resulted in excess charges being
recorded at the time of initial recognition, or the failure to properly
release or adjust accruals for subsequent changes in estimates and
assumptions.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Approximately $62 of net adjustments related to special charges for plant and
equipment and certain real estate facilities. These adjustments related to
$53 of excess depreciation and amortization charges taken on previously
written-down assets, $14 of computational errors related to foreign currency
adjustments, $14 of incorrect recognition of proceeds received on the sale of
previously written-down assets, and $4 of other provisions determined to be
in excess of appropriate amounts, partially offset by the need to recognize
additional exit costs of $23 net for properties which had not previously been
accrued to special charges.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks also had appropriately accrued $44 of certain costs
associated with contract settlements with customers and suppliers related to
exit activities. However, the timely reassessment of the estimates and
assumptions used to establish these accruals was not carried out and
accordingly the restatement adjustments reflected the release of such
accruals in the appropriate periods.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Further, the timely reassessment of estimates and assumptions used in the
establishment of certain workforce reduction provisions was not carried out
and significant provisions for costs associated with fringe benefits offered
to terminated employees were not released in the appropriate periods. While
these errors did not impact the cumulative reduction of the special charges
in the $328 of adjustments noted above, certain periods reflect adjustments
to these provisions to recognize them in the appropriate periods.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks determined that approximately $196 of accruals and provisions
related to certain items should not have been recorded as the appropriate
conditions and documentation supporting the establishment of these accruals
and provisions did not exist at the time of such recognition. The restatement
adjustments included the reversal of these accruals and provisions in the
periods in which they were originally recorded.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | These restatement adjustments included $51 release of provisions previously
established to bring into balance certain inter-company payables and
receivables, $35 reversal of accruals for costs associated with programs to
upgrade certain financial information systems and $25 reversal of accruals
for discretionary bonuses in excess of amounts reasonably expected to be
paid. Other adjustments made in connection with the restatements totaled $85
which related to the need to make modifications to accruals in a number of
specific areas of risk in Nortel Networks businesses, including adjustments
to accounts payable balances, warranty provisions, and other provisions and
accruals. In addition, Nortel Networks determined that a $33 adjustment
which had previously been recorded as a reduction of the provisions related
to discontinued operations should have been recorded as an expense to
continuing operations. This restatement adjustment has increased expense in
prior periods relating to continuing operations, but has reduced discontinued
operations expense by a similar amount.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

11



---



##### Table of Contents





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



| |  | Nortel Networks has determined that certain tax liabilities, principally in
Canada and the United States of approximately $142, were netted against
deferred tax assets as at September 30, 2002 and subsequent period ends. As
a result, the valuation allowance recorded in those affected tax
jurisdictions at September 30, 2002 should have included an additional amount
of approximately $142. The correction to the valuation allowance resulted in
an increase to tax expense for the affected period.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks reduced the net
deferred tax asset as at June 30, 2003 by
approximately $26 for the tax impacts of the restatement adjustments. In tax
jurisdictions where Nortel Networks had a valuation allowance, the deferred
tax asset and corresponding valuation allowance were reduced to account for
the impact of the related restatement adjustments.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks recognized approximately $122 of net revenue in circumstances
in which such revenue should have been deferred to later periods.
Adjustments of $99 primarily related to the accounting treatment of certain
contract related obligations with a limited number of customers. In these
cases, such obligations should not have been recorded; rather, recognition of
revenue should have been deferred. Also, in the Caribbean and Latin America
region, Nortel Networks determined that there were $23 in revenue calculation
errors. In the restatements, Nortel Networks deferred the recognition of
such revenues to the appropriate periods and released associated accrued
costs in the appropriate periods.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | From January 1, 1999 to June 30, 2003, Nortel Networks had recorded $107 of
net losses on the translation of foreign currency denominated balances of its
Brazilian entities in the currency translation adjustment account included in
accumulated other comprehensive loss on its consolidated balance sheet. In connection
with the comprehensive review, Nortel Networks determined that the
appropriate accounting treatment would have been to record the foreign
exchange losses in its consolidated statement of operations in the appropriate periods.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The restatements also reflected $59 of foreign currency translation
adjustments as a result of the other restatement adjustment amounts.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  | Consolidated statement of operations for the three months ended September 30,
2002 as restated
| |  | ----------------------------------------------------------------------------------------------



| |  | Net loss applicable to common shares for the three months ended September 30,
2002 was reduced by $62 from $1,437 to $1,375. The major components of the
reduction included a $62 net decrease in income tax expense resulting from
the effect on the valuation allowance recorded at September 30, 2002 of the
prior period restatement adjustments offset by the current period income tax
adjustment of $142 as noted above. Additionally, there was a $22 decrease
resulting from the release of special charges primarily related to costs
associated with severance and fringe benefits for terminated employees.
These reductions in net loss were partially offset by a $17 increase in
selling, general and administrative expense which resulted primarily from the
reversal of a previously recorded release of accruals for inter-company out
of balance amounts and a $22 increase in other expense primarily due to $36
in losses from foreign exchange translation adjustments related to Nortel
Networks Brazilian operations offset by $14 for other items.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated statement of operations for the nine months ended September 30,
2002 as restated
| |  | ---------------------------------------------------------------------------------------------



| |  | Net loss for the nine months ended September 30, 2002 was reduced by $233
from $2,801 to $2,568. The major components of the reduction included a $122
improvement in gross profit primarily from adjustments to contract and
customer-related accruals, $84 from the release of special charges primarily
related to costs associated with severance and fringe benefits for terminated
employees, a $32 decrease in selling, general and administrative expense and
a $30 decrease in research and development expense each due to a net decrease
in other accruals and provisions. These reductions in net loss were
offset by a $19 increase in other expenses which included $36 in
losses from foreign exchange
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12



---



##### Table of Contents





| |  | translation adjustments related to Nortel
Networks Brazilian operations and reduced by $17 of net adjustments for other
items. Income tax adjustments of $17 represented the net effect of the tax
expense related to the restatement adjustments, the resulting valuation
allowance adjustment and the income tax adjustment of $142 as noted above.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated balance sheet as at December 31, 2002 as restated
| |  | --------------------------------------------------------------



| |  | Restatement adjustments
| |  | -----------------------



| |  | The above discussion regarding the restatements identified and classified the
various adjustments by category and provided their measurement with respect
to the net decrease in accumulated deficit as at June 30, 2003. The
consolidated balance sheet which follows below presents the cumulative impact
of the restatement adjustments classified by balance sheet line item as at
December 31, 2002. The adjustments as at December 31, 2002 are of the same
nature as those as at June 30, 2003. The changes to the consolidated balance
sheet as a result of the cumulative impact of the restatement adjustments as
at December 31, 2002 included a reduction in contractual liabilities largely
due to the adjustments for contract and customer-related accruals, a
reduction in restructuring liabilities as a result of the adjustments to
special charges related to restructuring actions, a reduction in other
accrued liabilities principally from adjustments related to other accruals
and provisions; and a reduction to the deferred tax asset principally related
to the incorrect netting of certain tax liabilities against the deferred tax
asset.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Reclassification adjustments were made between line items which also impacted
the unaudited consolidated balance sheet as at December 31, 2002. The
principal reclassifications resulted in, among other things, a net reduction
to cash and notes payables of $70 to reflect, upon consolidation, that a bank
note payable by one subsidiary was fully collateralized by, and could be
offset against, a deposit in the same bank by another subsidiary, an
approximate $370 increase in accounts receivable and in other accrued
liabilities to recognize advance billings in excess of revenues as a
liability, and a $90 increase in net inventory with offsets in other current
and other long-term assets.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Filing of restated financial statements
| |  | ---------------------------------------



| |  | At the earliest possible time in the fourth quarter of 2003, Nortel Networks
expects to file with the SEC the Nortel Networks Form 10-K/A and amended
Quarterly Reports on Form 10-Q/A for the quarterly periods ended March 31,
2003 and June 30, 2003 containing restated financial statements for the
relevant periods.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

13



---



##### Table of Contents





| |  | Consolidated Statements of Operations (unaudited)
| |  | -------------------------------------------------



Three months ended September 30, 2002
    
    
    Nine months ended September 30, 2002As
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    As
    
    
    previously
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restated
    
    
    reported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    2,353
    
    
    $
    (4
    )
    
    $
    2,349
    
    
    $
    8,033
    
    
    $
    1
    
    
    $
    8,034Cost of revenues
    
    
    1,513
    
    
    
    (13
    )
    
    
    1,500
    
    
    
    5,612
    
    
    
    (121
    )
    
    
    5,491Gross profit
    
    
    840
    
    
    
    9
    
    
    
    849
    
    
    
    2,421
    
    
    
    122
    
    
    
    2,543Selling, general and administrative expense
    
    
    678
    
    
    
    17
    
    
    
    695
    
    
    
    2,182
    
    
    
    (32
    )
    
    
    2,150Research and development expense
    
    
    553
    
    
    
    (9
    )
    
    
    544
    
    
    
    1,697
    
    
    
    (30
    )
    
    
    1,667Amortization of acquired technology
    
    
    6
    
    
    
    
    
    
    
    6
    
    
    
    17
    
    
    
    
    
    
    
    17Special chargesGoodwill impairment
    
    
    264
    
    
    
    
    
    
    
    264
    
    
    
    264
    
    
    
    
    
    
    
    264Other special charges
    
    
    585
    
    
    
    (22
    )
    
    
    563
    
    
    
    1,335
    
    
    
    (84
    )
    
    
    1,251Gain on sale of businesses
    
    
    
    
    
    
    (3
    )
    
    
    (3
    )
    
    
    (3
    )
    
    
    (8
    )
    
    
    (11
    )Operating earnings (loss)
    
    
    (1,246
    )
    
    
    26
    
    
    
    (1,220
    )
    
    
    (3,071
    )
    
    
    276
    
    
    
    (2,795
    )Other income (expense)  net
    
    
    4
    
    
    
    (22
    )
    
    
    (18
    )
    
    
    (24
    )
    
    
    (19
    )
    
    
    (43
    )Interest expenseLong-term debt
    
    
    (34
    )
    
    
    (3
    )
    
    
    (37
    )
    
    
    (104
    )
    
    
    (6
    )
    
    
    (110
    )Other
    
    
    (12
    )
    
    
    (1
    )
    
    
    (13
    )
    
    
    (33
    )
    
    
    (2
    )
    
    
    (35
    )Earnings (loss) from continuing operations
before income taxes, minority interests and
equity in net loss of associated companies
    
    
    (1,288
    )
    
    
    
    
    
    
    (1,288
    )
    
    
    (3,232
    )
    
    
    249
    
    
    
    (2,983
    )Income tax benefit (expense)
    
    
    (137
    )
    
    
    62
    
    
    
    (75
    )
    
    
    447
    
    
    
    (17
    )
    
    
    430(1,425
    )
    
    
    62
    
    
    
    (1,363
    )
    
    
    (2,785
    )
    
    
    232
    
    
    
    (2,553
    )Minority interests  net of tax
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )
    
    
    19
    
    
    
    (13
    )
    
    
    6Equity in net loss of associated companies  net of tax
    
    
    (5
    )
    
    
    (2
    )
    
    
    (7
    )
    
    
    (19
    )
    
    
    (7
    )
    
    
    (26
    )Net earnings (loss) from continuing operations
    
    
    (1,431
    )
    
    
    60
    
    
    
    (1,371
    )
    
    
    (2,785
    )
    
    
    212
    
    
    
    (2,573
    )Net earnings from discontinued operations  net of tax
    
    
    
    
    
    
    2
    
    
    
    2
    
    
    
    
    
    
    
    21
    
    
    
    21Net earnings (loss)
    
    
    (1,431
    )
    
    
    62
    
    
    
    (1,369
    )
    
    
    (2,785
    )
    
    
    233
    
    
    
    (2,552
    )Dividends on preferred shares
    
    
    (6
    )
    
    
    
    
    
    
    (6
    )
    
    
    (16
    )
    
    
    
    
    
    
    (16
    )Net earnings (loss) applicable to common shares
    
    $
    (1,437
    )
    
    $
    62
    
    
    $
    (1,375
    )
    
    $
    (2,801
    )
    
    $
    233
    
    
    $
    (2,568
    )


14



---



##### Table of Contents








| |  | Consolidated Balance Sheet (unaudited)
| |  | --------------------------------------



December 31, 2002Aspreviously
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    Reclassification
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    3,813
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    3,743Restricted cash and cash equivalents
    
    
    249
    
    
    
    
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    1,993
    
    
    
    (11
    )
    
    
    265
    
    
    
    2,247Inventories  net
    
    
    889
    
    
    
    7
    
    
    
    90
    
    
    
    986Income taxes recoverable
    
    
    58
    
    
    
    
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    793
    
    
    
    
    
    
    
    
    
    
    
    793Other current assets
    
    
    706
    
    
    
    14
    
    
    
    (52
    )
    
    
    668Total current assets
    
    
    8,501
    
    
    
    10
    
    
    
    233
    
    
    
    8,744Investments
    
    
    246
    
    
    
    2
    
    
    
    
    
    
    
    248Plant and equipment  net
    
    
    1,441
    
    
    
    23
    
    
    
    
    
    
    
    1,464Goodwill
    
    
    2,021
    
    
    
    
    
    
    
    
    
    
    
    2,021Deferred income taxes  net
    
    
    2,797
    
    
    
    (144
    )
    
    
    
    
    
    
    2,653Other assets
    
    
    747
    
    
    
    9
    
    
    
    10
    
    
    
    766Total assets
    
    $
    15,753
    
    
    $
    (100
    )
    
    $
    243
    
    
    $
    15,896LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    100
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    30Trade and other accounts payable
    
    
    931
    
    
    
    (32
    )
    
    
    
    
    
    
    899Payroll and benefit-related liabilities
    
    
    513
    
    
    
    (14
    )
    
    
    
    
    
    
    499Contractual liabilities
    
    
    1,546
    
    
    
    (333
    )
    
    
    
    
    
    
    1,213Restructuring
    
    
    761
    
    
    
    (224
    )
    
    
    
    
    
    
    537Other accrued liabilities
    
    
    2,803
    
    
    
    (215
    )
    
    
    306
    
    
    
    2,894Long-term debt due within one year
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    6,887
    
    
    
    (818
    )
    
    
    236
    
    
    
    6,305Long-term debt
    
    
    1,919
    
    
    
    (1
    )
    
    
    31
    
    
    
    1,949Deferred income taxes  net
    
    
    366
    
    
    
    
    
    
    
    
    
    
    
    366Other liabilities
    
    
    2,351
    
    
    
    (6
    )
    
    
    (24
    )
    
    
    2,321Total liabilities
    
    
    11,523
    
    
    
    (825
    )
    
    
    243
    
    
    
    10,941Minority interests in subsidiary companies
    
    
    78
    
    
    
    51
    
    
    
    
    
    
    
    129SHAREHOLDERS EQUITYPreferred shares, without par value Authorized shares: unlimited; issued and outstanding shares:30,000,000 at September 30, 2003 and December 31, 2002
    
    
    536
    
    
    
    
    
    
    
    
    
    
    
    536Common shares, without par value Authorized shares: unlimited; issued and outstanding shares:1,460,978,638 at September 30, 2003 and December 31, 2002
    
    
    1,211
    
    
    
    
    
    
    
    
    
    
    
    1,211Additional paid-in capital
    
    
    21,991
    
    
    
    13
    
    
    
    
    
    
    
    22,004Accumulated deficit
    
    
    (18,093
    )
    
    
    486
    
    
    
    
    
    
    
    (17,607
    )Accumulated other comprehensive loss
    
    
    (1,493
    )
    
    
    175
    
    
    
    
    
    
    
    (1,318
    )Total shareholders equity
    
    
    4,152
    
    
    
    674
    
    
    
    
    
    
    
    4,826Total liabilities and shareholders equity
    
    $
    15,753
    
    
    $
    (100
    )
    
    $
    243
    
    
    $
    15,896


15



---



##### Table of Contents





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



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



| |  | In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (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 No. 123, Accounting for Stock-based Compensation
(SFAS 123) to allow the recognition of stock-based compensation under
the fair value based method.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Prior to January 1, 2003, Nortel Networks, as permitted under 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. Under SFAS 123 and APB 25, Nortel Networks did not expense
employee stock-based compensation using the fair value based method.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 nine months ended September 30, 2003
was $7 and $18, 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:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Three months ended September 30,
    
    
    Nine months ended September 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Net earnings (loss) applicable to common shares  as reported
    
    $
    224
    
    
    $
    (1,375
    )
    
    $
    372
    
    
    $
    (2,568
    )Stock-based compensation  reported (a)
    
    
    46
    
    
    
    4
    
    
    
    92
    
    
    
    10Stock-based compensation  pro forma (b)
    
    
    (105
    )
    
    
    (309
    )
    
    
    (268
    )
    
    
    (781
    )Net earnings (loss) applicable to common shares  pro forma
    
    $
    165
    
    
    $
    (1,680
    )
    
    $
    196
    
    
    $
    (3,339
    )
 (a)
    
    Stock-based compensation  reported included stock option
expense, the employer portion of stock purchase plan contributions
and restricted stock units expense. For the three months and nine
months ended September 30, 2003, the amounts were net of tax of nil.
For the three months and nine months ended September 30, 2002, the
amounts were net of tax of nil 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 and restricted stock units expense. For
the three months and nine months ended September 30, 2003, the
amounts were net of tax of nil. For the three months and nine months
ended September 30, 2002, the amounts were net of tax of nil 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 September 30,
    
    
    Nine months ended September 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Black-Scholes weighted-average assumptionsExpected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    93.29
    %
    
    
    79.14
    %
    
    
    92.49
    %
    
    
    71.33
    %Risk-free interest rate
    
    
    3.17
    %
    
    
    3.37
    %
    
    
    2.81
    %
    
    
    4.49
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4
    
    
    
    4Weighted average stock option fair value
per option granted
    
    $
    1.94
    
    
    $
    0.60
    
    
    $
    1.57
    
    
    $
    3.50


16



---



##### Table of Contents





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



| |  | In November 2002, the FASB issued FASB Interpretation No. (FIN) 45
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others  an
interpretation of FASB Statements No. 5, 57, and 107 and rescission of
FASB interpretation No. 34 (FIN 45). FIN 45 defines a guarantee as a
contract that contingently requires a guarantor to pay a guaranteed party
as a result of changes in an underlying asset, liability or equity
security of the guaranteed party or a third partys failure to perform
under a specified agreement. FIN 45 requires that a liability be
recognized for the estimated fair value of the guarantee at its inception.
Guarantees issued prior to January 1, 2003 are not subject to the
recognition and measurement provisions, but are subject to expanded
disclosure requirements. Nortel Networks has entered into agreements that
contain features which meet the definition of a guarantee under FIN 45.
Effective December 31, 2002 Nortel Networks adopted the disclosure
requirements of FIN 45. In addition, 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. The adoption of FIN 45 did not have a
material impact on the results of operations and financial condition of
Nortel Networks (see note 11).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | In June 2001, the FASB issued 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. Effective January 1, 2003, Nortel
Networks adopted the initial recognition and measurement provisions of
SFAS No. 143. The adoption of SFAS 143 resulted in a decrease to net
earnings of $8 (net of tax of nil) which has been reported as a cumulative
effect of an accounting change, the recording of a long-lived asset of $5
and an asset retirement obligation liability of $13.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (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 the FASB Emerging Issues Task Force (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 recognition
of costs associated with an exit or disposal activity when the liability
is incurred, whereas under EITF 94-3 a liability for an exit cost was
recognized when an entity committed to an exit plan. In addition, SFAS
146 establishes that fair value is the objective for initial measurement
of the liability. The effect of SFAS 146 is to change the timing of
recognition and the basis for measuring certain liabilities creating
valuation differences between SFAS 146 and EITF 94-3. Exit and disposal
activities 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.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | Consolidation of variable interest entities
| | --- | -------------------------------------------



| |  | In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities (FIN 46). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements
to those entities defined as Variable Interest Entities (more commonly
referred to as special purpose entities) in which equity investors do not
have the characteristics of a controlling financial interest or there is
not 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. In October 2003, the FASB
issued FASB Staff Position (FSP) No. FIN 46-6 deferring the effective
date for applying the provisions of FIN 46 for Variable Interest Entities
created prior to February 1, 2003 to the end of the first interim or
annual period ending after December 15, 2003. While the criteria for
deferral were met, Nortel Networks elected early application of FIN 46.
Effective July 1, 2003, Nortel Networks prospectively began
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17



---



##### Table of Contents





| |  | consolidating certain special purpose entities in which Nortel Networks was considered
the primary beneficiary following the guidance of FIN 46.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As at September 30, 2003, certain lease financing transactions that were
structured through single transaction special purpose entities did not
have sufficient equity at risk as defined in FIN 46. In addition, Nortel
Networks retained certain risks associated with guaranteeing recovery of
the unamortized principal balance of the special purpose entities debt
which represented the majority of the risks associated with the special
purpose entities activities. The amount of the above guarantee will be
adjusted over time as the underlying debt matures. As at September 30,
2003, the Nortel Networks consolidated balance sheet included $179 in
long-term debt and $179 of plant and equipment  net related to these
special purpose entities. These amounts represented both the collateral
and maximum exposure to loss as a result of Nortel Networks involvement
with these entities.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 September 30, 2003,
Nortel Networks was not required to, and did not, consolidate or provide
any of the additional disclosures set out in FIN 46, with respect to the
special purpose entities involving receivable sales.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | Accounting for certain financial instruments with characteristics of
both liabilities and equity
| | --- | ------------------------------------------------------------------------------------------------



| |  | In May 2003, the FASB issued 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.
As at September 30, 2003, Nortel Networks continued to consolidate two
enterprises with limited lives. Upon liquidation, the net assets of these
entities will be distributed to the owners based on their relative
interests at that time. The minority interest included in the balance
sheet related to these entities as at September 30, 2003 was $37. Nortel
Networks has not yet determined the fair value of this minority interest
as at September 30, 2003. In November 2003, the FASB issued FSP No. FAS
150-3 deferring indefinitely the effective date for applying the specific
provisions within SFAS 150 related to the classification and measurement
of mandatorily redeemable noncontrolling interests. The adoption of SFAS
150 did not have a material impact on Nortel Networks results of
operations and financial condition.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (g) | Accounting for revenue arrangements with multiple deliverables
| | --- | --------------------------------------------------------------



| |  | In November 2002, the EITF reached a consensus on Issue No. 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 adopted the requirements of EITF 00-21 on a
prospective basis effective July 1, 2003. The adoption of EITF 00-21 did
not have a material impact on Nortel Networks results of operations and
financial condition.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (h) | Amendment of statement 133 on derivative instruments and hedging
activities
| | --- | ---------------------------------------------------------------------------



| |  | 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 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 FIN
45, and (4) amends certain other existing pronouncements. SFAS 149 is
effective for contracts entered into or modified after June 30, 2003,
except as stated below, and for hedging relationships designated after
June 30, 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The provisions of SFAS 149 that relate to 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
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

18



---



##### Table of Contents





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



| |  | Effective July 1, 2003 Nortel Networks applied the requirements of SFAS
149 on a prospective basis to contracts entered into or modified after
June 30, 2003. The adoption of SFAS 149 did not have a material impact
on Nortel Networks results of operations and financial condition.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (i) | Determining whether an arrangement contains a lease
| | --- | ---------------------------------------------------



| |  | In May 2003, the EITF reached a consensus on Issue No. 01-8, Determining
Whether an Arrangement Contains a Lease (EITF 01-8). EITF 01-8
provides guidance on how to determine whether an arrangement contains a
lease that is within the scope of FASB Statement No. 13, Accounting for
Leases. The guidance in EITF 01-8 is based on whether the arrangement
conveys to the purchaser (lessee) the right to use a specific asset, and
is effective for Nortel Networks for arrangements entered into or modified
after June 30, 2003. As at September 30, 2003, the adoption of EITF 01-8
did not have a material impact on Nortel Networks results of operations
and financial condition. However, the impact of EITF 01-8 on Nortel
Networks future results of operations and financial position will depend
on the terms contained in contracts signed or contracts amended
prospectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

19



---



##### Table of Contents





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



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



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



| |  | Accounts receivable  net:
| |  | --------------------------



September 30,
    
    
    December 31,2003
    
    
    2002Trade receivables
    
    $
    1,788
    
    
    $
    1,915Related party receivables
    
    
    186
    
    
    
    83Contracts
in process(a)
    
    
    553
    
    
    
    7652,527
    
    
    
    2,763Less: provision for doubtful accounts
    
    
    (277
    )
    
    
    (516
    )Accounts receivable  net
    
    $
    2,250
    
    
    $
    2,247
 (a)
    
    Amounts represented the recognized sales value of performance that
was not billed or billable to customers as at September 30, 2003 and
December 31, 2002, respectively.




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



September 30,
    
    
    December 31,2003
    
    
    2002Raw materials
    
    $
    299
    
    
    $
    343Work in process
    
    
    262
    
    
    
    308Finished goods
    
    
    367
    
    
    
    335Inventories
 net(a)
    
    $
    928
    
    
    $
    986
 (a)
    
    Net of inventory provisions of $988 and $1,070 as at September 30,
2003 and December 31, 2002, respectively. Other reserves for claims
related to contract manufacturers and suppliers of $129 and $167 at
September 30, 2003 and December 31, 2002, respectively, were included in
other accrued liabilities. These accruals were related to cancellation
charges, contracted for inventory in excess of future demand and the
settlement of certain other claims.




| |  | Plant and equipment  net:
| |  | --------------------------



September 30,
    
    
    December 31,2003
    
    
    2002Cost:Land
    
    $
    59
    
    
    $
    53Buildings
    
    
    1,328
    
    
    
    1,161Machinery and equipment
    
    
    2,956
    
    
    
    3,3894,343
    
    
    
    4,603Less: accumulated depreciation:Buildings
    
    
    (568
    )
    
    
    (479
    )Machinery and equipment
    
    
    (2,307
    )
    
    
    (2,660
    )(2,875
    )
    
    
    (3,139
    )Plant
and equipment  net(a)
    
    $
    1,468
    
    
    $
    1,464
 (a)
    
    Included assets held for sale with a carrying value of $48 and $78 as
at September 30, 2003 and December 31, 2002, respectively, related to
owned facilities that were being actively marketed. These assets were
written down in previous periods to their estimated fair values less
costs to sell. The write down was included in special charges. We
expect to dispose of all of these facilities by mid-2005.


20



---



##### Table of Contents





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



September 30,
    
    
    December 31,2003
    
    
    2002Outsourcing and selling, general and administrative related
    
    $
    417
    
    
    $
    616Customer deposits
    
    
    52
    
    
    
    58Product related
    
    
    166
    
    
    
    237Warranty and known product defects
    
    
    329
    
    
    
    359Deferred income
    
    
    512
    
    
    
    586Miscellaneous taxes
    
    
    120
    
    
    
    126Income taxes payable
    
    
    86
    
    
    
    98Current liabilities of discontinued operations
    
    
    81
    
    
    
    44Interest payable
    
    
    33
    
    
    
    52Advance billings in excess of earnings (a)
    
    
    329
    
    
    
    365Other
    
    
    168
    
    
    
    353Other accrued liabilities
    
    $
    2,293
    
    
    $
    2,894
 (a)
    
    Amounts represented billings in excess of revenues recognized to date
on long-term contracts.




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



| |  | Change in operating assets and liabilities:
| |  | -------------------------------------------



September 30,
    
    
    September 30,2003
    
    
    2002Accounts receivable
    
    $
    22
    
    
    $
    924Inventories
    
    
    98
    
    
    
    394Income taxes
    
    
    23
    
    
    
    1,278Restructuring
    
    
    (448
    )
    
    
    (844
    )Accounts payable and accrued liabilities
    
    
    (675
    )
    
    
    (1,009
    )Other operating assets and liabilities
    
    
    (335
    )
    
    
    (120
    )Total change in operating assets and liabilities
    
    
    (1,315
    )
    
    
    623


Interest and income taxes paid (recovered):




September 30,
    
    
    September 30,2003
    
    
    2002Interest paid
    
    $
    93
    
    
    $
    168Income taxes paid (recovered)
    
    $
    9
    
    
    $
    (1,223
    )




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

21



---



##### Table of Contents





| |  | 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).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the nine months ended September 30, 2003, Nortel Networks determined
that there was no triggering event requiring a test for impairment of
goodwill.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the three months ended September 30, 2002, an impairment test was
performed on goodwill in accordance with SFAS 142 for all reporting units due
to a significant adverse change in the business climate and taking into
consideration Nortel Networks market capitalization at the end of the third
quarter of 2002. All of Nortel Networks reporting units had fair values in
excess of their carrying values with the exception of Optical Networks. As a
result of Nortel Networks impairment test, Nortel Networks wrote off $264 of
goodwill within the Optical Networks segment during the three months ended
September 30, 2002.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Goodwill by reportable segment as at September 30, 2003 was as follows:
| |  | -----------------------------------------------------------------------



Wireless
    
    
    Enterprise
    
    
    Wireline
    
    
    OpticalNetworks
    
    
    Networks
    
    
    Networks
    
    
    Networks
    
    
    Other
    
    
    TotalBalance  net as at December 31, 2002
    
    $
    21
    
    
    $
    1,520
    
    
    $
    480
    
    
    $
    
    
    
    $
    
    
    
    $
    2,021Change:Additions(a)
    
    
    2
    
    
    
    11
    
    
    
    13
    
    
    
    3
    
    
    
    
    
    
    
    29Foreign exchange
    
    
    
    
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    3Balance  net as at September 30, 2003
    
    $
    23
    
    
    $
    1,533
    
    
    $
    494
    
    
    $
    3
    
    
    $
    
    
    
    $
    2,053
 (a)
    
    See note 8 for details.




| |  | Investments
| |  | -----------



September 30,
    
    
    December 31,2003
    
    
    2002Investments at cost
    
    $
    169
    
    
    $
    180Investments in associated companies at equity
    
    
    14
    
    
    
    68Investments
    
    $
    183
    
    
    $
    248




| |  | The following table provides summarized statements of operations of a certain
significant associated company for the nine months ended September 30, 2003
and 2002, respectively, which Nortel Networks accounted for under the equity
method. The unaudited financial statements of this associated company are
denominated in a foreign currency and the summarized information below has
been translated into United States dollars at the average rates for the
period for revenues and expenses.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Equity in net loss of associated companies  net of tax for the nine months
ended September 30, 2003 included Nortel Networks interest in this associated
company until the disposal of that interest during the three months ended
September 30, 2003.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Nine months ended September 30,2003
    
    
    2002Revenues
    
    $
    426
    
    
    $
    390Operating loss
    
    $
    62
    
    
    $
    34Net loss
    
    $
    86
    
    
    $
    45


22



---



##### Table of Contents





|5. |  | 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

23



---



##### Table of Contents





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



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



Three months ended September 30,
    
    
    Nine months ended September 30,2003
    
    
    2002
    
    
    2003
    
    
    2002RevenuesWireless Networks
    
    $
    1,005
    
    
    $
    936
    
    
    $
    2,939
    
    
    $
    3,196Enterprise Networks
    
    
    579
    
    
    
    616
    
    
    
    1,738
    
    
    
    1,923Wireline Networks
    
    
    439
    
    
    
    484
    
    
    
    1,494
    
    
    
    1,758Optical Networks
    
    
    243
    
    
    
    309
    
    
    
    810
    
    
    
    1,120Other
    
    
    
    
    
    
    4
    
    
    
    1
    
    
    
    37Total
    
    $
    2,266
    
    
    $
    2,349
    
    
    $
    6,982
    
    
    $
    8,034Contribution marginWireless Networks
    
    
    410
    
    
    
    278
    
    
    
    1,073
    
    
    
    861Enterprise Networks
    
    
    141
    
    
    
    108
    
    
    
    379
    
    
    
    289Wireline Networks
    
    
    138
    
    
    
    98
    
    
    
    469
    
    
    
    330Optical Networks
    
    
    92
    
    
    
    (125
    )
    
    
    131
    
    
    
    (756
    )Other
    
    
    (86
    )
    
    
    (205
    )
    
    
    (208
    )
    
    
    (331
    )Total
    
    $
    695
    
    
    $
    154
    
    
    $
    1,844
    
    
    $
    393Research and development expense
    
    
    (480
    )
    
    
    (544
    )
    
    
    (1,454
    )
    
    
    (1,667
    )Amortization of acquired technology
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    (17
    )Special charges
    
    
    (70
    )
    
    
    (827
    )
    
    
    (180
    )
    
    
    (1,515
    )Gain on sale of businesses
    
    
    20
    
    
    
    3
    
    
    
    28
    
    
    
    11Other income  net
    
    
    100
    
    
    
    (18
    )
    
    
    130
    
    
    
    (43
    )Interest expense
    
    
    (25
    )
    
    
    (50
    )
    
    
    (80
    )
    
    
    (145
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in net loss of
associated companies
    
    $
    240
    
    
    $
    (1,288
    )
    
    $
    288
    
    
    $
    (2,983
    )


24



---



##### Table of Contents





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



| |  | During the three months and nine months ended September 30, 2003, Nortel
Networks continued to implement its restructuring work plan. Changes in the
provision for special charges are shown below:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Contractsettlement
    
    
    Plant andWorkforce
    
    
    and lease
    
    
    equipmentreduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    TotalProvision balance as at December 31, 2002(a)
    
    $
    233
    
    
    $
    629
    
    
    $
    
    
    
    $
    9
    
    
    $
    871Special charges:For the three months ended March 31, 2003
    
    
    67
    
    
    
    31
    
    
    
    21
    
    
    
    
    
    
    
    119For the three months ended June 30, 2003
    
    
    23
    
    
    
    15
    
    
    
    23
    
    
    
    
    
    
    
    61For the three months ended September 30, 2003
    
    
    73
    
    
    
    5
    
    
    
    1
    
    
    
    
    
    
    
    79Revisions to prior accruals:For the three months ended March 31, 2003
    
    
    (22
    )
    
    
    46
    
    
    
    (32
    )
    
    
    
    
    
    
    (8
    )For the three months ended June 30, 2003
    
    
    (13
    )
    
    
    (44
    )
    
    
    (5
    )
    
    
    
    
    
    
    (62
    )For the three months ended September 30, 2003
    
    
    1
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    (9
    )Cumulative provision (drawdowns) adjustments in 2003:Cash drawdowns
    
    
    (243
    )
    
    
    (197
    )
    
    
    
    
    
    
    (9
    )
    
    
    (449
    )Non-cash drawdowns
    
    
    (47
    )
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    (55
    )Foreign exchange and other adjustments
    
    
    21
    
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    36Provision balance as at September 30, 2003(a)
    
    $
    93
    
    
    $
    490
    
    
    $
    
    
    
    $
    
    
    
    $
    583
 (a)
    
    At September 30, 2003 and December 31, 2002, the short-term provision
balances were $269 and $537, respectively, and the long-term provision
balances were $314 and $334, respectively (included in other
liabilities).




| |  | Regular full-time (RFT) employee notifications included in special charges
were as follows:
| |  | ---------------------------------------------------------------------------------------------



Employees (approximate)Direct(a)
    
    
    Indirect(b)
    
    
    TotalRFT employee notifications for the three months ended:March 31, 2003
    
    
    300
    
    
    
    500
    
    
    
    800June 30, 2003
    
    
    
    
    
    
    300
    
    
    
    300September 30, 2003
    
    
    100
    
    
    
    100
    
    
    
    200
 (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 nine months ended September 30, 2003
| |  | -----------------------------------------------------



| |  | During the three months and nine months ended September 30, 2003, Nortel
Networks recorded total special charges of $70 and $180, respectively, which
were net of revisions of $9 and $79, respectively, related to prior accruals.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of $163 for the nine months ended September 30,
2003 were related to severance and benefit costs, including a pension
settlement loss of $47, associated with approximately 1,300 employees
notified of termination during the nine months ended September 30, 2003 which
extended across all segments. Offsetting these charges were net revisions of
$34 which were primarily related to termination benefits where actual costs
were lower than the estimated amounts across all segments. During the nine
months ended September 30, 2003, the workforce reduction provision balance
was drawn down by cash payments of $243 and the reclassification of the
pension settlement amount to the pension liability account. The remaining
provision is expected to be substantially drawn down by mid-2004.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contract settlement and lease costs of $51 for the nine months ended
September 30, 2003 consisted of net lease charges related to leased
facilities (comprised of office, warehouse and manufacturing space) and
leased furniture that were newly
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

25



---



##### Table of Contents





| |  | identified as no longer being used 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 $8 resulting from changes in sublease revenue and cost to vacate
estimates associated with certain properties which extended across all
segments. During the nine months ended September 30, 2003, the provision
balance for contract settlement and lease costs was drawn down by cash
payments of $197. The remaining provision, net of approximately $353 in
estimated sublease revenue, is expected to be substantially drawn down by the
end of 2010.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and equipment write downs of $45 for the nine months ended September
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 $37 to prior write downs of assets held for sale
resulted primarily from adjustments to original plans or estimated amounts
for certain facility closures.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | At September 30, 2003, Nortel Networks net deferred tax assets, excluding
discontinued operations, were $3,359, 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 nine months ended September 30, 2003, Nortel Networks recorded a tax
expense on pre-tax income of $288 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, and the draw down of our
deferred tax assets and current income tax provisions in certain taxable
jurisdictions, partially offset by the recognition of tax refunds received in
the period.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 September 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. Our valuation allowance is primarily attributed to
continued uncertainty in the industry. If market conditions deteriorate
further or future results of operations are less than expected, an additional
tax valuation allowance may be required for all or a portion of our deferred
tax assets.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|8. |  | Divestitures, closures and acquisitions
|-- |  | ---------------------------------------



| |  | Acquisitions and Divestitures
| |  | -----------------------------



| |  | High speed module operations
| |  | ----------------------------



| |  | On August 10, 2003, Nortel Networks sold certain assets related to its high
speed module operations to BreconRidge Manufacturing Solutions Corporation
(BreconRidge). Nortel Networks received proceeds of $6 in the form of cash
and a note receivable. As a result of this transaction, Nortel Networks
recorded a loss of $1 during the three months ended September 30, 2003. The
transaction included a minimum purchase commitment with BreconRidge requiring
Nortel Networks to purchase approximately $11 and $33 of products during 2003
and 2004, respectively.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Germany and Nortel Networks France
| |  | --------------------------------------------------



| |  | 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 at that time 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. (NNF) to Nortel Networks. On
July 18, 2003, Nortel Networks exercised its call option and share exchange
rights to acquire the minority interest held by EADS of 42 percent in Nortel
Networks Germany GmbH & Co. KG (NNG) and to sell Nortel Networks equity
interest of 41 percent in EADS Telecom S.A.S., formerly EADS Defence and
Security Networks S.A.S (EADS Telecom) to EADS. The transactions were
completed on September 18, 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The purchase price of $236 for the minority interests of NNF and NNG included
$58 of cash, an in-kind component of approximately $82, representing the
return of a loan note that was owed to Nortel Networks by EADS Telecom, and
the remaining shares of EADS Telecom held by Nortel Networks. The allocation
of the purchase price resulted in the
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

26



---



##### Table of Contents





| |  | elimination of $65 of minority
interest, settlement of a net liability of $96 related to the put and call
options, and an increase of $46 in other assets and $29 in Goodwill (see note
4 for goodwill by reportable segment). The other assets of $46 related
primarily to customer contracts and customer relationships and will be
amortized over their estimated lives averaging 9 years, and were included in
the consolidated balance sheet as at September 30, 2003. The sale of Nortel
Networks 41 percent interest in EADS Telecom has resulted in the receipt of
cash of $11 and a reduction in equity investments of $23. As a result of
this transaction, Nortel Networks recognized a gain of $76 which is included
in other income (expense)  net for the three months ended September 30,
2003. Except as noted below, there was no additional impact on the results
of operations and financial condition, as NNF and NNG were already included
in the consolidated results. The allocation referred to above for goodwill,
other intangibles and gain are preliminary estimates and are subject to
change pending completion of the valuation report.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As a result of the sale of Nortel Networks 41 percent interest in EADS
Telecom, the remaining unamortized deferred gain of $21, related to the sale
of substantially all of the assets in the Cogent Defence Systems business
during the year ended December 31, 2001, was recognized and included in gain
on sale of business. The gain had been deferred because Nortel Networks had
an interest in EADS Telecom which had purchased the assets of the Cogent Defence
Systems business from Nortel Networks.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|9. |  | 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 nine months ended September 30, 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | At September 30, 2003 and December 31, 2002, Nortel Networks had total unused
committed credit facilities of $750. These credit facilities terminate on
April 15, 2005.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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). 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.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 $131 was utilized as at September 30, 2003. The remainder is
uncommitted support, subject to certain limitations, for performance bonds,
receivables sales and/or securitizations, of which $167 was utilized as at
September 30, 2003. For additional information, see note 20 in the Nortel
Networks Annual Report.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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
19).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|10. |  | Financial instruments and hedging activities
|--- |  | --------------------------------------------



| |  | On January 27, 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.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|11. |  | Guarantees
|--- |  | ----------

27



---



##### Table of Contents





| |  | Nortel Networks has entered into agreements that contain features which meet
the definition of a guarantee under FIN 45. FIN 45 defines a guarantee as a
contract that contingently requires Nortel Networks to pay a guaranteed party
as a result of changes in an underlying asset, liability or equity security
of the guaranteed party or a third partys failure to perform under a
specified agreement. As at September 30, 2003, the fair value of Nortel
Networks outstanding guarantees subject to the recognition and measurement
provisions of FIN 45 was insignificant. A description of the major types of
Nortel Networks outstanding guarantees as at September 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.
Some of these types of guarantees have indefinite terms while others have
specific terms extending as far as June 2008.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks also entered into guarantees related to the escrow of
shares in business combinations in prior periods. 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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is unable to estimate the maximum potential liability for
these types of indemnification guarantees as the business sale agreements
generally do not specify a maximum amount and the amounts are dependent
upon the outcome of future contingent events, the nature and likelihood of
which cannot be determined.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Historically, Nortel Networks has not made any significant indemnification
payments under such agreements and no significant amount has been accrued
in the accompanying consolidated financial statements with respect to the
contingency associated with these guarantees.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks has periodically entered into agreements with customers
and suppliers that include limited intellectual property indemnification
obligations that are customary in the industry. These types of guarantees
typically have indefinite terms and 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.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The nature of the intellectual property indemnification obligations
generally prevents Nortel Networks from making a reasonable estimate of
the maximum potential amount it could be required to pay to its customers
and suppliers. Historically, Nortel Networks has not made any significant
indemnification payments under such agreements and as at September 30,
2003, the amount which has been accrued in the accompanying consolidated
financial statements with respect to the contingency associated with these
indemnities was $6.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (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. Most of
these lease agreements also require Nortel Networks to pay for facility
restoration costs at the end of the lease term if the sub-lessee fails to
do so. These lease agreements have expiration dates through June 2015.
The maximum amount that Nortel Networks may be required to pay under these
types of agreements is $59 as at September 30, 2003. Nortel Networks
generally has the ability to attempt to recover such lease payments from
the defaulting party through rights of subrogation.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Historically, Nortel Networks has not made any significant payments under
these types of guarantees and no amount has been accrued in the
accompanying consolidated financial statements with respect to the
contingent aspect of these guarantees.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

28



---



##### Table of Contents





| | (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. Under most such arrangements, the Nortel Networks guarantee is
secured, usually by the assets being purchased or financed. The liability
for such guarantees accrued in the accompanying consolidated financial
statements was $8 as at September 30, 2003.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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, premium, if any,
interest 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 premium, if any, and interest.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (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 or reduce their
return 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
apply to issues that arise during the term of the credit and support
facilities, or for as long as the security agreements remain in effect
(see notes 9 and 19).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is unable to estimate the maximum potential liability for
these types of indemnification guarantees as the agreements do not specify
a maximum amount and the amounts are dependent upon the outcome of future
contingent events, the nature and likelihood of which cannot be determined
at this time.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Historically, Nortel Networks has not made any significant indemnification
payments under such agreements and no amount has been accrued in the
accompanying consolidated financial statements with respect to the
contingent aspect of these indemnification guarantees.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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, or as a result of regulatory penalties that
may be suffered by the counterparty as a consequence of the transaction.
Certain receivables securitization transactions include indemnifications
requiring the repurchase of the receivables if the particular transaction
becomes invalid. As at September 30, 2003, Nortel Networks had
approximately $330 of quantifiable securitized receivables which were
subject to repurchase under this provision, in which case Nortel Networks
would assume all rights to collect such receivables. The indemnification
provisions generally expire upon expiration of the securitization
agreements, which extend through December of 2004, or collection of the
receivable amount by the counterparty.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is generally unable to estimate the maximum potential
liability for all of these types of indemnification guarantees as certain
agreements do not specify a maximum amount and the amounts are dependent
upon the outcome of future contingent events, the nature and likelihood of
which cannot be determined at this time.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Historically, Nortel Networks has not made any significant indemnification
payments or receivable repurchases under such agreements and no amount has
been accrued in the accompanying consolidated financial statements with
respect to the contingent aspect of these indemnification guarantees.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

29



---



##### Table of Contents





| | (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 payment amount.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The nature of such agreements prevents Nortel Networks from making a
reasonable estimate of the maximum potential amount it could be required
to pay to its counterparties. The difficulties in assessing the amount of
liability result primarily from the unpredictability of future changes in
laws, the inability to determine how laws apply to counterparties and the
lack of limitations on the potential liability.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Historically, Nortel Networks has not made any significant indemnification
payments under such agreements and no amount has been accrued in the
accompanying consolidated financial statements with respect to the
contingent aspect of these guarantees.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 defect are considered. Revisions are made when actual experience
differs materially from historical experience. Known product defects were
included in the warranty reconciliation below and were specifically accrued
for as Nortel Networks became aware of such defects. 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 September 30, 2003:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Balance as at December 31, 2002
    
    $
    359Payments
    
    
    (127
    )Warranties issued
    
    
    167Revisions
    
    
    (70
    )Balance as at September 30, 2003
    
    $
    329




|12. |  | 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 the corresponding
restricted cash and cash equivalents, as at:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



September 30,
    
    
    December 31,2003
    
    
    2002Bid and performance related bonds(a)
    
    $
    422
    
    
    $
    400Other bonds(b)
    
    
    48
    
    
    
    35Total bid, performance related and other bonds
    
    $
    470
    
    
    $
    435
 (a)
    
    Net of restricted cash and cash equivalent amounts of $53 and $195 as
at September 30, 2003 and December 31, 2002, respectively.


30



---



##### Table of Contents





(b)
    
    Net of restricted cash and cash equivalent amounts of $37 and $19 as
at September 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 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 monitors the
credit exposure of Nortel Networks. The following table sets forth customer
financing related information and commitments, excluding discontinued
operations, as at:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



September 30,
    
    
    December 31,2003
    
    
    2002Drawn and outstanding  gross
    
    $
    449
    
    
    $
    1,091Provisions for doubtful accounts
    
    
    (322
    )
    
    
    (799
    )Drawn and outstanding  net(a)
    
    
    127
    
    
    
    292Undrawn commitments
    
    
    116
    
    
    
    801Total customer financing
    
    $
    243
    
    
    $
    1,093
 (a)
    
    Included short-term and long-term amounts. Short-term and long-term
amounts were included in accounts receivable  net and other assets,
respectively, in the consolidated balance sheets.




| |  | During the three months and nine months ended September 30, 2003, Nortel
Networks recorded net customer financing bad debt recoveries of $6 and $53,
respectively, primarily as a result of favorable settlements and adjustments
to other existing provisions. The recoveries of $6 and $53, respectively,
were included in the consolidated statements of operations within selling,
general and administrative expense.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the nine months ended September 30, 2003, Nortel Networks entered into
certain agreements to restructure and/or settle various customer financing
and related receivables. As a result of these transactions, Nortel Networks
received cash consideration of approximately $220 to settle outstanding
receivables of approximately $600 (with a net carrying value of $120).
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 nine months ended September 30, 2003, Nortel Networks reduced
undrawn customer financing commitments by $685 as a result of the expiration
or cancellation of commitments and changing customer business plans.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | On October 19, 2002, Nortel Networks entered into a number of put option and
call option agreements (the Options) as well as a share exchange agreement
(the Share Exchange) with EADS, its partner at that time in three European
joint ventures. The Options and the Share Exchange were exercised and the
transaction closed during the three months ended September 30, 2003 (see note
8).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|13. |  | Restricted cash and cash equivalents
|--- |  | ------------------------------------



| |  | As at September 30, 2003 and December 31, 2002, approximately $113 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

31



---



##### Table of Contents





|14. |  | Comprehensive income (loss)
|--- |  | ---------------------------



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



Three months ended September 30,
    
    
    Nine months ended September 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Net earnings (loss)
    
    $
    230
    
    
    $
    (1,369
    )
    
    $
    390
    
    
    $
    (2,552
    )Other comprehensive income (loss) adjustments:Change in foreign currency translation adjustment(a)
    
    
    31
    
    
    
    (63
    )
    
    
    311
    
    
    
    77Unrealized gain (loss) on investments  net(b)
    
    
    43
    
    
    
    (4
    )
    
    
    89
    
    
    
    (7
    )Unrealized derivative gain (loss) on cash flow hedges  net(c)
    
    
    (8
    )
    
    
    (8
    )
    
    
    12
    
    
    
    7Comprehensive income (loss)
    
    $
    296
    
    
    $
    (1,444
    )
    
    $
    802
    
    
    $
    (2,475
    )
 (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 were
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 nil and $1 for the three months
and nine months ended September 30, 2003, respectively, and net of tax
of $3 and $5 for the three months and nine months ended September 30,
2002, respectively.(c)
    
    During the three months and nine months ended September 30, 2003, $7
and $19 of net derivative gains were reclassified to net earnings
(loss), respectively. During the three months and nine months ended
September 30, 2002, nil and $15, respectively, of net derivative losses
were reclassified to net earnings (loss). Nortel Networks estimates
that $10 of net derivative gains (losses) included in accumulated other
comprehensive income (loss) will be reclassified into net earnings
(loss) within the next 12 months.




|15. |  | Discontinued operations
|--- |  | -----------------------



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



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



Three months ended September 30,
    
    
    Nine months ended September 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Revenues
    
    $
    2
    
    
    $
    
    
    
    $
    8
    
    
    $
    138Net earnings from discontinued operations  net of tax(a)
    
    $
    44
    
    
    $
    2
    
    
    $
    206
    
    
    $
    21
 (a)
    
    Net earnings from discontinued operations were net of an income tax
benefit of $8 and nil for the three months and nine months ended
September 30, 2003, respectively, and net of applicable income tax of
nil for the three months and nine months ended September 30, 2002.


32



---



##### Table of Contents





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



September 30,
    
    
    December 31,2003
    
    
    2002Accounts receivable  net(a)
    
    $
    
    
    
    $
    20Inventories  net
    
    
    
    
    
    
    Deferred income taxes
    
    
    58
    
    
    
    146Other current assets
    
    
    
    
    
    
    45Total current assets of discontinued operations(b)
    
    $
    58
    
    
    $
    211Other long-term assets(a)(b)
    
    
    89
    
    
    
    48Total assets of discontinued operations
    
    $
    147
    
    
    $
    259Current liabilities(b)(c)
    
    $
    81
    
    
    $
    44Long-term liabilities(b)
    
    
    1
    
    
    
    2Total liabilities of discontinued operations
    
    $
    82
    
    
    $
    46
 (a)
    
    Included customer financing receivables of nil (net of provisions of
$61) and $66 (net of provisions of $486) as at September 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 $64 and $81 as at September 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:
| |  | --------------------------------------



Nine months ended September 30,2003
    
    
    2002Cash flows from discontinued operationsOperating activities
    
    $
    77
    
    
    $
    240Investing activities
    
    
    241
    
    
    
    97Net cash from discontinued operations
    
    $
    318
    
    
    $
    337




| |  | Nine months ended September 30, 2003
| |  | ------------------------------------



| |  | On August 6, 2003, Nortel Networks received cash of $20 relating to the
repayment of a subordinated, unsecured, convertible, promissory note
receivable from Netgear, Inc. (Netgear). The note was part of the
consideration received by Nortel Networks upon its sale of its 68.5 percent
interest in Netgear in February 2002. As the note had a carrying value of
nil, a gain of $20 was recognized during the three months ended September 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

33



---



##### Table of Contents





|16. |  | 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 September 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:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



September 30,
    
    
    December 31,2003
    
    
    2002Owing from (to) NNC
    
    $
    76
    
    
    $
    (17
    )Owing from NNC subsidiaries
    
    $
    110
    
    
    $
    100Related party receivables
    
    $
    186
    
    
    $
    83Stock option fair value increment (addition to 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.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|17. |  | Contingencies
|--- |  | -------------



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



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



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

34



---



##### Table of Contents





| |  | 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. The District Court held oral arguments on
September 3, 2003 and issued an order granting class certification on
September 5, 2003. On September 23, 2003, the defendants filed a motion in
the Second Circuit for permission to appeal the class certification decision.
The plaintiffs opposition to the motion was filed on October 2, 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
NNC, certain of its current and former officers and directors and its auditor
as defendants. The factual allegations in the Ontario Claim are
substantially similar to the allegations in the consolidated amended
complaint filed in the United States District Court described above. The
Ontario Claim is on behalf of all Canadian residents who purchased NNC
securities (including options on NNC securities) between October 24, 2000 and
February 15, 2001. The plaintiffs claim damages of Canadian $5,000, plus
punitive damages in the amount of Canadian $1,000, prejudgment and
postjudgment interest and costs of the action. On September 23, 2003, the
Court issued an order allowing the plaintiffs to proceed to amend the Ontario
Claim and requiring that the plaintiffs serve class certification materials
by December 15, 2003. On September 24, 2003, the plaintiffs filed a notice
of discontinuance of the original action filed in Ontario.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

35



---



##### Table of Contents





| |  | 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 appealed 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. On
September 3, 2003, the defendants filed a petition for review with the
California Supreme Court seeking permission to appeal the Court of Appeal
decision. On October 22, 2003, the California Supreme Court denied, without
opinion, the defendants petition for review.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 or NNC, as applicable, and any
named directors and officers of Nortel Networks or NNC, as applicable, intend to vigorously
defend these actions, suits, claims and proceedings.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|18. |  | Subsequent events
|--- |  | -----------------



| |  | There were no events subsequent to September 30, 2003 required to be
reported.
| |  | ------------------------------------------------------------------------------



|19. |  | 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 September 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
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

36



---



##### Table of Contents





| |  | 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 9).
Accordingly, if the EDC Support Facility is secured by cash or other
alternate collateral acceptable to EDC and if the $750 April 2000 five year
credit facilities 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 September 30, 2003 and December 31, 2002 and for the
three months and nine months ended September 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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

37



---



##### Table of Contents



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

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    559
    
    
    $
    1,712
    
    
    $
    662
    
    
    $
    (667
    )
    
    $
    2,266Cost of revenues
    
    
    385
    
    
    
    798
    
    
    
    573
    
    
    
    (667
    )
    
    
    1,089Gross profit
    
    
    174
    
    
    
    914
    
    
    
    89
    
    
    
    
    
    
    
    1,177Selling, general and administrative expense
    
    
    106
    
    
    
    324
    
    
    
    52
    
    
    
    
    
    
    
    482Research and development expense
    
    
    206
    
    
    
    213
    
    
    
    61
    
    
    
    
    
    
    
    480Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other special charges
    
    
    24
    
    
    
    36
    
    
    
    10
    
    
    
    
    
    
    
    70Gain on sale of businesses
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    
    
    
    
    (20
    )Operating earnings (loss)
    
    
    (162
    )
    
    
    361
    
    
    
    (34
    )
    
    
    
    
    
    
    165Other income (expense)  net
    
    
    23
    
    
    
    26
    
    
    
    51
    
    
    
    
    
    
    
    100Interest expenseLong-term debt
    
    
    (16
    )
    
    
    (2
    )
    
    
    (7
    )
    
    
    
    
    
    
    (25
    )Other
    
    
    
    
    
    
    (12
    )
    
    
    12
    
    
    
    
    
    
    
    Earnings (loss) from continuing operations before
income taxes, minority interests and equity in net
earnings (loss) from continuing operations
    
    
    (155
    )
    
    
    373
    
    
    
    22
    
    
    
    
    
    
    
    240Income tax benefit (provision)
    
    
    (3
    )
    
    
    164
    
    
    
    (196
    )
    
    
    
    
    
    
    (35
    )(158
    )
    
    
    537
    
    
    
    (174
    )
    
    
    
    
    
    
    205Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    (14
    )Equity in net earnings (loss) of associated companies net of tax
    
    
    344
    
    
    
    (486
    )
    
    
    2
    
    
    
    135
    
    
    
    (5
    )Net earnings (loss) from continuing operations
    
    
    186
    
    
    
    51
    
    
    
    (186
    )
    
    
    135
    
    
    
    186Net earnings from discontinued operations net of tax
    
    
    44
    
    
    
    29
    
    
    
    
    
    
    
    (29
    )
    
    
    44Net earnings (loss)
    
    
    230
    
    
    
    80
    
    
    
    (186
    )
    
    
    106
    
    
    
    230Dividends on preferred shares
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )Net earnings (loss) applicable to common shares
    
    $
    224
    
    
    $
    80
    
    
    $
    (186
    )
    
    $
    106
    
    
    $
    224


38



---



##### Table of Contents



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

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    600
    
    
    $
    1,783
    
    
    $
    652
    
    
    $
    (686
    )
    
    $
    2,349Cost of revenues
    
    
    517
    
    
    
    1,136
    
    
    
    533
    
    
    
    (686
    )
    
    
    1,500Gross profit
    
    
    83
    
    
    
    647
    
    
    
    119
    
    
    
    
    
    
    
    849Selling, general and administrative expense
    
    
    251
    
    
    
    385
    
    
    
    59
    
    
    
    
    
    
    
    695Research and development expense
    
    
    235
    
    
    
    249
    
    
    
    60
    
    
    
    
    
    
    
    544Amortization of acquired technology
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    6Special chargesGoodwill impairment
    
    
    
    
    
    
    203
    
    
    
    61
    
    
    
    
    
    
    
    264Other special charges
    
    186
    
    
    
    380
    
    
    
    (3
    )
    
    
    
    
    
    
    563Gain on sale of businesses
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (3
    )Operating earnings (loss)
    
    
    (589
    )
    
    
    (576
    )
    
    
    (55
    )
    
    
    
    
    
    
    (1,220
    )Other income (expense)  net
    
    
    (31
    )
    
    
    33
    
    
    
    (20
    )
    
    
    
    
    
    
    (18
    )Interest expenseLong-term debt
    
    (31
    )
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    (37
    )Other
    
    
    
    
    
    (7
    )
    
    
    (6
    )
    
    
    
    
    
    
    (13
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (651
    )
    
    
    (550
    )
    
    
    (87
    )
    
    
    
    
    
    
    (1,288
    )Income tax benefit (provision)
    
    
    (111
    )
    
    
    4
    
    
    
    32
    
    
    
    
    
    
    
    (75
    )(762
    )
    
    
    (546
    )
    
    
    (55
    )
    
    
    
    
    
    
    (1,363
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Equity in net earnings (loss) of associated companies net of tax
    
    
    (609
    )
    
    
    (226
    )
    
    
    (2
    )
    
    
    830
    
    
    
    (7
    )Net earnings (loss) from continuing operations
    
    
    (1,371
    )
    
    
    (772
    )
    
    
    (58
    )
    
    
    830
    
    
    
    (1,371
    )Net earnings from discontinued operations net of tax
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    (1
    )
    
    
    2Net loss
    
    
    (1,369
    )
    
    
    (771
    )
    
    
    (58
    )
    
    
    829
    
    
    
    (1,369
    )Dividends on preferred shares
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )Net loss applicable to common shares
    
    $
    (1,375
    )
    
    $
    (771
    )
    
    $
    (58
    )
    
    $
    829
    
    
    $
    (1,375
    )


39



---



##### Table of Contents



Supplemental Consolidating Statements of Operations for the nine months ended September 30, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    2,197
    
    
    $
    4,996
    
    
    $
    2,043
    
    
    $
    (2,254
    )
    
    $
    6,982Cost of revenues
    
    
    1,295
    
    
    
    3,207
    
    
    
    1,482
    
    
    
    (2,254
    )
    
    
    3,730Gross profit
    
    
    902
    
    
    
    1,789
    
    
    
    561
    
    
    
    
    
    
    
    3,252Selling, general and administrative expense
    
    
    338
    
    
    
    923
    
    
    
    147
    
    
    
    
    
    
    
    1,408Research and development expense
    
    
    605
    
    
    
    654
    
    
    
    195
    
    
    
    
    
    
    
    1,454Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other special charges
    
    
    85
    
    
    
    108
    
    
    
    (13
    )
    
    
    
    
    
    
    180Gain on sale of businesses
    
    
    (2
    )
    
    
    (18
    )
    
    
    (8
    )
    
    
    
    
    
    
    (28
    )Operating earnings (loss)
    
    
    (124
    )
    
    
    122
    
    
    
    240
    
    
    
    
    
    
    
    238Other income (expense)  net
    
    
    73
    
    
    
    104
    
    
    
    (47
    )
    
    
    
    
    
    
    130Interest expenseLong-term debt
    
    
    (50
    )
    
    
    (1
    )
    
    
    (20
    )
    
    
    
    
    
    
    (71
    )Other
    
    
    (2
    )
    
    
    (39
    )
    
    
    32
    
    
    
    
    
    
    
    (9
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (103
    )
    
    
    186
    
    
    
    205
    
    
    
    
    
    
    
    288Income tax benefit (provision)
    
    
    152
    
    
    
    (116
    )
    
    
    (79
    )
    
    
    
    
    
    
    (43
    )49
    
    
    
    70
    
    
    
    126
    
    
    
    
    
    
    
    245Minority interests  net
    
    
    
    
    
    
    
    
    
    
    (18
    )
    
    
    
    
    
    
    (18
    )Equity in net earnings (loss) of associated companies net of tax
    
    
    135
    
    
    
    865
    
    
    
    11
    
    
    
    (1,046
    )
    
    
    (35
    )Net earnings (loss) from continuing operations
    
    
    184
    
    
    
    935
    
    
    
    119
    
    
    
    (1,046
    )
    
    
    192Net earnings from discontinued operations net of tax
    
    
    206
    
    
    
    134
    
    
    
    
    
    
    
    (134
    )
    
    
    206Net earnings (loss) before cumulative effect of accounting
change  net of tax
    
    
    390
    
    
    
    1,069
    
    
    
    119
    
    
    
    (1,180
    )
    
    
    398Cumulative effect of accounting changes  net of tax
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    (8
    )Net earnings (loss)
    
    
    390
    
    
    
    1,061
    
    
    
    119
    
    
    
    (1,180
    )
    
    
    390Dividends on preferred shares
    
    
    (18
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18
    )Net earnings (loss) applicable to common shareholders
    
    $
    372
    
    
    $
    1,061
    
    
    $
    119
    
    
    $
    (1,180
    )
    
    $
    372


40



---



##### Table of Contents



Supplemental Consolidating Statements of Operations for the nine months ended September 30, 2002:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    2,198
    
    
    $
    5,990
    
    
    $
    2,108
    
    
    $
    (2,262
    )
    
    $
    8,034Cost of revenues
    
    
    1,987
    
    
    
    4,010
    
    
    
    1,756
    
    
    
    (2,262
    )
    
    
    5,491Gross profit
    
    
    211
    
    
    
    1,980
    
    
    
    352
    
    
    
    
    
    
    
    2,543Selling, general and administrative expense
    
    
    479
    
    
    
    1,387
    
    
    
    284
    
    
    
    
    
    
    
    2,150Research and development expense
    
    
    673
    
    
    
    782
    
    
    
    212
    
    
    
    
    
    
    
    1,667Amortization of acquired technology
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    
    
    
    
    17Special chargesGoodwill impairment
    
    
    
    
    
    
    203
    
    
    
    61
    
    
    
    
    
    
    
    264Other special charges
    
    
    438
    
    
    
    677
    
    
    
    136
    
    
    
    
    
    
    
    1,251Gain on sale of businesses
    
    
    (1
    )
    
    
    (4
    )
    
    
    (6
    )
    
    
    
    
    
    
    (11
    )Operating earnings (loss)
    
    
    (1,378
    )
    
    
    (1,082
    )
    
    
    (335
    )
    
    
    
    
    
    
    (2,795
    )Other income (expense)  net
    
    
    3
    
    
    
    (17
    )
    
    
    (29
    )
    
    
    
    
    
    
    (43
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Long-term debt
    
    
    (90
    )
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    (110
    )Other
    
    
    (3
    )
    
    
    (24
    )
    
    
    (8
    )
    
    
    
    
    
    
    (35
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (1,468
    )
    
    
    (1,123
    )
    
    
    (392
    )
    
    
    
    
    
    
    (2,983
    )Income tax benefit (provision)
    
    
    216
    
    
    
    84
    
    
    
    130
    
    
    
    
    
    
    
    430(1,252
    )
    
    
    (1,039
    )
    
    
    (262
    )
    
    
    
    
    
    
    (2,553
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    6Equity in net earnings (loss) of associated companies net of tax
    
    
    (1,321
    )
    
    
    (562
    )
    
    
    (8
    )
    
    
    1,865
    
    
    
    (26
    )Net earnings (loss) from continuing operations
    
    
    (2,573
    )
    
    
    (1,601
    )
    
    
    (264
    )
    
    
    1,865
    
    
    
    (2,573
    )Net earnings from discontinued operations net of tax
    
    
    21
    
    
    
    14
    
    
    
    
    
    
    
    (14
    )
    
    
    21Net loss
    
    
    (2,552
    )
    
    
    (1,587
    )
    
    
    (264
    )
    
    
    1,851
    
    
    
    (2,552
    )Dividends on preferred shares
    
    
    (16
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16
    )Net loss applicable to common shares
    
    $
    (2,568
    )
    
    $
    (1,587
    )
    
    $
    (264
    )
    
    $
    1,851
    
    
    $
    (2,568
    )


41



---



##### Table of Contents



Supplemental Consolidating Balance Sheets as at September 30, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    (41
    )
    
    $
    2,633
    
    
    $
    901
    
    
    $
    
    
    
    $
    3,493Restricted cash and cash equivalents
    
    
    19
    
    
    
    56
    
    
    
    38
    
    
    
    
    
    
    
    113Accounts receivable  net
    
    
    292
    
    
    
    1,346
    
    
    
    426
    
    
    
    
    
    
    
    2,064Intercompany/related party accounts receivable
    
    
    242
    
    
    
    884
    
    
    
    1,916
    
    
    
    (2,856
    )
    
    
    186Inventories  net
    
    
    428
    
    
    
    304
    
    
    
    196
    
    
    
    
    
    
    
    928Income taxes recoverable
    
    
    7
    
    
    
    38
    
    
    
    14
    
    
    
    
    
    
    
    59Deferred income taxes  net
    
    
    108
    
    
    
    307
    
    
    
    
    
    
    
    
    
    
    
    415Other current assets
    
    
    95
    
    
    
    210
    
    
    
    113
    
    
    
    
    
    
    
    418Total current assets
    
    
    1,150
    
    
    
    5,778
    
    
    
    3,604
    
    
    
    (2,856
    )
    
    
    7,676Investments
    
    
    1,834
    
    
    
    (7,502
    )
    
    
    205
    
    
    
    5,646
    
    
    
    183Plant and equipment  net
    
    
    389
    
    
    
    731
    
    
    
    348
    
    
    
    
    
    
    
    1,468Goodwill
    
    
    
    
    
    
    1,956
    
    
    
    97
    
    
    
    
    
    
    
    2,053Deferred income taxes  net
    
    
    1,532
    
    
    
    1,586
    
    
    
    106
    
    
    
    
    
    
    
    3,224Other assets
    
    
    435
    
    
    
    1,165
    
    
    
    899
    
    
    
    (1,934
    )
    
    
    565Total assets
    
    $
    5,340
    
    
    $
    3,714
    
    
    $
    5,259
    
    
    $
    856
    
    
    $
    15,169LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    6
    
    
    $
    3
    
    
    $
    14
    
    
    $
    
    
    
    $
    23Trade and other accounts payable
    
    
    239
    
    
    
    478
    
    
    
    49
    
    
    
    
    
    
    
    766Intercompany/related party accounts payable
    
    
    (3,635
    )
    
    
    2,823
    
    
    
    3,668
    
    
    
    (2,856
    )
    
    
    Payroll and benefit-related liabilities
    
    
    90
    
    
    
    486
    
    
    
    129
    
    
    
    
    
    
    
    705Contractual liabilities
    
    
    45
    
    
    
    458
    
    
    
    265
    
    
    
    
    
    
    
    768Restructuring
    
    
    74
    
    
    
    129
    
    
    
    66
    
    
    
    
    
    
    
    269Other accrued liabilities
    
    
    435
    
    
    
    1,573
    
    
    
    285
    
    
    
    
    
    
    
    2,293Long-term debt due within one year
    
    
    11
    
    
    
    95
    
    
    
    6
    
    
    
    
    
    
    
    112Total current liabilities
    
    
    (2,735
    )
    
    
    6,045
    
    
    
    4,482
    
    
    
    (2,856
    )
    
    
    4,936Long-term debt
    
    
    1,547
    
    
    
    9
    
    
    
    402
    
    
    
    
    
    
    
    1,958Deferred income taxes  net
    
    
    
    
    
    
    249
    
    
    
    31
    
    
    
    
    
    
    
    280Other liabilities
    
    
    898
    
    
    
    1,639
    
    
    
    1,685
    
    
    
    (1,934
    )
    
    
    2,288(290
    )
    
    
    7,942
    
    
    
    6,600
    
    
    
    (4,790
    )
    
    
    9,462Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    77
    
    
    
    
    
    
    
    77SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    342
    
    
    
    
    
    
    
    (342
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    5,975
    
    
    
    647
    
    
    
    (6,622
    )
    
    
    1,211Additional paid-in capital
    
    
    22,024
    
    
    
    1,528
    
    
    
    3,988
    
    
    
    (5,516
    )
    
    
    22,024Accumulated deficit
    
    
    (17,235
    )
    
    
    (13,038
    )
    
    
    (6,027
    )
    
    
    19,065
    
    
    
    (17,235
    )Accumulated other comprehensive income (loss)
    
    
    (906
    )
    
    
    965
    
    
    
    (26
    )
    
    
    (939
    )
    
    
    (906
    )Total shareholders equity
    
    
    5,630
    
    
    
    (4,228
    )
    
    
    (1,418
    )
    
    
    5,646
    
    
    
    5,630Total liabilities and shareholders equity
    
    $
    5,340
    
    
    $
    3,714
    
    
    $
    5,259
    
    
    $
    856
    
    
    $
    15,169


42



---



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


43



---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the nine months ended September 30, 2003:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    184
    
    
    $
    927
    
    
    $
    119
    
    
    $
    (1,038
    )
    
    $
    192Adjustments to reconcile net earnings (loss) from
continuing operations to net cash from (used in)
operating activities, net of effects from acquisitions
and divestitures of businesses:Amortization and depreciation
    
    
    77
    
    
    
    173
    
    
    
    76
    
    
    
    
    
    
    
    326Non-cash portion of special charges
and related asset write downs
    
    
    4
    
    
    
    8
    
    
    
    (4
    )
    
    
    
    
    
    
    8Equity in net loss of associated companies
    
    
    (135
    )
    
    
    (865
    )
    
    
    (11
    )
    
    
    1,046
    
    
    
    35Current and deferred stock option compensation
    
    
    3
    
    
    
    13
    
    
    
    3
    
    
    
    
    
    
    
    19Deferred income taxes
    
    
    
    
    
    
    12
    
    
    
    32
    
    
    
    
    
    
    
    44Other liabilities
    
    
    62
    
    
    
    56
    
    
    
    1
    
    
    
    
    
    
    
    119Gain on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )Gain on sale of investments and businesses
    
    
    (10
    )
    
    
    (45
    )
    
    
    (12
    )
    
    
    
    
    
    
    (67
    )Other  net
    
    
    292
    
    
    
    (276
    )
    
    
    30
    
    
    
    (8
    )
    
    
    38Change in operating assets and liabilities
    
    
    (809
    )
    
    
    (167
    )
    
    
    (339
    )
    
    
    
    
    
    
    (1,315
    )Net cash from (used in) operating activities
    
    
    (336
    )
    
    
    (164
    )
    
    
    (105
    )
    
    
    
    
    
    
    (605
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (23
    )
    
    
    (39
    )
    
    
    (32
    )
    
    
    
    
    
    
    (94
    )Proceeds on disposals of plant and equipment
    
    
    7
    
    
    
    12
    
    
    
    3
    
    
    
    
    
    
    
    22Decrease (increase) in restricted cash and
cash equivalents
    
    
    (11
    )
    
    
    132
    
    
    
    26
    
    
    
    
    
    
    
    147Increase in long-term receivables
    
    
    1
    
    
    
    (12
    )
    
    
    (1
    )
    
    
    
    
    
    
    (12
    )Decrease in long-term receivables
    
    
    195
    
    
    
    10
    
    
    
    2
    
    
    
    
    
    
    
    207Acquisitions of investments and businesses
 net of cash acquired
    
    
    (60
    )
    
    
    (5
    )
    
    
    11
    
    
    
    
    
    
    
    (54
    )Proceeds on sale of investments and businesses
    
    
    6
    
    
    
    45
    
    
    
    
    
    
    
    
    
    
    
    51Investments in subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net cash from (used in) investing activities
    
    
    115
    
    
    
    143
    
    
    
    9
    
    
    
    
    
    
    
    267Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (18
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18
    )Increase (decrease) in notes payable  net
    
    
    4
    
    
    
    4
    
    
    
    (47
    )
    
    
    
    
    
    
    (39
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Repayments of long-term debt
    
    
    (199
    )
    
    
    
    
    
    
    (68
    )
    
    
    
    
    
    
    (267
    )Decrease in capital leases payable
    
    
    
    
    
    
    (2
    )
    
    
    (1
    )
    
    
    
    
    
    
    (3
    )Issuance of common shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of prepaid forward purchase contracts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock option fair value increment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net cash from (used in) financing activities
    
    
    (213
    )
    
    
    2
    
    
    
    (116
    )
    
    
    
    
    
    
    (327
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    74
    
    
    
    22
    
    
    
    
    
    
    
    97Net cash from (used in) continuing operations
    
    
    (433
    )
    
    
    55
    
    
    
    (190
    )
    
    
    
    
    
    
    (568
    )Net cash from (used in) discontinued operations
    
    
    141
    
    
    
    196
    
    
    
    (19
    )
    
    
    
    
    
    
    318Net increase (decrease) in cash and
cash equivalents
    
    
    (292
    )
    
    
    251
    
    
    
    (209
    )
    
    
    
    
    
    
    (250
    )Cash and cash equivalents at beginning of
period
    
    
    251
    
    
    
    2,382
    
    
    
    1,110
    
    
    
    
    
    
    
    3,743Cash and cash equivalents at end of period
    
    $
    (41
    )
    
    $
    2,633
    
    
    $
    901
    
    
    $
    
    
    
    $
    3,493


44



---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the nine months ended September 30, 2002:

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    (3,346
    )
    
    $
    (1,372
    )
    
    $
    (268
    )
    
    $
    2,413
    
    
    $
    (2,573
    )Adjustments to reconcile net earnings (loss) from
continuing operations to net cash from (used in)
operating activities, net of effects from acquisitions
and divestitures of businesses:Amortization and depreciation
    
    
    61
    
    
    
    325
    
    
    
    29
    
    
    
    
    
    
    
    415Non-cash portion of special charges
and related asset write downs
    
    
    223
    
    
    
    550
    
    
    
    67
    
    
    
    
    
    
    
    840Equity in net loss of associated companies
    
    
    2,097
    
    
    
    333
    
    
    
    8
    
    
    
    (2,413
    )
    
    
    25Current and deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deferred income taxes
    
    
    (71
    )
    
    
    (317
    )
    
    
    (50
    )
    
    
    
    
    
    
    (438
    )Other liabilities
    
    
    (16
    )
    
    
    1
    
    
    
    (14
    )
    
    
    
    
    
    
    (29
    )Gain on repurchases of outstanding debt securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gain on sale of investments and businesses
    
    
    (10
    )
    
    
    (7
    )
    
    
    
    
    
    
    
    
    
    
    (17
    )Other  net
    
    
    306
    
    
    
    130
    
    
    
    159
    
    
    
    
    
    
    
    595Change in operating assets and liabilities
    
    
    (895
    )
    
    
    1,456
    
    
    
    62
    
    
    
    
    
    
    
    623Net cash from (used in) operating activities
    
    
    (1,651
    )
    
    
    1,099
    
    
    
    (7
    )
    
    
    
    
    
    
    (559
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (40
    )
    
    
    (214
    )
    
    
    (35
    )
    
    
    
    
    
    
    (289
    )Proceeds on disposals of plant and equipment
    
    
    5
    
    
    
    351
    
    
    
    
    
    
    
    
    
    
    
    356Decrease (increase) in restricted cash and
cash equivalents
    
    
    (47
    )
    
    
    (352
    )
    
    
    (21
    )
    
    
    
    
    
    
    (420
    )Increase in long-term receivables
    
    
    60
    
    
    
    (187
    )
    
    
    (122
    )
    
    
    
    
    
    
    (249
    )Decrease in long-term receivables
    
    
    19
    
    
    
    151
    
    
    
    83
    
    
    
    
    
    
    
    253Acquisitions of investments and businesses
 net of cash acquired
    
    
    (5
    )
    
    
    (24
    )
    
    
    
    
    
    
    
    
    
    
    (29
    )Proceeds on sale of investments and businesses
    
    
    20
    
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    44Investments in subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net cash from (used in) investing activities
    
    
    12
    
    
    
    (251
    )
    
    
    (95
    )
    
    
    
    
    
    
    (334
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (16
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16
    )Increase (decrease) in notes payable  net
    
    
    
    
    
    
    (184
    )
    
    
    (130
    )
    
    
    
    
    
    
    (314
    )Proceeds from long-term debt
    
    
    
    
    
    
    1
    
    
    
    31
    
    
    
    
    
    
    
    32Repayments of long-term debt
    
    
    (5
    )
    
    
    (4
    )
    
    
    (13
    )
    
    
    
    
    
    
    (22
    )Increase (decrease) in capital leases payable
    
    
    (3
    )
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    (7
    )Issuance of common shares
    
    
    1,997
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,997Issuance of prepaid forward purchase contracts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock option fair value increment
    
    
    
    
    
    
    (525
    )
    
    
    
    
    
    
    
    
    
    
    (525
    )Net cash from (used in) financing activities
    
    
    1,973
    
    
    
    (716
    )
    
    
    (112
    )
    
    
    
    
    
    
    1,145Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    3
    
    
    
    10
    
    
    
    3
    
    
    
    
    
    
    
    16Net cash from (used in) continuing operations
    
    
    337
    
    
    
    142
    
    
    
    (211
    )
    
    
    
    
    
    
    268Net cash from (used in) discontinued operations
    
    
    119
    
    
    
    218
    
    
    
    
    
    
    
    
    
    
    
    337Net increase (decrease) in cash and
cash equivalents
    
    
    456
    
    
    
    360
    
    
    
    (211
    )
    
    
    
    
    
    
    605Cash and cash equivalents at beginning of
period
    
    
    (42)
    
    
    
    2,284
    
    
    
    1,162
    
    
    
    
    
    
    
    3,404Cash and cash equivalents at end of period
    
    $
    414
    
    
    $
    2,644
    
    
    $
    951
    
    
    $
    
    
    
    $
    4,009


45



---



##### 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, or MD&A, 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 our 2002 Annual Report, we mean our Annual Report on Form 10-K
for the year ended December 31, 2002 filed with the Securities and Exchange
Commission, or SEC, on March 10, 2003, and, when filed with the SEC, the
amended Annual Report onForm 10-K/Afor the year ended December 31, 2002, or
Nortel NetworksForm 10-K/A, subject to the restated financial information as
described below and in Restatements in note 2 of the accompanying unaudited
consolidated financial statements. Except as noted, this MD&A gives effect to
the restatement adjustments. 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 are removing barriers to
business opportunity through the supply of communications technology and
infrastructure to enable value-added internet protocol, or IP, data, voice and
multimedia services that support the Internet and other public and private
networks using wireline and wireless technologies. A substantial portion of
our business has a technology focus and is dedicated to research and
development. This focus is a core strength and a factor that differentiates us
from many of our competitors. We envision a network society where people are
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, or NNC. NNC holds all of our outstanding common shares but none
of our outstanding preferred shares. NNC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 NNC, while
acquisitions involving only cash consideration are generally completed by us.

Developments in 2003

Restatements

In 2001, we entered into an unprecedented period of business realignment in
response to a significant adjustment in the telecommunications industry.
Industry demand for networking equipment dramatically declined in response to
the industry adjustment, severe economic downturns in various regions around
the world and a tightening in global capital markets. We implemented a
company-wide restructuring plan to streamline our operations and activities
around core markets and operations, which included significant workforce
reductions, global real estate closures and dispositions, substantial
write-downs of our capital assets, goodwill and other intangible assets and
extensive contract settlements with customers and suppliers around the world.
As a result of these actions, our workforce declined significantly from January
1, 2001 to September 30, 2003 and over the same time period we significantly
reduced our facilities.

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

Based on the completion of the comprehensive review and certain related reviews
or, collectively, the comprehensive review, we determined that approximately $948
of certain liabilities (primarily accruals and provisions) carried on our
previously

46



---



##### Table of Contents



reported balance sheet as at June 30, 2003 needed to be released to income in
prior periods as part of the restatements. These provisions were either
initially recorded incorrectly in prior periods or not properly released or
adjusted for changes in estimates in the appropriate periods. In certain
cases, costs were incorrectly charged to operations rather than to the
appropriate provisions. Following our determination to restate certain
consolidated financial statements, we also determined that we would correct
certain known errors that were previously not recorded because the amount of
the errors was not material to the consolidated financial statements.
Specifically, among other items, we have made certain revenue adjustments to
reflect revenue which should have been deferred instead of recognized in a
particular period. Also, as part of the restatements, we made adjustments to
correct errors related to our deferred income tax assets and foreign currency
translation accounts. In addition, we made reclassification adjustments within
the balance sheet to better reflect the underlying nature of certain items;
these reclassifications did not impact the net assets as at the end of any
period. The net effect of all of these adjustments was a reduction in
accumulated deficit as at June 30, 2003 of $492.

We have also undertaken a series of physical counts and reconciliations of
plant and equipment. While we believe that the portion of the work completed
to date supports the carrying value of the plant and equipment recorded in our
balance sheet as at September 30, 2003, the conclusion of this work could
result in adjustments to the carrying value of certain assets.

The following presents our accumulated deficit, as previously reported and
after giving effect to the restatement adjustments, as at June 30, 2003, March
31, 2003, December 31, 2002, December 31, 2001 and December 31, 2000:



| |  | Accumulated deficit
| |  | -------------------

June 30,
    
    
    March 31,
    
    
    December 31,
    
    
    Prior(a)2003
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    yearsAccumulated deficitAs previously reported
    
    $
    17,951
    
    
    $
    18,001
    
    
    $
    18,093
    
    
    $
    14,507
    
    
    $
    402As restated
    
    
    17,459
    
    
    
    17,559
    
    
    
    17,607
    
    
    
    14,336
    
    
    
    370Cumulative adjustment
    
    $
    (492
    )
    
    $
    (442
    )
    
    $
    (486
    )
    
    $
    (171
    )
    
    $
    (32
    )
    
    $
    (4
    )


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

The following presents the impact on revenues and earnings (loss) of the
restatement adjustments for the quarterly periods ended June 30, 2003 and March
31, 2003 and the years ended December 31, 2002, 2001 and 2000:

47



---



##### Table of Contents





| |  | Restated revenues and earnings (loss)
| |  | -------------------------------------

Three months ended
    
    
    December 31,June 30,
    
    
    March 31,
    
    
    
    
    
    
    
    
    
    
    
    Prior(a)
    
    
    Total2003
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    years
    
    
    adjustmentsRevenuesAs previously reported
    
    $
    2,328
    
    
    $
    2,397
    
    
    $
    10,546
    
    
    $
    17,375
    
    
    $
    27,853Adjustments
    
    
    12
    
    
    
    (21
    )
    
    
    8
    
    
    
    (103
    )
    
    
    (17
    )
    
    $
    (1
    )
    
    $
    (122
    )As restated
    
    $
    2,340
    
    
    $
    2,376
    
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836Earnings (loss)Earnings (loss) from
continuing operationsAs previously reported
    
    $
    57
    
    
    $
    (67
    )
    
    $
    (3,039
    )
    
    $
    (11,555
    )
    
    $
    (871
    )Adjustments
    
    
    52
    
    
    
    (36
    )
    
    
    294
    
    
    
    125
    
    
    
    28
    
    
    $
    4
    
    
    $
    467As restated
    
    $
    109
    
    
    $
    (103
    )
    
    $
    (2,745
    )
    
    $
    (11,430
    )
    
    $
    (843
    )Earnings (loss) from discontinued
operations-net of taxAs previously reported
    
    $
    
    
    
    $
    164
    
    
    $
    
    
    
    $
    (2,538
    )
    
    $
    (414
    )Adjustments
    
    
    (2
    )
    
    
    
    
    
    
    21
    
    
    
    14
    
    
    
    
    
    
    $
    
    
    
    $
    33As restated
    
    $
    (2
    )
    
    $
    164
    
    
    $
    21
    
    
    $
    (2,524
    )
    
    $
    (414
    )Net earnings (loss)As previously reported
    
    $
    50
    
    
    $
    92
    
    
    $
    (3,061
    )
    
    $
    (14,105
    )
    
    $
    (1,316
    )Adjustments
    
    
    50
    
    
    
    (44
    )
    
    
    315
    
    
    
    139
    
    
    
    28
    
    
    $
    4
    
    
    $
    492As restated
    
    $
    100
    
    
    $
    48
    
    
    $
    (2,746
    )
    
    $
    (13,966
    )
    
    $
    (1,288
    )


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

The following presents details by category aggregating to the net decrease in
accumulated deficit of $492 as at June 30, 2003, resulting from the restatement
adjustments:



| |  | Net decrease in accumulated deficit by category
| |  | -----------------------------------------------

Contract and customer-related accruals
    
    $
    424Special charges related to restructuring actions
    
    
    328Other accruals and provisions
    
    
    196Total accruals and provision adjustments
    
    $
    948Income tax adjustments
    
    $
    (168
    )Revenue adjustments
    
    
    (122
    )Foreign currency translation adjustments related to Brazilian operations
    
    
    (107
    )Foreign currency translation adjustments  other
    
    
    (59
    )Decrease in accumulated deficit as at June 30, 2003
    
    $
    492




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

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



| |  | Consolidated statement of operations for the three months ended September 30, 2002 as restated
| |  | ----------------------------------------------------------------------------------------------

Net loss for the three months ended September 30, 2002 was reduced by $62 from
$1,437 to $1,375. The major components of the reduction included a $62 net
decrease in income tax expense (resulting from the effect on the valuation
allowance recorded at September 30, 2002 of the prior period restatement
adjustments offset by the current period income tax adjustment of $142 as noted
above. Additionally, there was a $22 decrease resulting from the release of
special charges primarily related to costs associated with severance and fringe
benefits for terminated employees. These reductions in net loss were partially
offset by a $17 increase in selling, general and administrative expense (which
resulted primarily from the reversal of a previously recorded release of
accruals for inter-company out of balance amounts) and a $22 increase in other
expense

48



---



##### Table of Contents



primarily due to $36 in losses from foreign exchange translation
adjustments related to our Brazilian operations offset by $19 for
other items.



| |  | Consolidated statement of operations for the nine months ended September 30, 2002 as restated
| |  | ---------------------------------------------------------------------------------------------

Net loss for the nine months ended September 30, 2002 was reduced by $233 from
$2,801 to $2,568. The major components of the reduction included a $122
improvement in gross profit primarily from adjustments to contract and
customer-related accruals, $84 from the release of special charges
primarily related to costs associated with severance and fringe benefits for
terminated employees, a $32 decrease in selling, general and administrative
expense and a $30 decrease in research and development expense, each due to a
net decrease in other accruals and provisions. These reductions in net loss
were partially offset by a $19 increase in other expenses (which included $36
in losses from foreign exchange translation adjustments related to our
Brazilian operations and reduced by $17 of net adjustments for other items).
Income tax adjustments of $17 represented the net effect of the tax expense
related to the restatement adjustments, the resulting valuation allowance
adjustment and the income tax adjustment as noted above.



| |  | Consolidated balance sheet as at December 31, 2002 as restated
| |  | --------------------------------------------------------------



| |  | Restatement adjustments
| |  | -----------------------

The discussion included in Restatements in note 2 of the accompanying
unaudited consolidated financial statements identified and classified the
various adjustments by category and provided their measurement with respect to
the net decrease in accumulated deficit as at June 30, 2003. The consolidated
balance sheet included in Restatements in note 2 of the accompanying
unaudited consolidated financial statements presents the cumulative impact of
the restatement adjustments classified by balance sheet line item as at
December 31, 2002. The adjustments as at December 31, 2002 are of the same
nature as those as at June 30, 2003. The changes to the consolidated balance
sheet as a result of the cumulative impact of the restatement adjustments as at
December 31, 2002 included a reduction in contractual liabilities largely due
to the adjustments for contract and customer-related accruals, a reduction in
restructuring liabilities as a result of the adjustments to special charges
related to restructuring actions, a reduction in other accrued liabilities
principally from adjustments related to other accruals and provisions and a
reduction to the deferred tax asset of $144 principally related to the
incorrect netting of certain tax liabilities against the deferred tax asset.



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

Reclassification adjustments were made between line items which also impacted
the unaudited consolidated balance sheet as at December 31, 2002. The
principal reclassifications resulted in, among other things, a net reduction to
cash and notes payables of $70 to reflect, upon consolidation, that a bank note
payable by one subsidiary was fully collateralized by, and could be offset
against, a deposit in the same bank by another subsidiary, an approximate $370
increase in accounts receivable and in other accrued liabilities to recognize
advance billings in excess of revenues as a liability, and a $90 increase in
net inventory with offsets in other current and other long-term assets.



| |  | Filing of restated financial statements
| |  | ---------------------------------------

At the earliest possible time in the fourth quarter of 2003, we expect to file
with the SEC the Nortel Networks Form 10-K/A and amended Quarterly Reports on
Form 10-Q/A for the quarterly periods ended March 31, 2003 and June 30, 2003
containing restated financial statements for the relevant periods.

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

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

For further information on the impact of the restatements on the consolidated
statements of operations for the three months and nine months ended September
30, 2002 and the balance sheet as at December 31, 2002, see Significant
accounting policies and Restatements in notes 1 and 2, respectively, of the
accompanying unaudited consolidated financial statements.

Employee benefit plans

49



---



##### Table of Contents



During the first nine months of 2003, we made required cash contributions to
our registered defined benefit pension plans of $54 as well as additional
voluntary contributions of $170. We expect to make additional required cash
contributions of approximately $24 in the fourth quarter of 2003. Subject to
the impact of global capital market and interest rate fluctuations, we expect
to make required cash contributions in 2004 under applicable legislation in
amounts similar to those required in 2003.

Ownership adjustment in our French and German operations

On September 18, 2003, consistent with our overall global business strategy, we
realigned our business activities in France and Germany by increasing our
ownership in our core businesses in these countries. As a result of this
realignment, we acquired the 42% minority interest in Nortel Networks Germany
GmbH & Co. KG and the 45% minority interest in Nortel Networks France S.A.S.,
previously held by European Aeronautic Defence and Space Company EADS N.V., or
EADS, our former partner in three European joint ventures. At the completion
of these transactions, our ownership in each company increased to 100%. These
companies are responsible for the sales and marketing of our products in France
and Germany. At the same time, EADS increased its ownership in EADS Telecom
S.A.S. (formerly EADS Defence and Security Networks S.A.S.), or EADS Telecom,
from 59% to 100% as a result of acquiring our equity ownership in that company.
For additional information, see Joint ventures/minority interests.

Customer financing commitments

During the first nine months of 2003, we reduced our undrawn customer financing
commitments by $685 as a result of the expiration or cancellation of
commitments and changing customer business plans. As of September 30, 2003,
approximately $84 of the $116 in undrawn commitments was not available for
funding under the terms of our financing agreements. For additional
information, see Customer financing.

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. All other material
terms of the EDC support facility remained unchanged. See Available support
facility for additional information.

Discontinued operations

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



| |  | the sale of 8 million common shares of Arris Group Inc., or Arris,
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;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | the receipt of $20 cash related to the repayment of a promissory note
receivable from Netgear, Inc., or Netgear, on August 6, 2003. The note
was part of the consideration received by us upon the sale of our
remaining interest in Netgear in February 2002.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

50



---



##### Table of Contents



estimated 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 third
quarter of 2003 and $19 in the first nine months 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 Stock-based
compensation in note 3(a) of the accompanying unaudited consolidated financial
statements and Significant accounting policies in note 2(t) of our financial
statements in our 2002 Annual Report.

Results of operations  continuing operations

Segment revenues

3 months ended September 30,
    
    
    9 months ended September 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    1,005
    
    
    $
    936
    
    
    $
    69
    
    
    
    7
    
    
    $
    2,939
    
    
    $
    3,196
    
    
    $
    (257
    )
    
    
    (8
    )Enterprise Networks
    
    
    579
    
    
    
    616
    
    
    
    (37
    )
    
    
    (6
    )
    
    
    1,738
    
    
    
    1,923
    
    
    
    (185
    )
    
    
    (10
    )Wireline Networks
    
    
    439
    
    
    
    484
    
    
    
    (45
    )
    
    
    (9
    )
    
    
    1,494
    
    
    
    1,758
    
    
    
    (264
    )
    
    
    (15
    )Optical Networks
    
    
    243
    
    
    
    309
    
    
    
    (66
    )
    
    
    (21
    )
    
    
    810
    
    
    
    1,120
    
    
    
    (310
    )
    
    
    (28
    )Other(a)
    
    
    
    
    
    
    4
    
    
    
    (4
    )
    
    
    (100
    )
    
    
    1
    
    
    
    37
    
    
    
    (36
    )
    
    
    (97
    )Consolidated
    
    $
    2,266
    
    
    $
    2,349
    
    
    $
    (83
    )
    
    
    (4
    )
    
    $
    6,982
    
    
    $
    8,034
    
    
    $
    (1,052
    )
    
    
    (13
    )


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

In the second quarter of 2003, Wireless Networks
revenues were $1,000, Enterprise
Networks revenues were $548, Wireline Networks revenues were $494, Optical
Networks revenues were $298 and Other revenues were nil.

Geographic revenues

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

3 months ended September 30,
    
    
    9 months ended September 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeUnited States
    
    $
    1,146
    
    
    $
    1,205
    
    
    $
    (59
    )
    
    
    (5
    )
    
    $
    3,494
    
    
    $
    4,125
    
    
    $
    (631
    )
    
    
    (15
    )EMEA(a)
    
    
    545
    
    
    
    581
    
    
    
    (36
    )
    
    
    (6
    )
    
    
    1,767
    
    
    
    1,926
    
    
    
    (159
    )
    
    
    (8
    )Canada
    
    
    126
    
    
    
    110
    
    
    
    16
    
    
    
    15
    
    
    
    391
    
    
    
    524
    
    
    
    (133
    )
    
    
    (25
    )Other
regions(b)
    
    
    449
    
    
    
    453
    
    
    
    (4
    )
    
    
    (1
    )
    
    
    1,330
    
    
    
    1,459
    
    
    
    (129
    )
    
    
    (9
    )Consolidated
    
    $
    2,266
    
    
    $
    2,349
    
    
    $
    (83
    )
    
    
    (4
    )
    
    $
    6,982
    
    
    $
    8,034
    
    
    $
    (1,052
    )
    
    
    (13
    )


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

In the second quarter of 2003, revenues in the
United States were $1,150,
revenues in EMEA were $582, revenues in Canada were $138 and revenues in Other
regions were $470.

Consolidated revenues



| |  | Q3 2003 vs. Q3 2002 and first 9 months of 2003 vs. first 9 months of 2002
| |  | -------------------------------------------------------------------------

In 2001, we entered into an unprecedented period of business realignment in
response to a significant industry adjustment. We implemented a company-wide
restructuring work plan to streamline our operations and activities around core
markets and operations. During 2003, we have begun to experience a period of
relative stability. In 2003, our consolidated revenues were $2,266 in the
third quarter, $2,340 in the second quarter and $2,376 in the first quarter.
As well, throughout 2003, we have announced several new contracts, primarily in
our Wireless Networks segment, as certain service provider customers began to
expand and upgrade their existing networks. Although we expect to continue to
see select areas of revenue growth throughout our four reportable segments and
our geographic regions, we can provide no assurance that these select growth
areas that have begun to emerge will continue in the future as customers
continue to make selective decisions on the timing of upgrades and expansions
of existing networks and installations of new networks.

51



---



##### Table of Contents



Our consolidated revenues declined 4% in the third quarter of 2003 compared to
the third quarter of 2002 and declined 13% in the first nine months of 2003
compared to the first nine months of 2002. The decline in the first nine
months of 2003 was across all segments and was primarily due to the continuing
industry adjustment and capital spending restrictions experienced by our
service provider and enterprise customers. As well, the decline in the first
nine months of 2003 was attributed to tightened capital markets, mainly
experienced in the first half of 2003. 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 4% decline in revenues in the third quarter
of 2003 compared to the same period in 2002 was primarily due to a:



| |  | 5% decline in revenues in the United States primarily due to capital
spending restrictions experienced by our service provider and enterprise
customers and their focus on capital and cash flow management;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 6% decline in revenues in the Europe, Middle East and Africa region,
or EMEA, primarily due to a substantial reduction in capital spending as
a result of the continuing industry adjustment and customers continuing
to focus on maximizing return on invested capital; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 3% decline in revenues in the Asia Pacific region, or Asia Pacific,
primarily due to the completion of certain customer upgrades and
expansions to meet increased customer demand in the first half of 2003
which were originally scheduled to occur in the second half of 2003;
partially offset by
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 15% increase in revenues in Canada primarily due to a certain Code
Division Multiple Access, or CDMA, customer upgrading and expanding
their existing network; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 6% increase in revenues in the Caribbean and Latin America region, or
CALA, primarily due to new CDMA and Global System for Mobile
communications, or GSM, contracts as certain service provider customers
migrated from Time Division Multiple Access, or TDMA, to CDMA and GSM
technologies.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, the 13% decline in revenues in the first nine
months of 2003 compared to the same period in 2002 was primarily due to a:



| |  | 15% decline in revenues in the United States primarily due to capital
spending restrictions experienced by our service provider and enterprise
customers and their focus on capital and cash flow management in the
first nine months of 2003 as well as tightened capital markets mainly
during the first half of 2003;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 8% decline in revenues in EMEA primarily due to capital spending
restrictions by service provider and enterprise customers and tightened
capital markets mainly during the first half of 2003 which were
partially offset by increases in revenue related to new GSM contracts
with certain service providers;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 25% decline in revenues in Canada primarily due to capital spending
restrictions experienced by our service provider customers and their
focus on capital and cash flow management as well as tightened capital
markets mainly during the first half of 2003; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 23% 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
which were partially offset by increases in revenue related to new GSM
contracts with certain service providers.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q3 2003 vs. Q2 2003
| |  | -------------------

Our consolidated revenues declined $74 from $2,340 in the second quarter of
2003 to $2,266 in the third quarter of 2003. The decrease was primarily due to
an 11% decrease in revenues in our Wireline Networks segment and an 18%
decrease in revenues in our Optical Networks segment. These declines were
primarily due to the continuing industry adjustment and continued cautious
spending by our service provider customers. The declines were partially offset
by a 6% increase in our Enterprise Networks segment, primarily due to an
increase in revenues associated with certain of our traditional circuit
switching products and packet voice solutions.

Geographic revenues for the third quarter of 2003 compared to the second
quarter of 2003 declined 6% in EMEA, declined 9% in Asia Pacific and declined
9% in Canada. These declines were partially offset by a 13% increase in CALA.
Revenues in the United States were essentially flat in the third quarter of
2003 compared to the second quarter of 2003.

52



---



##### Table of Contents





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

Given the ongoing economic uncertainty, customers continue to spend cautiously.
We expect to generally 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 provider customers;
| | - | --------------------------------------------------------



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



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



| |  | the financial difficulties of certain service provider customers;
| | - | -----------------------------------------------------------------



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



| |  | continued capital market uncertainties.
| | - | ---------------------------------------

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 in the United States is expected to remain cautious while
service provider customers continue to 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 sustained growth in industry spending is not expected
to occur until economic and financial concerns have subsided. Market
visibility remains limited and we do not expect that our results of operations
for any quarter will necessarily be consistent with our historical quarterly
profile or indicative of our expected results in future quarters. See Forward
looking statements for other factors that may affect our revenues.

Wireless Networks revenues

The following chart summarizes recent quarterly revenues for Wireless Networks:

(BAR GRAPH-QUARTERLY REVENUES FOR WIRELESS NETWORKS)



| |  | Q3 2003 vs. Q3 2002
| |  | -------------------

Wireless Networks revenues increased 7% in the third quarter of 2003 compared
to the third quarter of 2002 primarily due to increased spending by our
wireless service provider customers on our CDMA and GSM technologies.

CDMA revenues increased in the third quarter of 2003 compared to the third
quarter of 2002 primarily due to an increase in capital spending by our
customers in the United States and Asia Pacific. In particular, certain of our
major customers in the United States began to upgrade and expand their existing
networks to higher data speeds. The increase in Asia Pacific was primarily due
to new contracts with certain service provider customers and other customers
expanding their existing networks to meet increased subscriber demand. These
increases were partially offset by a substantial decline in EMEA, primarily due
to the completion of key customer network deployments during the first half of
2003.

TDMA revenues declined substantially in the third quarter of 2003 compared to
the third 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 were a smaller portion of Wireless
Networks revenues in the third quarter of 2003 compared to the third quarter of
2002.

53



---



##### Table of Contents



Overall GSM revenues increased significantly in the third quarter of 2003
compared to the third quarter of 2002, primarily due
to a substantial increase in EMEA, a significant increase in the United States
and a substantial increase in CALA. The substantial increase in EMEA was
primarily due to new contracts with certain service provider customers and
other customers expanding their existing network. In the United States, the
significant increase in GSM revenues was primarily due to accelerated network
expansions with certain service providers to meet increased subscriber demand.
CALA revenues increased primarily due to incremental shipments to certain
customers in the third quarter of 2003 related to contracts awarded in prior
periods.

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

From a geographic perspective, the 7% increase in Wireless Networks revenues in
the third quarter of 2003 compared to the same period in 2002 was primarily due
to a:



| |  | 37% increase in revenues in CALA primarily due to incremental
shipments to certain customers in the third quarter of 2003 related to
contracts awarded in prior periods;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 4% increase in revenues in the United States primarily due to certain
of our major CDMA and GSM customers upgrading and expanding their
existing networks; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 61% increase in Canada primarily due to a certain CDMA customer
upgrading and expanding its existing network.
| | - | -------------------------------------------------------------------------------------------------------------



| |  | First nine months of 2003 vs. first nine months of 2002
| |  | -------------------------------------------------------

In the first nine months of 2003, Wireless Networks revenues declined 8%
compared to the same period in 2002 primarily due to the ongoing focus by
wireless service providers on capital and cash flow management, primarily in
the first six months of 2003, 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 during the first six months of 2003.

CDMA revenues decreased slightly in the first nine months of 2003 primarily due
to a significant decline in the United States and Canada as customers continued
to experience capital spending restrictions as a result of their continued
focus on capital and cash flow management. In Asia Pacific, CDMA revenues
increased substantially in the first nine months of 2003 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 nine months of 2003 compared
to the first nine months of 2002 primarily due to the continued transition to
newer wireless technologies. The substantial decline was primarily due to
customers in the United States and Canada continuing to migrate from the mature
TDMA technology to GSM and CDMA technologies. In the first nine months of
2003, TDMA revenues accounted for less than 10% of total Wireless Networks
revenues.

GSM revenues were essentially flat in the first nine months of 2003 compared to
the first nine months of 2002. Asia Pacific revenues declined substantially
and United States revenues decreased. These declines were partially offset by
substantial increases in EMEA and CALA. The substantial decline in Asia
Pacific was primarily due to many of our GSM customers delaying their current
network deployment schedules due to sufficient capacity in their existing
networks to meet additional subscriber demand. In the United States, the
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 nine months of 2003 primarily due to new contracts
and incremental shipments to certain service providers related to contracts
awarded in prior periods.

UMTS revenues were essentially flat in the first nine months of 2003 compared
to the first nine months of 2002 as operators have continued to delay their
deployment plans.

From a geographic perspective, the 8% decrease in Wireless Networks revenues in
the first nine months of 2003 compared to the same period in 2002 was primarily
due to a:



| |  | 14% decline in revenues in the United States and a 44% decline in
Canada primarily due to customers focus on capital and cash flow
management, technology migration and a slower subscriber growth; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 4% decline in revenues in Asia Pacific primarily due to network
completions; partially offset by
| | - | ------------------------------------------------------------------------------------------------

54



---



##### Table of Contents





| |  | 15% increase in revenues in EMEA and a 16% increase in CALA primarily
due to new GSM contracts with certain
service providers and other customers expanding their existing networks to
meet increased subscriber demand.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q3 2003 vs. Q2 2003
| |  | -------------------

Compared to the second quarter of 2003, Wireless Networks revenues were
essentially flat in the third quarter of 2003. CDMA revenues increased
primarily due to increases in the United States and Canada as a result of new
contracts and network expansions. UMTS revenues declined significantly in EMEA
as operators delayed deployment plans.

From a geographic perspective, United States revenues increased 9% and CALA
revenues increased 18% in the third quarter of 2003 compared to the second
quarter of 2003. These increases were essentially offset by a 13% decline in
revenues in EMEA, an 8% decline in Asia Pacific and a 23% decline in Canada.



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

During the first nine months of 2003, Wireless Networks revenues continued to
be primarily generated by sales of CDMA and GSM technologies. We expect this
trend will continue in the fourth quarter of 2003. Also, we continue to expect
that revenues associated with our TDMA technologies will decline in 2003
compared to 2002. Regarding our UMTS technologies, we expect that revenues
will remain a small portion of overall Wireless Networks revenues in 2003.

Although we experienced an increase in our Wireless Networks revenues in the
third quarter of 2003 compared to the second quarter of 2003, many customers
continued to be cautious with their capital expenditure plans. While we have
seen encouraging indicators in the wireless market, we can provide no assurance
that the growth areas that have begun to emerge will continue in the future.

Enterprise Networks revenues

The following chart summarizes recent quarterly revenues for Enterprise
Networks:

(BAR GRAPH-QUARTERLY REVENUES FOR ENTERPRISE NETWORKS)



| |  | Q3 2003 vs. Q3 2002
| |  | -------------------

Enterprise Networks revenues declined 6% in the third quarter of 2003 compared
to the third quarter of 2002 due to a decrease in the data networking and
security portion of this segment and a moderate decline in the circuit and
packet voice portion of this segment.

Revenues from the circuit and packet voice portion of this segment decreased in
the third quarter of 2003 compared to the third quarter of 2002 primarily due
to a decrease in revenues in the United States and 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 decline was primarily due to reduced
capital spending by enterprise customers on our applications products. The
declines mentioned above were partially offset by a substantial increase in
revenues associated with our packet voice solutions as a result of the
continuing evolution of traditional circuit switching technology towards
converged IP telephony solutions.

Revenues in the data networking and security portion of this segment decreased
in the third quarter of 2003 compared to the third quarter of 2002. The
decrease was primarily due to pricing pressure driven by competition for
enterprise customers, a decline in revenues associated with our legacy routing
portfolio and a decline in new service contracts and service contract

55



---



##### Table of Contents



renewals.
These declines were experienced primarily in the United States and Asia
Pacific.

From a geographic perspective, the 6% decline in Enterprise Networks revenues
in the third quarter of 2003 compared to the third quarter of 2002 was
primarily due to a:



| |  | 9% decline in revenues in the United States primarily due to a
decline in service contract renewals, a reduction in demand for our
legacy routing products and a decrease in demand for our traditional
circuit switching products; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 5% decline in revenues in EMEA primarily due to a decline in revenues
associated with our applications products and continued pricing
pressures on certain data products.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | First nine months of 2003 vs. first nine months of 2002
| |  | -------------------------------------------------------

Enterprise Networks revenues declined 10% in the first nine months of 2003
compared to the same period in 2002 due to a significant decrease in the data
networking and security portion of this segment and a decrease in the circuit
and packet voice portion of this segment. As well, primarily in the first half
of 2003, enterprise customers continued to implement 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 nine months of 2003 compared to the same period in 2002. We
experienced a decrease in revenues associated with our traditional circuit
switching and interactive voice response products primarily due to sufficient
network capacity and continuing capital spending restrictions as a result of
the economic uncertainty in the industry. Also, during the first half of 2003,
we experienced 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. 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 nine months of 2003 compared to
the same period in 2002. The significant decrease in revenues was primarily
due to a decline in new service contracts and service contract renewals, a
decline in revenues associated with our legacy routing portfolio and a decline
in revenue from certain of our data networking products primarily due to
pricing pressures driven by increased
competition.

From a geographic perspective, the 10% decline in Enterprise Networks revenues
in the first nine months of 2003 compared to the same period in 2002 was
primarily due to a:



| |  | 14% decline in revenues in the United States primarily due to
customer spending restrictions, a reduction in revenues associated with
our legacy routing portfolio, pricing pressures on certain of our data
products and a reduction in the number of new service contracts and
service contract renewals;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 6% decline in revenues in EMEA primarily due to continuing economic
uncertainty in the region, delays 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, pricing pressures on certain data networking
products and a delay in purchasing decisions on certain of our
interactive voice response product as customers waited for the next
release of this product; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 25% 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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q3 2003 vs. Q2 2003
| |  | -------------------

Enterprise Networks revenues increased 6% in the third quarter of 2003 compared
to the second quarter of 2003 primarily due to:



| |  | an increase in revenues associated with certain of our traditional
circuit switching products due to demand for new systems and product
upgrades that allowed customers to migrate their existing technologies
towards IP telephony;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase in revenues associated with other circuit switching
products as the realignment of our channel strategy to address the
demand of small and medium sized customers began to have a positive
impact; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | continued growth in revenues associated with our IP telephony
solutions.
| | - | ------------------------------------------------------------------------

56



---



##### Table of Contents



From a geographic perspective, the 6% increase in the third quarter of 2003
compared to the second quarter of 2003 was primarily due to a 9% increase in
revenues in the United States and a 30% increase in revenues in CALA. Revenues
in our other regions were relatively unchanged from the second quarter of 2003.



| |  | 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 experienced an increase in revenues in the third quarter of 2003 compared to
the second quarter of 2003, our enterprise customers remain cautious when
making their capital spending decisions. Also, we anticipate that demand will
continue for our traditional circuit switching products, however it is
difficult to determine the extent to which future declines in demand will occur
as a result of the migration to voice over packet technologies. Further, we
continue to work towards completion of the realignment of our channel strategy
to address the demand of the small and medium sized enterprise customers.

Wireline Networks revenues

The following chart summarizes recent quarterly revenues for Wireline Networks:

(BAR GRAPH-QUARTERLY REVENUES FOR WIRELINE NETWORKS)



| |  | Q3 2003 vs. Q3 2002
| |  | -------------------

Wireline Networks revenues declined 9% in the third quarter of 2003 compared to
the third 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 third quarter of 2003 compared to the third quarter of
2002 primarily due to a significant decrease in our traditional circuit
switching product revenues, mainly in the United States, and also uncertainty
related to the impact of the recent FCC decision regarding UNEs. The decline
in our circuit switching product revenues was primarily due to the continuing
impact of capital spending restrictions experienced by our service provider
customers. Revenues from our packet voice solutions increased substantially in
the United States in the third quarter of 2003 compared to the third 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 and certain other service provider customers expanding their
existing networks.

Revenues from the data networking and security portion of this segment
decreased slightly in the third quarter of 2003 compared to the third quarter
of 2002 primarily due to revenue declines in the United States, Asia Pacific
and CALA. In these regions, we continued to experience a decline in demand for
our mature products which was further compounded by the ongoing industry
adjustment as service providers continued to reduce their capital expenditures
compared to the same period in 2002.

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



| |  | 17% decline in revenues in the United States primarily due to the
continuing impact of capital spending restrictions experienced by our
service provider customers and also uncertainty related to the impact of
the recent FCC decision
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

57



---



##### Table of Contents





| |  | regarding UNEs; and
| |  | -------------------



| |  | 43% decline in revenues in CALA primarily due to service provider
capital spending restrictions; partially offset by
| | - | --------------------------------------------------------------------------------------------------------------------



| |  | 8% increase in revenues in EMEA primarily due to increased demand for
our traditional circuit switching products.
| | - | -----------------------------------------------------------------------------------------------------------------



| |  | First nine months of 2003 vs. first nine months of 2002
| |  | -------------------------------------------------------

Wireline Networks revenues declined 15% in the first nine months of 2003
compared to the same period in 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 nine months of 2003 compared to the same period in
2002 primarily due to a substantial decrease in our traditional circuit
switching product revenues and also uncertainty related to the impact of the
recent FCC decision regarding UNEs. The decline in our circuit switching
revenues was primarily due to the continuing impact of capital spending
restrictions experienced by our service provider customers during the first
nine months of 2003 and tightened capital markets mainly during the first half
of 2003. Revenues from our packet voice solutions increased substantially in
the United States and Canada in the first nine months of 2003 compared to the
first nine months of 2002 primarily due to new service provider contracts
throughout 2003 and some incremental one time shipments in the first quarter of
2003 related 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 in the first nine months of 2003 compared to the first nine months of
2002 primarily due to significant declines in Asia Pacific, Canada and the
United States and a substantial decline in CALA. 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 15% decline in Wireline Networks revenues in
the first nine months of 2003 compared to the same period in 2002 was primarily
due to a:



| |  | 70% 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;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 12% decline in revenues in the United States primarily due to the
continuing impact of capital spending restrictions
experienced by our service provider customers, tightened capital markets
mainly during the first half of 2003 and also uncertainty related to the
impact of the recent FCC decision regarding UNEs;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 15% decline in revenues in Asia Pacific primarily due to capital
spending restrictions experienced by our service provider customers; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------



| |  | 5% decline in revenues in EMEA primarily due to a reduction in
capital spending by service provider customers during the first nine
months of 2003 and tightened capital markets mainly during the first
half of 2003.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q3 2003 vs. Q2 2003
| |  | -------------------

Our Wireline Networks revenues decreased 11% in the third quarter of 2003
compared to the second quarter of 2003 primarily due to:



| |  | a significant decline in the circuit and packet voice portion of this
segment, primarily in the United States and EMEA, due to a significant
decrease in our circuit switching product revenues resulting from
continued cautious spending by our service provider customers; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a moderate decrease in the data networking and security portion of
this segment primarily due to continued cautious spending by our United
States service provider customers.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, Wireline Networks revenues decreased 11% in the
third quarter of 2003 compared to the second quarter of 2003 primarily as a
result of a 20% decrease in the United States, a 7% decline in EMEA and a 23%
decline in Canada, partially offset by a 24% increase in revenues in Asia
Pacific.



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

We anticipate that service provider customers 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

58



---



##### Table of Contents



while limiting capital expenditures and operating costs. Although we
experienced an increase in revenues in our packet-based technologies in the
first nine months of 2003 compared to the same period in 2002, the timing of
when service provider customers 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 service
provider customers continue to assess its impact.
We expect that the continuing industry adjustment and reassessment of capital
spending by our customers may have a further 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:

(BAR GRAPH-QUARTERLY REVENUES FOR OPTICAL NETWORKS)



| |  | Q3 2003 vs. Q3 2002
| |  | -------------------

Optical Networks revenues declined 21% in the third quarter of 2003 compared to
the third quarter of 2002. This decline was primarily due to the continuing
industry adjustment and continued reductions in capital spending by our
customers in EMEA, Asia Pacific and United States in both the long-haul and
metro optical portions of this segment.

Revenues in the long-haul portion of this segment decreased substantially in
the third quarter of 2003 compared to the third quarter of 2002. The
substantial decline was primarily due to a substantial decline in 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. In addition,
significant excess inventories continued to exist in this portion of Optical
Networks which resulted in ongoing pricing pressures across all regions.

In the fourth quarter of 2002, we sold certain optical components assets to
Bookham Technology plc, or Bookham. As a result, our third quarter results in
2003 in the long-haul portion of this segment do not reflect revenues generated
from these assets. In the third quarter of 2002, revenues generated from the
optical components assets sold to Bookham were approximately 5% of the total
revenues of $309. For additional information related to the sale of these
assets to Bookham, you should refer to the information contained in our 2002
Annual Report.

Revenues in the metro optical portion of this segment decreased significantly
in the third quarter of 2003 compared to the third quarter of 2002. The
significant decline in revenues was primarily due to substantial declines in
the United States and Asia Pacific as a result of the continuing industry
adjustment and capital spending restrictions by customers. As well, in Asia
Pacific, certain customer upgrades and expansions to meet increased customer
demand that were originally scheduled to occur in the second half of 2003 were
completed in the first half of 2003.

From a geographic perspective, the 21% decline in Optical Networks revenues in
the third quarter of 2003 compared to the third quarter of 2002 was primarily
due to a:



| |  | 38% decline in revenues in EMEA primarily related to a substantial
reduction in capital spending as a result of the continuing industry
adjustment and customers continuing to focus on maximizing return on
invested capital;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 22% decline in revenues in Asia Pacific primarily due to the
completion of certain customer upgrades and expansions to meet increased
customer demand in the first half of 2003 which were originally
scheduled to occur in the second half of 2003; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 11% decline in revenues in the United States primarily related to a
substantial reduction in capital spending as a result of the continuing
industry adjustment and customers continuing to focus on maximizing
return on invested capital.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

59



---



##### Table of Contents





| |  | First nine months of 2003 vs. first nine months of 2002
| |  | -------------------------------------------------------

Optical Networks revenues declined 28% in the first nine months of 2003
compared to the same period in 2002. These
declines were primarily the result of the continuing industry adjustment,
tightened capital markets mainly during the first half of 2003 and reductions
in capital spending by our United States, Canada and EMEA customers in both the
long-haul and metro portions of this segment.

Revenues in the long-haul portion of this segment declined substantially in the
first nine months of 2003 compared to the first nine months of 2002. The
substantial decline was primarily due to the continuing industry adjustment,
tightened capital markets mainly during the first half of 2003 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 across all regions.

As mentioned above, our long-haul revenues in the first nine months of 2003 do
not reflect revenues generated from the optical components assets sold to
Bookham. In the first nine months of 2002, revenues associated with these
assets were approximately 5% of the total Optical Networks revenues of $1,120.

Revenues in the metro optical portion of this segment decreased significantly
in the first nine months of 2003 compared to the first nine months of 2002.
The significant decrease was primarily due to substantial declines 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 mainly during the first half of 2003 and customer
spending restrictions. The substantial increase in revenues in Asia Pacific
was primarily due to new customer contracts during the first half of 2003 for
expansions of existing networks to meet increased customer demand.

From a geographic perspective, the 28% decline in Optical Networks revenues in
the first nine months of 2003 compared to the same period in 2002 was primarily
due to a:



| |  | 45% decline in EMEA, 30% decline in the United States and a 42%
decline in Canada primarily related to a substantial reduction in
capital spending as a result of the continuing industry adjustment,
tightened capital markets mainly during the first half of 2003 and
customers continuing to focus on maximizing return on invested capital;
and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 28% decline in CALA primarily related to a reduction in capital
spending and excess network capacity and assets; partially offset by
| | - | ------------------------------------------------------------------------------------------------------------------------------------



| |  | 14% increase in Asia Pacific primarily due to new customer contracts
for expansions of existing networks to meet increased customer demand.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | Q3 2003 vs. Q2 2003
| |  | -------------------

Optical Networks revenues decreased 18% in the third quarter of 2003 compared
to the second quarter of 2003 primarily reflecting the global weakness of the
optical long-haul market. Revenues associated with the optical long-haul
portion of this segment decreased substantially due to declines in all regions
caused by the continuing industry adjustment and capital spending restrictions
by customers.

From a geographic perspective, Optical Networks revenues decreased 18% in the
third quarter of 2003 compared to the second quarter of 2003 primarily as a
result of a 25% decrease in revenues in the United States and a 30% decrease in
Asia Pacific partially offset by a 26% increase in revenues in Canada.



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

Our major customers in the optical long-haul portion of Optical Networks 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 in the near term will be
increasingly directed to opportunities that enhance customer performance,
revenue generation and cost reduction. Further, we believe that building out
new networks for increased bandwidth will remain long term projects.

On August 10, 2003, we essentially finalized the realignment of Optical
Networks with the sale of certain assets of our high speed module operations.
We do not expect that the sale of these assets will have a material impact on
our business, results of

60



---



##### Table of Contents



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
transformation towards packet-based networks.

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 overall Optical Networks
revenues.

Due to the severe reduction in the number and size of new optical long-haul
network build-outs and due to the nature of the relationship between the
products within the optical long-haul portion of this segment, it is difficult
to predict when a meaningful recovery in the optical long-haul market will
occur. 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 September 30,
    
    
    9 months ended September 30,2003
    
    
    2002
    
    
    Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    Change
    
    
    % ChangeGross profit
    
    $
    1,177
    
    
    $
    849
    
    
    $
    328
    
    
    
    39
    
    
    $
    3,252
    
    
    $
    2,543
    
    
    $
    709
    
    
    
    28Gross margin
    
    
    51.9
    %
    
    
    36.1
    %
    
    15.8 pts
    
    
    44
    
    
    
    46.6
    %
    
    
    31.7
    %
    
    14.9 pts
    
    
    47


Gross margin improved 15.8 percentage points in the third quarter of 2003
compared to the third quarter of 2002 primarily due to:



| |  | an increase of approximately 6 percentage points related to reduced
inventory provisioning and other operations related costs in the third
quarter of 2003 compared to the same period in 2002;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of approximately 4 percentage points related to favorable
changes in product mix;
| | - | ---------------------------------------------------------------------------------------------



| |  | an increase of approximately 3 percentage points related to continued
improvements in our cost structure primarily as a result of favorable
supplier pricing which was partially offset by continued pricing
pressures on the sale of certain of our products; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of approximately 2 percentage points related to a
reduction in accruals of $52 associated with a customer contract
settlement with one of our Optical Networks customers.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Gross margin also improved 14.9 percentage points in the first nine months of
2003 compared to the same period in 2002 primarily due to:



| |  | an increase of approximately 9 percentage points related to reduced
inventory provisioning, contract and customer settlement costs and other
operations related costs in the first nine months of 2003 compared to
the same period in 2002;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of approximately 4 percentage points related to continued
improvements in our cost structure primarily as a result of favorable
supplier pricing which was partially offset by continued pricing
pressures on the sale of certain of our products; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of approximately 2 percentage points related to favorable
changes in product mix; 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 nine months 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. The gross margin for the third quarter of 2003 benefited from
certain factors that are not expected to be repeated and, as a result, we
expect that gross margin will trend in the mid-40% range in the near term. See
Forward looking statements for factors that may affect our gross margins.



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

61



---



##### Table of Contents





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

Wireless Networks gross margin improved by approximately 12 percentage points
in the third quarter of 2003 compared to the third quarter of 2002 and by
approximately 8 percentage points in the first nine months of 2003 compared to
the same period in 2002. These improvements were primarily due to:



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



| |  | improvements in our product costs primarily due to favorable material pricing; and
| | - | ----------------------------------------------------------------------------------



| |  | improvements in other operations related costs.
| | - | -----------------------------------------------



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

Enterprise Networks gross margin improved by approximately 4 percentage points
in the third quarter of 2003 compared to the third quarter of 2002. The
improvement in gross margin was primarily due to:



| |  | improvements in our product costs primarily as a result of favorable
material 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;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the resolution of certain supplier claims in the third quarter of
2003 which were not experienced in the third quarter of 2002; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | reduced inventory provisioning in the third quarter of 2003 as a
result of our inventory levels being better aligned to customer demand.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

Enterprise Networks gross margin improved by approximately 5 percentage points
in the first nine months of 2003 compared to the same period in 2002. The
improvement in gross margin was primarily due to:



| |  | improvements in our product costs primarily as a result of favorable
material 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
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | reduced inventory provisioning as a result of our inventory levels
being better aligned to customer demand and a decrease in other contract
and customer settlement costs.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

Wireline Networks gross margin increased by approximately 2 percentage points
in the third quarter of 2003 compared to the third quarter of 2002 primarily
due to:



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



| |  | reductions in other operations related costs.
| | - | ---------------------------------------------

Wireline Networks gross margin increased by approximately 5 percentage points
in the first nine months of 2003 compared to the first nine months of 2002.
These increases were primarily due to:



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



| |  | reductions in other operations related costs; and
| | - | -------------------------------------------------



| |  | reduced inventory provisioning as a result of our inventory levels
being better aligned to customer demand and a decrease in other contract
and customer settlement costs.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

Optical Networks gross margin improved by approximately 62 percentage points in
the third quarter of 2003 compared to the third quarter of 2002. The
improvement in gross margin was primarily due to:



| |  | a reduction in accruals of $52 associated with a customer contract settlement;
| | - | ------------------------------------------------------------------------------



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



| |  | reduced inventory provisioning in the third quarter of 2003 compared to the same period in 2002;
| | - | ------------------------------------------------------------------------------------------------

62



---



##### Table of Contents





| |  | the sale of certain optical components assets to Bookham in the
fourth quarter of 2002 and, as a result, our gross margin in the third
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 favorable
supplier pricing which was partially offset by continued pricing
pressures on the sale of certain products.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Optical Networks gross margin improved by approximately 61 percentage points in
the first nine months of 2003 compared to the same period in 2002. The
improvement in gross margin was primarily due to:



| |  | reduced inventory provisioning and other contract and customer settlement costs in the first nine months of 2003;
| | - | -----------------------------------------------------------------------------------------------------------------



| |  | 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 nine months of 2003 excluded the
impact of excess capacity of those optical components assets; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | improvements in our cost structure primarily as a result of 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 September 30,
    
    
    9 months ended September 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeSG&A expense
    
    $
    482
    
    
    $
    695
    
    
    $
    (213
    )
    
    
    (31
    )
    
    $
    1,408
    
    
    $
    2,150
    
    
    $
    (742
    )
    
    
    (35
    )As % of revenues
    
    
    21.3
    %
    
    
    29.6
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    20.2
    %
    
    
    26.8
    %
    
    
    N/A
    
    
    
    N/A


Selling, general and administrative, or SG&A, expense declined $213 in the
third quarter of 2003 compared to the third 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;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | a reduction in accruals of $16 in the third quarter of 2003
associated with a customer contract settlement with one of our Optical
Networks customers; partially offset by
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase in accruals related to our restricted stock unit program
for senior executives which are allocated across all of our reportable
segments.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

In the first nine months of 2003, SG&A expense declined $742 compared to the
same period in 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;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | net customer financing bad debt recoveries during the first nine
months of 2003 primarily as a result of favorable settlements related to
our customer financing activities and adjustments to other existing
provisions; partially offset by
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | accruals in the first nine months of 2003 for the employee return to
profitability bonus plan for which no similar accrual was made in the
first nine months of 2002; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase in accruals related to our stock based compensation,
including restricted stock unit and stock option programs, both of which
are allocated across all of our reportable segments.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

63



---



##### Table of Contents





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



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

Wireless Networks SG&A expense increased significantly in the third quarter of
2003 compared to the third quarter of 2002 primarily due to an increase in the
accrual related to the restricted stock unit program.

Wireless Networks SG&A expense decreased significantly in the first nine months
of 2003 compared to the same period in 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; partially offset by
| | - | --------------------------------------------------------------------------------------------



| |  | an increase in accruals related to the restricted stock unit program.
| | - | ---------------------------------------------------------------------



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

Enterprise Networks SG&A expense decreased significantly in both the third
quarter of 2003 compared to the third quarter of 2002 and the first nine months
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 third
quarter of 2003 compared to the third quarter of 2002 and the first nine months
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 third quarter
of 2003 compared to the third quarter of 2002 and the first nine months 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;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | a reduction in accruals of $16 in the third quarter of 2003
associated with a customer contract settlement; partially offset by
| | - | -------------------------------------------------------------------------------------------------------------------------------



| |  | an increase in accruals related to the restricted stock unit program.
| | - | ---------------------------------------------------------------------



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

64



---



##### Table of Contents



3 months ended September 30,
    
    
    9 months ended September 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    410
    
    
    $
    278
    
    
    $
    132
    
    
    
    47
    
    
    $
    1,073
    
    
    $
    861
    
    
    $
    212
    
    
    
    25Enterprise Networks
    
    
    141
    
    
    
    108
    
    
    
    33
    
    
    
    31
    
    
    
    379
    
    
    
    289
    
    
    
    90
    
    
    
    31Wireline Networks
    
    
    138
    
    
    
    98
    
    
    
    40
    
    
    
    41
    
    
    
    469
    
    
    
    330
    
    
    
    139
    
    
    
    42Optical Networks
    
    
    92
    
    
    
    (125
    )
    
    
    217
    
    
    
    174
    
    
    
    131
    
    
    
    (756
    )
    
    
    887
    
    
    
    117Other
    
    
    (86
    )
    
    
    (205
    )
    
    
    119
    
    
    
    58
    
    
    
    (208
    )
    
    
    (331
    )
    
    
    123
    
    
    
    37Consolidated
    
    $
    695
    
    
    $
    154
    
    
    $
    541
    
    
    
    351
    
    
    $
    1,844
    
    
    $
    393
    
    
    $
    1,451
    
    
    
    369


As a result of the gross margin and SG&A expense changes discussed above, our
consolidated contribution margin improved by $541 in the third quarter of 2003
compared to the third quarter of 2002 and by $1,451 in the first nine months of
2003 compared to the first nine months of 2002. All of our four reportable
segments contributed positive contribution margin in the third quarter and
first nine months of 2003.



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

3 months ended September 30,
    
    
    9 months ended September 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeR&D expense
    
    $
    480
    
    
    $
    544
    
    
    $
    (64
    )
    
    
    (12
    )
    
    $
    1,454
    
    
    $
    1,667
    
    
    $
    (213
    )
    
    
    (13
    )As % of revenues
    
    
    21.2
    %
    
    
    23.2
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    20.8
    %
    
    
    20.7
    %
    
    
    N/A
    
    
    
    N/A


Research and development, or R&D, expense decreased $64 in the third quarter of
2003 compared to the third 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 $213 in the first nine months of 2003 compared to
the same period in 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 nine months 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 the current volume of our business. 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:



| |  | strategic 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------

We expect that our 2003 fourth quarter R&D expense will be similar to that of
the third quarter of 2003. Further, 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 third quarter of 2003, we recorded special charges of $70 related to our
continued restructuring work plan. Included in this charge was a reduction of
$9 related to net revisions to prior accruals. Workforce reduction charges of
$73 related to the
cost of severance and benefits across all segments associated with
approximately 200 employees notified of termination during the third quarter of
2003. Net revisions of $1 to increase prior accruals related to changes in
estimates associated with termination benefits that were higher than originally
estimated. Contract settlement and lease costs were $5 and related to leased
facilities and furniture that were no longer being used. These costs extended
across all segments. Net revisions of $10

65



---



##### Table of Contents



to reduce prior accruals primarily
related to changes in estimates associated with the cost of vacating previously
identified properties and changes in sublease revenue assumptions across all
segments. Also, we recorded a charge of $1 for current period write downs
related to various leasehold improvements and excess Optical Networks
equipment.

In the first nine months of 2003, we recorded special charges of $180 related
to our continued restructuring work plan. Included in this charge was a
reduction of $79 related to revisions to prior accruals. Workforce reduction
charges of $163 related to the cost of severance and benefits associated with
approximately 1,300 employees notified of termination during the first nine
months of 2003 which extended across all segments. Net revisions of $34 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 $51 and related to newly identified leased
facilities and furniture, across all segments, which we determined were no
longer being used. Net revisions of $8 were recorded to reduce prior accruals
related to changes in estimates associated with the cost of vacating previously
identified properties and changes in sublease revenues across all segments.
Also, we recorded charges of $45 related to current period write downs for
various leasehold improvements and excess Optical Networks equipment. Net
revisions of $37 to reduce prior accruals related to adjustments in our
original plans or estimates for the closure of certain facilities.

In the third quarter of 2002, we recorded special charges of $827 related to
our restructuring work plan. Included in this charge was an increase of $13
related to revisions to prior accruals. Workforce reduction charges of $281
related to the cost of severance and benefits associated with approximately
3,500 employees notified of termination which extended across all segments.
Net revisions of $20 to increase prior accruals primarily related to
termination benefits where actual costs were higher than our original estimates
across all segments. Contract settlement and lease costs included negotiated
settlements of approximately $129 to either cancel contracts or renegotiate
existing contracts across all of our segments. Net revisions of $5 were
recorded to reduce prior accruals related to changes in estimates associated
with the cost of vacating previously identified properties and changes in
sublease revenues across all segments. Plant and equipment write downs of $52
primarily related to Optical Networks. Net revisions of $2 to reduce prior
accruals related to adjustments in our original plans or estimates for the
closure of certain facilities. Under Statement of Financial Accounting
Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, or SFAS 144, assets held for sale are to be measured at the lower of
their carrying amount or fair values less costs to sell. In the third quarter
of 2002, certain plant and equipment and inventory in Optical Networks met the
criteria of assets held for sale. Based on the expected fair value of these
assets to be realized on sale, we recorded a charge of $88 against their
carrying amounts. Also, as a result of the continued decline in both our
overall market value generally and within Optical Networks specifically, we
evaluated the goodwill associated with the businesses within Optical Networks
for potential impairment. The conclusion of those evaluations was that the
fair value associated with these businesses could no longer support the
carrying value of the remaining goodwill associated with them. As a result, we
recorded a goodwill write down of $264.

In the first nine months of 2002, we recorded special charges of $1,515 related
to our restructuring work plan. Included in this charge was a reduction of
$105 related to revisions to prior accruals. Workforce reduction charges of
$747 were related to the cost of severance and benefits associated with the
approximately 9,800 employees notified of termination which extended across all
segments. Net revisions of $59 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 included negotiated
settlements of approximately $198 to either cancel contracts or renegotiate
existing contracts across all of our segments. Net revisions of $37 were
recorded to reduce prior accruals related to changes in estimates associated
with the cost of vacating previously identified properties and changes in
sublease revenues across all segments. Plant and equipment write downs of $323
primarily related to Optical Networks. Net revisions of $9 to reduce prior
accruals related to adjustments in our original plans or estimates for the
closure of certain facilities. As mentioned above, SFAS 144 charges of $88
were recorded in the first nine months of 2002 to reflect the fair value of
assets held for sale and a goodwill write down of $264 was recorded to reflect
the impairment of certain businesses in Optical Networks.

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

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

Gain on sale of businesses

In the first nine months of 2003, gain on sale of businesses of $28 primarily
related to the recognition of the unamortized deferred gain of $21 on the sale
of substantially all of the assets of our Cogent Defence Systems business
during the year

66



---



##### Table of Contents



ended December 31, 2001. This remaining unamortized gain of
$21 was recognized in the third quarter of 2003 as a result of the sale of our
41% interest in EADS Telecom as discussed in Developments in 2003.

In the first nine months of 2002, gain on sale of businesses of $11 primarily
related to the sale of certain assets of our Service Commerce operation support
system business to MetaSolv, Inc.

Other income (expense)  net

In the first nine months of 2003, other income  net was $130, which primarily
included:



| |  | a gain of $76 related to the sale of our interest in EADS Telecom in
conjunction with the changes in ownership of our French and German
operations;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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.
| | - | ---------------------------------------------------------------

In the first nine months of 2002, other expense  net was $43, which primarily
related to the loss on sale or write down of certain minority investments,
partially offset by interest income on our short term investments.

Interest expense

Interest expense decreased $25 in the third quarter of 2003 compared to the
third quarter of 2002 and declined $65 in the first nine months of 2003
compared to the same period in 2002. These declines were primarily due to a
reduction in the outstanding balances of our notes payable and long-term debt.

We expect that our quarterly interest expense in the fourth quarter of 2003
will remain at a level similar to that of the third quarter of 2003.

Income tax benefit

In the first nine months of 2003, we recorded an income tax expense of $43 on
pre-tax income of $288 from continuing operations before minority interests and
equity earnings in net loss of associated companies. This tax expense resulted
from various non-income related taxes and the draw down of our deferred tax
assets and current income tax provisions in taxable jurisdictions, partially
offset by the recognition of tax refunds received in the period.

In the first nine months of 2002, we recorded a tax benefit of $802, which was
partially offset by the recognition of a certain additional valuation allowance
of $372, on a pre-tax loss of $2,983 from continuing operations before minority
interests and equity earnings in net loss of associated companies. Consistent
with our quarterly review procedures, in the third quarter of 2002, we
performed an evaluation of the recoverability of our deferred income tax assets
and determined that it was appropriate to recognize a certain additional income
tax valuation allowance of $372. The increase in the valuation allowance was
attributable to the decline in our forecasted taxable income due to the
uncertainty regarding the timing of a meaningful recovery in the industry.

We will continue to assess the valuation allowance recorded against our
deferred tax assets on a quarterly basis. The valuation allowance is in
accordance with SFAS No. 109, Accounting for Income Taxes, which requires
that a tax valuation allowance 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 allowance is primarily attributed to continued
uncertainty in the industry. If market conditions deteriorate further or
future results of operations are less than expected, an additional tax
valuation allowance may be required for all or a portion of our deferred tax
assets. For additional information, see Tax asset valuation.

Net earnings (loss) from continuing operations

As a result of the items discussed under our results of operations, net
earnings was $186 in the third quarter of 2003. This amount represented an
improvement of $1,557 compared to our net loss of $1,371 in the third quarter
of 2002. Also, our net
earnings in the first nine months of 2003 was $192 which excluded the
cumulative effect of accounting change  net of tax, of $8. Our net earnings
in the first nine months of 2003 represented an improvement of $2,765 compared
to our net loss of

67



---



##### Table of Contents



$2,573 in the first nine months of 2002.

Results of operations  discontinued operations

During the third quarter of 2003, net earnings from discontinued operations of
$44 (net of tax) primarily related to gains associated with cash settlements of
certain receivables and notes including the cash payment of a subordinated,
unsecured promissory note receivable by Netgear.

During the first quarter of 2003, we substantially completed the wind-down of
our access solutions operations and recorded net earnings of $162 (net of tax)
related to the sale of certain components of this business. The $162 in net
earnings was primarily related to a $101 gain from the disposition of certain
shares and a membership interest in certain Arris 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 15 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 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 related to our critical
accounting policies, see our 2002 Annual Report.

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 adopted this guidance
prospectively for all revenue arrangements entered into after June 30, 2003 and
the adoption of this pronouncement did not have a material impact on our
business, results of operations and financial condition. For additional
information, see Accounting for revenue arrangements with multiple
deliverables in note 3(g) of the accompanying unaudited consolidated financial
statements.

Provisions for receivables

We recorded receivable recoveries, related to continuing operations, of $66 in
the first nine months of 2003. We recorded receivable provisions, related to
continuing operations, of $278 during the same period in 2002. The receivable
recoveries of $66 in the first nine months of 2003 primarily related to
significant trade and customer financing receivable recoveries mainly as a
result of favorable settlements related to our sale or restructuring of various
receivables. These recoveries were partially offset by receivable provisions
recorded during the first nine months of 2003 related to our normal business
activity. The receivable provisions recorded in the first nine months of 2002
primarily related to the financial difficulties of several of our service
provider and enterprise customers as a result of the significant industry
adjustment.

The following table summarizes our accounts receivable and long-term receivable
balances and related reserves of our continuing operations as at:

68



---



##### Table of Contents



September 30,
    
    
    December 31,2003
    
    
    2002Gross accounts receivable
    
    $
    2,527
    
    
    $
    2,763Related reserves
    
    
    (277
    )
    
    
    (516
    )Net accounts receivable
    
    $
    2,250
    
    
    $
    2,247Accounts receivable reserves as a percentage of gross accounts receivable
    
    
    11
    %
    
    
    19
    %Gross long-term receivables
    
    $
    366
    
    
    $
    1,001Related reserves
    
    
    (294
    )
    
    
    (736
    )Net long-term receivables
    
    $
    72
    
    
    $
    265Long-term receivable reserves as a percentage of gross long-term receivables
    
    
    80
    %
    
    
    74
    %


Throughout 2002, we recorded significant provisions related to receivables from
our continuing operations. In the first nine months 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, related to continuing operations, of $134 in the
first nine months of 2003 compared to $488 during the same period in 2002. The
decrease in inventory provisions and other provisions was primarily due to our
inventory levels being better aligned to customer demand in 2003 compared to
2002. The following table summarizes our inventory balances and related
reserves of our continuing operations as at:

September 30,
    
    
    December 31,2003
    
    
    2002Gross inventory
    
    $
    1,916
    
    
    $
    2,056Related reserves
    
    
    (988
    )
    
    
    (1,070
    )Net inventory
    
    $
    928
    
    
    $
    986Inventory reserves as a percentage of gross inventory
    
    
    52
    %
    
    
    52
    %Other reserves for claims related to our contract manufacturers and suppliers(a)
    
    
    (129
    )
    
    
    (167
    )


|(a) |  | This amount was included in other accrued liabilities and related to
cancellation charges, inventory in excess of future demand and the
settlement of certain other claims.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During the remainder of 2003, we believe that we will generally 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

Our net deferred tax asset balance was $3,359 at September 30, 2003 and $3,080
at December 31, 2002. We currently have deferred tax assets resulting from net
operating loss carryforwards, tax credit carryforwards and deductible temporary
differences, all of which will reduce future taxes payable in our significant
tax jurisdictions. These carryforwards expire at various dates beginning in
2003. 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 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

69



---



##### Table of Contents



determination that some or all of the net deferred tax assets are not
realizable. As a result, we may need to establish an additional tax valuation
allowance for all or a portion of the net deferred tax assets, which may have a
material adverse effect on our business, results of operations and financial
condition.

Goodwill valuation

We perform our annual test for the possible impairment of goodwill on October 1
of each year. Commencing January 1, 2002, we test goodwill for possible
impairment on an annual basis and at any other time if an event occurs or
circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. Circumstances that could trigger an
impairment test include, but are not limited to:



| |  | a significant adverse change in legal factors or in the business climate;
| | - | -------------------------------------------------------------------------



| |  | an adverse action or assessment by a regulator;
| | - | -----------------------------------------------



| |  | unanticipated competition;
| | - | --------------------------



| |  | loss of key personnel;
| | - | ----------------------



| |  | the likelihood that a reporting unit or a significant portion of a reporting unit will be sold or disposed of;
| | - | --------------------------------------------------------------------------------------------------------------



| |  | results of testing for recoverability of a significant asset group within a reporting unit; and/or
| | - | --------------------------------------------------------------------------------------------------



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

The determination as to whether a write down of goodwill is necessary involves
significant judgment based on the short-term and long-term projections of the
future performance of the reporting unit to which the goodwill is attributed.
The assumptions supporting the estimated future cash flows of the reporting
unit, including the discount rate used and estimated terminal value, reflect
our best estimates.

The carrying value of goodwill was $2,053 at September 30, 2003 and $2,021 at
December 31, 2002. The increase in goodwill primarily related to our
acquisition of the minority interests in our French and German operations as
discussed in Developments in 2003. For additional information on this
transaction, including the allocation of the purchase price, see Nortel
Networks Germany and Nortel Networks France in note 8 of the accompanying
unaudited consolidated financial
statements.

Pension and post-retirement benefits

During the first nine months of 2003, we made $54 in required cash
contributions to our registered defined benefit pension plans as well as
additional voluntary contributions of $170. We expect to make additional
required cash contributions of approximately $24 in the fourth quarter of 2003.
Subject to the impact of global capital markets and interest rate
fluctuations, we expect to make required cash contributions in 2004 under
applicable legislation in amounts similar to those required in 2003.

If the actual operation of the defined benefit plans differs from the
assumptions disclosed in our 2002 Annual Report, additional contributions by us
may be required. If we are required to make significant contributions to fund
the defined benefit plans, reported results could be materially and adversely
affected and our cash flow available for other uses may be significantly
reduced.

Liquidity and capital resources

Cash flows

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

70



---



##### Table of Contents



9 months ended September 30,2003
    
    
    2002Net cash used in operating activities of continuing operations
    
    $
    (605
    )
    
    $
    (559
    )Net cash from (used in) investing activities of continuing operations
    
    
    267
    
    
    
    (334
    )Net cash from (used in) financing activities of continuing operations
    
    
    (327
    )
    
    
    1,145Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    97
    
    
    
    16Net cash from continuing operations
    
    
    (568
    )
    
    
    268Net cash from discontinued operations
    
    
    318
    
    
    
    337Net increase in cash and cash equivalents
    
    
    (250
    )
    
    
    605Cash and cash equivalents at beginning of period
    
    
    3,743
    
    
    
    3,404Cash and cash equivalents at end of period
    
    $
    3,493
    
    
    $
    4,009


As of September 30, 2003, our primary source of liquidity was our current cash
and cash equivalents, or cash. At September 30, 2003, we had cash of $3,493
excluding $113 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 changes from what 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 $605 due to net earnings from
continuing operations of $192, plus an adjustment of $518 for non-cash and
other items, less an adjustment of $1,315 related to the net decrease in our
operating assets and liabilities. The net decrease of $1,315 in our operating
assets and liabilities was primarily due to:



| |  | an increase of $22 in accounts
receivable mainly due to increased cash collections;
| | - | -----------------------------------------------------------------------------------



| |  | an increase of $98 in
inventories mainly due to product shipments exceeding additions to
inventories during the first nine months of 2003;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of $23 in income
taxes;
| | - | -----------------------------------



| |  | a decrease of $448 related to
restructuring payments;
| | - | -----------------------------------------------------



| |  | a decrease of $1,010 related to
our other operating assets and liabilities primarily as a result of
the proportionate decrease in these assets and liabilities as a
result of the decline in sales volumes and the associated size of our
business and the settlement of the liability associated with the put
option related to the sale of our interest in EADS Telecom in
conjunction with the changes in ownership of our French and German
operations.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As a result of previously incurred tax losses and
tax credits, we do not expect that will have to make significant cash
income tax payments for the foreseeable future.

Cash flows from investing activities were $267 and were primarily due to a net
decrease of $195 in long-term receivables primarily due to cash collections of
outstanding customer financing amounts associated with two customers, a
decrease of $147 in restricted cash and cash equivalents held as cash
collateral for certain bid, performance related and other bonds, proceeds of
$22 from the sale of plant and equipment and proceeds of $51 from the sale of
certain investments and businesses. These amounts were partially offset by $94
in plant and equipment expenditures and $54 associated with acquisitions of
certain investments and businesses. For the year 2003, we expect that our
plant and equipment purchases will decline substantially from the $335 in
purchases we made in 2002.

Cash flows used in financing activities were $327 and were primarily due to
$267 used to reduce our long-term debt, a reduction of our notes payable by
a net of $39 and $18 in preferred share dividends.

Uses of liquidity

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



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



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



| |  | costs relating to workforce reduction and other restructuring activities;
| | - | -------------------------------------------------------------------------



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



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



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



| |  | customer financings.
| | - | --------------------

71



---



##### Table of Contents



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 $100 to $125 in restructuring work plan
related cash outflows during the fourth quarter of 2003. For the entire year
2003, we currently expect to incur approximately $550 to $600 in restructuring
work plan related cash outflows.

As of September 30, 2003, the remaining balance sheet reserve of $93 related to
workforce reduction initiatives and is expected to be substantially drawn down
by mid-2004. The remaining balance sheet reserve of $490, net of approximately
$353 in estimated sublease revenues, related to contract settlement and lease
costs is expected to be substantially drawn down by the end of 2010.



| |  | 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 in our 2002 Annual Report except for the
following changes noted below.

During the first nine months of 2003, our remaining cash obligations under our
operating leases decreased by $247 from $1,671 at December 31, 2002 to $1,424
at September 30, 2003 as a result of normal business activity. Also in 2003,
we have made all required cash contributions to our registered defined benefit
pension plans as well as additional voluntary contributions, totaling
approximately $224.

In the third quarter of 2003, we repaid the remaining $164 of our 6.00% Notes
that were due September 1, 2003. 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.



| |  | 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 which might become due under these bonds would be
related to our non-performance under the applicable contract. 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 following table provides information related to these types of bonds as at:

September 30,
    
    
    December 31,2003
    
    
    2002Bid and performance related bonds(a)
    
    $
    422
    
    
    $
    400Other bonds(b)
    
    
    48
    
    
    
    35Total bid, performance related and other bonds
    
    $
    470
    
    
    $
    435


|(a) |  | Net of restricted cash and cash equivalents of $53 as at September 30,
2003 and $195 as at December 31, 2002.
|--- |  | -------------------------------------------------------------------------------------------------------------
|(b) |  | Net of restricted cash and cash equivalents of $37 as at September 30,
2003 and $19 as at December 31, 2002. 

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 higher 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.

72



---



##### Table of Contents



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 performance bonds
of which $131 was utilized as of September 30, 2003. The remainder is
uncommitted support for performance bonds, receivables sales and/or
securitizations of which $167 was utilized at September 30, 2003. 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. For additional information,
see Third party debt agreements in note 11(d) of the accompanying unaudited
consolidated financial statements.



| |  | 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.

During the third quarter of 2003, we renegotiated a key supply arrangement that
was initially put into place prior to the industry and economic downturn that
commenced in 2001. The renegotiated agreement is reflective of the current
market environment, and the terms include a reduction in our minimum spending
levels plus an extension in the time period, from 2004 to 2009, within which
these minimum levels must be met. As well, we are no longer obligated to
compensate the supplier for direct costs if the minimum spending levels are not
met. The renegotiated agreement includes a graduated liquidated damages remedy
for the benefit of the supplier if the minimum spending levels are not met by
the end of the agreement in 2009. However, based upon the renegotiated terms,
we expect to meet the minimum spending levels.



| |  | 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.

73



---



##### Table of Contents



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

September 30,
    
    
    December 31,2003
    
    
    2002Drawn and outstanding  gross
    
    $
    449
    
    
    $
    1,091Provisions for doubtful accounts
    
    
    (322
    )
    
    
    (799
    )Drawn and outstanding  net(a)
    
    
    127
    
    
    
    292Undrawn commitments
    
    
    116
    
    
    
    801Total customer financing
    
    $
    243
    
    
    $
    1,093


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

In the first nine months of 2003, we entered into certain agreements to
restructure and/or settle various customer financing and related receivables.
As a result of these transactions, we received cash consideration of
approximately $220 to settle outstanding receivables of approximately $600
(with a net carrying value of approximately $120). Also, we recorded net
customer financing bad debt recoveries of $53, primarily as a result of these
favorable settlements and adjustments to other
existing provisions.

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
minimizing our overall customer financing exposures in accordance with any
obligations under our financing agreements. During the first nine months of
2003, we reduced undrawn commitments by $685 as a result of the expiration or
cancellation of commitments and changing customer business plans. As of
September 30, 2003, approximately $84 of the $116 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. We continue to be
focused on the strategic use of our customer financing capacity.

We continue to regularly assess the levels of our customer financing provisions
based on a loan-by-loan review to evaluate whether the terms of each loan
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:



| |  | 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. 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 discussed in our Developments in 2003, 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 at that time in three European joint ventures.
During July 2003, the options and share exchange were exercised which, on
September 18, 2003, required us to deliver consideration of approximately $236
which included approximately $58 of cash, an in-kind component of approximately
$82 representing the return of a loan note that was owed to us by EADS Telecom
and our remaining shares of EADS Telecom.

74



---



##### Table of Contents



For additional information, see
Nortel Networks Germany and Nortel Networks France in note 8 of the
accompanying unaudited consolidated financial statements.

Discontinued operations

As of September 30, 2003, accruals related to our discontinued access solutions
operations totaled $82 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 nine months of 2003, we generated cash
of approximately $318 on the disposition of various assets from the access
solutions operations.

For additional information related to our discontinued operations, see
Discontinued operations in note 15 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 NNL and Nortel Networks Inc., or NNI, and
permit borrowings for general corporate purposes. As of September 30, 2003,
there were no amounts 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 be not less than $1,888 at
any time. As of September 30, 2003, we were in compliance with this covenant.
We continue to monitor our financial position in light of this covenant. If we
incur net losses or record additional charges related to our restructuring work
plan, the accounting of our registered pension plans, the valuation of deferred
income tax assets or for other events, our consolidated tangible net worth may
be reduced below the $1,888 threshold. If we are unable to comply with the
consolidated tangible net worth covenant, we will be unable to access the $750
April 2000 five year credit facilities.



| |  | Available support 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. The facility provides for up to $750 in support including:



| |  | $300 of committed revolving support for performance bonds or similar
instruments of which $131 was utilized as at September 30, 2003; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------



| |  | $450 of uncommitted support for performance bonds, receivables sales
and/or securitizations of which $167 was utilized as at September 30,
2003 (see Long-term debt, credit and support facilities in note 9 of
the accompanying unaudited consolidated financial statements).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As a result of an amendment on July 10, 2003, this facility expires on December
31, 2005. 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 that our debt
rating by Standard & Poors, or S&P, 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, NNL and NNI would also, as a result, be in default under the
$750 April 2000 five
year credit facilities and we and NNC would be in default under our outstanding
public debt.

Our obligations under the EDC support facility 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 NNCs 4.25%
convertible senior notes. The security provided under the security agreements
is comprised of:



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



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



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

75



---



##### Table of Contents



If our senior long-term debt rating by Moodys returns to Baa2 (with a stable
outlook) and our rating by S&P 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. Accordingly, if the EDC Support Facility is secured by
cash or other alternate collateral acceptable to EDC and if the $750 April 2000
five year credit facilities 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.

For additional information related 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 9 and 19, 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 19 of the
accompanying unaudited consolidated financial statements. For information
related 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, we and NNC 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 September 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.

Credit ratings

Rating on long-termdebt issued orguaranteed byNortel Networks
    
    
    Rating on preferredLimited/Nortel
    
    
    shares issued byNetworks
    
    
    Nortel NetworksRating agency
    
    Corporation
    
    
    Limited
    
    
    Last updateStandard & Poors Ratings Service
    
    
    B
    
    
    CCC
    
    
    September 4, 2003Moodys Investor Services, Inc.
    
    
    B3
    
    
    Caa3
    
    
    November 1, 2002


On September 4, 2003, S&P affirmed its ratings on Nortel Networks Limited,
including its B long-term corporate credit
rating. At the same time, it revised its outlook to stable from negative. On
October 24, 2003, S&P confirmed that its rating and outlook were unaffected by
our October 23, 2003 announcement that we intended to restate certain financial
statements. Moodys rating remained on negative outlook. There can be no
assurance that our credit ratings will not be lowered or that these ratings
agencies will not issue adverse commentaries, potentially resulting in higher
financing costs and reduced access to capital markets or alternative financing
arrangements. A reduction in 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 transactions through special purpose
entities. Our receivable sales transactions are

76



---



##### Table of Contents



generally conducted either
directly with financial institutions or with multi-seller conduits. Under some
of these agreements, we have continued as servicing agent and/or have provided
limited recourse. The fair value of these retained interests is based on the
market value of servicing the receivables, historical payment patterns and
appropriate discount rates as applicable. The amounts associated with any
servicing assets approximate our cost of servicing and, as such, no servicing
asset or liability has been recognized in our accompanying unaudited
consolidated financial statements. Also, we have not historically experienced
significant credit losses with respect to receivables sold with limited
recourse.

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 2002 Annual
Report except for items previously identified in our Contractual cash
obligations discussion.

Contingent liabilities and commitments



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

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



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

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



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

See Joint ventures/minority interests for additional information related 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 our credit and support facilities and security agreements;
| | - | ------------------------------------------------------------------------------------------------------



| |  | indemnification of counterparties in receivables securitization transactions; 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 11 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 related to our derivative financial instruments, you
should refer to Significant accounting policies

77



---



##### Table of Contents



in note 2(s) and Financial
instruments and hedging activities in note 11 of the consolidated financial
statements contained in our 2002 Annual Report.

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.

Historically, we have managed interest rate exposures using a diversified
portfolio of fixed and floating rate instruments denominated in several major
currencies. In all cases, we have managed exposures to interest rate
volatility using interest rate swaps which are intended to 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 2002 Annual
Report.

Legal proceedings

NNC 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 NNC 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 or officers, intend to vigorously defend these actions, suits,
claims, proceedings and investigations. For additional information related to
our legal proceedings, see Contingencies in note 17 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

78



---



##### Table of Contents



achieve sustained profitability and
meet the changes in industry and market conditions. We must manage the
potentially higher growth areas of our business, as well as the non-core areas,
in order for us to achieve sustained profitability.

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

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



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



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

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

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

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

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

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



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



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



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



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



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



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



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

79



---



##### Table of Contents





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



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



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



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



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



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



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



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



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

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

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

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

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

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



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



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



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



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



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



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



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



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



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



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



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



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



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

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

80



---



##### Table of Contents



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

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



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



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

According to the AICPA, a reportable condition is a matter that comes to an
auditors attention that represents a significant deficiency in the design or
operation of internal control that could adversely affect an entitys ability
to initiate, record, process
and report financial data consistent with the assertions of management in the
financial statements. A material weakness is a reportable condition in which
the design or operation of one or more of the internal control components does
not reduce to a relatively low level the risk that misstatements caused by
error or fraud in amounts that would be material in relation to the financial
statements being audited may occur and not be detected within a timely period
by employees in the normal course of performing their assigned functions.

The material weaknesses noted above, if not addressed, could result in
accounting errors such as those underlying the restatements of our consolidated
financial statements more fully discussed in note 2 of the accompanying
unaudited consolidated financial statements and Developments in 2003 
Restatements in the MD&A. Our failure to fully address these material
weaknesses could have a material adverse effect on our business, results of
operations and financial condition. Please see Item 4. Controls and Procedures
below.

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

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



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



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



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



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



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



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



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



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



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



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



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



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



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

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

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

Competition for certain key positions and specialized technical personnel in
the high-technology industry remains strong, despite current economic
conditions. We believe that our future success depends in part on our
continued ability to hire, assimilate in a timely manner and retain qualified
personnel, particularly in key senior management positions and in our key areas
of potential growth. An important factor in attracting and retaining qualified
employees is our ability to provide

81



---



##### Table of Contents



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

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

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

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

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

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



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



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



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



| |  | if operating cash flows are not sufficient to meet our operating
expenses, capital expenditures and debt service
| | - | ----------------------------------------------------------------------------------------------------------------

82



---



##### Table of Contents





| |  | requirements as they
become due, we may be required, in order to meet our debt service
obligations, to delay or reduce capital expenditures or the introduction
of new products, sell assets and/or forego business opportunities
including acquisitions, research and development projects or product
design enhancements.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

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

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

83



---



##### Table of Contents



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

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

We have risks related to our defined benefit plans.

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

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

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

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

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

We cannot be sure what the rate of such convergence of voice and data networks
will be, due to the dynamic and rapidly evolving nature of the communications
business, the technology involved and the availability of capital.
Consequently,

84



---



##### Table of Contents



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

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

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

The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. We expect our success to depend, in substantial
part, on the timely and
successful introduction of high quality, new products and upgrades, as well as
cost reductions on current products to address the operational speed,
bandwidth, efficiency and cost requirements of our customers. Our success will
also depend on our ability to comply with emerging industry standards, to
operate with products of other suppliers, to address emerging market trends, to
provide our customers with new revenue-generating opportunities and to compete
with technological and product developments carried out by others. The
development of new, technologically advanced products, including IP-optimized
networking solutions, software products and 3G wireless networks, is a complex
and uncertain process requiring high levels of innovation, as well as the
accurate anticipation of technological and market trends. Investments in such
development may result in expenses growing at a faster rate than revenues,
particularly since the initial investment to bring a product to market may be
high. We may not be successful in targeting new market opportunities, in
developing and commercializing new products in a timely manner or in achieving
market acceptance for our new products.

85



---



##### Table of Contents



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 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

86



---



##### Table of Contents



content requirements and type approvals, create
barriers to entry. In addition, pursuing international opportunities may
require significant investments for an extended period before we realize
returns on such investments, if any, and such investments may result in
expenses growing at a faster rate than revenues. Furthermore, such projects
and investments could be adversely affected by:



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



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



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



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



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



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



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



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



| |  | taxation;
| | - | ---------



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



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



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



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

Difficulties in foreign financial markets and economies and of foreign
financial institutions, particularly in emerging markets, could adversely
affect demand from customers in the affected countries. An inability to
maintain or expand our business in international and emerging markets could
have a material adverse effect on our business, results of operations and
financial condition.

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

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

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

87



---



##### Table of Contents



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

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

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

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

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

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

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

88



---



##### Table of Contents



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

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

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

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

We have entered into a number of strategic alliances with suppliers, developers
and members in our industry to facilitate product compatibility, encourage
adoption of industry standards or to offer complementary product or service
offerings to meet customer needs. In some cases, the companies with which we
have strategic alliances also compete against us in some of our business areas.
If a member of a strategic alliance fails to perform its obligations, if the
relationship fails to develop as expected or if the relationship is terminated,
we could experience delays in product availability or impairment of our
relationships with our customers.

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

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

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

Litigation and any potential regulatory proceeding or action may be time
consuming, expensive and distracting from the conduct of our business, and the
outcome of litigation and any potential regulatory proceeding or action is
difficult to predict. The adverse resolution of any specific lawsuit or any
potential regulatory proceeding or action could have a material adverse effect
on our business, results of operations and financial condition. To the extent
expenses incurred in connection with litigation or any potential regulatory
proceeding or action (which may include substantial fees of attorneys and other

89



---



##### Table of Contents



professional advisors and potential obligations to indemnify officers and
directors who may be parties to such actions) are not covered by available
insurance, such expenses could adversely affect our cash position.

Recent accounting pronouncements

There were no significant accounting pronouncements during the third quarter of
2003.

90



---



##### Table of Contents






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
(MD&A) and in our Annual Report on Form 10-K for the year ended December 31,
2002 filed with the SEC on March 10, 2003, subject to the restated financial
information described in the MD&A and in Restatements in note 2 of the
accompanying unaudited consolidated financial statements.




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 the Chief Financial
Officer, pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as
amended (the Exchange Act), of the effectiveness of the design and operation
of Nortel Networks disclosure controls and procedures. In connection with the
comprehensive and related reviews and work undertaken in connection with the
restatements of Nortel Networks financial statements for the years ended
December 31, 2000, 2001 and 2002 and the quarterly periods ended March 31 and
June 30, 2003 (as more fully described in note 2 to the accompanying unaudited
consolidated financial statements and Developments in 2003  Restatements in
the MD&A), Nortel Networks identified a number of deficiencies in Nortel
Networks internal control over financial reporting. In addition, as part of the
communications by our independent auditors Deloitte & Touche LLP (D&T) to the
Nortel Networks Audit Committee with respect to D&Ts interim audit procedures
for the year ending December 31, 2003, D&T informed the Audit Committee that
they had identified the following reportable conditions each of which
constituted a material weakness (as each such term is defined under standards
established by the American Institute of Certified Public Accountants) in the
Companys internal control:



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



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

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

Based on the evaluation described above and D&Ts communication to the Nortel
Networks Audit Committee, the President and Chief Executive Officer and the
Chief Financial Officer have concluded that these material weaknesses, if not
addressed, could result in accounting errors such as those underlying the
restatements of the Nortel Networks consolidated financial statements. In this
regard, Nortel Networks has already undertaken changes to its internal control
over financial reporting by initiating more thorough reviews of its balance
sheet accounts at appropriate levels within Nortel Networks finance
organization across all of its segments and major geographic regions. The
President and Chief Executive Officer and the Chief Financial Officer further
concluded, after taking into account such changes to internal control over
financial reporting undertaken by Nortel Networks, that the design and
operation of the Companys 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 of the material weaknesses identified above.



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

Nortel Networks initiated, and disclosed in its Quarterly Report on Form 10-Q
for the period ended June 30, 2003, a comprehensive review and analysis of its
assets and liabilities. On October 23, 2003, Nortel Networks announced it would
restate its consolidated financial statements for the years ended December 31,
2000, 2001 and 2002 and the fiscal quarters ended March 31, 2003 and June 30,
2003. The restatements primarily relate to the determination by Nortel
Networks that $948 of liabilities (primarily accruals and provisions) carried
on its previously reported balance sheet as at June 30, 2003

91



---



##### Table of Contents



needed to be released to income in prior periods. These provisions were either
initially recorded incorrectly in prior periods or not properly released or
adjusted for changes in estimates in the appropriate periods. In certain cases,
costs were incorrectly charged to operations rather than to the appropriate
provisions. Following its determination to restate its financial statements,
Nortel Networks also determined that it would correct certain known errors that
were previously not recorded because the amount of the errors was not material
to the consolidated financial statements. Specifically, among other items,
Nortel Networks has made certain revenue adjustments to reflect revenue which
should have been deferred instead of recognized in a particular period. Also,
as part of the restatements, Nortel Networks made adjustments to correct errors
relating to its deferred income tax assets and foreign currency translation
accounts. The net effect of the restatement adjustments to Nortel Networks
accumulated deficit as at June 30, 2003 was $492. Please see note 2 to the
accompanying unaudited consolidated financial statements and Developments in
2003  Restatements in the MD&A for further information concerning the
restatements and their impact on Nortel Networks financials statements.

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



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



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



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



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



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

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

With the exception of the items noted above, there has been no change in Nortel
Networks internal control over financial reporting during the quarter ended
September 30, 2003 that has materially affected or is reasonably likely to
materially affect our internal control over financial reporting.

92



---



##### Table of Contents






PART II

OTHER INFORMATION




ITEM 1. Legal Proceedings

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




ITEM 6. Exhibits And Reports On Form 8-K



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



|10.1 |  | Nortel Networks Limited SUCCESS Plan, as amended and restated on July 28,
2003 with effect from January 1, 2003.
|---- |  | ----------------------------------------------------------------------------------------------------------------



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



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



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



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



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



| |  | Nortel Networks Limited filed a Current Report on Form 8-K dated November
13, 2003 related to the expected timing for the filing of its Third
Quarter 2003 Form 10-Q.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

93



---



##### Table of Contents






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  
/s/ D.C. BEATTY
D.C. BEATTY
Chief Financial Officer
    
    Chief Accounting Officer  
/s/ M.J. GOLLOGLY
M.J. GOLLOGLY
Controller


Date: November 19, 2003

94