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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K þ
    
    Annual report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
 December 31, 2004
 o
    
    Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
 
 Commission file number 000-30758 Nortel Networks Limited  Canada
    
    62-12-62580(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)8200 Dixie Road, Suite 100, Brampton, Ontario, Canada
    
    L6T 5P6(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number including area code: (905) 863-0000 Securities registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registeredGuarantees of Nortel Networks Corporations
    
    New York Stock Exchange4.25% Convertible Senior Notes Due 2008
 Securities registered pursuant to Section 12(g) of the Act: Title of each class:   Common Shares without nominal or par value 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yesü          No At March 31, 2005, 1,460,978,638 common shares of Nortel Networks Limited were issued and
outstanding, all of which were held by Nortel Networks Corporation. The common shares of the
registrant are not traded on any stock exchange.




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TABLE OF CONTENTS PAGEPART IITEM 1.
    
    Business
    
    
    1Overview
    
    
    1Developments in 2004 and 2005
    
    
    2Networking solutions
    
    
    7Wireless Networks
    
    
    8Enterprise Networks
    
    
    11Wireline Networks
    
    
    14Optical Networks
    
    
    18Sales and distribution
    
    
    21Backlog
    
    
    21Product standards, certification and regulations
    
    
    21Sources and availability of materials
    
    
    22Seasonality
    
    
    23Strategic alliances, acquisitions and minority investments
    
    
    23Research and development
    
    
    24Intellectual property
    
    
    25Employee relations
    
    
    25Environmental matters
    
    
    27Financial information by operating segment and product category
    
    
    27Financial information by geographic area
    
    
    27Working capital
    
    
    27Risk factors
    
    
    27ITEM 2.
    
    Properties
    
    
    28ITEM 3.
    
    Legal Proceedings
    
    
    29ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    33PART IIITEM 5.
    
    Market for the
Registrants Common Equity and Related Stockholder Matters
    
    
    34Securities authorized for issuance under equity compensation plans
    
    
    34ITEM 6.
    
    Selected Financial Data
    
    
    35ITEM 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    37Business Overview
    
    
    39Developments in 2004 and 2005
    
    
    44Results of
operations  continuing operations
    
    
    52Results of
operations  discontinued operations
    
    
    76Liquidity and capital resources
    
    
    77Off-balance sheet arrangements
    
    
    88Application of critical accounting policies and estimates
    
    
    90Accounting changes and recent accounting pronouncements
    
    
    100Canadian supplement
    
    
    101Market risk
    
    
    102Equity price risk
    
    
    103Environmental matters
    
    
    104Legal proceedings
    
    
    104Risk factors/forward looking statements
    
    
    104ITEM 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    123
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PAGEITEM 8.
    
    Consolidated Financial Statements and Supplementary Data
    
    
    124ITEM 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    125ITEM 9A.
    
    Controls and Procedures
    
    
    126ITEM 9B.
    
    Other Information
    
    
    138PART IIIITEM 10.
    
    Directors and Executive Officers of the Registrant
    
    
    139Directors of the registrant
    
    
    139Executive officers and certain other non executive board appointed officers of the Registrant
    
    
    143Section 16(a) beneficial ownership reporting compliance
    
    
    146ITEM 11.
    
    Executive Compensation
    
    
    147Summary compensation tables
    
    
    147Annual cash incentive awards
    
    
    153Voluntary undertaking
    
    
    154Option grants in 2004 and 2003
    
    
    154Aggregate option exercises in 2004 and 2005 and year end option values
    
    
    155Long-term incentive plans awards in last two fiscal years
    
    
    157Retirement plans
    
    
    158Certain employment arrangements
    
    
    162Compensation of directors
    
    
    164Compensation committee interlocks and insider participation
    
    
    165ITEM 12.
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    166Security ownership of certain beneficial owners
    
    
    166Security ownership of directors and management
    
    
    166ITEM 13.
    
    Certain Relationships and Related Transactions
    
    
    169Indebtedness of management
    
    
    169Related party transactions
    
    
    170ITEM 14.
    
    Principal Accountant Fees and Services
    
    
    170Audit fees
    
    
    170Audit related fees
    
    
    171Tax fees
    
    
    171All other fees
    
    
    171PART IVITEM 15.
    
    Exhibits, Financial Statement Schedules
    
    
    172SIGNATURES
    
    
    180
 All dollar amounts in this
document are in United States dollars unless otherwise stated.           
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PART I 
  ITEM 1.
    BUSINESS 
 Overview Nortel Networks Limited is a recognized leader in delivering communications capabilities that
enhance the human experience, ignite and power global commerce, and secure and protect the worlds
most critical information. We offer converged multimedia networks that use innovative packet,
wireless, voice and optical technologies and are underpinned by high standards of security and
reliability. For both service providers and enterprises, these networks help to drive increased
profitability and productivity by reducing costs and enabling new business and consumer services
opportunities. Our networking solutions consist of hardware, software and services. Our business
consists of the design, development, manufacture, assembly, marketing, sale, licensing,
installation, servicing and support of these networking solutions. A substantial portion of our
business has a technology focus and is dedicated to making strategic investments in research and
development. This focus forms a core strength and is a factor that we believe differentiates us
from many of our competitors. We believe our acknowledged strength is strong customer loyalty as a
result of providing value to our customers through high reliability networks, a commitment to
ongoing support and an evolution of solutions as technology advancements in the products are made. Our networking solutions enable our service provider and enterprise customers to provide their own
customers or employees with services to communicate locally, regionally or globally through the use
of data, voice and multimedia communications. Our service provider customers include local and
long-distance communications companies, wireless service providers and cable operators. Our
networking solutions enable our service provider customers to deploy reliable, robust networks that
create opportunities to provide revenue-generating services and cost savings. Our enterprise
customers include large and small businesses, governments and institutions. Our networking
solutions enable our enterprise customers to deploy secure networks with seamless connectivity that
provide opportunities for cost efficiency and increased productivity. During 2004, our business was organized into four reportable segments: Wireless Networks;
Enterprise Networks; Wireline Networks; and Optical Networks. We refer you to the descriptions of
each of these segments below. Effective October 1, 2004, we established a new streamlined
organizational structure that included, among other things, combining the businesses of our four
reportable segments into two business organizations: (i) Carrier Networks and Global Operations,
and (ii) Enterprise Networks. We have reviewed the impact of these changes on our reportable
segments and concluded that, although certain structural changes were made to reflect this
reorganization effective October 1, 2004, we did not meet the accounting criteria to change our
reportable segments for the 2004 fiscal year. These two business organizations include four operating segments. The four operating segments are
Carrier Packet Networks, which is substantially an amalgamation of our previous Wireline Networks
and Optical Networks businesses; CDMA Networks, which was previously part of Wireless Networks; GSM
and UMTS Networks which was also previously part of Wireless Networks; and Enterprise Networks,
which remains substantially unchanged from the previous organization. For the first quarter of
2005 these four operating segments will become our reportable segments. For financial information by reporting segment and product category, see Segment information in
note 5 of the accompanying consolidated financial statements and Results of operations 
continuing operations  Segment revenues in Managements Discussion and Analysis of Financial
Condition and Results of Operations, or MD&A. The Companys principal executive offices are located at 8200 Dixie Road, Suite 100, Brampton,
Ontario, Canada, L6T 5P6, telephone number (905) 863-0000. The Company was incorporated in Canada
as the Northern Electric Company, Limited on January 5, 1914. The Company participated in a
corporate amalgamation with two of its wholly owned subsidiaries on January 14, 1982. The Company changed
its name to 1




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Northern Telecom Limited on March 1, 1976, to Nortel Networks Corporation on April 29,
1999, and to Nortel Networks Limited on May 1, 2000. On May 1, 2000, the Company participated in a
Canadian court-approved plan of arrangement with Nortel Networks Corporation, previously known as
New Nortel Inc., and BCE Inc., the largest shareholder of the Company prior to the plan of
arrangement, and changed its name to Nortel Networks Limited, or NNL. In connection with the plan
of arrangement, the Company became the principal operating subsidiary of Nortel Networks
Corporation. Where we say we, us, our or Nortel, we mean Nortel Networks Limited or Nortel Networks
Limited and its subsidiaries, as applicable. References to the Company mean Nortel Networks
Limited without its subsidiaries. Where we refer to the industry, we mean the telecommunications
industry. The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and all amendments to those reports available free of charge under Investor Relations
on our website at www.nortel.comas soon as reasonably practicable after we electronically file
this material with, or furnish this material to, the United States Securities and Exchange
Commission, or SEC. Information contained on our website is not incorporated by reference into
this or any other report filed with or furnished to the SEC. 
 Developments in 2004 and 2005 Business environment In 2004, there was increased spending in the industry compared to 2003 by both service provider and
enterprise customers as certain service provider customers began to expand and upgrade their
existing networks, including next generation wireless technologies
and Voice over Internet
Protocol, or IP, solutions. This increase in industry spending was
strongest with the build-out of
new technologies in both established and emerging markets and with the build-out of traditional
technologies in emerging markets. In 2005, we expect that these trends will continue; however, the
rate of increase may be slower. Although there was increased spending in the industry by both service provider and enterprise
customers in 2004, we experienced a decline in revenue compared to 2003. There was decreased
spending on our traditional technologies as customers continued to transition to next generation
technologies. This decreased spending on traditional technologies outpaced the increased spending
on new technologies with many of our customers realigning capital spending with their current
levels of earnings in order to maximize their return on invested capital. Also, excess network
capacity and competition continued to exist in the industry which led to continued pricing
pressures on the sale of certain of our products. However, based on current customer orders in
emerging markets, particularly in Asia and the Caribbean and Latin America region, or CALA,
increased deployments of Voice over IP and next generation wireless technologies, including
Universal Mobile Telecommunications System, or UMTS, we believe that we are well positioned to grow
our revenues in 2005. For example, throughout 2004 and into 2005 we announced several new contracts
across all of our reportable segments, but primarily in our Wireless Networks segment, as certain
service provider customers began to expand and upgrade their existing networks and new network
build outs were started in emerging markets. In 2005, we expect increased consolidation of certain service providers in the industry,
particularly in the U.S. We expect this trend to result in a net reduction in customer spending as
these service providers focus on improving the efficiency of their combined networks rather than
network expansion. Competition in the industry remains strong and our traditional large
competitors, newer competitors, particularly from China and certain smaller niche competitors
continue to increase their market share. We and our competitors remain focused on certain key
factors such as customer relationships, installed networks, innovative and reliable products,
services and price. 2




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For 2005, we expect overall revenue growth over 2004 primarily due to:  
    
    continued growth in our voice over packet technologies and our third generation
wireless technologies;
    
    expansion and enhancement of existing networks by our customers due to subscriber
growth and competitive pressures;
    
    build out of the Bharat Sanchar Nigram Limited, or BSNL, contract in the Asia Pacific
region;
    
    anticipated growth in our Enterprise Networks business, particularly in our converged
networks products;
    
    expected continued growth in metro optical and carrier Voice over IP; and
    
    expected focus on new product areas, such as, Wireless Local Area Networks, or WLAN,
and carrier routing. Revenue growth generated from spending by our customers in the above areas of our business is
expected to be partially offset by revenue declines from customers limiting their investments in
mature technologies as they focus on maximizing return on invested capital. In addition, we expect
to continue to experience pricing pressures on sales of certain of our products as a result of
increased competition, particularly from low cost suppliers. We also anticipate declines in
revenue due to consolidation of service providers which may reduce overall spending on telecom
equipment. Further, while customer support generally remains strong, the ongoing restatement
activities and the internal restructuring and realignment programs initiated in August 2004 had an
adverse impact on business performance in 2004 and will continue to have an adverse impact into
2005. Nortel Audit Committee Independent Review; restatements; related matters In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to a comprehensive review and analysis of our assets and liabilities, or
the Comprehensive Review, which resulted in the restatement (effected in December 2003) of our
consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the
quarters ended March 31, 2003 and June 30, 2003, or the First Restatement. In late October 2003, the Audit Committees of our and NNCs Boards of Directors, or the Audit
Committee, initiated an independent review of the facts and circumstances leading to the First
Restatement, or the Independent Review, and engaged the law firm now known as Wilmer Cutler
Pickering Hale & Dorr LLP, or WCPHD, to advise it in connection with the Independent Review. The
Audit Committee sought to gain a full understanding of the events that caused significant excess
liabilities to be maintained on the balance sheet that needed to be restated, and to recommend that
our Board of Directors adopt, and direct management to implement, necessary remedial measures to
address personnel, controls, compliance and discipline. In January 2005, the Audit Committee
reported the findings of the Independent Review, together with its recommendations for governing
principles for remedial measures that were developed for the Audit Committee by WCPHD. Each of our
and NNCs Boards of Directors has adopted these recommendations in their entirety and directed our
management to develop a detailed plan and timetable for their implementation, and will monitor
their implementation. As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in depth the concerns identified by WCPHD regarding provisioning activity and to review
certain provision releases. That examination, and other errors identified by management, led to the
restatement of our financial statements for the years ended December 31, 2002 and 2001 and the
quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003 and 2002, or
the Second Restatement, and our revision of previously announced unaudited results for the year
ended December 31, 2003. The need for the Second Restatement resulted in delays in filing our and
NNCs 2003 Annual Reports on Form 10-K for the year ended December 31, 2003, or the 2003 Annual
Reports, our and NNCs 2004 Annual Report on Form 10-K for the year ended December 31, 2004, or the
2004 Annual Reports, and our and NNCs Quarterly Reports on Form 10-Q for the first, second and
third quarters of 2004, or the 2004 Quarterly Reports, and is expected to result in a delay in
filing our and NNCs Quarterly Reports on Form 10-Q for the first quarter of 2005, or the 2005 First Quarter Reports beyond the SECs required filing
dates. We refer to the 2003 Annual Reports, the 2004 Annual Reports, and the 2004 Quarterly
Reports together as the Reports. 3




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Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue recognition and undertook a process of
revenue reviews. As described in more detail in the Controls and Procedures section of this
report, in light of the resulting adjustments to revenues previously reported in relevant periods,
the Audit Committee is reviewing the facts and circumstances leading to the restatement of these
revenues for specific transactions identified in the Second Restatement. This review has a
particular emphasis on the underlying conduct that led to the initial recognition of these
revenues. The Audit Committee is seeking a full understanding of the historic events that required
the revenues for these specific transactions to be restated and will consider any appropriate
additional remedial measures, including those involving internal controls and processes. The Audit
Committee has engaged WCPHD to advise it in connection with this review. See Risk factors/forward
looking statements. The key developments in 2004 with respect to the foregoing matters are the following:  
    
    Over the course of the Second Restatement process, we
and our independent auditors identified a number of
material weaknesses in our internal control over
financial reporting (all but one of which continued
to exist as of December 31, 2004). See the Controls
and Procedures section of this report. Further, in
connection with the Independent Review, we terminated
for cause (i) our former president and chief
executive officer, former chief financial officer and
former controller in April 2004 and (ii) seven
additional senior finance employees with significant
responsibilities for our financial reporting as a
whole or for their respective business units and
geographic areas in August 2004.
    
    We are under investigation by the SEC and the Ontario
Securities Commission, or OSC, Enforcement Staff and
have received a U.S. federal grand jury subpoena for
the production of certain documents sought in
connection with an ongoing criminal investigation
being conducted by the U.S. Attorneys Office for the
Northern District of Texas, Dallas Division.
Further, the Integrated Market Enforcement Team of
the Royal Canadian Mounted Police, or RCMP, has
advised us that it would be commencing a criminal
investigation into Nortels financial accounting
situation. In addition, numerous class action
complaints have been filed against Nortel, including
class action complaints under the Employee Retirement
Income Security Act, or ERISA. In addition, a
derivative action complaint has been filed against
Nortel. See Contingencies in note 20 in the
accompanying consolidated financial statements.
    
    As a result of the delayed filing of our Reports, we
and NNC were not in compliance with our obligations
to deliver the Reports under our and NNCs public
debt indentures and were required to seek waivers
from Export Development Corporation, or EDC, under
the EDC Support Facility. The waivers also applied
to certain related breaches under the EDC Support
Facility, or the Related Breaches. If we and NNC
fail to file the 2005 First Quarter Reports by May
31, 2005, EDC will have the right (absent a further
waiver) to terminate the EDC Support Facility,
exercise certain rights against collateral or require
us to cash collateralize all existing support. In
addition, the Related Breaches will continue beyond
the filing of the 2004 Annual Reports and the 2005
First Quarter Reports. With the filing of the 2004
Annual Reports with the SEC and the delivery of the
2004 Annual Reports to the trustees under our and
NNCs public debt indentures, we and NNC will be in
compliance with our delivery obligations under the
indentures. However, as a result of the expected
delay in filing the 2005 First Quarter Reports, we
and NNC may not be in compliance with our obligations
to deliver the 2005 First Quarter Reports to the
trustees under our and NNCs public debt indentures
if such reports are filed after May 25, 2005. These
delays have also resulted in our inability to use, in
its current form, the remaining approximately $800
million of capacity under our shelf registration
statement filed with the SEC for various types of
securities. In addition, these delays resulted in
our termination of our $750 million April 2000 five year credit facilities. See Developments in 2004 and 2005 and
Liquidity and capital resources in the MD&A section of this report. 4




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
    
    The OSC issued an order prohibiting all trading by
directors, officers and certain current and former
employees in the securities of Nortel Networks
Corporation and NNL. The order remains in effect
until two full business days following the receipt by
the OSC of all filings required to be made by us and
NNC pursuant to Ontario securities laws. Because
such filings would require amendments to each of the
quarterly periods of 2003 and for earlier periods
including 2002 and 2001, which we do not believe to
be feasible for the same reasons mentioned in the
Controls and Procedures section of this report with
respect to the restatement of 2000 selected financial
data, we and NNC plan to apply to the OSC to have
this order revoked once we and NNC have become
current with our filing obligations for 2005 under
Ontario securities laws. The OSC may, in its
discretion, revoke the order where in its opinion to
do so would not be prejudicial to the public
interest.
    
    We postponed our 2004 Annual Shareholders Meeting due to the delay in filing our 2003
financial statements. A combined 2004/2005 Annual Shareholders Meeting is scheduled to be held on
June 29, 2005.
    
    As a result of the delayed filing of certain of the Reports, NNC
is in breach of the continued listing requirements of the Toronto
Stock Exchange, or TSX, and the New York Stock Exchange, or NYSE.
We and NNC continue to co-operate with the NYSE and the TSX
concerning our and NNCs delay in filing our financial reports.
As of the date of this report, neither the NYSE nor the TSX has
commenced any suspension or delisting procedures in respect of
Nortel Networks Corporation common shares and other of our or NNCs
listed securities. The commencement of any suspension or delisting
procedure by either exchange remains, at all times, at the
discretion of such exchange, and would be publicly announced by
the exchange.
    
    We suspended as of March 10, 2004: the purchase of Nortel Networks
Corporation common shares under the stock purchase plans for
eligible employees in eligible countries that facilitate the
acquisition of Nortel Networks Corporation common shares; the
exercise of outstanding options granted under Nortel Networks
Corporation 2000 Stock Option Plan, or the 2000 Plan, and the
Nortel Networks Corporation 1986 Stock Option Plan as amended and
restated, or the 1986 Plan, or the grant of any additional options
under those plans, or the exercise of outstanding options granted
under employee stock option plans previously assumed by us in
connection with mergers and acquisitions; and the purchase of
units in a Nortel Networks stock fund or purchase of Nortel
Networks Corporation common shares under our defined contribution
and investment plans, until such time as, at the earliest, we are
in compliance with U.S. and Canadian regulatory securities filing
requirements.
    
    On April 28, 2004, Standard and Poors, or S&P, downgraded its
ratings on NNL, including its long-term corporate credit ratings
from B to B- and its preferred shares ratings from CCC to
CCC-. At the same time, it revised its outlook to developing
from negative. On April 28, 2004, Moodys Investors Service,
Inc. changed its outlook to potential downgrade from uncertain.
See Liquidity and capital resources  Credit ratings in the MD&A
section of this report. Strategic plan On August 19, 2004, we first announced a new strategic plan, which contains the following principal
components:  
    
    a renewed commitment to best corporate practices and ethical conduct, including the
establishment of the office of a chief ethics and compliance officer;
    
    a streamlined organizational structure to reflect alignment with carrier converged networks; 5




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
    
    an increased focus on the enterprise market and customers;
    
    optimized research and development programs for highly secure, available and reliable
converged networks;
    
    the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;
    
    the establishment of a chief marketing officer to drive overall marketing strategy;
    
    the strategic review of embedded services to assess opportunities in the professional
services business; and
    
    a distinct focus on government and defense customers. We provided further details concerning the strategic plan on September 30, 2004 and December 14,
2004. Our strategic plan also includes a work plan involving focused workforce reductions, including a
voluntary retirement program, of approximately 3,250 employees, real estate optimization and other
cost containment actions such as reductions in information services costs, outsourced services and
other discretionary spending. Our workforce actions are focused to disproportionately protect
customer and sales facing roles as well as continue our focus on new innovative solutions. We
anticipate cost savings of approximately $500 million in 2005 related to this work plan partially offset by
planned investments in certain strategic areas such as the finance organization. In 2005, we are focusing on regions and networking solutions that we believe will be areas of
potential growth and importance to our customers. On a regional basis, we see potential
significant growth opportunities in emerging markets such as China and India. Evidence of our
focus on these emerging market opportunities include our contract with BSNL to establish a wireless
network in India, our investment in Sasken Communication Technologies Ltd. of India to develop new
software and deploy our networking equipment and our planned joint venture with China Putian
Corporation. Globally, we believe security and reliability for service provider networks are
increasingly important to governments, defense interests and enterprises around the world. Other business developments We engaged in a number of activities in 2004 and into 2005, in part to respond to the industry
environment and in part to address various business matters that arose during those periods. Some
of our activities and other business developments included:  
    
    announcing the planned divestiture of substantially all of our remaining manufacturing
operations to Flextronics International Ltd., or Flextronics;
    
    contributing certain assets and liabilities of our directory and operator services
business in return for a 24% interest in VoltDelta, Resources LLC;
    
    entering into a memorandum of understanding with LG Electronics to establish a joint
venture for providing high quality, leading edge telecommunications equipment and
networking solutions to Korea and other markets globally; and
    
    announcing that Nortel Networks Inc., our wholly owned
subsidiary had entered into an agreement with PEC Solutions, Inc., or
PEC, providing for the acquisition of all of the outstanding shares
of PEC subject to certain conditions, including the successful
completion of a tender offer and regulatory approvals. For information on these and other developments in 2004, see Special charges in note 6,
Acquisitions, divestitures and closures in note 9, Long-term debt, credit and support
facilities in note 10 and Subsequent events in note 21 of the accompanying consolidated
financial statements and Developments in 2004 and 2005 in the MD&A section of this report. 6




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Networking solutions Networking In our industry, networking refers to:  
    
    the connecting of two or more communications devices, such as telephones and personal
computers, across short or long distances to create a network;
    
    the connecting of two or more networks; or
    
    the connecting of equipment used in a network. Network components A telecommunications network generally consists of equipment and software that enable network
access, core networking and network services. Network access equipment and software enables
information to enter or exit a network, and resides with or near an end-user of the network.
Network access can be obtained through the use of either wireline cable (such as fiber optic,
copper wire or coaxial) or wireless radio signals. Core networking equipment and software direct, route or switch the data, voice and multimedia
communications signals from one part of the network to another. Core network equipment and
software also transport communications signals to and from network access equipment and other core
networking equipment located in another location. These functions are carried out primarily
through the use of routers, circuit and packet switches, and fiber optic technologies. Network services consist of various user capabilities that are enabled through the use of software
elements in a network. User capabilities may be configured to extend throughout the network and
include features such as location-based services, security services, calling features and
multimedia services. Network services can be personalized to suit the users needs and to support
various applications. Networking solutions Our networking solutions include network equipment, software and other technologies that
enable communications between two or more points defining a network through the use of data, voice
and multimedia networking. Our networking solutions may consist of a combination of products and
services provided by our four reportable segments consisting of Wireless Networks, Enterprise
Networks, Wireline Networks and Optical Networks. For a discussion of our recent establishment of
a new organizational structure that includes, among other things, combining the businesses of our
four segments into two business organizations, see Business  Overview. Networking solutions can be circuit-based or packet-based. Our circuit-based networking solutions
consist of technologies that require a separate network circuit to be maintained for each
communications signal for the duration of the transmission. Our packet-based networking solutions
consist of technologies which involve the conversion of a data, voice or multimedia communications
signal into pieces, or packets, that are directed or routed through the network independently and
then re-assembled at the destination. This enables large numbers of communications signals to be
directed or routed simultaneously and more efficiently than in circuit networking. Our data
networking solutions consist of products and services designed to enable the transportation of data
information across a network. Our security solutions consist of products and services designed to
ensure that information can be securely transported across a network and to prevent unauthorized
users from being able to disrupt the network. 7




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Wireless Networks includes network access and core networking solutions 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,
and data networking and security solutions used by our enterprise customers. Wireline Networks
includes circuit and packet voice solutions, and data networking and security solutions used by our
service provider customers. Optical Networks includes metropolitan, regional and long-haul optical
transport and switching solutions and managed broadband services. Within each of our reportable
segments, our networking solutions also consist of related professional services which may include:
strategic planning, network design and engineering; network optimization; network operations
planning and consulting; and installation and ongoing technical support. For more information about our networking solutions, please refer to our segment descriptions
below. 
 Wireless Networks Products Wireless networking, also known as mobility networking, refers to communications networks that
enable end-users to be mobile while they send and receive voice and data communications using
wireless devices, such as cellular telephones, personal digital assistants and other computing and
communications devices. These networks use specialized network access equipment and specialized
core networking equipment that enable an end-user to be connected and identified when not in a
fixed location. The technology for wireless communications networks has evolved and continues to
evolve, through various technology generations. Our existing wireless solutions span second and third generation wireless technologies and most
major global digital standards for mobile networks. The majority of wireless communications
networks existing today are still based on second generation, or 2G, wireless technologies, which
consist of circuit switching technology with modest data transmission capabilities. However, third
generation, or 3G, networks have been launched in several regions. 3G wireless technologies
consist of packet networking technology with high-speed data, voice and multimedia transmission
capabilities. We support all of the following primary international standards for wireless communications
networks:  
    
    Time Division Multiple Access, or TDMA, is a 2G wireless standard supported mainly in
the United States, Canada and CALA.
    
    Code Division Multiple Access, or CDMA, is a 2G wireless standard, also known as IS-95
or cdmaOne, and is supported globally. CDMA networks are evolving to 3G according to the
CDMA 3G 1xRTT (single channel (1x) Radio Transmission Technology) standard, also known as
CDMA2000, for voice and high-speed data mobility. CDMA 3G 1xEV-DO, or Evolution Data
Optimized, and CDMA 3G 1xEV-DV, or Evolution Data and Voice, are extensions of CDMA 3G
standards for high speed wireless networks for data, voice and multimedia communications.
    
    Global System for Mobile communications, or GSM, is a 2G wireless standard supported
globally. GSM networks are evolving to carry data, as well as voice, with the
introduction of General Packet Radio Standard, or GPRS. GPRS is viewed as a 2.5G
technology that provides faster and therefore increased data transmission capabilities.
Enhanced Data Rates for Global Evolution, or EDGE, is a further evolution of GSM systems
to support higher data speeds. In addition to higher data speeds, EDGE provides increased
voice capacity for existing GSM operators. An additional variant of this standard, called
GSM-R, focuses on the delivery of communications and control services for railway systems.
    
    UMTS is now a commercial standard for 3G networks based on Wideband CDMA, or WCDMA,
technology. UMTS combines WCDMA-based radio access with packet switching technology to
yield high capacity, high speed wireless networks for data, voice and multimedia
communications. We also offer a range of related professional services to our customers. 8




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Network access Radio network access equipment uses radio waves to provide wireless access to the subscribers
device, enabling the wireless subscriber to connect to the network to send and receive data, voice
and multimedia communications. The key network elements in radio access are base station
transceivers or access points and base station/radio network controllers. We offer our customers a
wide range of base station transceivers and base station controllers for all of the standards that
we support. Core networking Core networking equipment directs, routes or switches communications signals within a
service providers wireless communications network. The key network elements in the core part of a
wireless communications network are mobile switching centers, home location registers and packet
data serving nodes.  
    
    Mobile switching centers direct or switch data, voice and multimedia communications
signals from one network circuit to another and also support advanced voice services like
3-way calling, calling party number/name delivery, call holding and call redirection.
    
    A home location register is a database that contains subscriber data, such as
provisioning and service information, and dynamic information, such as the wireless
handsets current location.
    
    Packet data serving nodes are hardware and software network equipment elements that
aggregate and manage data communications between wireless subscriber devices and
public/private data networks, such as the Internet. Packet data serving nodes deliver
valuable network services including content-based billing, security, virtual private
networks and quality of service. Our mobile switching centers, home location registers and packet data serving nodes support all of
the primary international standards for wireless communications networks. Product development Our wireless networking products in development include the next evolution of our CDMA 3G,
GSM/GPRS/EDGE, WLAN and UMTS products.  
    
    Our CDMA 3G 1xRTT products are generally available and have been deployed in several
commercial networks in all our geographic regions. Our CDMA 3G 1xEV-DO product is
currently being deployed by several large operators in the United States and Brazil and is
generally available for commercial deployment. We are currently working with the various
standards bodies to finalize the specifications for CDMA 3G 1xEV-DV.
    
    There are several GSM/GPRS/EDGE products that are being developed to allow GSM
operators to offer higher data rates on existing GSM spectrum allocations. We have
successfully completed customer trials of Adaptive MultiRate, or AMR, base station
transceivers. AMR allows service providers to use the radio spectrum allocated to them
more efficiently to support more customers on the same network.
    
    The enhanced version of our GSM base station controller, the GSM BSC 3000 (formerly,
the BSCe3), became generally available for commercial deployment in 2003. Our EDGE base
station transceivers, including both hardware and software, are generally available and
are being deployed by several customers in the United States and Europe.
    
    Our UMTS radio network access and core networking products are generally available and
have been launched by several operators in the Europe, Middle East and Africa region, or
EMEA, and in the United States. Our UMTS networking products have been deployed in the
initial launch of the first commercial UMTS network to be deployed in the United States.
We are continuing to develop our UMTS solutions for use in the Asia Pacific (including
Greater China) region. 9




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
    
    We are working at establishing strategic relationships with other companies for
research, development and manufacture of equipment that conforms to the Chinese 3G
TD-SCDMA standard.
    
    We continue to work on developing access technologies such as UMTS-HSDPA, or High Speed
Downlink Packet Access, 1x-EV, or single channel Evolution, OFDM, or Orthogonal Frequency
Division Multiplexing, and MIMO, or Multiple Input Multiple Output, antenna technologies
to increase the speed and efficiency of broadband wireless access from 3G networks
deployed today.
    
    Our Wireless Mesh Network solution, designed to allow our customers to reduce the costs
of high-speed wireless data transport from wireless access networks to wired broadband
networks, is now generally available and has been deployed in the United States and Asia
Pacific.
    
    Our enterprise grade WLAN access products are generally available for commercial
deployment by our wireless service provider customers. Markets We anticipate that demand for wireless networking equipment will be driven by continued
subscriber and traffic growth, and the effectiveness of 2.5G and 3G wireless networking systems.
There are two key aspects to the migration from 2G wireless communications technologies to 2.5G and
3G wireless communications technologies. The first is that all current 3G technologies, including
CDMA 3G and UMTS, are based on spread spectrum technology. The second is that the migration from
2G to 2.5G and 3G technologies is largely based on a transition from circuit switching technologies
in 2G core networks to packet-based networking technologies in 3G core networks. We believe that
our extensive experience in deploying CDMA wireless communications networks, combined with our
expertise in packet-based networking for wireline networks, will be a competitive strength during
the migration from 2G wireless communications networks to 2.5G and 3G wireless communications
networks. Commercial CDMA 3G networks have been launched in the United States, Canada, CALA and the Asia
Pacific region. CDMA networks operating in the 450 MHz radio spectrum are also expanding into
Central and Eastern Europe. GPRS and UMTS networks have already been launched in EMEA, the Asia
Pacific region and the United States. In addition, EDGE has been launched to support higher speed
transmission of data in the United States and also by several operators in Western Europe and the
Asia Pacific region. GSM-R has already been deployed by many countries across the world, including
member states of the European Union, China and India. The GSM-R market is one of the fastest
growing segments of the overall wireless market. In the United States, Canada and CALA, usage rates of wireless communications services continue to
increase, and we anticipate that capital spending decisions by wireless service providers will be
driven by capacity requirements, new wireless subscribers, increased use of wireless devices for
Internet access and technology migration from 2G wireless technologies to 2.5G and 3G wireless
technologies. We also anticipate that the migration from 2G to 2.5G and 3G wireless will initially
be driven by CDMA 3G 1xRTT and 1xEV-DO deployment for CDMA-based networks, and by GPRS, EDGE and
UMTS deployment for GSM- and TDMA-based networks. Within EMEA, wireless subscriber growth remains slower in many Western European countries, largely
due to relatively high wireless subscriber penetration levels. However, other parts of EMEA
continue to grow their subscriber base due to the lower market penetration for wireless services.
Investment decisions by wireless service providers in Western Europe are being driven by
anticipated growth in wireless data communications services. As a result, infrastructure spending
in Western Europe is currently primarily driven by the migration from GSM to GPRS and UMTS
technologies, and the associated migration from circuit switching technologies to packet-based
networking technologies. In the Asia Pacific region, we anticipate that capital spending by wireless service providers will
be driven by the migration to 3G technologies in Japan and Korea, and by continued growth in
wireless subscribers in the Peoples Republic of China, or China. Growth in China may be further
driven by anticipated new national licenses for 3G. However, the timing of the issuance of new
national licenses for 3G in China is 10




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uncertain. The issuance of new national licenses for 3G in China is also expected to impact the
entire 3G market. Many countries in South and South East Asia have very low wireless subscriber
penetration levels, and are expected to experience increased wireless subscriber growth over the
next five years. India is also anticipated to be a major wireless infrastructure market in the
next five years. Customers Our Wireless Networks customers are wireless service providers, and their customers are the
subscribers for wireless communications services. The top 20 global wireless service providers
collectively account for a majority of all wireless subscribers around the world. We are currently
focused on increasing our market presence among the top global wireless service providers. None of
our Wireless Networks customers represented more than 10% of Nortels consolidated revenues in
2004. Competition Our major competitors in the global wireless infrastructure business have traditionally
included Telefonaktiebolaget LM Ericsson, Nokia Corporation, Siemens Aktiengesellschaft, Motorola,
Inc. and Lucent Technologies Inc. Nokia and Siemens compete in the sale of GSM and UMTS equipment,
whereas Lucent competes in the sale of CDMA and UMTS equipment. Motorola is a competitor in the
sale of GSM, UMTS and CDMA equipment. Ericsson competes in the sale of equipment for all of the
major wireless communications technologies. More recently, Samsung Electronics Co., Ltd. has
emerged as a competitor in the sale of CDMA systems, and Huawei Technologies Co., Ltd. and ZTE
Corporation have emerged as competitors for GSM, CDMA and UMTS systems in China and many other
developing countries. NEC Corporation and Fujitsu Limited have emerged as competitors for UMTS
equipment. The primary global factors of competition for our Wireless Networks products include:  
    
    technology leadership, product features and availability;
    
    product quality and reliability;
    
    conformity to existing and emerging regulatory and industry standards;
    
    warranty and customer support;
    
    price and cost of ownership;
    
    interoperability with other networking products;
    
    network management capabilities;
    
    traditional supplier relationships, particularly in EMEA and the Asia Pacific region;
    
    regulatory certification; and
    
    provision of customer financing. We intend to compete with our traditional and emerging competitors as the global market for
wireless networking equipment migrates to 3G technologies. 
 Enterprise Networks Products Our Enterprise Networks solutions portfolio provides data, voice and multimedia communications
solutions for our enterprise customers. We also provide our enterprise customers with related
professional services. Circuit and packet voice solutions Our voice portfolio includes a broad range of circuit and packet voice communications
solutions. 11




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
    
    Our communications servers and remote gateway products provide converged data, voice
and multimedia communications systems, using Voice over IP, or session initiation
protocol, or SIP, for service providers and enterprises. SIP is a standard protocol for
initiating an interactive user session that involves multimedia elements such as video,
voice, chat, gaming and virtual reality. Our enterprise solutions can be used by
customers building new networks and customers who want to transform their existing
communications network into a more cost effective, packet-based network supporting data,
voice and multimedia communications.
    
    Our customer premises-based circuit and packet telephone switching systems are designed
for small, medium and large commercial enterprises and government agencies. These systems
provide or can be configured with multiple applications, including voice communications
features, such as voice messaging, call waiting and call forwarding, as well as advanced
voice services, converged multimedia applications and other networking capabilities.
    
    Our customer contact center, messaging and interactive voice and web service solutions
are advanced communications tools designed to work with our customer premises-based
solutions. These tools enable employees to efficiently and productively communicate with
business contacts and other employees regardless of where they are located, the applicable
time zone or whether they choose to interact over the telephone or the Internet. Data networking and security solutions We offer a broad range of data networking (packet switching and routing) and security
solutions for our enterprise customers. Our packet switching and routing systems include data
switching systems, aggregation products, virtual private network gateways and routers, including:  
    
    Our data switches, secure routers and associated security products provide data
switching designed to allow our customers to provide Internet data security and IP
services including IP routing, virtual private networks, deep packet inspection, firewall
applications, policy management and data traffic flow management. These products also
enable our customers to manage and prioritize the Internet content that is provided to
end-users and balance the amount of communications traffic on multiple Internet servers.
    
    Our Ethernet switch portfolio is a series of high performance packet switches for our
enterprise customers small to large local area networks that use the Ethernet, a standard
computer networking protocol for local area networks.
    
    Our multi-protocol routers offer high-speed, high-capacity and medium-capacity data
switching to support a wide range of data communications technologies, including
multi-protocol label switching, asynchronous transfer mode, IP and frame relay services.
Our Ethernet routing switches deliver IP routing and switching.
    
    Our portfolio of WLAN service switching products is designed to provide secure and
efficient transmission of WLAN data and voice traffic for mobile users. Our WLAN voice
products integrate with our communications servers and gateway products to provide a
wireless Voice over IP solution for our customers.
    
    Our portfolio of optical network switching products is designed to extend the range of
storage area networks to enable our customers to consolidate their data servers. Our
products enable enterprises to deploy these storage area networks in alternate locations,
providing geographic redundancy as part of their business continuity strategy. Product development We are currently focused on developing products that support the continuing evolution of voice
and data communications systems toward converged or combined data, voice and multimedia networks,
including:  
    
    The continued development of our multimedia communication server for enterprise, a
product that provides the capability to deliver converged data, voice and multimedia
applications and enhanced networking capabilities. 12




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
    
    Additions to the applications in our communications server products to allow
integration of Voice over IP, voice extensible markup language, new operating systems and
servers, and voice recognition speech products.
    
    New developments in data networking products that will deliver resiliency, enable
increased data network traffic and provide suitable service levels and network
connectivity and power to devices over the same line.
    
    The development of the next generation web platform, which will feature higher
performance, scalability (that is, the ability to grow a service or capability with
incremental cost) and integrated applications.
    
    Enhancements to our security portfolio including the new secure sockets layer, or SSL,
and switching products and a new high-end secure router product. In addition, we have
entered into and continue to pursue strategic relationships that enhance our end-to-end
security solutions.
    
    Updates to our customer premises-based telephone systems to support our software that
enables those systems to function entirely as a packet-based system or as a hybrid packet
and circuit switching system. Markets We offer Enterprise Networks products to enterprises around the world. With the growth of
data, voice and multimedia communications over the public telephone network, the public Internet
and private voice and data communications networks, there is an increasing opportunity to converge
disparate networks towards a single, high performance network that can support various types of
communications traffic and applications. We believe that in order to meet the growing demand for increased capacity at lower per-minute
rates, enterprises will transition their circuit-based voice communications to more cost effective
packet-based technologies. As a result, demand for packet-based networking equipment that supports
the convergence of data, voice and multimedia communications over a single communications network
and that provides greater network capacity, reliability, speed, quality and performance is
increasing. Globally, enterprise customers continue to invest in equipment for their communications networks,
primarily for network security and resiliency, for Voice over IP, WLANs and for virtual private
networks. In the United States and Canada, enterprise customers are investing in Voice over IP as
they transition from traditional voice products to our enterprise line of communication servers and
remote gateway products that enable conversion from voice communication networks to packet-based
networks supporting data, voice and multimedia communications. In EMEA, our customers are
beginning to invest in new technologies, such as Voice over IP. In the Asia Pacific region,
Enterprise Networks customers are investing in networking equipment to improve the connections
among their regional sites and branch offices. In CALA, enterprises are continuing to drive demand
for networking equipment that supports the growing use of the Internet in the region. Customers We offer our products and services to a broad range of enterprise customers around the world,
including large businesses and their branch offices, small businesses and home offices, as well as
government agencies, educational and other institutions and utility organizations. Key industry
sectors for our business customers include the telecommunications, high-technology manufacturing,
government (including the defense sector) and financial services sectors. We also serve customers
in the healthcare, retail, education, hospitality, services, transportation and other industry
sectors. We are currently focused on increasing our market presence with enterprise customers. In
particular, we intend to focus on leading enterprise customers with high performance networking
needs. Certain of our service provider customers, as well as system integrators, also act as
distribution channels for our Enterprise Networks sales. None of our Enterprise Networks customers
represented more than 10% of Nortels consolidated revenues in 2004. 13




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Competition Our principal competitors in the sale of our Enterprise Networks solutions are Cisco Systems,
Inc., Avaya Inc., Siemens, Alcatel S.A., and NEC Corporation. Avaya is our largest competitor in
the sale of voice equipment while Cisco is our largest competitor in the sale of data networking
equipment to enterprises. We also compete with smaller companies that address specific niches,
such as Juniper Networks, Inc., 3Com Corporation, Foundry Networks, Inc., Extreme Networks, Inc.
and Enterasys Networks, Inc. in data networking; and Mitel Networks Corporation in Internet-based
voice communications solutions. We expect competition to remain intense as enterprises look for
ways to maximize the effectiveness of their existing networks while reducing ongoing capital
expenditures and operating costs. The principal global factors of competition in the sale of our Enterprise Networks solutions
include:  
    
    technology leadership, product features and availability;
    
    product quality and reliability;
    
    conformity to existing and emerging regulatory and industry standards;
    
    sales distribution and channel marketing strategy;
    
    warranty and customer support;
    
    price and cost of ownership;
    
    interoperability with other networking products;
    
    installed base of product;
    
    alternative solutions offered to enterprises by service providers;
    
    the leveraging of existing customer-supplier relationships; and
    
    the availability of distribution channels. 
 Wireline Networks Products Our Wireline Networks portfolio addresses the demand by our service provider customers for
cost efficient data, voice and multimedia communications solutions. Our wireline solutions,
including related professional services, simplify network architectures by bringing data, voice,
multimedia and emerging broadband applications for revenue generating services together on one
packet network. Circuit and packet voice solutions We are a leader in the development and deployment of highly scalable circuit switched and
secure voice over packet solutions such as Voice over IP for wireline and wireless service
providers around the world. Our voice over packet solutions offer service providers opportunities
for new revenue sources and sustainable operating and capital cost reduction, as well as high
levels of reliability and network resiliency. Our solutions include the following:  
    
    Our wireline voice over packet network solutions for service providers, which include
softswitches and media gateways. The portfolio provides the complete range of voice over
packet solutions, including local, toll, long-distance and international gateway
capabilities, and enables voice applications to run on the new multi-service packet
network. These solutions leverage more efficient packet-based, as opposed to
circuit-based, technologies that drive reduced capital and operational costs for service
providers and provide a platform for the delivery of new revenue-generating services, such
as Centrex IP and Voice over IP virtual private networks.  
    
    Our multimedia communications services portfolio allows our customers to deploy new,
enhanced multimedia services, including video, collaboration as well as call control and
call management services. The portfolio consists of a SIP-based application server that can enable an
interactive user session involving multimedia elements. For example, users are provided
with the flexibility to customize their communications by selecting the medium over which
they wish to receive a particular message (such as wireline or wireless telephony, e-mail
and instant messaging) by setting screening criteria such as time of day and day of week,
month or year. 14




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
    
    Our portfolio of digital, circuit-based telephone switches provides local, toll,
long-distance and international gateway capabilities for service providers. These systems
enable service providers to connect end-users making local and long-distance telephone
calls. These products can evolve to voice over packet solutions.  
    
    Our Nortel Networks Developers Partner Program helps to drive the interoperability of
our Voice over IP multimedia communications and our digital, circuit-based telephone
switch portfolios with third party vendors including infrastructure and application
companies.  
    
    Our Converged Multimedia Services (CMS) solution comprised of a
new portfolio of networking equipment compliant with the emerging IP Multimedia Subsystem
(IMS) standard. Available for GSM/UMTS customers in the second half of 2005, the solution
is designed to enable fixed, mobile and cable operators to create a converged core network
and rapidly deploy a wide variety of new services. The CMS solution currently is in
trial in multiple countries in Europe. These solutions work alone or in combination with each other to provide traditional voice services,
advanced packet voice services and enhanced multimedia services to service providers around the
world. Data networking and security solutions We offer a wide range of data networking (packet switching and routing) solutions to our
service provider customers. Our wide area network, or WAN, solutions and IP service routers enable
our service provider customers to offer connectivity solutions and high value services to both
enterprises and residential customers. Connectivity solutions include packet services such as:
frame relay; Asynchronous Transfer Mode, or ATM; Ethernet; and IP access for digital subscriber
line and cable users. High-value services, such as IP virtual private networks, enable an
enterprise to connect with other enterprise sites and remote users and to securely connect with
business partners. These high-value services also provide enhanced network capabilities, such as
network security, network address translation and class of service, that enable service providers
to offer a wide range of networking services beyond basic connection to the network. In 2004, we
announced a new multiservice provider edge networking device that allows service providers to
converge multiple networks at the network edge to enable the delivery of voice, data, multimedia
and wireless services over a single, converged network. When we refer to the network edge, we are
referring to the point at which access networks meet the core network. Product development Research and development investments are focused on creating new and improving existing,
packet-based residential and business services for wireline and wireless service providers. Also,
we continue to develop products that support the evolution of data, voice and multimedia
communications systems toward converged or combined voice and data networks, including:  
    
    Enhancements to our voice over packet solutions that will allow service providers to
connect any business telephone system, using standard Voice over IP protocols, into a
common dialing plan with connectivity to the public switched telephone network.
Additional enhancements to our packet voice solutions will continue to focus on
interoperability with other manufacturers equipment, including gateway and integrated
access device manufacturers, as well as on meeting the needs of the Asian and European
markets. We continue to make improvements to our softswitch portfolio by utilizing the
latest commercial technology to provide our customers with converged wireline and wireless
service support, superior application choices, integrated network management and linear
scalable capacity. 15




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
    
    Enhancements to our multimedia communications portfolio, that will allow a service
provider to offer intelligent multimedia services across any manufacturers circuit
switches. Additionally, development will focus on increasing the breadth and usability of
multimedia communications applications.  
    
    Additions to the digital, circuit-based telephone switch portfolio that will allow
service providers to offer and manage IP voice and multimedia (Centrex IP) services to
those businesses that use traditional business telephones as well as businesses that use
next generation telephones designed for use in IP networks.  
    
    Enhancements to our IP services router that enable an increase in the number of
residential subscribers and virtual private network sites that can be supported, and the
amount of bandwidth that can be applied to an enterprise site. Development will also
focus on enhancing the ability of our service provider customers to provide additional
revenue-generating services.  
    
    A focus on cable standards compliance to enhance our solutions for the cable operator
markets in the United States, Canada and EMEA, including support for the open cable
standard protocol for cable media gateways.  
    
    Enhancements to our WAN switch portfolio to improve interoperability with other
vendors products. In addition, development will focus on enhancing the migration to
converged networks which simultaneously support data, voice and multimedia.  
    
    Continued development of a multiservice provider edge networking device designed to
converge multiple communications services operating at the IP or multi-protocol label
switching network edge. This device is currently undergoing customer trials and is not
yet generally available. As well, we continue to develop enhancements to our existing
line of WAN switch and IP service router products that are intended to efficiently
aggregate different types of data traffic at the network edge.  
    
    Continued integration of a service provider core network router into our voice over
packet portfolio to enable us to provide a complete end-to-end solution. Markets With the growth of data, voice and multimedia communications over the public telephone
network, the public Internet and private voice and data communications networks, there is an
increasing opportunity to converge disparate networks towards a single, high performance packet
network that can support most types of communications traffic and applications. Converged voice
and data networks also provide an opportunity for service providers to offer new revenue-generating
services while reducing their ongoing operational costs year over year as they incorporate
packet-based technology in their networks. We believe our advantage lies in our ability to
transition and upgrade our customers installed base of voice and data network solutions to a
multimedia-enabled IP network. To meet the growing demand for new revenue generating services and network efficiency, we
anticipate growth in demand for packet-based networking equipment that supports the convergence of
data, voice and multimedia communications over a single communications network and that provides
greater network capacity, reliability, speed, quality and performance. We anticipate a continued
increase in deployments of service provider Voice over IP networks worldwide. While we anticipate
growth in Voice over IP networks, we also anticipate a decline in traditional voice networks. Cable operators and new Internet telephone service providers are entering the voice and data
markets and are increasing the competitive pressure on established service providers. For example,
cable operators provide high speed data services as well as voice services by using Voice over IP
technology. Similarly, established service providers are using existing broadband networks and
expanding those broadband networks to offer bundled services such as telephone, high speed Internet
and television services across those broadband networks. As a result of this increased competitive
pressure as well as regulatory changes, the pace of consolidation among service providers in the
United States has increased. 16




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The market for our Wireline Networks products is global. Service providers are expected over the
long term to continue to modernize with packet-based networks and converge voice and data
communications networks in order to deploy new revenue-generating service offerings. We anticipate
an increased emphasis by service providers towards end-user networks in addition to their efforts
to modernize the inter-connection of those networks. In EMEA, we also continue to see market
demand for certain networking products, including equipment for Voice over IP and equipment for
virtual private networking. In EMEA, we anticipate continued opportunities with alternate
operators, cable operators and wireless operators and anticipate new opportunities in emerging
markets. In the Asia Pacific region, we continue to see market demand for certain networking products,
including equipment for Voice over IP and multimedia services and equipment for virtual private
networking. Deregulation in China has created opportunities for new entrants who are building out
their networks with packet-based technologies. In CALA, service providers are also focused on
implementing Voice over IP technology to enable opportunities for additional growth, network
efficiency and revenue-generating services. There is also a growing demand for voice over IP
technology among cable operators in CALA. Customers We offer our Wireline Networks products and services to a wide range of service providers
including local and long distance telephone companies, wireless and cable operators, as well as
other communication service providers. We also offer applicable data networking and security solutions from our Wireline Networks to
enterprises for private networking, as well as to service providers and system integrators that in
turn build, operate and manage networks for their customers such as businesses, government agencies
and utility organizations. None of our Wireline Networks customers represented more than 10% of
Nortels consolidated revenues in 2004. Competition Our principal competitors in the Wireline Networks business are large communications companies
such as Siemens, Alcatel, Cisco and Lucent. In addition, we compete with smaller companies that
address specific niches within this market, such as Sonus Systems Limited, BroadSoft, Inc. and
Taqua Inc. in packet and Internet-based voice communications solutions; Juniper and Laurel
Networks, Inc. in multiservice provider edge solutions; and Ciena Corporation (which acquired
Wavesmith Networks, Inc. in 2003) in multiservice WAN solutions; and Redback Networks Inc. in
aggregation products. Certain competitors are also strong on a regional basis, such as ZTE
Corporation and Huawei in the Asia Pacific region. Some niche competitors are partnering with
larger companies to enhance their product offerings and large communications competitors are also
looking for these partnerships or alliances to complete their product offerings. No one competitor
is dominant in the Wireline Networks market. The primary global factors of competition for our wireline products include:  
    
    technology leadership, product features and availability;  
    
    price and total cost of ownership;  
    
    ability to create new revenue-generating services for service providers and cable operators;  
    
    conformity to existing and emerging regulatory and industry standards;  
    
    installed base of products and customer relationships;  
    
    network management capabilities;  
    
    product quality and reliability; and  
    
    warranty and customer support. 17




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Competition remains intense as a result of reduced investment in existing traditional networks by
service providers, the continued consolidation in the service provider industry, and the continued
focus by suppliers on growing revenue in new broadband and IP technologies. 
 Optical Networks Products Our Optical Networks solutions portfolio addresses the varying optical communication needs of
service providers and enterprises. Optical networks transport data, voice and multimedia
communications within and between cities, countries or continents by transmitting communications
signals in the form of light waves through fiber optic cables. Optical networking is the most
common method for transporting communications signals between the various locations within a
service providers network and is unmatched for delivering vast amounts of data reliably and
cost-effectively with service and bandwidth flexibility and scalability. Our optical networking solutions are designed to provide metropolitan, regional and long-haul,
high-capacity transport and switching of data, voice and multimedia communications signals. These
solutions include photonic Coarse/Dense Wavelength Division Multiplexing, or C/DWDM, transmission
solutions, synchronous optical transmission solutions, optical switching solutions and network
management and intelligence software. We also offer our customers a variety of related
professional services. Our solutions include the following:  
    
    Our photonic networking C/DWDM solutions allow multiple light wave signals to be
transmitted on the same fiber optic strand simultaneously by using different wavelengths
of light to distinguish specific signals, thereby increasing the capacity and flexibility
of a network. Our long-haul DWDM line systems span distances up to 2,000 kilometers and
our metro wavelength division multiplexing, or WDM, series provides networking solutions
within a city or region for up to 600 kilometres.  
    
    Our synchronous optical transmission systems use traditional optical standards,
including the Synchronous Optical Network, or SONET, standard, which is the most common
standard in the United States and Canada and some countries in the Asia Pacific region,
and the Synchronous Digital Hierarchy, or SDH, standard, which is the most common standard
in EMEA, CALA and many other countries. Our synchronous next-generation SONET/SDH
solutions comprise multi-service optical platforms that integrate diverse protocols and
technologies to deliver services over a cost effective, scalable and reliable converged
services network.  
    
    Our optical switching solutions enable communication signals in optical fibers to be
selectively directed or switched from one network circuit to another.  
    
    Our network management software and intelligence solutions are designed to give our
customers the ability to monitor and improve the performance of their networks. Our Optical Networks solutions enable customers to enhance and transform their networks towards a
scalable and reliable network for delivering diverse high speed data and voice communication
services. Such network transformation is expected to increase deployment of managed broadband
services, such as:  
    
    Optical Ethernet solutions that combine the strengths of the Ethernet network computing
protocol with those of optical communications. Optical Ethernet solutions transport
communications signals carrying Ethernet packets in the form of light waves through fiber
optic cables between locations within a city or between cities.  
    
    Optical storage connectivity solutions, which allow the interconnection of data centers
for the efficient preservation and sharing of business-critical data to ensure business
continuity and disaster recovery.  
    
    Managed wavelength solutions, which offer multiple protocol and transmission speed
networking capability to reliably interconnect business sites. 18




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In addition, in February 2004, we announced strategic alliances with Calix Networks, Inc., ECI
Telecom Ltd. and KEYMILE AG that will expand our broadband networking solutions portfolio and
enable our service provider customers to deliver a new set of emerging broadband services to their
enterprise and residential end-users. Product development We are focused on developing next generation optical networking systems, including the
evolution of our next generation SONET/SDH systems, our metro C/DWDM systems and our optical
long-haul and regional line and terminal solutions. We have:  
    
    introduced advanced metro optical network products enabling the convergence of multiple
platforms onto a single architecture, lowering network costs, enhancing functionality and
delivering consistent service quality and scalability to meet varying enterprise needs;  
    
    enhanced the capabilities of our existing metro optical network products to enable new
storage area solutions that address emerging enterprise business continuity requirements;  
    
    implemented mesh restoration capabilities on the optical switching platform; and  
    
    introduced a new regional/long-haul product that utilizes photonic networking DWDM
technology, which assists customers in lowering their network costs by providing improved
optical performance. We also continue to develop and enhance our Optical Networks portfolio, including by:  
    
    enhancing our optical Ethernet portfolio by introducing new Ethernet switching and
transport capabilities designed to improve the productivity of our enterprise customers
and the services offered by our service provider customers;  
    
    providing flexibility, simplicity and automation enhancements to our common photonic
layer product that facilitate the deployment and operation of regional and long-haul
optical links;  
    
    offering solutions which enhance value from optical solutions for end users, i.e. in
our metro edge and metro access solutions; and  
    
    investing in improving the density, capacity and flexibility of our optical
transmission systems. We also continue to invest in core technologies, such as efficient service adaptation, aggregation,
switching and management, that enable our customers worldwide to deploy innovative optical
networking services which we believe will lead the networking transformation towards high
performance packet-based networks. Markets We are a leading provider of optical networking products to service providers and enterprises
around the world. Compared to the last few years, the global optical market has stabilized.
Service providers remain focused on maximizing return on invested capital by increasing their
capacity utilization rates and the efficiency of their existing networks. Some service providers
have delayed the deployment of next generation products. However, there remain opportunities to
deliver new technologies and services that enable service providers to offer additional
revenue-generating services. We also expect that enterprises will continue to generate demand for
optical networking solutions that enable them to operate their networks more efficiently. The outlook for optical equipment sales may be further impacted by service providers preferring to
lease excess network capacity from others or purchase assets from other operators rather than
making capital investments in their own networks. We expect that any additional capital spending
by our customers will continue to be directed toward opportunities that enhance customer
performance, generate revenue and reduce costs in the near term. However, as service providers
begin to more effectively utilize and eventually exceed their network capacity, we expect that they may incrementally enhance that
capacity. The timing and impact of these developments remain difficult to predict. 19




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The market for our Optical Networks solutions is global. In the United States and Canada, new
networks are not currently being built by service providers in anticipation of market demand, but
are instead being built to more closely align with actual end-user demand. Several service
providers in the United States have announced plans to deploy optical fiber networks to allow
access to these networks by residential end-users. Within EMEA, the building of pan-European
optical networks by service providers is now mature and many service providers have begun to focus
on building their metropolitan and regional optical networks. We expect that the increased usage
of broadband wireless data provided by 3G networks may eventually drive the increased deployment of
optical networks. The demand for additional and enhanced services by enterprises is increasing in
Europe and may also encourage service providers to invest in the creation of networks that offer
services such as optical Ethernet and storage connectivity. In EMEA, European government-sponsored
service providers and networking equipment suppliers enjoy favorable positions within many European
countries. In the Asia Pacific region, the industry is continuing to develop and may provide a significant
market for new optical networking equipment over the next several years. As a result, there has
been an increased focus on the Asia Pacific region by virtually all suppliers of optical networking
equipment. Similar to what is occurring in Europe within the EMEA region, the Asia Pacific region
may experience increased demand for additional and enhanced services by enterprises which may
encourage service providers to invest in the creation of networks that offer services such as
optical Ethernet and storage connectivity. In CALA, where a few service providers account for a
significant percentage of the industry, the building of national optical network infrastructures is
largely complete. Customers Our Optical Networks business is primarily focused on offering our optical networking
solutions to service providers around the world. The service provider customers for our optical
networking products include local and long-distance telephone companies, cable operators, Internet
service providers and other communications service providers. We are currently focused on
increasing our market presence with key service provider customers worldwide, which we expect to
account for a substantial proportion of service provider optical capital spending. We are also focused on enterprises and we continue to provide optical solutions for private
enterprise networking and also for service providers to build and operate custom dedicated and
shared networks for enterprises. We leverage numerous distribution channels for delivering optical
networking solutions to enterprises from our own direct sales force for large enterprises and
governments and through distributors, resellers and partners to offer our solution to medium-sized
enterprises and smaller enterprises. None of our Optical Networks customers represented more than
10% of Nortels consolidated revenues in 2004. Competition Our major competitors in the sale of optical networking equipment include Alcatel, Lucent,
Siemens, Fujitsu Limited, Marconi plc, Cisco, Huawei, NEC, Ciena and ADVA International Inc.
Market position in the global market for optical networking equipment can fluctuate significantly
on a quarter-by-quarter basis. However, we continue to be a leading global provider of optical
networking equipment. No one competitor is dominant in the optical networking equipment market. The primary global factors of competition for our Optical Networks products include:  
    
    technology leadership, product features and availability;  
    
    product quality and reliability;  
    
    conformity to existing and emerging regulatory and industry standards;  
    
    warranty and customer support; 20




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
    
    price and cost of ownership;  
    
    interoperability with other networking products;  
    
    network management capabilities;  
    
    traditional supplier relationships, particularly in EMEA and the Asia Pacific region; and  
    
    regulatory certification, particularly for incumbent local and long-distance telephone
companies. Our focus is on increasing market share relative to our competitors. 
 Sales and distribution All of our reportable segments use the Nortel direct sales force to market and sell to
customers around the world. The Nortel global sales force operates on a regional basis and markets
and sells our products and services to customers located in the following regional areas: Canada;
United States; CALA; EMEA; and Asia Pacific. Our sales office bases for our direct sales force are
aligned with our customers on a country and regional basis. We have dedicated sales account teams for certain major service provider customers. These
dedicated teams are located close to the customers main purchasing locations. In addition, teams
within the regional sales groups are dedicated to our enterprise customers. Our Enterprise
Networks sales teams work directly with the top regional enterprises, and are also responsible for
managing regional distribution channels. We also have centralized marketing, product management
and technical support teams dedicated to individual product lines that support the global sales and
support teams. In the Asia Pacific region, particularly in China, we also use agents to interface with our
customers. In addition, we have some small non-exclusive distribution agreements with distributors
in EMEA, CALA and the Asia Pacific region. In Enterprise Networks, certain service providers,
system integrators, value-added resellers and stocking distributors act as non-exclusive
distribution channels for our products. 
 Backlog Our backlog was approximately $4.1 billion as of December 31, 2004. A majority of backlog
consists of orders confirmed with a binding purchase order or contract for our network solutions
typically scheduled for delivery to our customers within the next twelve months. A significant
portion of backlog may also include orders that relate to revenue that has been deferred for
periods longer than twelve months. However, orders are subject to possible rescheduling by
customers. Although we believe that the orders included in the backlog are firm, we may elect to
permit cancellation of orders without penalty where management believes that it is in our best
interest to do so. Prior to including orders in backlog, customers must have approved credit
status. However, from time to time, some customers may become unable to pay for or finance their
purchases in which case the order is removed from our backlog. 
 Product standards, certification and regulations Our products are subject to equipment standards, registration and certification in Canada, the
United States, the European Union and other countries. We design and manufacture our products to
satisfy a variety of regulatory requirements and protocols established to, for instance, avoid
interference among users of radio frequencies and to permit interconnection of equipment. For
example, our equipment must satisfy the United States Federal Communications Commissions, or FCC,
emissions testing requirements, and must be certified to safety, electrical noise and
communications standards compliance. Different regulations and regulatory processes exist in each
country. In order for our products to be used in some jurisdictions, regulatory approval and, in some cases,
specific country compliance testing and re-testing may be required. The delays inherent in this
regulatory approval process may force us to reschedule, postpone or cancel introduction of products or new capabilities
in certain geographic areas, and may result in reductions in our sales. The failure to comply with
current or future regulations or changes in the interpretation of existing regulations in a
particular country could result in the suspension or cessation of sales in that country or require
us to incur substantial costs to modify our products to comply with the regulations of that
country. To support our compliance efforts, we work with consultants and testing laboratories as
necessary to ensure that our products comply with the requirements of Industry Canada in Canada,
the FCC in the United States and the European Telecommunications Standards Institute in Western
Europe, as well as with the various regulations of other countries. For additional information,
see Environmental Matters. 21




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The operations of our service provider customers are subject to extensive country-specific
telecommunications regulations. In the United States, on February 20, 2003, the FCC announced a
decision in its triennial review proceeding of the agencys rules regarding unbundled network
elements. The text of the FCCs order and reasons for the decision were released on August 21,
2003. The FCC decision, subsequent judicial review of the decision, FCC adoption of interim rules
and subsequent adoption of new unbundling rules with an effective date of March 11, 2005 are
affecting, and may continue to affect, the decisions of certain of our United States-based service
provider customers regarding investment in their telecommunications infrastructure. These
unbundled network elements rules and/or material changes in other country-specific
telecommunications regulations at any time or from time to time may affect capital spending by
service providers in the United States and/or around the world, and this may in turn affect the
United States and/or global markets for networking solutions. 
 Sources and availability of materials Since 1999, our manufacturing and supply chain strategy has evolved and has resulted in the
gradual transformation of our traditional manufacturing model, in which our products were primarily
manufactured and assembled in-house, to primarily an outsourced model which relies on electronic
manufacturing services, or EMS, suppliers. By the end of 2003, most of our manufacturing
activities had been divested to leading EMS suppliers. We have continued to pursue an outsourced
manufacturing model and in January 2004 announced our intention to divest substantially all of our
remaining manufacturing activities. On June 29, 2004, we announced that we had reached an
agreement with Flextronics to divest substantially all of Nortels remaining manufacturing
operations, located in Canada and Brazil, with the anticipation that Flextronics will also acquire
similar operations in France and Northern Ireland, subject to the completion of the required
information and consultation processes. The transfer of the optical design operations and related
assets in Ottawa, Canada and Monkstown, Northern Ireland closed in the fourth quarter of 2004. In
the first quarter of 2005, we completed the portion of the transaction related to the manufacturing
activities in Montreal, Canada. We previously reported that the portion of the transaction related
to the manufacturing activities in Calgary, Canada is expected to close in the second quarter of
2005 and that the balance of the transaction is expected to close on separate dates occurring
during the first half of 2005. We and Flextronics are currently discussing the timing of these
transactions in order to optimize the business transition between the companies. As a result of
these discussions, it is now expected that the balance of the
transaction relating to the
manufacturing operations in Chateaudun, France, Calgary and Monkstown
will close by the end of the first
quarter in 2006. As a result, we and Flextronics intend to enter into
an amendment agreement to extend the term of the original agreement
and offer to reflect this updated schedule. These transactions are subject to customary conditions and regulatory approvals.
For recent developments in the evolution of our supply chain strategy, see Developments in 2004
and 2005  Evolution of our supply chain strategy in the MD&A section of this report. We believe that the use of an outsourced manufacturing model has enabled us to benefit from leading
manufacturing technologies, leverage existing resources from around the world, lower our cost of
sales, quickly adjust to fluctuations in market demand and decrease our investment in plant,
equipment and inventories. We continue to retain in-house all strategic management and overall
control responsibilities associated with our various supply chains, including all customer
interfaces, customer service, order management, quality assurance, product cost-management, new
product introduction, and network solutions integration, testing and fulfillment. 22




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Through our existing manufacturing model, we are generally able to obtain sufficient materials and
components from global sources to meet the needs of our four reportable segments. In each of our
reportable segments, we:  
    
    make significant purchases of electronic components and assemblies, optical components,
original equipment manufacturer, or OEM, products, software products, outsourced
assemblies and other materials and components from many domestic and foreign sources;  
    
    develop and maintain alternative sources for certain essential materials and
components; and  
    
    occasionally maintain special inventories of components internally or request that they
be maintained by suppliers to satisfy customer demand or to minimize effects of possible
market shortages. In 2004, we continued to purchase, manufacture, or otherwise obtain sufficient components and
materials to supply our products, systems and networks within customary delivery periods. For more information on our supply arrangements, see Commitments in note 13 of the accompanying
consolidated financial statements and Developments in 2004 and 2005 and Liquidity and capital
resources  Uses of liquidity  Contractual cash obligations in the MD&A section of this report. Seasonality In 2004, we experienced a seasonal decline in revenues in the first quarter of 2004 compared
to the fourth quarter of 2003, followed by growth in the second quarter of 2004 compared to the
first quarter of 2004 in all of our four reportable segments. Revenues in all of our segments in
the fourth quarter of 2004 were highest compared to the other quarters in 2004. The quarterly
profile of our business results in 2005 is not expected to be consistent across all of our
reportable segments. We expect a seasonal decline in revenue in the first quarter of 2005 and
there is no assurance 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
Results of operations  continuing operations and Risk factors/forward looking statements in
the MD&A section of this report. Strategic alliances, acquisitions and minority investments We use strategic alliances to deliver certain solutions to our customers. These alliances are
typically formed to fill product or service gaps in areas that support our core businesses. We
believe strategic alliances also augment our access to potential new customers. We intend to
continue to pursue strategic alliances with businesses that offer technology and/or resources that
would enhance our ability to compete in existing markets or exploit new market opportunities. As
the information technology and communications markets converge, we expect that our rate of forming
strategic alliances will increase in order to fill the need for complimentary technology and
network integration skills. While we did not make any material acquisitions in 2004, in the future, we may consider selective
opportunistic acquisitions of companies with resources and product or service offerings capable of
providing us with additional enhancements to our networking solutions or access to new markets.
For information regarding the risks associated with strategic alliances and acquisitions, see Risk
factors/forward looking statements in the MD&A section of this report. We continue to hold minority investments in certain start-up businesses with technology, products
or services that, at the time of investment, had the potential to fulfill key existing or emerging
market opportunities. When minority investments are no longer required to maintain our strategic
relationship, or the relationship is no longer strategic to our core businesses, we intend to exit
such investments at an opportune time. 23




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Our investment activity remained at a low level in 2004. We may make selective minority
investments in start-up ventures and certain other companies where we believe the relationship
could lay the foundation for future alliances that would support our customer solutions. In
certain circumstances, we may also acquire an equity position in a company as consideration for a
divested business. See Developments in 2004 and 2005  Other business developments in the MD&A
section of this report. 
 Research and development In order to remain among the technology leaders in anticipated growth areas, we intend to
continue to make strategic investments in our research and development activities. Our research
and development activities  specifically, research, design and development, systems engineering
and other product development activities  represent focused investments to drive market leadership
across our product portfolios. We refer you to the four Product development discussions
contained in the descriptions of Wireless Networks, Enterprise Networks, Wireline Networks and
Optical Networks above. Our research and development investments are focused on network transformation and next generation
products and solutions including wireless voice and data, voice over packet, multimedia services
and applications, broadband networking and network security. We also conduct network planning and
systems engineering on behalf of, or in conjunction with, major customers. Although we derive many
of our products from substantial internal research and development activities, we supplement this
with technology acquired or licensed from third parties. Our research and development forms a core strength and is a factor differentiating us from many of
our competitors. As at December 31, 2004, we employed approximately 12,890 regular full-time
research and development employees (excluding employees on notice of termination) including
approximately:  
    
    5,000 regular full-time research and development employees in Canada;  
    
    4,550 regular full-time research and development employees in the United States;  
    
    2,140 regular full-time research and development employees in EMEA; and  
    
    1,200 regular full-time research and development employees in other countries. In August and September 2004, we announced a strategic plan that included a focused workforce
reduction of approximately 3,250 employees, or about 10% of our workforce. It is expected that
approximately 1,400 regular full-time research and development employees will be affected by the
workforce reduction, which is expected to principally affect employees in Wireline Networks and
Optical Networks. See Employee relations. We also conduct research and development activities through affiliated laboratories in other
countries. The following table sets forth our consolidated expenses for research and development for each of
the three fiscal years ended December 31: (millions of dollars)
    
    2004
    
    
    2003
    
    
    2002R&D expense
    
    $
    1,959
    
    
    $
    1,965
    
    
    $
    2,084R&D costs incurred on behalf of others (a)
    
    
    40
    
    
    
    72
    
    
    
    49Total
    
    $
    1,999
    
    
    $
    2,037
    
    
    $
    2,133
 (a)
    
    These costs included research and development charged to our customers pursuant to
contracts that provided for full recovery of the estimated cost of development, material,
engineering, installation and all other applicable costs, which were accounted for as contract
costs. 24




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Intellectual property Our intellectual property is fundamental to Nortel and the business of each of our four
reportable segments. In particular, our success is dependent upon our proprietary technology. We
generate, maintain, utilize and enforce a substantial portfolio of intellectual property rights,
including trademarks, and an extensive portfolio of patents covering significant innovations
arising from research and development activities. In all of our reportable segments, we use our
intellectual property rights to protect our investments in research and development activities, to
strengthen our leadership positions, to protect our good name, to promote our brand name
recognition, to enhance our competitiveness and to otherwise support our business goals and
objectives. However, our intellectual property rights may be challenged, invalidated or
circumvented, or fail to provide us with significant competitive advantages. See Risk
factors/forward looking statements in the MD&A section of this report. The duration and level of
protection of our intellectual property rights are dependent upon the laws and requirements of the
jurisdictions providing or controlling those rights. As of December 31, 2004, we and our parent, Nortel Networks Corporation, had on a consolidated
basis, approximately:  
    
    3,500 United States patents;  
    
    2,200 patents in other countries; and  
    
    5,600 pending patent applications worldwide. We were granted 520 United States patents in 2004. Our patents outside of the United States are primarily counterparts to our United States patents.
We have entered into some mutual patent cross-license agreements with several major corporations to
enable each party to operate without risk of a patent infringement claim from the other. In
addition, we are actively licensing certain of our patents and/or technology to third parties. We
also occasionally license single patents or groups of patents from third parties. Our trademarks and trade names, Nortel and Nortel Networks, are two of our most valuable assets.
We sell our products primarily under the Nortel and Nortel Networks brand names. We have
registered the Nortel and Nortel Networks trademarks, and many of our other trademarks, in
countries around the world. As of December 31, 2004, we and our parent, Nortel Networks
Corporation, owned on a consolidated basis approximately 100 registered trademarks in the United
States, and approximately 1,985 registered trademarks in other countries. In addition, as of
December 31, 2004, we had approximately 130 pending trademark registrations worldwide. 
 Employee relations At December 31, 2004, we employed approximately 33,990 regular full-time employees (excluding
employees on notice of termination), including approximately:  
    
    12,120 regular full-time employees in the United States;  
    
    8,990 regular full-time employees in Canada;  
    
    7,430 regular full-time employees in EMEA; and  
    
    5,450 regular full-time employees in other countries. We also employ individuals on a regular part-time basis and on a temporary full-time basis. In
addition, we engage the services of contractors as required. As part of our resizing activities to further reduce our cost structure and streamline operations,
we notified for termination and provisioned for the exit of approximately 1,800 regular full-time
employees during 2004. As well, divestitures and outsourcing affecting non-core businesses completed or entered
into in 2004 resulted in additional reductions. On June 29,
2004, we announced that we had reached an agreement 25




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with Flextronics to divest certain manufacturing operations in Canada and Brazil, with
the anticipation that Flextronics will also acquire similar operations in France and Northern
Ireland, subject to the completion of the required information and consultation process. Under the
terms of the agreement, it is intended that approximately 2,500 Nortel employees would transfer to
Flextronics. Approximately 170 employees located in Ottawa and Monkstown were transferred in
connection with the closing of the optical design business in the fourth quarter of 2004.
Approximately 910 employees located in Montreal were transferred in connection with the completion
of the transaction related to the manufacturing activities in Montreal in the first quarter of
2005. The timing for the transfer of the remaining employees to Flextronics is under review. In addition, in August and September 2004 we announced a new strategic plan, including a new
streamlined organizational structure which will lead to an anticipated reduction in employees of
approximately 3,250, or about 10% of the workforce. Approximately 64% of employee actions related
to the focused workforce reduction were completed by the end of 2004, including approximately 55%
that were notified of termination or acceptance of voluntary retirement, with the remainder
comprising voluntary attrition of employees that were not replaced. The remainder of employee
actions are expected to be completed by June 30, 2005. In addition, however, the Company continues
to hire in certain strategic areas such as investments in the finance organization. The workforce
reduction will be subject to completion of the appropriate information and consultation processes
with the relevant employee representatives in certain jurisdictions, as required by law. For
additional information, see Sources and availability of materials, Special charges in note 6 of
the accompanying consolidated financial statements and Results of operations  continuing
operations  Consolidated operating expenses  Special charges in the MD&A section of this report. At December 31, 2004, labor contracts covered approximately five percent of our employees
worldwide. At the same date, five labor contracts covered approximately twelve percent of our
employees in Canada including:  
    
    one labor contract covering approximately seven percent of Canadian unionized employees
which expires in February, 2006;  
    
    one labor contract covering less than one percent of Canadian unionized employees which
expires in August 2006;  
    
    one labor contract covering approximately nine percent of Canadian unionized employees
which expires in 2014;  
    
    one labor contract covering approximately 68% of Canadian unionized employees which was
renewed, ratified and became effective April 13, 2004; and  
    
    one labor contract covering approximately 15% of Canadian unionized employees which
expires in 2008. At December 31, 2004, labor contracts covered approximately four percent of our employees in EMEA
and all of our employees in Brazil. These labor contracts generally have a one year term, and
primarily relate to remuneration. We have no labor contracts in the United States. We believe our employee relations are generally positive. Employee morale continues to be an area
of focus as a result of ongoing workforce reductions associated with our restructuring activities
occurring since 2001, the recent reductions resulting from our strategic plan announced in August
and September 2004, and the restatement of our financial results and related matters. Although the
recruitment and retention of technically skilled employees in recent years was highly competitive
in the global networking industry, the economic conditions during the past few years have lessened
the competition for skilled employees in our industry. As the market continues to improve, we
believe it will become increasingly important to our future success to recruit and retain skilled
employees. During 2004, approximately 2,400 regular full-time employees were hired. See Risk factors/forward looking statements in the MD&A
section of this report. 26




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Environmental matters Our operations are subject to a wide range of environmental laws in various jurisdictions
around the world. We seek to operate our business in compliance with such laws. Nortel is subject
to new European product content laws and product takeback and recycling requirements that will
require full compliance by 2006. We expect that these laws will require us to incur additional
compliance costs. Although costs relating to environmental matters have not resulted in a material
adverse effect on our business, results of operations, financial condition and liquidity in the
past, there can be no assurance that we will not be required to incur such costs in the future. We
have a corporate environmental management system standard and an environmental program to promote
compliance. We also have a periodic, risk-based, integrated environment, health and safety audit
program. As part of our environmental program, we attempt to evaluate and assume responsibility
for the environmental impacts of our products throughout their life cycles. Our environmental
program focuses on design for the environment, supply chain and packaging reduction issues. We
work with our suppliers and other external groups to encourage the sharing of non-proprietary
information on environmental research. For additional information on environmental matters, see
Contingencies  Environmental matters in note 20 of the accompanying consolidated financial
statements. 
 Financial information by operating segment and product category For financial information by operating segment and product category, see Segment information
in note 5 of the accompanying consolidated financial statements and Results of operations 
continuing operations  Segment revenues in the MD&A section of this report. 
 Financial information by geographic area For financial information by geographic area, see Segment information in note 5 of the
accompanying consolidated financial statements and Results of operations  continuing operations -
Geographic revenues in the MD&A section of this report. 
 Working capital For a discussion of our working capital practices, see Long-term debt, credit and support
facilities in note 10 of the accompanying consolidated financial statements and Liquidity and
capital resources in the MD&A section of this report. 
 Risk factors THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD LOOKING INFORMATION THAT IS SUBJECT TO
IMPORTANT RISKS AND UNCERTAINTIES. THE RESULTS OR EVENTS PREDICTED IN THESE STATEMENTS MAY DIFFER
MATERIALLY FROM ACTUAL RESULTS OR EVENTS. RESULTS OR EVENTS COULD DIFFER FROM CURRENT EXPECTATIONS
AS A RESULT OF A WIDE RANGE OF RISK FACTORS. FOR INFORMATION REGARDING SOME OF THE RISK FACTORS
INVOLVED IN OUR BUSINESS AND OPERATIONS, SEE RISK FACTORS/FORWARD LOOKING STATEMENTS IN THE MD&A
SECTION OF THIS REPORT. 27




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ITEM 2. Properties At December 31, 2004, we operated 189 sites around the world occupying approximately 13.3
million square feet. The following table sets forth additional information regarding these sites: Number of SitesType of Site*
    
    
    Owned
    
    
    
    Leased
    
    
    
    Geographic LocationsManufacturing and repair
    
    
    
    7
    
    
    
    
    
    
    
    
    Canada, EMEA, CALA and the Asia Pacific regionDistribution centers
    
    
    
    
    
    
    
    
    5
    
    
    
    United States, Canada, EMEA and the Asia Pacific regionOffices
(administration, sales
and field service)
    
    
    
    4
    
    
    
    
    160
    
    
    
    All geographic regionsResearch and development
    
    
    
    4
    
    
    
    
    9
    
    
    
    United States, Canada, EMEA and the Asia Pacific regionTOTAL**
    
    
    
    15
    
    
    
    
    174
  *
    
    Indicates the primary use of the site. A number of our sites are mixed-use facilities.**
    
    Excludes approximately 6.5 million square feet, consisting primarily of leased and/or vacant
property designated as part of a planned square footage reduction in connection with our
restructuring activities commenced in 2001. At December 31, 2004 approximately 2.8 million
square feet of such property was sub-leased. At December 31, 2004, our facilities were primarily used, on a consolidated basis,
approximately as follows:  
    
    20% by Wireless Networks;  
    
    10% by Enterprise Networks;  
    
    10% by Wireline Networks;  
    
    5% by Optical Networks;  
    
    25% by global operations; and  
    
    30% by one or more of our reporting segments and/or corporate facilities. In 2004, we continued to reduce the number of sites and square footage of our global facilities to
better align ourselves with current market conditions. We believe our facilities are suitable and
adequate, and have sufficient capacity to meet our current needs. We continue to evaluate our
future real estate needs based on the current industry environment and taking into account our
business requirements. In 2004, we purchased land and two buildings that were previously leased by
Nortel. Our strategic plan announced in August and September 2004 includes the reduction of
approximately 2 million square feet of occupied space as a result of workforce reductions and
improved space utilization through the consolidation of locations. We expect the square footage
reduction to be completed by the end of 2005. For additional details, see Special charges in note 6 and Long-term debt, credit and support
facilities in note 10 of the accompanying consolidated financial statements, and Liquidity and
capital resources  Sources of liquidity in the MD&A section of this report. Security over substantially all of Nortel Networks Limiteds assets, including certain real estate
assets in North America, became effective in April 2002 under certain credit and security
agreements entered into by Nortel Networks Limited and several of its subsidiaries. For additional
details regarding these agreements and the security, see Long-term debt, credit and support
facilities in note 10, Subsequent events in note 21 and Supplemental consolidating financial
information in note 23 of the accompanying consolidated financial statements and Developments in
2004 and 2005  Credit facilities and security agreements
and Liquidity and capital resources  Sources of liquidity  Available support facility in the MD&A
section of this report. 28




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ITEM 3.
    
    Legal Proceedings 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 U.S. District Courts for the Eastern District of New
York, for the Southern District of New York and for the District of New Jersey and the provinces of
Ontario, Quebec and British Columbia in Canada, on behalf of shareholders who acquired Nortel
Networks Corporation securities as early as October 24, 2000 and as late as February 15, 2001,
allege, among other things, violations of U.S. 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 U.S. 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 grounds 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 U.S. District Court for the Southern
District of New York on behalf of shareholders who acquired the securities of JDS between January
18, 2001 and February 15, 2001, alleging violations of the same U.S. federal securities laws as the
above-noted lawsuits. On April 1, 2002, NNC filed a motion to dismiss both the above consolidated U.S. shareholder class
action and the above JDS shareholder class action complaints on the grounds that they failed to
state a cause of action under U.S. 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 U.S.
class action complaint. Plaintiffs appealed the dismissal of the JDS shareholder class action
complaint. On November 19, 2003, oral argument was held before the U.S. Court of Appeals for the
Second Circuit on the JDS shareholders appeal of the dismissal of their complaint. On May 19,
2004, the Second Circuit issued an opinion affirming the dismissal of the JDS shareholder class
action complaint and on July 14, 2004 the Second Circuit denied plaintiffs motion for rehearing.
On October 12, 2004, the plaintiffs filed a petition for writ of certiorari in the U.S. Supreme
Court. On November 12, 2004, the defendants filed Brief for the Respondents in Opposition, and on
November 22, 2004, the plaintiffs filed Reply to Brief in Opposition. On January 10, 2005, the
U.S. Supreme Court denied the petition for writ of certiorari. With respect to the consolidated
U.S. shareholder class action, the plaintiffs served a motion for class certification on March 21,
2003. On May 30, 2003, the defendants served an opposition to the motion for class certification.
Plaintiffs reply was served on August 1, 2003. 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 November 24, 2003, the Second Circuit denied the motion. On March 10, 2004, the District
Court approved the form of notice to the class which was published and mailed. 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 auditors as defendants. The factual allegations in the Ontario
Claim are substantially similar to the allegations in the consolidated amended complaint filed in
the U.S. District Court described above. The Ontario Claim is on behalf of all Canadian residents
who purchased Nortel Networks Corporation securities (including options on Nortel Networks
Corporation 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. On December 12, 2003,
plaintiffs counsel requested an extension of time to January 21, 2004 to deliver class
certification materials. On January 21, 2004, plaintiffs
counsel advised the Court that the two representative plaintiffs in the action no longer wished to proceed, but 29




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counsel was prepared to
deliver draft certification materials pending the replacement of the representative plaintiffs. On
February 19, 2004, the plaintiffs counsel advised the Court of a potential new representative
plaintiff. On February 26, 2004, the defendants requested the Court to direct the plaintiffs
counsel to bring a motion to permit the withdrawal of the current representative plaintiffs and to
substitute the proposed representative plaintiff. On June 8, 2004, the Court signed an order
allowing a Second Fresh as Amended Statement of Claim that substituted one new representative
plaintiff, but did not change the substance of the prior claim. A purported class action lawsuit was filed in the U.S. District Court for the Middle District of
Tennessee on December 21, 2001, on behalf of participants and beneficiaries of the Nortel Long-Term
Investment Plan (the Plan) at any time during the period of March 7, 2000 through the filing date
and who made or maintained Plan investments in Nortel Networks Corporation common shares, under the
Employee Retirement Income Security Act (ERISA) for Plan-wide relief and alleging, among other
things, material misrepresentations and omissions to induce Plan participants to continue to invest
in and maintain investments in Nortel Networks Corporation common shares in the Plan. A second
purported class action lawsuit, on behalf of the Plan and Plan participants for whose individual
accounts the Plan purchased Nortel Networks Corporation common shares during the period from
October 27, 2000 to February 15, 2001 and making similar allegations, was filed in the same court
on March 12, 2002. A third purported class action lawsuit, on behalf of persons who are or were
Plan participants or beneficiaries at any time since March 1, 1999 to the filing date and making
similar allegations, was filed in the same court on March 21, 2002. The first and second purported
class action lawsuits were consolidated by a new purported class action complaint, filed on May 15,
2002 in the same court and making similar allegations, on behalf of Plan participants and
beneficiaries who directed the Plan to purchase or hold shares of certain funds, which held
primarily Nortel Networks Corporation common shares, during the period from March 7, 2000 through
December 21, 2001. On September 24, 2002, plaintiffs in the consolidated action filed a motion to
consolidate all the actions and to transfer them to the U.S. District Court for the Southern
District of New York. The plaintiffs then filed a motion to withdraw the pending motion to
consolidate and transfer. The withdrawal was granted by the District Court on December 30, 2002.
A fourth purported class action lawsuit, on behalf of the Plan and Plan participants for whose
individual accounts the Plan held Nortel Networks Corporation common shares during the period from
March 7, 2000 through March 31, 2001 and making similar allegations, was filed in the U.S. 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 U.S. District Court for 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 U.S. District Court for the Middle District of
Tennessee (the Consolidated ERISA Action). 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 30, 2004, the plaintiffs filed a motion for certification of a class consisting
of participants in, or beneficiaries of, the Plan who held shares of the NNC Stock Fund during the
period from March 7, 2000 through March 31, 2001. On April 27, 2004, the Court granted the
defendants motion to stay discovery pending resolution of defendants motion to dismiss. On June
15, 2004, the plaintiffs filed a First Amended Consolidated Class Action Complaint that added
additional current and former officers and employees as defendants and expanded the purported class
period to extend from March 7, 2000 through to June 15, 2004. 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 U.S. 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 U.S. Court of Appeals for the Ninth Circuit denied the plaintiffs appeal of
that decision. On April 18, 1997, a second lawsuit was filed in the California Court, purportedly
on behalf of a class of shareholders who acquired Bay Networks common shares pursuant to the
registration statement and prospectus that became effective on November 15, 1995. The two actions
in the California Court were consolidated in April 1998; however, the California Court denied the
plaintiffs motion for class certification. In January 2000, the California Court of Appeal
rejected the plaintiffs appeal of the decision. A petition for review was filed with the
California Supreme Court by the plaintiffs and was denied. In February 2000, new plaintiffs who
allege to have been shareholders of Bay Networks during the relevant periods, filed a motion for
intervention in the California Court seeking to become the representatives of a class of
shareholders. The motion was granted on June 8, 2001 and the new plaintiffs filed their
complaint-in-intervention on an individual and purported class representative basis alleging
misrepresentations made in connection with the purchase and sale of securities of Bay Networks in
violation of California statutory and common law. On March 11, 2002, the California Court granted
the defendants motion to strike the class allegations. The plaintiffs were permitted to proceed
on their individual claims. The intervenor-plaintiffs appealed the
dismissal of their class allegations. On July 25, 2003, the California 30




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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. On December 22, 2003, the plaintiffs served
their motion for certification of a class of purchasers of Bay Networks common shares from July
25, 1995 through to October 14, 1996. Hearing of the plaintiffs motion for class certification
was held on May 4, 2004. On July 27, 2004, the Court entered an Amended Order Denying Motion of
Intervenor Plaintiffs for Class Certification and Setting Further Hearing. On August 9, 2004, the
intervenor-plaintiffs obtained Court approval to dismiss their claims and this action and, on
September 30, 2004, the Court entered dismissal with prejudice of the entire action of all parties
and all causes of action. Subsequent to the March 10, 2004 announcement in which NNC indicated it was likely that it and
Nortel would need to revise their previously announced unaudited results for the year ended
December 31, 2003, and the results reported in certain of their quarterly reports for 2003, and to
restate their previously filed financial results for one or more earlier periods, NNC and certain
of its then current and former officers and directors were named as defendants in 27 purported
class action lawsuits. These lawsuits in the U.S. District Court for the Southern District of New
York on behalf of shareholders who acquired Nortel Networks Corporation securities as early as
February 16, 2001 and as late as May 15, 2004, allege, among other things, violations of U.S.
federal securities laws. These matters are also the subject of investigations by Canadian and U.S.
securities regulatory and criminal investigative authorities. On June 30, 2004, the Court signed
Orders consolidating the 27 class actions and appointing lead plaintiffs and lead counsel. The
plaintiffs filed a consolidated class action complaint on September 10, 2004, alleging a class
period of April 24, 2003 through and including April 27, 2004. On November 5, 2004, Nortel
Networks Corporation and the Audit Committee Defendants filed a motion to dismiss the consolidated
class action complaint. On January 18, 2005, the lead plaintiffs, NNC, and the Audit Committee
Defendants reached an agreement in which NNC would withdraw its motion to dismiss and plaintiffs
would dismiss Count II of the complaint which asserts a claim against the Audit Committee
Defendants. On April 5, 2004, NNC announced that the SEC had issued a formal order of investigation in
connection with NNCs previous restatement of its financial results for certain periods, as
announced in October 2003, and NNC announcements in March 2004 regarding the likely need to revise
certain previously announced results and restate previously filed financial results for one or more
periods. The matter had been the subject of an informal SEC inquiry. On April 13, 2004, NNC
announced that it had received a letter from the staff of the Ontario Securities Commission (OSC)
advising that there is an OSC Enforcement Staff investigation into the same matters that are the
subject of the SEC investigation. On May 14, 2004, NNC announced that it had received a federal grand jury subpoena for the
production of certain documents, including financial statements and corporate, personnel and
accounting records, in connection with an ongoing criminal investigation being conducted by the
U.S. Attorneys Office for the Northern District of Texas, Dallas Division. On May 18, 2004, a purported class action lawsuit was filed in the U.S. District Court for the
Middle District of Tennessee on behalf of individuals who were participants and beneficiaries of
the Plan at any time during the period of December 23, 2003 through the filing date and who made or
maintained Plan investments in Nortel Networks Corporation common shares, under the ERISA for
Plan-wide relief and alleging, among other things, breaches of fiduciary duty. On September 3,
2004, the Court signed a stipulated order consolidating this action with the Consolidated ERISA
Action described above. On June 16, 2004, a second purported class action lawsuit, on behalf of
the Plan and Plan participants for whose individual accounts the Plan purchased Nortel Networks
Corporation common shares during the period from October 24, 2000 to June 16, 2004, and making
similar allegations, was filed in the U.S. District Court for the Southern District of New York.
On August 6, 2004, the Judicial Panel on Multidistrict Litigation issued a conditional transfer
order to transfer this action to the U.S. District Court for the Middle District of Tennessee for
coordinated or consolidated proceedings pursuant to 28 U.S.C. section 1407 with the Consolidated
ERISA Action described above. On August 20, 2004, plaintiffs filed a notice of opposition to the
conditional transfer order with the Judicial Panel. On December 6, 2004, the Judicial Panel denied
the opposition and ordered the action transferred to the U.S. District Court for the Middle
District of Tennessee for coordinated or consolidated proceedings with the Consolidated ERISA
Action described above. On January 3, 2005, this action was received in the U.S. District Court
for the Middle District of Tennessee and consolidated with the Consolidated ERISA Action described
above. On July 28, 2004, Nortel and NNC, and certain directors and officers, and certain former directors
and officers, of Nortel and NNC, were named as defendants in a purported class proceeding in the
Ontario Superior Court of Justice on behalf of shareholders who acquired Nortel Networks
Corporation securities as early as November 12, 2002 and as late as July 28, 2004. This lawsuit
alleges, among other things, breaches of trust and fiduciary duty, oppressive conduct and
misappropriation of corporate assets and trust property in respect of the payment of cash bonuses
to executives, officers and employees in 2003 and 2004 under the NNC Return to Profitability bonus
program and seeks damages of Canadian $250 and
an order under the Canada Business Corporations Act directing that an investigation be made
respecting these bonus payments. 31




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On July 30, 2004, a shareholders derivative complaint was filed in the U.S. District Court for the
Southern District of New York against certain directors and officers, and certain former directors
and officers, of NNC alleging, among other things, breach of fiduciary duties owed to NNC during
the period from 2000 to 2003 including by causing NNC to engage in unlawful conduct or failing to
prevent such conduct; causing NNC to issue false statements; and violating the law. On February
14, 2005, the defendants filed a motion to dismiss the derivative complaint. On August 16, 2004, NNC received a letter from the Integrated Market Enforcement Team of the Royal
Canadian Mounted Police (RCMP) advising NNC that the RCMP would be commencing a criminal
investigation into Nortels financial accounting situation. On February 16, 2005, a motion for authorization to institute a class action on behalf of residents
of Québec, who purchased NNC securities between January 29, 2004 and March 15, 2004, was filed in
the Québec Superior Court naming NNC as a defendant. The motion alleges that NNC made
misrepresentations about 2003 financial results. On March 9, 2005, Nortel and NNC, and certain of its current and former officers and directors and
its auditors were named as defendants in a purported class action proceeding filed in the Ontario
Superior Court of Justice, Commercial List, on behalf of all Canadian residents who purchased
Nortel Networks Corporation securities from April 24, 2003 to April 27, 2004. This lawsuit
alleges, among other things, negligence, misrepresentations, oppressive conduct, insider trading
and violations of Canadian corporation and competition laws in connection with NNCs 2003 financial
results and seeks damages of Canadian $3,000, plus punitive damages in the amount of Canadian
$1,000, prejudgment and postjudgment interest and costs of the action. Except as otherwise described herein, in each of the matters described above, the plaintiffs are
seeking an unspecified amount of monetary damages. Nortel is also a defendant in various other suits, claims, proceedings and investigations which
arise in the normal course of business. Nortel is unable to ascertain the ultimate aggregate amount of monetary liability or financial
impact to Nortel of the above matters which, unless otherwise specified, seek damages from the
defendants of material or indeterminate amounts or could result in fines and penalties. Nortel
cannot determine whether these actions, suits, claims and proceedings will, individually or
collectively, have a material adverse effect on the business, results of operations, financial
condition and liquidity of Nortel. Nortel, or NNC, as applicable, and
any named directors and officers of Nortel, or NNC, as applicable, intend to
vigorously defend these actions, suits, claims and proceedings. Nortel will continue to
cooperate fully with all authorities in connection with the regulatory and criminal
investigations. Environmental matters Nortels operations are subject to a wide range of environmental laws in various jurisdictions
around the world. Nortel seeks to operate its business in compliance with such laws. In 2004,
Nortel became subject to new European product content laws and product takeback and recycling
requirements that will require full compliance by 2006. It is expected that these laws will
require Nortel to incur additional compliance costs. Although costs relating to environmental
matters have not resulted in a material adverse effect on the business, results of operations,
financial condition and liquidity in the past, there can be no assurance that Nortel will not be
required to incur such costs in the future. Nortel has a corporate environmental management system
standard and an environmental program to promote such compliance. Moreover, Nortel has a periodic,
risk-based, integrated environment, health and safety audit program. 32




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Nortels environmental program focuses its activities on design for the environment, supply chain
and packaging reduction issues. Nortel works with its suppliers and other external groups to
encourage the sharing of non-proprietary information on environmental research. Nortel is exposed to liabilities and compliance costs arising from its past and current generation,
management and disposal of hazardous substances and wastes. As of December 31, 2004, the accruals
on the consolidated balance sheet for environmental matters were $31. Based on information
available as of December 31, 2004, management believes that the existing accruals are sufficient to
satisfy probable and reasonably estimable environmental liabilities related to known environmental
matters. Any additional liability that may result from these matters, and any additional
liabilities that may result in connection with other locations currently under investigation, are
not expected to have a material adverse effect on the business, results of operations, financial
condition and liquidity of Nortel. Nortel has remedial activities under way at 12 sites which are either currently or previously owned
or occupied facilities. An estimate of Nortels anticipated remediation costs associated with all
such sites, to the extent probable and reasonably estimable, is included in the environmental
accruals referred to above in an approximate amount of $31. Nortel is also listed as a potentially responsible party (PRP) under the U.S. Comprehensive
Environmental Response, Compensation and Liability Act (CERCLA) at six Superfund sites in the
U.S. An estimate of Nortels share of the anticipated remediation costs associated with such
Superfund sites is expected to be de minimis and is included in the environmental accruals of $31
referred to above. Liability under CERCLA may be imposed on a joint and several basis, without regard to the extent of
Nortels involvement. In addition, the accuracy of Nortels estimate of environmental liability is
affected by several uncertainties such as additional requirements which may be identified in
connection with remedial activities, the complexity and evolution of environmental laws and
regulations, and the identification of presently unknown remediation requirements. Consequently,
Nortels liability could be greater than its current estimate. ITEM 4.
    
    Submission of Matters to a Vote of Security Holders Not applicable.
 33




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##### Table of Contents



PART II 
  ITEM 5.
    
    Market for the Registrants Common Equity and Related Stockholder Matters The common shares of the Company are no longer listed and posted for trading on any stock
exchange. Nortel Networks Corporation is the sole holder of 100% of the issued and outstanding
common shares of the Company. The common shares of Nortel Networks Corporation are listed and
posted for trading on the New York Stock Exchange in the United States and on the Toronto Stock
Exchange in Canada. 
 Securities authorized for issuance under equity compensation plans Not applicable. 34




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##### Table of Contents



PART II  ITEM 6.
    Selected Financial Data The selected financial data presented below was derived from Nortel Networks Limiteds
(Nortel) audited consolidated financial statements and related notes thereto included elsewhere
in this Annual Report on Form 10-K except for the summarized balance sheet data as of December 31,
2002, 2001 and 2000 and summarized results of operations data for the year ended December 31, 2001.
Readers should note the following information regarding the selected financial data presented
below. As reported in its 2003 Annual Report on Form 10-K, Nortel restated its consolidated financial
statements for the fiscal years ended December 31, 2002 and 2001 and the quarters ended March 31,
June 30 and September 30, 2003. Except for selected balance sheet data as of December 31, 2000,
financial data for the year ended December 31, 2000 has not been restated or presented in the
selected financial data presented below. Due to the identified material weaknesses in Nortels
internal control over financial reporting, significant turnover in Nortels finance personnel,
changes in accounting systems, documentation weaknesses, a likely inability to obtain third party
corroboration in certain cases due to the substantial industry adjustment in recent years and the
passage of time generally, Nortel has determined that extensive additional efforts over an extended
period of time would have been required to restate its 2000 selected financial data. See Controls
and Procedures  Second Restatement  Use of Estimates in Financial Reporting; Omissions of 2000
Selected Financial Data section of this report. Nortel also believes that selected financial data
for this period would not be meaningful to investors due to the significant industry adjustment in
the telecommunications industry beginning in 2001, which significantly impacted Nortels financial
results in 2001 and subsequent periods and limits the relevance of financial results in periods
prior to 2001 for purposes of analysis of trends in subsequent periods. Previously reported
financial information for 2000 should not be relied upon. 35




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##### Table of Contents



(millions of U.S. dollars)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001Results of OperationsRevenues
    
    $
    9,828
    
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763Research and development expense
    
    
    1,959
    
    
    
    1,965
    
    
    
    2,084
    
    
    
    3,128Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    264
    
    
    
    2,239Other special charges
    
    
    180
    
    
    
    285
    
    
    
    1,358
    
    
    
    2,939Operating earnings (loss)
    
    
    (82
    )
    
    
    152
    
    
    
    (2,398
    )
    
    
    (12,619
    )Other income (expense)  net
    
    
    240
    
    
    
    433
    
    
    
    (28
    )
    
    
    (519
    )Income tax benefit (expense)
    
    
    29
    
    
    
    33
    
    
    
    438
    
    
    
    2,573Net earnings (loss) from continuing operations
    
    
    58
    
    
    
    430
    
    
    
    (2,163
    )
    
    
    (11,006
    )Net earnings (loss) from discontinued
operations  net of tax
    
    
    49
    
    
    
    184
    
    
    
    (101
    )
    
    
    (2,031
    )Cumulative
effect of accounting changes  net of tax
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    15Dividends on preferred shares
    
    
    33
    
    
    
    35
    
    
    
    26
    
    
    
    27Net earnings (loss) applicable to common shares
    
    
    74
    
    
    
    567
    
    
    
    (2,290
    )
    
    
    (13,049
    )
 (millions of U.S. dollars)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Financial Position as of December 31Total assets
    
    $
    16,944
    
    
    $
    16,456
    
    
    $
    16,714
    
    
    $
    20,971
    
    
    $
    33,211Total debt(a)
    
    
    2,102
    
    
    
    2,227
    
    
    
    2,433
    
    
    
    3,410
    
    
    
    2,452Minority interests in subsidiary companies
    
    
    94
    
    
    
    80
    
    
    
    94
    
    
    
    118
    
    
    
    148Preferred shares
    
    
    536
    
    
    
    536
    
    
    
    536
    
    
    
    536
    
    
    
    609Common shareholders equity
    
    
    5,788
    
    
    
    5,654
    
    
    
    4,644
    
    
    
    5,512
    
    
    
    16,810
 (a)
    
    Total debt includes long-term debt, long-term debt due within one year and notes payable.
 See notes 3, 6 and 9 to the accompanying consolidated financial statements for the impact of
accounting changes, special charges and acquisitions, divestitures and closures, respectively, that affect the comparability of the above selected
financial data.   36




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##### Table of Contents



ITEM 7.
    Managements Discussion and Analysis of Financial
Condition and Results of Operations  Table of Contents Business overview
    
    
    39Our business
    
    
    39Our segments
    
    
    39Our business environment
    
    
    40Our strategic plan and outlook
    
    
    42How we measure performance
    
    
    43Developments in 2004 and 2005
    
    
    442004 consolidated results summary
    
    
    44Nortel Audit Committee Independent Review; restatements; related matters
    
    
    45Comprehensive Review and First Restatement
    
    
    45Independent Review
    
    
    45Second Restatement
    
    
    46Material weaknesses in internal control over financial
reporting
    
    
    46Revenue Independent Review
    
    
    47Personnel actions
    
    
    47EDC Support Facility
    
    
    47Credit facilities and security agreements
    
    
    48Debt securities
    
    
    48Shelf registration statement
    
    
    48Credit ratings
    
    
    49Regulatory actions and pending litigation
    
    
    49Stock-based compensation plans
    
    
    49Evolution of our supply chain strategy
    
    
    50Other business developments
    
    
    50Directory and operator services business
    
    
    50Bharat Sanchar Nigram Limited contract
    
    
    51Joint Ventures
    
    
    51Optical components operations
    
    
    51Acquisitions
    
    
    51Results of operations  continuing operations
    
    
    52Consolidated revenues
    
    
    52Segment revenues
    
    
    53Wireless Networks revenues
    
    
    54Enterprise Networks revenues
    
    
    56Wireline Networks revenues
    
    
    57Optical Networks revenues
    
    
    58Geographic revenues
    
    
    60Consolidated gross profit and gross margin
    
    
    61Consolidated operating expenses
    
    
    62Selling, general and administrative expense
    
    
    62Research and development expense
    
    
    63Special charges
    
    
    63(Gain) loss on sale of businesses and assets
    
    
    68Other income (expense)  net
    
    
    69Interest expense
    
    
    69Income tax benefit (expense)
    
    
    70Net earnings (loss) from continuing operations
    
    
    70Segment Management EBT
    
    
    71Wireless Networks
    
    
    71Enterprise Networks
    
    
    72
 37




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##### Table of Contents



Wireline Networks
    
    
    73Optical Networks
    
    
    74Other
    
    
    75Results of operations  discontinued operations
    
    
    76Liquidity and capital resources
    
    
    77Cash flows
    
    
    77Operating activities
    
    
    78Investing activities
    
    
    81Financing activities
    
    
    81Uses of liquidity
    
    
    82Contractual cash obligations
    
    
    83Customer financing
    
    
    84Acquisitions
    
    
    85Sources of liquidity
    
    
    85Credit facilities
    
    
    86Available support facility
    
    
    86Shelf registration statement and base shelf prospectus
    
    
    87Credit ratings
    
    
    87Preferred shares
    
    
    87Off-balance sheet arrangements
    
    
    88Bid, performance related and other bonds
    
    
    88Receivables securitization and certain lease financing transactions
    
    
    89Other indemnifications or guarantees
    
    
    90Application of critical accounting policies and estimates
    
    
    90Revenue recognition
    
    
    90Provisions for doubtful accounts
    
    
    92Provisions for inventory
    
    
    93Provisions for product warranties
    
    
    94Income taxes
    
    
    94Tax asset valuation
    
    
    94Tax contingencies
    
    
    95Goodwill valuation
    
    
    96Pension and post-retirement benefits
    
    
    97Special charges
    
    
    99Other contingencies
    
    
    99Accounting changes and recent accounting pronouncements
    
    
    100Accounting changes
    
    
    100Recent accounting pronouncements
    
    
    100Canadian supplement
    
    
    101Market risk
    
    
    102Equity price risk
    
    
    103Environmental matters
    
    
    104Legal proceedings
    
    
    104Risk factors/forward looking statements
    
    
    104Risks relating to our restatements and related matters
    
    
    105Risks relating to our business
    
    
    111
 38




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Managements Discussion and Analysis of Financial Condition and Results of Operations You should read this Managements Discussion and Analysis of Financial Condition and Results
of Operation, or MD&A, in combination with the accompanying audited consolidated financial
statements prepared in accordance with accounting principles generally accepted in the United
States, or U.S. GAAP. A number of our and Nortel Networks Corporations past filings with the
United States Securities and Exchange Commission, or SEC, remain subject to ongoing review by the
SECs Division of Corporation Finance. Ongoing SEC review may require us to amend this Annual
Report onForm 10-Kor our other public filings further. See Risk factors/forward looking
statements. This section contains forward looking statements and should be read in conjunction with the risk
factors described below under Risk factors/forward looking statements. All dollar amounts in
this MD&A are in millions of United States, or U.S., dollars unless otherwise stated. Where we say we, us, our or Nortel, we mean Nortel Networks Limited or Nortel Networks
Limited and its subsidiaries, as applicable, and where we refer to the industry, we mean the
telecommunications industry. Business overview Our business Nortel is a recognized leader in delivering communications capabilities that enhance the human
experience, ignite and power global commerce, and secure and protect the worlds most critical
information. Serving both service provider and enterprise customers, we deliver innovative
technology solutions encompassing end-to-end broadband, Voice over Internet Protocol, or VoIP,
multimedia services and applications, and wireless broadband solutions designed to help people
solve the worlds greatest challenges. Our networking solutions consist of hardware, software and
services. Our business consists of the design, development, manufacture, assembly, marketing,
sale, licensing, installation, servicing and support of these networking solutions. A substantial
portion of our business has a technology focus and is dedicated to making strategic investments in
research and development, or R&D. This focus forms a core strength and is a factor that we believe
differentiates us from many of our competitors. We believe our acknowledged strength is strong
customer loyalty as a result of providing value to our customers through high reliability networks,
a commitment to ongoing support and an evolution of solutions as technology advancements in the
products are made. 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 Stock Exchange, or NYSE, and Toronto Stock Exchange, or
TSX under the symbol NT. Our cumulative Redeemable Class A Preferred Shares Series 5 and
Non-cumulative Redeemable Class A Preferred Shares Series 7 are traded on the TSX under the symbols
NTL.PR.F and NTL.PR.G, respectively. Acquisitions involving any share consideration are completed
by NNC, while acquisitions involving only cash consideration are generally completed by Nortel. Our segments During 2004, our operations were organized into four reportable segments as follows:  
    
    Wireless Networks  Our Wireless Networks segment provides communications network
solutions that enable our wireless service provider customers to offer their customers, the
subscribers for wireless communication services, the ability to be mobile while they send
and receive voice and data communications using wireless devices, such as cellular
telephones, personal digital assistants and other computing and communications devices.
Our Wireless Networks segment consists of Code Division Multiple Access, or CDMA, Global
System for Mobile communications, or GSM, Time Division Multiple Access, or TDMA, and
Universal Mobile Telecommunications Systems, or UMTS, products.
    
    Enterprise Networks  Our Enterprise Networks segment provides data, voice and
multimedia communications solutions to our enterprise customers. Our Enterprise Networks
customers consist of a broad range of enterprise customers around the world, including
large businesses and their branch offices, small businesses and home offices,
as well as government agencies, educational and other institutions and utility
organizations. Our Enterprise Networks segment consists of: (i) circuit and packet voice
solutions and (ii) data networking and security solutions. 39




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##### Table of Contents




    
    Wireline Networks  Our Wireline Networks segment provides data, voice and multimedia
communications solutions to service providers that operate wireline networks. Our service
provider customers include local and long distance telephone companies, wireless service
providers, cable operators and other communication service providers. Our Wireline
Networks segment consists of: (i) circuit and packet voice solutions and (ii) data
networking and security solutions.
    
    Optical Networks  Our Optical Networks segment solutions transport data, voice and
multimedia communications within and between cities, countries or continents by
transmitting communications signals in the form of light waves through fiber optic cables.
Our Optical Networks customers include local and long-distance telephone companies,
wireless service providers, cable operators and other communications service providers.
Our Optical Networks segment consists of long-haul and metropolitan optical products. Commencing in the second quarter of 2004, the primary financial measure used by the chief executive
officer, or CEO, in assessing performance and allocating resources to the segments was management
earnings (loss) before income taxes, or Management EBT. This measure includes the cost of
revenues, selling, general and administrative, or SG&A, expense, R&D expense, interest expense,
other income (expense)  net, minority interests  net of tax and equity in net loss of associated
companies  net of tax. Effective October 1, 2004, we established a new streamlined organizational structure that included,
among other things, combining the businesses of our four reportable segments into two business
organizations: (i) Carrier Networks and Global Operations, and (ii) Enterprise Networks. We have
reviewed the impact of these changes on our reportable segments and concluded that, although
certain structural changes were made to reflect this reorganization effective October 1, 2004, we
did not meet the criteria to change our reportable segments under Statement of Financial Accounting
Standards, or SFAS, No. 131, Disclosures about Segments of an Enterprise and Related Information
for the 2004 fiscal year. Our operating results on a segmented basis for the new business
organizations were not available for review by our chief operating decision maker, as a significant
amount of our finance resources were allocated to our restatement activity discussed in greater
detail under Developments in 2004 and 2005. These two business organizations include four operating segments. The four operating segments are
Carrier Packet Networks, which is substantially an amalgamation of our previous Wireline Networks
and Optical Networks businesses; CDMA Networks, which was previously part of Wireless Networks; GSM
and UMTS Networks which was also previously part of Wireless Networks; and Enterprise Networks,
which remains substantially unchanged from the previous organization. For the first quarter of
2005 these four operating segments will become our reportable segments. Our business environment In 2004, there was increased spending in the industry compared to 2003 by both service
provider and enterprise customers as certain service provider customers began to expand and upgrade
their existing networks, including next generation wireless technologies and VoIP solutions. This
increase in industry spending was strongest with the build-out of new technologies in both
established and emerging markets and with the build-out of traditional technologies in emerging
markets. In 2005, we expect that these trends will continue; however, the rate of increase may be
slower. Although there was increased spending in the industry by both service provider and enterprise
customers in 2004, we experienced a decline in revenue compared to 2003. There was decreased
spending on our overall traditional technologies as customers continued to transition to next
generation technologies. This decreased spending on traditional technologies outpaced the
increased spending on new technologies with many of our customers realigning capital spending with
their current levels of earnings in order to maximize their return on invested capital. Also,
excess network capacity and competition continued to exist in the industry, which led to continued
pricing pressures on the sale of certain of our products. However, based on current customer
orders in emerging markets, particularly in Asia and the Caribbean and Latin America region, or
CALA, and increased deployments of VoIP and next generation wireless technologies, including UMTS,
we believe that we are well positioned to grow our revenues in 2005. For example, throughout 2004
and into 2005 we announced several new contracts across all of our reportable segments, but
primarily in our Wireless Networks segment, as certain service provider customers began to expand
and upgrade their existing networks and new network build-outs were started in emerging markets. In 2005, we expect increased consolidation of certain service providers, particularly in the U.S.
We expect this trend to result in a net reduction in customer spending as these service providers focus on improving the
efficiency of their combined networks rather than network expansion. Competition in the industry
remains strong and our traditional large competitors, newer competitors, particularly from China,
and certain smaller niche competitors continue to increase their market share and create pricing
and margin pressures. We and our competitors remain focused on certain key factors such as customer
relationships, installed networks, innovative and reliable products, services and price. 40




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As first announced on August 19, 2004, we put in place a new strategic plan that recognizes our
business environment and the evolution of the converged network (see Business overview  Our
strategic plan and outlook). We are currently in a challenging transitional period as we
implement the new strategic plan. In an increasingly cost-competitive environment, we are taking
steps that we believe will better position us to grow market share and improve our results and cash
generation. As part of our strategic plan, we also announced a focused workforce reduction of
approximately 3,250 employees. Over the last five years, we have divested most of our manufacturing activities to Electronic
Manufacturing Services, or EMS, suppliers. On June 29, 2004, we announced an agreement with
Flextronics International Ltd., or Flextronics, regarding the divestiture of substantially all of
our remaining manufacturing operations. We believe that the use of an outsourced manufacturing
model has enabled us to benefit from leading manufacturing technologies, leverage existing
resources from around the world, lower our cost of revenues, quickly adjust to fluctuations in
market demand and decrease our investment in plant, equipment and inventories. We continue to
retain in-house all strategic management and overall control responsibilities associated with our
various supply chains, including all customer interfaces, customer service, order management,
quality assurance, product cost-management, new product introduction, and network solutions
integration, testing and fulfillment. In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to a comprehensive review and analysis of our assets and liabilities, or
the Comprehensive Review, which resulted in the restatement (effected in December 2003) of our
consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the
quarters ended March 31, 2003 and June 30, 2003, or the First Restatement. In late October 2003,
the Audit Committees of our and NNCs Boards of Directors, or the Audit Committee, initiated an
independent review of the facts and circumstances leading to the First Restatement, or the
Independent Review, and engaged the law firm now known as Wilmer Cutler Pickering Hale & Dorr LLP,
or WCPHD, to advise it in connection with the Independent Review. The Audit Committee sought to
gain a full understanding of the events that caused significant excess liabilities to be maintained
on the balance sheet that needed to be restated, and to recommend that our Board of Directors
adopt, and direct management to implement, necessary remedial measures to address personnel,
controls, compliance and discipline. In January 2005, the Audit Committee reported the findings of
the Independent Review, together with its recommendations for governing principles for remedial
measures that were developed for the Audit Committee by WCPHD. Each of our and NNCs Boards of
Directors has adopted these recommendations in their entirety and directed our management to
develop a detailed plan and timetable for their implementation, and will monitor their
implementation. The Summary of Findings and of Recommended Remedial Measures of the Independent
Review is set forth in full in Item 9A of our and NNCs 2003 Annual Reports on Form 10-K, or the
2003 Annual Reports. As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in depth the concerns identified by WCPHD regarding provisioning activity and to review
certain provision releases. That examination, and other errors identified by management, led to the
restatement of our financial statements for the years ended December 31, 2002 and 2001 and the
quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003 and 2002, or
the Second Restatement, and our revision of previously announced unaudited results for the year
ended December 31, 2003. The need for the Second Restatement resulted in delays in filing the 2003
Annual Reports, our and NNCs 2004 Annual Reports on Form 10-K for the year ended December 31,
2004, or the 2004 Annual Reports, and our and NNCs Quarterly Reports on Form 10-Q for the first,
second and third quarters of 2004, or the 2004 Quarterly Reports, and is expected to result in a
delay in filing our and NNCs Quarterly Reports on Form 10-Q for the first quarter of 2005, or the
2005 First Quarter Reports, beyond the SECs required filing dates. We refer to the 2003 Annual
Reports, the 2004 Annual Reports and the 2004 Quarterly Reports together as the Reports. Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue recognition and undertook a process of
revenue reviews. As described in more detail in the Controls and Procedures section of this
report, in light of the resulting adjustments to revenues previously reported in relevant periods,
the Audit Committee is reviewing the facts and circumstances leading to the restatement of these
revenues for specific transactions identified in the Second Restatement. This review has a
particular emphasis on the underlying conduct that led to the initial recognition of these revenues. The Audit Committee is seeking a full understanding of the historic
events that required the revenues for these specific transactions to be restated and will consider
any appropriate additional remedial measures, including those involving internal controls and
processes. The Audit Committee has engaged WCPHD to advise it in connection with this review. See
Risk factors/forward looking statements. 41




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Over the course of the Second Restatement process, we and our independent auditors identified a
number of material weaknesses in our internal control over financial reporting (all but one of
which continued to exist as of December 31, 2004). See the Controls and Procedures section of
this report. Further, in connection with the Independent Review, we terminated for cause our
former president and chief executive officer, former chief financial officer and former controller
in April 2004 and seven additional senior finance employees with significant responsibilities for
our financial reporting as a whole or for their respective business units and geographic areas in
August 2004. We are subject to significant pending civil litigation and ongoing regulatory and
criminal investigations in the U.S. and Canada, which could require us to pay substantial
judgments, settlements, fines or other penalties. We have made a number of recent appointments that are intended to enhance and complement our senior
executive team. These appointments included the new roles of chief operating officer, chief
marketing officer, chief strategy officer, chief ethics and compliance officer and chief research
officer and a new chief technology officer to lead the strategic vision for our product and
technology portfolio. Our strategic plan and outlook On August 19, 2004, we announced a new strategic plan intended to enable us to build on our
market leadership in developing the converged networks of the future and improve business
efficiency and operating cost performance in an increasingly competitive market. We provided
further details concerning the strategic plan on September 30, 2004 and December 14, 2004. It is
our intention to be optimally positioned to maximize strategic opportunities as they arise and
leverage our acknowledged strengths in high reliability networks and strong customer loyalty. We
are driving our business forward on a platform of integrity with a focus on cash, costs and
revenues as strategic goals. We remain committed to our business strategy of technology and
solutions evolution in helping our customers transform their networks and implement new
applications and services to drive improved productivity, reduced costs and revenue growth. The principal components of the strategic plan are:  
    
    a renewed commitment to best corporate practices and ethical conduct, including the
establishment of the office of a chief ethics and compliance officer;
    
    a streamlined organizational structure to reflect alignment with carrier converged networks;
    
    an increased focus on the enterprise market and customers;
    
    optimized R&D programs for highly secure, available and reliable converged networks;
    
    the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;
    
    the establishment of a chief marketing officer to drive overall marketing strategy;
    
    the strategic review of embedded services to assess opportunities in the professional services business; and
    
    a distinct focus on government and defense customers. Our strategic plan also includes a work plan involving focused workforce reductions, including a
voluntary retirement program, of approximately 3,250 employees, real estate optimization and other
cost containment actions such as reductions in information services costs, outsourced services and
other discretionary spending. Our workforce actions are focused to disproportionately protect
customer and sales facing roles as well as continue our focus on new innovative solutions. We
anticipate cost savings of approximately $500 in 2005 related to this work plan, partially offset
by planned investments in certain strategic areas such as the finance organization. For further information related to our work plan, see Results of operations  Continuing
operations  Consolidated operating expenses  Special charges. In 2005, we are focusing on regions and networking solutions that we believe will be areas of
potential growth and importance to our customers. On a regional basis, we see potential
significant growth opportunities in emerging markets such as China and India. Evidence of our
focus on these emerging market opportunities includes our contract with Bharat Sanchar Nigram
Limited, or BSNL, to establish a wireless network in India, our investment in Sasken Communication
Technologies Ltd. of India to develop new software and deploy our networking equipment and our
planned joint venture with China Putian Corporation. Globally, we believe security and reliability
for service provider networks are increasingly important to governments, defense interests and
enterprises around the world. In 2005, we expect our Management EBT to increase as compared to 2004 primarily due to expected
higher revenues, the 42




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impact of cost savings generated by our work plan, and lower costs resulting
from the substantial completion of our restatement activities. We expect that the increase will be
partially offset by increased investment costs in certain parts of the business and accruals for
expected employee bonuses for 2005 which were not incurred in 2004. The expected increase in
Management EBT is also expected to be partially offset by increased special charges in 2005
compared to 2004 associated with our work plan and an expected absence of gain on sale of
businesses and assets and income tax recoveries that were included in our 2004 results. For the first quarter of
2005, we expect modest growth in revenues compared to the first
quarter of 2004, gross margins to be in the range of 40 to 44 percent
of revenue, operating expenses to increase slightly compared to the
first quarter of 2004 and an ending cash balance of approximately
$3,500. How we measure performance Our 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. In 2004, each reportable segment
was managed separately with each segment manager reporting directly or indirectly to the CEO. The
CEO relies on the information derived directly from our management reporting system. Commencing in
the second quarter of 2004, in conjunction with the appointment of William A. Owens as our
president and chief executive officer, the primary financial measure used by the CEO in assessing
performance and allocating resources to the segments was Management EBT. This primary financial
measure replaced contribution margin, the previously disclosed primary financial measure used for
earlier periods. See Segment information  General description in note 5 of the accompanying
consolidated financial statements. Each reportable segment is also allocated resources and assets based on whether projected customer
demand would support additional investment. We make adjustments to resources and assets within a
reportable segment in response to market conditions or where opportunities for improved
efficiencies present themselves. Working capital for each segment is primarily managed by our
regional finance organization which manages accounts receivable performance and by our global
operations organization which manages inventory and accounts payable. Our other significant assets
including cash and cash equivalents, deferred income taxes, goodwill and a significant portion of
plant and equipment that relate to real estate and information systems infrastructure are managed
at a corporate level and are not allocated to or managed by our segments. Our financial targets focus on cash, costs and revenue. We expect to achieve targeted improvements
in cash flow from operations by driving improved earnings performance and working capital
management. We measure working capital performance through the use of working capital metrics (see
Liquidity and capital resources  cash flows). In particular, we are focused on improvements in
accounts receivable performance and levels of inventory. We have also set targets for cost reductions that include reducing our operating expenditures,
which is our combined SG&A and R&D spending, as a percentage of revenue. We are also focused on
maximizing cost effectiveness as we continue to experience pricing pressures for many of our
products. We expect operating expenses as a percent of revenue to
trend towards the low 30s by the end of 2005 primarily driven
by benefits from our previously announced restructuring work plan and
reductions in restatement, accounting and reporting costs. We have implemented a variety of programs to drive lower costs including our work plan
which targets a reduction of approximately 3,250 employees and cost savings of approximately $500
on an annual basis. Our model of outsourced manufacturing, including our agreement with
Flextronics, is important to maximizing our long term cost effectiveness. As a global supplier in the communications equipment market, one of the keys to our long term
success is revenue growth. In addition to efficiently providing global sales and support and
product development, it is important that we maintain or gain market share for us to be viewed by
our customers as a long term, innovative networking solutions supplier. We are focusing on
government, security and services to drive revenue growth as
evidenced by our recent announcement of our planned acquisition of PEC Solutions, Inc., or PEC. In addition to the above financial measures, we also monitor performance in the following areas:
status with our key customers on a global basis; the achievement of expected milestones of our key
R&D projects; and the achievement of our key strategic initiatives. In an effort to ensure we are
creating value for our customers and maintaining strong relationships with those customers, we
monitor our project implementation, customer service levels and the status of key contracts. We
also conduct regular customer satisfaction and loyalty surveys to monitor customer relationships.
With respect to our R&D projects, we measure content, quality and timeliness versus project plans.
Our key strategic initiatives include our finance transformation project which will include, among
other things, implementing a new information technology program (SAP) to provide an integrated global financial system; our supply chain evolution strategy with
Flextronics; planned new joint ventures in Asia; and improvements in the effectiveness of our
strategic alliances. 43




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Developments in 2004 and 2005 2004 consolidated results summary Summary of consolidated statements of operations data: % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of(millions of U.S. dollars)
    
    2004
    
    
    revenues
    
    
    2003
    
    
    revenues
    
    
    2002
    
    
    revenuesRevenues
    
    $
    9,828
    
    
    
    
    
    
    $
    10,193
    
    
    
    
    
    
    $
    10,994Gross profit
    
    
    4,093
    
    
    
    42
    
    
    
    4,332
    
    
    
    43
    
    
    
    3,855
    
    
    
    35Selling, general and administrative expense
    
    
    2,124
    
    
    
    22
    
    
    
    1,931
    
    
    
    19
    
    
    
    2,532
    
    
    
    23Research and development expense
    
    
    1,959
    
    
    
    20
    
    
    
    1,965
    
    
    
    19
    
    
    
    2,084
    
    
    
    19Amortization of intangibles
    
    
    10
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    19
    
    
    
    Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    264
    
    
    
    2Other special charges
    
    
    180
    
    
    
    1
    
    
    
    285
    
    
    
    3
    
    
    
    1,358
    
    
    
    13(Gain) loss on sale of businesses and assets
    
    
    (98
    )
    
    
    (1
    )
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )
    
    
    Operating earnings (loss)
    
    
    (82
    )
    
    
    
    
    
    
    152
    
    
    
    2
    
    
    
    (2,398
    )
    
    
    (22
    )Other income (expense)  net
    
    
    240
    
    
    
    2
    
    
    
    433
    
    
    
    4
    
    
    
    (28
    )
    
    
    Interest expenseLong-term debt
    
    
    (108
    )
    
    
    (1
    )
    
    
    (98
    )
    
    
    (1
    )
    
    
    (135
    )
    
    
    (1
    )Other
    
    
    (8
    )
    
    
    
    
    
    
    (26
    )
    
    
    
    
    
    
    (55
    )
    
    
    (1
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    42
    
    
    
    1
    
    
    
    461
    
    
    
    5
    
    
    
    (2,616
    )
    
    
    (24
    )Income tax benefit (expense)
    
    
    29
    
    
    
    
    
    
    
    33
    
    
    
    
    
    
    
    438
    
    
    
    471
    
    
    
    1
    
    
    
    494
    
    
    
    5
    
    
    
    (2,178
    )
    
    
    (20
    )Minority interests  net of tax
    
    
    (13
    )
    
    
    
    
    
    
    (28
    )
    
    
    
    
    
    
    32
    
    
    
    Equity in net loss of associated companies  net of tax
    
    
    
    
    
    
    
    
    
    
    (36
    )
    
    
    (1
    )
    
    
    (17
    )
    
    
    Net earnings (loss) from continuing operations
    
    
    58
    
    
    
    1
    
    
    
    430
    
    
    
    4
    
    
    
    (2,163
    )
    
    
    (20
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    49
    
    
    
    
    
    
    
    184
    
    
    
    2
    
    
    
    (101
    )
    
    
    (1
    )Net earnings (loss) before cumulative effect of accounting change
    
    
    107
    
    
    
    1
    
    
    
    614
    
    
    
    6
    
    
    
    (2,264
    )
    
    
    (21
    )Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss)
    
    $
    107
    
    
    
    1
    
    
    $
    602
    
    
    
    6
    
    
    $
    (2,264
    )
    
    
    (21
    )
 Our revenues declined by approximately 4% in 2004 compared to 2003 and declined by
approximately 7% in 2003 compared to 2002. In 2004 compared to 2003, revenues declined across all
segments with the exception of Wireless Networks which increased 10%. In 2004, our consolidated
revenues were $2,615 in the fourth quarter, $2,179 in the third quarter, $2,590 in the second
quarter and $2,444 in the first quarter, with the fourth quarter generally being our strongest
quarter of the year. Wireless Networks continues to be our largest segment, with revenues of
$4,839 representing 49% of our 2004 consolidated revenues, compared to revenues of $4,389
representing 43% of our 2003 consolidated revenues. Our gross margin decreased slightly to 42% in 2004 compared to 43% in 2003. The slight decrease
was primarily due to pricing pressures on certain of our products due to increased competition,
unfavorable product mix, an estimated project loss of approximately $160 recorded in 2004 related
to a wireless network contract with BSNL in India that we entered into in August 2004 and lower
sales volume. This was partially offset by continued improvements in our cost structure, lower
inventory and warranty provisions and decreased expenses related to our employee bonus plans in
2004. For further information related to the BSNL contract, see
Other business developments  Bharat Sanchar Nigram Limited. SG&A expense increased by 3% as a percentage of revenues in 2004 compared to 2003 primarily due to
increased costs related to our restatement activities, unfavorable foreign exchange rate
fluctuation impacts associated with the strengthening of the Canadian dollar, euro and British
pound against the U.S. dollar, increased employee related expenses and lower net trade and customer
financing receivable recoveries in 2004. R&D expense increased by approximately 1% as a percentage of revenues in 2004 compared to 2003
primarily due to unfavorable foreign exchange impacts, partially offset by the continued impact of
our workforce reductions. 44




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Special charges decreased substantially in 2004 compared to 2003 because a substantial portion of
activities associated with our restructuring work plan initiated in 2001 has been completed. These
activities included workforce reductions, contract settlements and facility closures. This was
partially offset by special charges associated with the implementation of our new strategic plan,
including a new restructuring work plan initiated in 2004. For further information related to our
2004 work plan, see Results of Operations  continuing operations  Consolidated operating
expenses  Special charges. Gain on sale of businesses and assets was $98 in 2004 compared to $4 in 2003. The $98 gain was
primarily due to a gain of approximately $30 related to the sale of our directory and operator
services, or DOS, business to VoltDelta Resources LLC, or VoltDelta, and a gain of $78 related to
the sale of certain assets in CALA. Our discontinued operations contributed $49 of net earnings in 2004 compared to $184 of net
earnings in 2003. The $49 of net earnings was primarily the result of a customer financing
agreement that was restructured and a gain related to the reassessment of our remaining provisions
for discontinued operations in 2004. For further information related to discontinued operations,
see Results of Operations  discontinued operations. We reported net earnings before cumulative effect of accounting changes of $107 in 2004 compared to
net earnings before cumulative effect of accounting changes of $614 in 2003 primarily due to the
factors mentioned above. We record any material adjustments identified before the applicable financial statements are
published and consider the materiality of any adjustments relating to prior periods both to the
current period and to the prior periods. In the course of the preparation of our 2004 financial
statements, and in part as a result of the application of our compensating procedures and
processes, we have recorded adjustments related to prior periods which are included in our 2004
financial statements. These adjustments include, among other items, an Asia Optical revenue
deferral of approximately $80 and a Brazil foreign exchange gain of approximately $32, both of which were recorded in the third quarter of 2004. We also recorded a revenue
deferral of approximately $50 in the fourth quarter of 2004 related to an EMEA Wireless
contract, which revenue was previously recognized primarily in 2002 and 2003. We determined that
this revenue should have been deferred and recognized upon delivery of the undelivered elements
such as services and/or hardware. The aggregate impact of the adjustments relating to prior periods
to our 2004 results was not material to our financial statements or to any individual segment or
geographic region, and resulted in a net reduction of approximately
$60 to our net earnings
(loss), primarily driven by a net reduction of approximately $60 in
our 2004 gross profit
of $4,100. These adjustments were immaterial to our 2003, 2002 and prior year results. Nortel Audit Committee Independent Review; restatements; related matters  Comprehensive Review and First Restatement In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to the Comprehensive Review, which resulted in the First Restatement.
See the Controls and Procedures section of this report. In connection with the Comprehensive Review, Deloitte & Touche LLP, or Deloitte, our independent
auditors, informed the Audit Committee on July 24, 2003 of a reportable condition that did not
constitute a material weakness in our internal control over financial reporting (throughout this
report with respect to dates and periods ended before December 31, 2004, reportable condition and
material weakness have the meanings as formerly set forth under standards established by the
American Institute of Certified Public Accountants, or AICPA, which are applicable for 2003; with
respect to dates and periods ending on or after December 31, 2004, material weakness has the
meaning set forth under Public Company Accounting Oversight Board Auditing Standard No. 2
throughout this report). Later, on November 18, 2003, as part of the communications by Deloitte to
the Audit Committee with respect to Deloittes interim audit procedures for the year ended December
31, 2003, Deloitte informed the Audit Committee that it had identified certain reportable
conditions, each of which constituted a material weakness in our internal control over financial
reporting. These material weaknesses identified in the First Restatement were also later
identified in connection with the Second Restatement together with certain additional material
weaknesses in our internal control over financial reporting, as described in greater detail in the
Controls and Procedures section of this report.  Independent Review In late October 2003, the Audit Committee initiated, and engaged WCPHD to advise it in
connection with, the Independent Review in order to gain a full understanding of the events that
caused significant excess liabilities to be maintained on the balance sheet that needed to be
restated, and to recommend that our Board of Directors adopt, and direct management to implement,
necessary remedial measures to address personnel, controls, compliance and discipline. The
Independent Review focused initially on events relating to the establishment and release of
contractual liability and other related provisions (also called accruals, reserves, or accrued
liabilities) in the second half of 2002 and the first half of 2003, including the involvement of
senior corporate leadership. As the Independent Review evolved, its focus broadened to include
specific provisioning activities in each of the business units and geographic regions. In light of
concerns raised in the initial phase of the Independent Review, the Audit Committee expanded the
review to include provisioning activities in the third and fourth quarters of 2003. As discussed more fully in the Controls and Procedures section of this report, the Independent
Review concluded that former corporate management (now terminated for cause) and former finance
management (now terminated for cause) in the Companys finance organization endorsed, and employees
carried out, accounting practices relating to the recording and release of provisions that were not
in compliance with U.S. GAAP in at least four quarters, including the third and fourth quarters of
2002 and the first and second quarters of 2003. In three of those four quarters  when Nortel was
at, or close to, break even  these practices were undertaken to meet internally imposed pro forma
earnings before taxes targets. While the dollar value of most of the individual provisions was
relatively small, the aggregate value of the provisions made the difference between a profit and a
reported loss, on a pro forma basis, in the fourth quarter of 2002 and the difference between a
loss and a reported profit, on a pro forma basis, in the first and second quarters of 2003. 45




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Second Restatement As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in depth the concerns identified by WCPHD regarding provisioning activity and to review
provision releases, down to a low threshold. That examination, and other errors identified by
management, led to the Second Restatement. On January 11, 2005, we filed our 2003 Annual Report on
Form 10-K in which we restated our results for the years ended December 31, 2002 and 2001. For
more information regarding the Second Restatement, see Managements Discussion and Analysis of
Financial Condition and Results of Operations in the 2003 Annual Reports, Item 9A of the 2003
Annual Reports and note 3 to the consolidated financial statements that accompany the 2003 Annual
Reports.  Material weaknesses in internal control over financial reporting As described above and in the Controls and Procedures section of this report, two material
weaknesses in our internal control over financial reporting were identified at the time of the
First Restatement. Over the course of the Second Restatement process, we and Deloitte identified a
number of additional material weaknesses in our internal control over financial reporting, as
further described in the Controls and Procedures section of this report. On January 10, 2005,
Deloitte confirmed to the Audit Committee the material weaknesses listed below:  
    
    lack of compliance with written Nortel procedures for monitoring and adjusting balances
related to certain accruals and provisions, including restructuring charges and contract
and customer accruals;
    
    lack of compliance with Nortel procedures for appropriately applying applicable GAAP to
the initial recording of certain liabilities including those described in SFAS No. 5,
Accounting for Contingencies, or SFAS No. 5, and to foreign currency translation as
described in SFAS No. 52, Foreign Currency Translation, or SFAS No. 52;
    
    lack of sufficient personnel with appropriate knowledge, experience and training in
U.S. GAAP and lack of sufficient analysis and documentation of the application of U.S.
GAAP to transactions, including but not limited to revenue transactions;
    
    lack of a clear organization and accountability structure within the accounting
function, including insufficient review and supervision, combined with financial reporting
systems that are not integrated and which require extensive manual interventions;
    
    lack of sufficient awareness of, and timely and appropriate remediation of, internal
control issues by Nortel personnel; and
    
    an inappropriate tone at the top, which contributed to the lack of a strong control
environment; as reported in the Independent Review Summary included in the 2003 Annual
Reports, there was a Management tone at the top
that conveyed the strong leadership message that earnings targets could be met through
application of accounting practices that finance managers knew or ought to have known were
not in compliance with U.S. GAAP and that questioning these practices was not acceptable. The first five of these six material weaknesses continued to exist at December 31, 2004. We
continue to identify, develop and implement remedial measures to address these material weaknesses
in our internal control over financial reporting, as described in the Controls and Procedures
section of this report. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, management has assessed our
internal control over financial reporting as at December 31, 2004, using the criteria issued by the
Committee of Sponsoring Organizations of the Treadway Commission, or
COSO, in Internal Control-Integrated
Framework. Based on that assessment, management determined that the first five of the six material weaknesses
listed above continued to exist as at December 31, 2004. Because of these material weaknesses,
management believes that, as at December 31, 2004, we did not maintain effective internal control
over financial reporting based on the COSO criteria. Our independent auditors have issued an
attestation report with respect to that assessment and conclusion. Management also determined, based on that assessment, that the sixth material weakness, relating to
an inappropriate tone at the top, was eliminated as at December 31, 2004 as a result of certain
modifications to our internal control over financial reporting, remedial measures and other
actions.
See the Controls and Procedures section of this report. 46




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Revenue Independent Review Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue recognition and undertook a process of
revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit
Committee is reviewing the facts and circumstances leading to the restatement of these revenues for
specific transactions identified in the Second Restatement. The review has a particular emphasis
on the underlying conduct that led to the initial recognition of these revenues. The Audit
Committee is seeking a full understanding of the historic events that required the revenues for
these specific transactions to be restated and will consider any appropriate additional remedial
measures, including those involving internal controls and processes. The Audit Committee has
engaged WCPHD to advise it in connection with this review, or the Revenue Independent Review.  Personnel actions In connection with the Independent Review, we have, among other actions, terminated for cause:  
    
    our former president and chief executive officer, former chief financial officer and
former controller in April 2004 (the former chief financial officer and former controller
having been placed on paid leaves of absence in March 2004); and
    
    seven additional senior finance employees with, or who had, significant
responsibilities for our financial reporting as a whole or for their respective business
units and geographic regions in August 2004. Each of these former members of management had responsibility for their respective positions at the
time of the Comprehensive Review and First Restatement. The Board of Directors determined that
each of these individuals had significant responsibilities for our financial reporting as a whole,
or for their respective business units and geographic regions, and that each was aware, or ought to
have been aware, that our provisioning activity, described above, did not comply with U.S. GAAP. We have demanded repayment by the individuals terminated for cause of payments made under our bonus
plans in respect of 2003. We have commenced litigation against our former president and chief
executive officer, former chief financial officer and former controller seeking the return of those
payments made to them.  EDC Support Facility The delayed filing of the Reports with the SEC, the trustees under our and NNCs public debt
indentures and Export Development Canada, or EDC, gave EDC the right to (i) terminate its
commitments under the $750 EDC support facility, or the EDC Support Facility, relating to certain
of our performance related obligations arising out of normal course business activities, and (ii)
exercise certain rights against the collateral pledged under related security agreements or require
us to cash collateralize all existing support. Throughout 2004 and into 2005, we obtained waivers from EDC with respect to these matters to permit
continued access to the EDC Support Facility in accordance with its terms while we and NNC worked
to complete our filing obligations. The waivers also applied to certain related breaches under the
EDC Support Facility relating to the delayed filings and the restatements and revisions to our and
NNCs prior financial results, or the Related Breaches. In connection with such waivers, EDC
reclassified the previously committed $300 revolving small bond sub-facility of the EDC Support
Facility as uncommitted support during the applicable waiver period. The $300 revolving small bond
sub-facility will not become committed support until all delayed filings have been filed with the
SEC, the trustees under our and NNCs public debt indentures and EDC and we obtain a permanent
waiver of the Related Breaches. We and NNC expect that the filing of the 2005 First Quarter Reports will be delayed and expect to
file the 2005 First Quarter Reports by the end of May 2005. On April 29, 2005, we obtained a new
waiver from EDC of certain defaults and related breaches by us under the EDC Support Facility. The
new waiver remains in effect until the earliest of certain events including the date on which we
and NNC have filed the 2004 Annual Reports and the 2005 First Quarter Reports, or May 31, 2005. If
we and NNC fail to file the 2005 First Quarter Reports by May 31, 2005, EDC will have the right
(absent a further waiver) to terminate the EDC Support Facility, exercise certain rights against
collateral or require us to cash collateralize all existing support. In addition, the Related
Breaches will continue beyond the filing of the 2004 Annual Reports and the 2005 First Quarter
Reports. Accordingly, beginning on the earlier of the date upon which we and NNC file the 2004
Annual Reports and the 2005 First Quarter Reports with the SEC and May 31, 2005, EDC will have the
right to terminate or suspend the EDC Support Facility notwithstanding the filing of the 2004
Annual Reports and the 2005 First Quarter Reports. While we intend to seek a permanent waiver from
EDC in connection with the Related Breaches, there can be no assurance that we will receive any
waiver or as to the terms of any such waiver. 47




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As of April 15, 2005, there was approximately $223 of outstanding support utilized under the EDC
Support Facility, approximately $155 of which was outstanding under the small bond sub-facility.
See Available support facility and Risk factors/forward looking statements.  Credit facilities and security agreements On April 28, 2004, we notified the lenders under our and Nortel Networks Inc., or NNI, $750
April 2000 five year credit facilities, or the Five Year Facilities, that we were terminating these
facilities. Absent such termination, the banks would have been permitted, upon 30 days notice, to
terminate their commitments under the Five Year Facilities as a result of our inability to file our
2003 Annual Report on Form 10-K by April 29, 2004. Upon termination, the Five Year Facilities were
undrawn. As a result of the termination of the Five Year Facilities, certain foreign security agreements
entered into by us and various of our subsidiaries, under which shares of certain of our
subsidiaries incorporated outside of the U.S. and Canada were pledged in favor of the banks under
the Five Year Facilities, EDC and the holders of our and NNCs outstanding public debt securities,
also terminated in accordance with their terms (see note 23 of the accompanying consolidated
financial statements). In addition, guarantees by certain subsidiaries of ours incorporated
outside of the U.S. and Canada terminated in accordance with their terms. Security agreements
remain in place under which substantially all of our assets located in the U.S. and Canada and
those of most of our U.S. and Canadian subsidiaries, including the shares of certain of our U.S.
and Canadian subsidiaries, are pledged in favor of EDC and the holders of our and NNCs outstanding
public debt securities. In addition, the guarantees by certain of our wholly owned subsidiaries,
including NNI, most of our Canadian subsidiaries, Nortel Networks (Asia) Limited, Nortel Networks
(Ireland) Limited and Nortel Networks U.K. Limited, of our obligations under the EDC Support
Facility and our and NNCs outstanding public debt securities, remain in place. See Liquidity and
capital resources.  Debt securities With the filing of the 2004 Annual Reports with the SEC and the delivery of the 2004 Annual
Reports to the trustees under our and NNCs public debt indentures, we and NNC will be in
compliance with our delivery obligations under the public debt indentures. However, as a result of the expected delay in filing the 2005 First Quarter Reports, we and NNC may
not be in compliance with our obligations to deliver the 2005 First Quarter Reports to the trustees
under our and NNCs public debt indentures if such reports are filed after May 25, 2005. Any
non-compliance with the delivery obligations under the public debt indentures with respect to the
2005 First Quarter Reports will not result in an automatic event of default and acceleration of the
outstanding long-term debt of NNC and us and such default and acceleration could not occur unless
notice of such non-compliance from holders of 25% of the outstanding principal amount of any
relevant series of debt securities is provided to us or NNC, as applicable, and we or NNC, as
applicable, failed to deliver the 2005 First Quarter Reports within 90 days after such notice is
provided, all in accordance with the terms of the indentures. While such notice could have been
given at any time after March 30, 2004 as a result of the delayed filing of the Reports, neither we
nor NNC has received such a notice to the date of this report. If notice were given and
acceleration of our and NNCs debt securities were to occur, we may be unable to meet our payment
obligations. If notice with respect to the delayed filing of the 2005 First Quarter Reports were
given, we believe that it is probable that we and NNC would file and deliver the 2005 First Quarter
Reports within 90 days of receipt of such a notice.  Shelf registration statement Owing to the delayed filing of the Reports and the expected delay in filing the 2005 First
Quarter Reports, we are currently unable to use, in its current form, the remaining approximately
$800 of capacity under our shelf registration statement filed with the SEC on May 13, 2002 for
various types of securities. After we have become current and timely with our SEC filings for a
period of twelve months, we will again become eligible for short form shelf registration with the
SEC. See Liquidity and capital resources and Risk factors/forward looking statements. 48




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Credit ratings On April 28, 2004, Standard and Poors, or S&P, downgraded its ratings on us, including our
long-term corporate credit ratings from B to B- and our preferred shares rating from CCC to
CCC-. At the same time, it revised its outlook to developing from negative. On April 28, 2004,
Moodys Investors Service, Inc., or Moodys, changed its outlook to potential downgrade from
uncertain. See Liquidity and capital resources  Credit ratings and Risk factors/forward
looking statements.  Regulatory actions and pending litigation We are under investigation by the SEC and the Ontario Securities Commission, or OSC,
Enforcement Staff. In addition, Nortel has received a U.S. federal grand jury subpoena for the
production of certain documents sought in connection with an ongoing criminal investigation being
conducted by the U.S. Attorneys Office for the Northern District of Texas, Dallas Division.
Further, the Integrated Market Enforcement Team of the Royal Canadian Mounted Police, or RCMP, has
advised us that it would be commencing a criminal investigation into our financial accounting
situation. We will continue to cooperate fully with all authorities in connection with these
investigations and reviews. See Legal proceedings and Risk factors/forward looking statements. In addition, numerous class action complaints have been filed against us and NNC, including class
action complaints under the Employee Retirement Income Security Act, or ERISA. In addition, a
derivative action complaint has been filed against NNC. These pending civil litigation actions and
regulatory and criminal investigations are significant and if decided against us, could materially
adversely affect our results of operations, financial condition and liquidity by requiring us to
pay substantial judgments, settlements, fines or other penalties. See Liquidity and capital resources, Legal proceedings and Risk
factors/forward looking statements. On May 31, 2004, the OSC issued a final order prohibiting all trading by our directors, officers
and certain current and former employees in the securities of Nortel Networks Corporation and
Nortel Networks Limited. This order will remain in effect until two full business days following
the receipt by the OSC of all filings required to be made by us and NNC pursuant to Ontario
securities laws. Because such filing would require amendments to each
of the quarterly periods of 2003 and for earlier periods including
2002 and 2001, which we do not believe to be feasible for the same
reasons mentioned in the Controls and Procedures section
of this report with respect to the restatement of 2000 selected
financial data, we and NNC plan to apply to the OSC to have this
order revoked once we and NNC have become current with our filing
obligations for 2005 under Ontario securities law. The OSC may, in
its discretion, revoke the order where in its opinion to do so would
not be prejudicial to the public interest. As a result of our delay in filing the Reports and the expected delay in filing the 2005 First
Quarter Reports, we were and expect to be in breach of the continued listing requirements of the
NYSE and TSX. We and NNC continue to co-operate with the NYSE and the TSX concerning our and NNCs
delay in filing our financial reports. As of the date of this report, neither the NYSE nor the TSX
has commenced any suspension or delisting procedures in respect of Nortel Networks Corporation
common shares and other of our or NNCs listed securities. The commencement of any suspension or
delisting procedure by either exchange remains, at all times, at the discretion of such exchange,
and would be publicly announced by the exchange. See Risk factors/forward looking statements.  Stock-based compensation plans As a result of our March 10, 2004 announcement that we and NNC would need to delay the filing
of our 2003 Annual Reports, we suspended as of March 10, 2004: the purchase of Nortel Networks
Corporation common shares under the stock purchase plans for eligible employees in eligible
countries that facilitate the acquisition of Nortel Networks Corporation common shares; the
exercise of outstanding options granted under the Nortel Networks Corporation 2000 Stock Option
Plan, or the 2000 Plan, or Nortel Networks Corporation 1986 Stock Option Plan as amended and
restated, or the 1986 Plan, or the grant of any additional options under those plans, or the
exercise of outstanding options granted under employee stock option plans previously assumed by us
in connection with mergers and acquisitions; and the purchase of units in a Nortel stock fund or
purchase of Nortel Networks Corporation common shares under our defined contribution and
investments plans, until such time as, at the earliest, that we and NNC are in compliance with U.S.
and Canadian regulatory securities filing requirements. Due to the suspension of the stock purchase plans as referred to above, in lieu of the employer
portion of stock purchase plan contributions, we made equivalent pre-tax payments to eligible
employees during the year ended December 31, 2004 totaling $7, which were recorded as compensation
expense. 49




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Evolution of our supply chain strategy On June 29, 2004, we announced an agreement with Flextronics regarding the divestiture of
substantially all of our remaining manufacturing operations, including product integration, testing
and repair operations carried out in Calgary and Montreal, Canada and Campinas, Brazil, as well as
certain activities related to these locations, including the management of the supply chain,
related suppliers, and third-party logistics. In Europe, Flextronics has made an offer to purchase
similar operations at our Monkstown, Northern Ireland and Chateaudun, France locations, subject to
the completion of the required information and consultation process. Under the terms of the agreement and offer, Flextronics will also acquire our global repair
services, as well as certain design assets in Ottawa, Canada and Monkstown related to hardware and
embedded software design, and related product verification for certain established optical
products. We have entered into a four year supply agreement with Flextronics for manufacturing services
(whereby Flextronics will manage approximately $2,500 of our annual cost of revenues) and a three
year supply agreement for design services. The transfer of the optical design operations and
related assets in Ottawa and Monkstown closed in the fourth quarter of 2004. In the first quarter
of 2005, we completed the portion of the transaction related to the manufacturing activities in
Montreal. We previously reported that the portion of the transaction related to the manufacturing
activities in Calgary is expected to close in the second quarter of 2005 and that the balance of
the transaction is expected to close on separate dates occurring during the first half of 2005. We
and Flextronics are currently discussing the timing of the closing of the balance of the
transaction in order to optimize the business transition between the companies. As a result of
these discussions, it is now expected that the balance of the transaction, relating to the
manufacturing operations in Chateaudun, Calgary and Monkstown, will close by the end of the first
quarter of 2006. As a result, we and Flextronics intend to enter into an amendment agreement to
extend the term of the original agreement and offer to reflect this updated schedule. These
transactions are subject to customary conditions and regulatory approvals. The successful completion of the agreement and offer with Flextronics will result in the transfer
of approximately 2,500 of our employees to Flextronics. We expect to receive cash proceeds ranging
from approximately $675 to $725, which will be allocated to each separate closing. We previously
announced that the estimated cash proceeds would be received substantially in 2005. We and
Flextronics are currently discussing the timing of the cash payments based on the expected change
to the original schedule. Such payments will be subject to a number of adjustments, including
potential post-closing date asset valuations and potential
post-closing indemnity payments. As of the first quarter of 2005, we have received proceeds of approximately $85.
Flextronics also has the ability in certain cases to exercise rights to sell back to us certain
inventory and equipment after the expiration of a specified period (of up to fifteen months)
following each respective closing date. We do not expect such rights to be exercised with respect
to any material amount of inventory and/or equipment. The allocation of proceeds related to this
transaction will be subject to an assessment of fair values related to the separate components
included therein. Direct transaction costs and other costs associated with transferring operations
to Flextronics (including transition, potential severance, information technology implementation
and real estate costs) are expected to be incurred. As at December 31, 2004, direct transaction
costs of $10 have been deferred as other assets and will be recognized as a cost of the ultimate
divestiture of the operations. Other business developments  Directory and operator services business On August 2, 2004, we completed the contribution of certain fixed assets, intangible assets
including customer contracts, software and other licenses, and liabilities of our DOS business to VoltDelta, a wholly owned
subsidiary of Volt Information Sciences, Inc., or VIS, in return for a 24 percent interest in
VoltDelta which was valued at $57. After a period of two years, we and VIS each have an option to
cause us to sell our VoltDelta shares to VIS for proceeds ranging from $25 to $70. As a result of
this transaction, approximately 160 of our DOS employees in North America and Mexico joined
VoltDelta. This non-monetary exchange has been recorded at fair value, and we recorded a gain of
$30 within sale of businesses and assets during 2004. The purchased option was initially recorded
at a fair value of $4 and is being assessed for impairment throughout the term until exercise or
expiration occurs. The written option is being marked to market through other income (expense) -
net each period until exercise or expiration occurs. As of December 31, 2004, the estimated fair
value of the written option was $9, which has been recorded in accrued liabilities. We are
providing certain transitional services to VoltDelta over a ten year period and the expected
proceeds of $4 are being recognized on a straight-line basis over the service term into other
income (expense)  net. We are accounting for our investment in VoltDelta under the equity method
and our proportionate share of VoltDeltas net earnings of $3 since August 2, 2004 has been
included in equity in net earnings (loss) of associated companies during 2004. 50




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Bharat Sanchar Nigram Limited contract In August 2004, we entered into a contract with BSNL to establish a wireless network in India
which we expect to generate approximately $500 in revenues to be recognized substantially in 2005.
We believe that this contract has strategic importance and we expect that it will position us to
capitalize on Indias potentially significant future growth for our long term benefit. Our
commitments to date for orders received as of December 31, 2004 under this contract have resulted
in an estimated project loss of approximately $160, which has been recorded as a charge to cost of
revenues and accrued within contractual liabilities in 2004. We expect to record an additional loss of
approximately $35 in the first half of 2005 as a result of additional orders received in that
period. The losses on this contract are primarily driven by the pricing pressures as a result of
the competitive nature of Indias telecom market and also our start up costs to become a
significant GSM vendor in this market. We believe that the revenue volumes driven by this contract
will create cost reduction benefits for our overall GSM business. In addition to the orders under the existing contract, BSNL may increase the amounts purchased
under the contract up to an additional 50% of the existing contract level to allow for business
expansion. We expect that there is the potential for further product losses, which will be
determined by the product mix and magnitude of additional orders.  Joint Ventures On January 20, 2005, we signed a Joint Venture Framework Agreement with China Putian
Corporation to establish a joint venture for R&D, manufacture and sale of third generation (3G)
mobile telecommunications equipment and products to customers in China. We expect to enter into a
definitive joint venture agreement by June 30, 2005. We anticipate that we will own 49% of the
joint venture and China Putian will own 51%. On January 23, 2005, we signed a Memorandum of Understanding with LG Electronics to establish a
joint venture for providing high quality, leading edge telecommunications equipment and networking
solutions to Korea and other markets globally. The proposed joint venture is subject to execution
of a definitive agreement. We expect to complete this transaction in the second half of 2005. We
anticipate that we will own 50% plus one share of the joint venture.  Optical components operations On December 2, 2004, we entered into a restructuring agreement with Bookham Technology plc, or
Bookham, a sole supplier of key components of our Optical Networks business. See Acquisitions,
divestitures and closures in note 9 of the accompanying consolidated financial statements. In
February 2005, we agreed to waive for a period of time minimum cash balance requirements under
certain Bookham notes and in March 2005, to adjust the
prepayment provisions of these notes and to amend our supply agreement with Bookham to provide
Bookham with financial flexibility to continue the supply of
components for our Optical
Networks products. See Related party transactions in note 19 of the accompanying consolidated
financial statements.  Acquisitions On April 26, 2005, we announced that Nortel Networks Inc., a wholly owned subsidiary of NNL
had entered into an agreement with PEC, providing for the acquisition of all of the outstanding
shares of PEC for $15.50 per share in cash, or approximately $448 million (net of cash acquired) in
the aggregate, plus transaction costs and expenses. The acquisition is subject to certain
conditions, including the successful completion of a tender offer and regulatory approvals. We
currently expect to complete the acquisition during the second quarter of 2005. 51




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Results of operations  continuing operations Consolidated revenues The following chart summarizes our quarterly revenues for 2004 and 2003: (BAR CHART)  2004 vs. 2003 In 2004, there was increased spending in the industry compared to 2003 by both service
provider and enterprise customers as certain service provider customers began to expand and upgrade
their existing networks, including next generation wireless technologies and VoIP solutions. This
increase in industry spending was strongest in the build-out of new technologies in both
established and emerging markets and with the build-out of traditional technologies in emerging
markets. Although there was increased spending in the industry by both service provider and
enterprise customers we experienced a decline in revenue in 2004 compared to 2003. There was
decreased spending on our overall traditional technologies as customers continued to transition to
next generation technologies. This decreased spending on traditional technologies outpaced the
increased spending on new technologies with many of our customers realigning capital spending with
their current levels of earnings in order to maximize their return on invested capital. Also,
excess network capacity and competition continued to exist in the industry, which led to continued
pricing pressures on the sale of certain of our products. Our consolidated revenues decreased 4% in 2004 compared to 2003 primarily due to declines across
all segments with the exception of Wireless Networks which increased 10%. Wireless Networks revenues increased 10% in 2004 compared to 2003 primarily due to increased
spending by our wireless service provider customers on our GSM and UMTS technologies as a result of
new contracts with certain customers as they continue to transition to next generation technologies
and other customers expanding their existing networks to meet increased subscriber demand or
enhancing their networks to support more sophisticated communication services. Enterprise Networks declined 9% in 2004 compared to 2003 primarily due to a substantial decline in
revenues of our traditional circuit switching products and interactive voice response products.
This substantial decline was primarily due to the recognition of revenues in 2003 deferred from
prior periods that did not occur to the same extent in 2004 as described below under Enterprise
Networks revenues. We also experienced declines in revenues associated with our legacy routing
portfolio and associated declines in new service contracts and service contract renewals. In
addition, we experienced a
decline in revenue from certain of our data networking products primarily due to pricing pressures
driven by increased competition. Wireline Networks revenues declined 14% in 2004 compared to 2003 primarily due to a substantial
decline in our traditional circuit switching revenues, which continued to decline at a faster rate
than the growth in our next generation wireline technologies. Optical Networks revenues declined 23% in 2004 compared to 2003 primarily due to a substantial
decline in the optical long-haul portion of this segment due to reduced customer spending and
ongoing pricing pressures. The revenues of the metro optical portion of this segment increased
significantly and surpassed long-haul revenues in terms of volume in 2004. In addition, a
substantial portion of the decline was due in part to a cumulative correction of revenues
previously recognized primarily in 2001 and 2002 relating to the delivery of future contractual
post-contract support, or PCS, and other services, as described below under Optical Networks
revenues. 52




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2005 Although we experienced a decline in revenue in 2004 compared to 2003, based on current
customer orders in emerging markets, particularly in Asia and CALA and increased deployments of
VoIP and next generation wireless technologies, including UMTS, we believe that we are well
positioned to grow our revenues in 2005. For example, throughout 2004 and into 2005, we announced
several new contracts across all of our reportable segments, but primarily in our Wireless Networks
segment, as certain service provider customers began to expand and upgrade their existing networks
and new network build-outs were started in emerging markets and as a result of new technologies.  For 2005, we expect overall revenue growth over 2004 primarily due to:  
    
    continued growth in our voice over packet technologies and our third generation wireless technologies;
    
    expansion and enhancement of existing networks by our customers due to subscriber growth
and competitive pressures;
    
    build-out of the BSNL contract in the Asia Pacific region. For further information
related to the BSNL contract, see Other business developments  Bharat Sanchar Nigram
Limited;
    
    anticipated growth in our Enterprise Networks business, particularly in our converged
networks products;
    
    expected focus on new technologies that create opportunities to optimize existing
networks while limiting capital expenditures and operating costs;
    
    expected continued growth in metro optical and carrier VoIP; and
    
    expected focus on new product areas, such as Wireless Local Area Networks, or WLAN, and carrier routing. Revenue growth generated from spending by our customers in the above areas of our business is
expected to be partially offset by revenue declines from:  
    
    customers limiting their investment in mature technologies as they focus on maximizing
return on invested capital;
    
    pricing pressures on sales of certain of our products as a result of increased
competition, particularly from low cost suppliers;
    
    consolidation of service providers which may reduce overall spending on telecom
equipment; and
    
    the impact of our financial restatement activities and the internal restructuring and
realignment programs that were initiated in August 2004. For additional information, see
Business overview  Our business environment. While customer support generally remains
strong, we believe that these activities had an adverse impact on business performance in
2004 and will continue to have an adverse impact into 2005. See Risk factors/forward looking statements for other factors that may affect our revenues. Segment revenues The following table summarizes our revenues for 2004, 2003 and 2002, by segment: For the years ended December 31,
    
    
    2004 vs 2003
    
    
    2003 vs 20022004
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    4,839
    
    
    $
    4,389
    
    
    $
    4,161
    
    
    $
    450
    
    
    
    10
    
    
    $
    228
    
    
    
    5Enterprise Networks
    
    
    2,354
    
    
    
    2,589
    
    
    
    2,415
    
    
    
    (235
    )
    
    
    (9
    )
    
    
    174
    
    
    
    7Wireline Networks
    
    
    1,723
    
    
    
    2,005
    
    
    
    2,572
    
    
    
    (282
    )
    
    
    (14
    )
    
    
    (567
    )
    
    
    (22
    )Optical Networks
    
    
    906
    
    
    
    1,179
    
    
    
    1,815
    
    
    
    (273
    )
    
    
    (23
    )
    
    
    (636
    )
    
    
    (35
    )Other(a)
    
    
    6
    
    
    
    31
    
    
    
    31
    
    
    
    (25
    )
    
    
    (81
    )
    
    
    
    
    
    
    Consolidated
    
    $
    9,828
    
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    (365
    )
    
    
    (4
    )
    
    
    (801
    )
    
    
    (7
    )
 (a)
    
    Other represented miscellaneous business activities and corporate functions.
 53




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Wireless Networks revenues The following chart summarizes recent quarterly revenues for Wireless Networks: (BAR CHART)  2004 vs. 2003 Wireless Networks revenues increased 10% in 2004 compared to 2003 primarily due to increased
spending by our service provider customers on our GSM and UMTS technologies. This was a result of
new contracts with certain customers as they continued to transition to next generation
technologies and other customers expanding their existing networks to meet increased subscriber
demand or enhancing their networks to support more sophisticated communication services. GSM revenues increased substantially in 2004 compared to 2003. The substantial increase was across
all regions primarily as a result of new contracts with certain customers and other customers
expanding their existing networks to meet increased subscriber demand or enhancing their networks
to support more sophisticated communication services. UMTS revenues increased substantially in 2004 compared to 2003 primarily due to increased
subscriber demand, new contracts with certain service provider customers and other customers
expanding their existing networks and the continued transition to this next generation technology. CDMA revenues increased slightly in 2004 compared to 2003 due to an increase in the U.S. and
substantial increases in EMEA and CALA. The increases in these regions were primarily due to new
contracts with certain service provider customers and other customers upgrading and expanding their
existing networks to meet increased subscriber demand. These increases in revenues were partially
offset by substantial declines in Asia Pacific and Canada primarily due to the completion of
certain customer network deployments during the first half of 2003. TDMA revenues declined substantially in 2004 compared to 2003 primarily due to the continued
transition by customers to newer wireless technologies. The substantial decline was primarily due
to customers across all regions continuing to migrate from the mature TDMA technology to GSM and
CDMA technologies. In 2004, TDMA revenues accounted for less than 2% of total Wireless Networks
revenues compared to 6% of total Wireless Networks revenues in 2003.  2003 vs. 2002 Wireless Networks revenues increased 5% in 2003 compared to 2002 due to a 31% increase in the
second half of 2003 partially offset by a 17% decrease in the first half of 2003 compared to the
same periods in 2002. The 31% increase in the second half of 2003 was primarily due to increased
spending by our service provider customers on our GSM, CDMA and
UMTS technologies as a result of new contracts with certain customers and other customers expanding
their existing networks to meet increased subscriber demand. The 17% decline in the first half of
2003 was primarily due to the ongoing focus by service providers on capital and cash flow
management and increased competition for customers by service providers. As a result, many of our
customers heavily scrutinized their capital expenditure requirements and postponed or reduced their
capital spending during the first six months of 2003. CDMA revenues increased in 2003 compared to 2002 due to a substantial increase in revenues in the
second half of 2003 compared to the same period in 2002. This substantial increase was partially
offset by a decrease in the first half of 2003 compared to the same period in 2002. The substantial increase in CDMA revenues in the second half of 2003 compared to the same period in
2002 was primarily 54




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due to a substantial increase in the U.S. and Canada as a result of our
customers expanding their existing networks and upgrading their existing networks to higher data
speeds. The substantial increase in the U.S. and Canada was partially offset by a substantial
decrease in EMEA. This substantial decline was primarily due to the completion of key customer
network deployments during the first half of 2003, which had been underway in 2002. The decrease in CDMA revenues in the first half of 2003 compared to the same period in 2002 was
primarily due to a substantial decline in Canada and a decline in the U.S. 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 half 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. GSM revenues increased significantly in 2003 compared to 2002 due to a substantial increase in
revenues in the second half of 2003 compared to the same period in 2002. This substantial increase
was partially offset by a significant decrease in the first half of 2003 compared to the same
period in 2002. The substantial increase in GSM revenues in the second half of 2003 compared to the same period in
2002 was primarily due to a substantial increase in the U.S. and EMEA. The substantial increase in
the U.S was primarily due to accelerated network expansions with certain service providers to meet
increased subscriber demand. The substantial increase in EMEA was mainly due to new contracts with
certain service provider customers and other customers expanding their existing networks. The significant decrease in GSM revenues in the first half of 2003 compared to the same period in
2002 was primarily due to substantial declines in Canada and Asia Pacific and a significant decline
in the U.S. The substantial decline in Asia Pacific was mainly due to a decline in the overall
growth rate of GSM technology deployments by service providers in the second half of 2002 and the
first half of 2003. As of the beginning of the first quarter of 2003, many of our GSM customers in
Asia Pacific had completed their current network deployments and, as a result, they had sufficient
capacity to meet additional subscriber demand. The substantial decline in Canada and the
significant decline in the U.S. were mainly due to the completion of network deployments by certain
service providers. In EMEA and CALA, GSM revenues increased substantially in the first half of
2003 primarily due to new contracts with certain service providers. UMTS revenues increased substantially in 2003 compared to 2002. This substantial increase was
primarily due to new contracts with certain service providers and the continued transition to this
next generation technology. TDMA revenues declined substantially in 2003 compared to 2002 primarily due to the continued
transition to newer wireless technologies. The substantial decline was primarily due to customers
in the U.S. and CALA continuing to migrate from the mature TDMA technology to GSM and CDMA
technologies. In 2003, TDMA revenues accounted for less than 6% of total Wireless Networks
revenues, down from 11% in 2002.  2005 We continue to expect a growing percentage of our Wireless Networks revenues to come from our
UMTS technology driven by strong growth anticipated in EMEA and Asia Pacific and moderate growth
anticipated in other global markets. For 2005, we expect overall revenue growth over 2004
primarily due to anticipated growth in our next generation wireless technologies, expansion and
enhancement of existing networks by our customers due to subscriber growth and competitive
pressures, build-out of the BSNL contract in the Asia Pacific region and focus on our new product
areas, such as WLAN. Spending by our customers in the above areas of our business is expected to be partially offset by
pricing pressures on sales
of certain of our products as a result of increased competition, particularly from low cost
suppliers. While we have seen encouraging indicators in certain areas of the wireless market, we can provide
no assurance that these growth areas that have begun to emerge will continue in the future. 55




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Enterprise Networks revenues The following chart summarizes recent quarterly revenues for Enterprise Networks: (BAR CHART)  2004 vs. 2003 Enterprise Networks revenues decreased 9% in 2004 compared to 2003 due to a significant
decrease in the circuit and packet voice portion of this segment and a slight decrease in the data
networking and security portion of this segment. Revenues from the circuit and packet voice portion of this segment decreased significantly
primarily due to a substantial decrease in revenues associated with our traditional circuit
switching and interactive voice response products primarily in the U.S. This substantial decrease
in revenues was primarily a result of the release of certain software, including the general
availability of Succession 3.0 in the fourth quarter of 2003. The general availability of this
software triggered the recognition of associated revenues deferred from prior periods, resulting in
a net increase in revenues of $150 in 2003 ($300 in the fourth quarter of 2003) that did not occur
to the same extent in 2004. In addition, revenues from certain products associated with various
software upgrade marketing programs initiated in 2004 did not meet the criteria for revenue recognition in 2004 and were deferred to
future periods. This decrease was partially offset by an increase in revenues across all regions
primarily associated with our converged Internet Protocol, or IP, telephony solutions as customers
continued to migrate towards converged packet voice solutions from our traditional circuit
switching products. Revenues associated with the data networking and security portion of this segment decreased
slightly primarily due to a decline in revenues associated with our legacy routing portfolio and
associated declines in new service contracts and service contract renewals. We also experienced a
decline in revenue from certain of our data networking products primarily due to pricing pressures
driven by increased competition. In addition, in 2003, we recognized revenues of approximately $60
compared with revenues of approximately $30 in 2004 primarily in the U.S. associated with the
delivery of certain data switch upgrades. These declines were partially offset by growth from
improved market penetration of certain new products.  2003 vs. 2002 Enterprise Networks revenues increased 7% in 2003 compared to 2002 due to a substantial
increase in the circuit and packet voice portion of this segment offset by a significant decrease
in the data networking and security portion of this segment. Revenues from the circuit and packet voice portion of this segment increased substantially in 2003
compared to 2002. We experienced a substantial increase in revenues associated with our
traditional circuit switching and interactive voice response solutions primarily in the U.S. as a
result of the release of certain software, including the general availability of Succession 3.0 in
the fourth quarter of 2003. The general availability of this software triggered the recognition of
associated revenues deferred from prior periods, resulting in a net increase in revenues of $150 in
2003 ($300 in the fourth quarter of 2003). In addition, there was 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 2003 compared to 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
solutions primarily due to pricing pressures driven by increased competition. This was partially
offset by a net increase due to the recognition of previously deferred revenues associated with the
delivery of certain data switch upgrades of approximately $60 in 2003. 56




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Enterprise Networks revenues declined sequentially in the first and second quarters of 2003 and
increased sequentially in the third and fourth quarters of 2003. The sequential declines in the
first half of 2003 were primarily due to customers having sufficient network capacity, continued
capital spending restrictions by our customers and delays associated with the establishment of new
channel relationships to address demand from small and medium sized enterprise customers. The
sequential increases in revenues in the second half of 2003 were primarily due to sequential
increases in revenues associated with our IP telephony solutions as our customers continued to
migrate toward packet voice solutions as well as revenue recognized due to the release of certain
software including Succession 3.0 in the fourth quarter of 2003. Further, we experienced
sequential revenue increases in the third and fourth quarters of 2003 from our interactive voice
response and security products as a result of certain new product releases in the second half of
2003.  2005 In 2005, we expect that data, voice and multimedia communications 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. Also, we anticipate that demand will
continue to decline for our traditional circuit switching solutions; 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. In 2005, we are focused on increasing our market presence with
enterprise customers. In particular, we are focusing on key enterprise customers with high
performance networking needs. While we have seen encouraging indicators in certain parts of the
enterprise market, we can provide no assurance that the growth areas that have begun to emerge will
continue in the future. Wireline Networks revenues The following chart summarizes recent quarterly revenues for Wireline Networks: (BAR CHART)  2004 vs. 2003 Wireline Networks revenues decreased 14% in 2004 compared to 2003 primarily due to a
substantial decline in our traditional circuit switching product revenues. Revenues from the circuit and packet voice portion of this segment decreased significantly
primarily due to a substantial decline in our traditional circuit switching product revenues. The
substantial decline in our traditional circuit switching product revenues was primarily due to
continued reductions in capital expenditures by our U.S, Canada and EMEA service provider customers
and a reduction in spending on our mature products in all regions. The substantial decline in
traditional circuit switching product revenues was partially offset by the substantial increase in
revenues related to our packet voice solutions in all regions but primarily in the U.S and CALA as
customers transitioned to these next-generation products from our traditional circuit switching
products. Revenues from the data networking and security portion of this segment decreased significantly in
2004 compared to 2003 primarily due to substantial declines in the U.S. and Canada, and a
significant decline in EMEA. In these regions, we experienced a decline in demand for our mature
products primarily due to the ongoing shift towards IP-based technology.  2003 vs. 2002 Wireline Networks revenues decreased 22% in 2003 compared to 2002 primarily due to a
substantial reduction in capital spending by our service provider customers as a result of the
continued industry adjustment. 57




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Revenues from the circuit and packet voice portion of this segment decreased substantially in 2003
compared to 2002 primarily due to a substantial decrease in the U.S in our traditional circuit
switching product revenues and also uncertainty related to the impact of the Federal Communications
Commission, or FCC, decision regarding the regulation of the availability of unbundled network
elements, or UNEs, released on August 21, 2003 and subsequent judicial review and FCC
reconsideration of the decision. The substantial decline in our circuit switching revenues was
primarily due to the continuing impact of capital spending restrictions experienced by our service
provider customers during 2003 and tightened capital markets mainly during the first half of 2003
across all regions. In addition, the decline was due in part to the completion of a major contract
in CALA in the first quarter of 2002. Revenues from our packet voice solutions increased
substantially across all regions except EMEA in 2003 compared to 2002 primarily due to new service
provider contracts throughout 2003. Revenues from the data networking and security portion of this segment decreased significantly in
2003 compared to 2002 primarily due to substantial declines in the U.S. and Asia Pacific and a
significant decline in CALA. In these regions, we experienced a decline in demand for our mature
products primarily due to the ongoing shift towards IP-based technology.  2005 In 2005, our service provider customers continue to increase the deployment of packet-based
technologies in their communications networks as they look for ways to optimize their existing
networks and offer new revenue generating services while limiting capital expenditures and
operating costs. However, the timing of when service provider customers will deploy packet-based
technologies on a wider scale is still unclear. The demand for our traditional circuit switching
products has continued to decline as certain service providers continued to reduce their capital
expenditures on these legacy technologies. While we have seen encouraging indicators in certain
areas of the wireline service provider market, we can provide no assurance that the growth areas
that have begun to emerge will continue in the future. Optical Networks revenues The following chart summarizes recent quarterly revenues for Optical Networks: (BAR CHART)  2004 vs. 2003 Optical Networks revenues decreased 23% in 2004 compared to 2003 primarily due to a
substantial decline in the long-haul portion of this segment partially offset by a significant
increase in the metro optical portion of this segment. Revenues in the long-haul portion of this segment declined substantially in the U.S., Asia Pacific
and EMEA, declined significantly in Canada and declined slightly in CALA. This was due in part to
reduced spending by customers as they
continued to focus on maximizing return on invested capital by increasing the capacity utilization
rates and efficiency of existing networks. Significant excess inventories and capacity continued
to exist in this portion of the segment which also resulted in ongoing pricing pressures across all
regions. In addition, a substantial portion of the decline was a result of a cumulative correction
made in the third quarter of 2004 for revenues previously recognized primarily in 2001 and 2002.
These previously recognized revenues related to past sales of equipment to certain customers in the
Asia Pacific region which we subsequently determined should have been deferred and recognized with
the delivery of future contractual PCS and other services over the term of the PCS. A
corresponding correction was made in the third quarter of 2004 to the associated costs of revenues
which should also have been deferred and recognized with the delivery of future contractual PCS and
other services. The adjustment to correct for the previously recognized revenues resulted in a
reduction in revenues of approximately $80 in the third quarter of 2004. These revenues and
associated costs of revenues will be recognized in future periods during the remaining term of the
PCS. As a result of the corresponding correction made to the associated costs of revenues, there
was no significant impact on our gross margin in 2004. 58




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Revenues in the metro optical portion of this segment increased significantly primarily due to
certain service provider customers primarily in the U.S. and EMEA upgrading and expanding their
existing networks. In 2004, the revenues in the metro optical portion of this segment surpassed
the revenues in the long-haul portion.  2003 vs. 2002 Optical Networks revenues decreased 35% in 2003 compared to 2002. The decline was primarily
the result of the continuing industry adjustment, excess capacity, tightened capital markets mainly
during the first half of 2003 and reductions in capital spending by our EMEA, U.S. and Canada
customers in both the long-haul and metro optical portions of this segment. Revenues in the long-haul portion of this segment decreased substantially in 2003 compared to 2002
primarily due to the continuing industry adjustment, excess capacity, tightened capital markets
mainly during the first half of 2003 and continued capital spending restrictions in the U.S.,
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 Asia Pacific,
optical long-haul revenues declined substantially in 2003 compared to 2002 primarily due to the
completion of network build-outs for certain customers in 2002 that were not repeated in 2003. In
addition, significant excess inventories continued to exist in this portion of the segment which
resulted in ongoing pricing pressures across all regions. In the fourth quarter of 2002, we sold certain optical components assets to Bookham. As a result,
our results in 2003 in the long-haul portion of this segment do not reflect revenues generated from
these assets. In 2002, revenues generated from the optical components assets sold to Bookham were
approximately 3% of the total Optical Networks revenues of $1,815. Revenues in the metro optical portion of this segment were relatively flat in 2003 compared to
2002. This was primarily due to a substantial decrease in EMEA partially offset by an increase in
revenues in the U.S. and a substantial increase in Asia Pacific. The substantial decrease in EMEA
was primarily the result of the continued industry adjustment, tightened capital markets mainly
during the first half of 2003 and customer spending restrictions. The increase in revenues in the
U.S. and the substantial increase in Asia Pacific were primarily due to new customer contracts
during the first half of 2003 for expansions of existing networks to meet increased customer
demand.  2005 In 2005, 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. We anticipate an increase in demand for Dense Wavelength Division Multiplexing solutions within the
metro optical portion of this segment. This expected increase is primarily due to new network
deployments by certain customers and other customers expanding their networks, driven by emerging
applications such as cable video on demand, all of which have resulted in increased demand for low
cost, high capacity connectivity between network sites. As a result, we expect that the metro
optical portion of this segment will continue to represent a larger percentage of overall Optical
Networks revenues. While we have seen encouraging indicators in certain parts of the optical
market, we can provide no assurance that the growth areas that have begun to emerge will continue
in the future. 59




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Geographic revenues The following table summarizes our geographic revenues based on the location of the customer: For the years ended December 31,
    
    
    2004 vs 2003
    
    
    2003 vs 20022004
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeUnited States
    
    $
    4,833
    
    
    $
    5,424
    
    
    $
    5,809
    
    
    $
    (591
    )
    
    
    (11
    )
    
    $
    (385
    )
    
    
    (7
    )EMEA(a)
    
    
    2,580
    
    
    
    2,366
    
    
    
    2,500
    
    
    
    214
    
    
    
    9
    
    
    
    (134
    )
    
    
    (5
    )Canada
    
    
    568
    
    
    
    587
    
    
    
    648
    
    
    
    (19
    )
    
    
    (3
    )
    
    
    (61
    )
    
    
    (9
    )Asia Pacific
    
    
    1,253
    
    
    
    1,307
    
    
    
    1,484
    
    
    
    (54
    )
    
    
    (4
    )
    
    
    (177
    )
    
    
    (12
    )CALA
    
    
    594
    
    
    
    509
    
    
    
    553
    
    
    
    85
    
    
    
    17
    
    
    
    (44
    )
    
    
    (8
    )Consolidated
    
    $
    9,828
    
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    (365
    )
    
    
    (4
    )
    
    $
    (801
    )
    
    
    (7
    )
 (a)
    
    The Europe, Middle East and Africa region.
  2004 vs. 2003 From a geographic perspective, the 4% decrease in revenues in 2004 compared to 2003 was
primarily due to a:  
    
    11% decline in revenues in the U.S. primarily due to a substantial decrease in Wireline
Networks revenues as our customers continued to reduce capital expenditures on our
traditional circuit switching products. The decrease in the U.S. is also due in part to a
substantial decrease in Enterprise Networks revenues primarily due to the recognition of
revenues in 2003 deferred from prior periods that did not occur to the same extent in 2004
as described under Enterprise Networks revenues. In addition, the long-haul portion of
the Optical Networks segment decreased substantially due in part to reduced spending by
customers as they continued to focus on maximizing return on invested capital by increasing
the capacity utilization rates and efficiency of existing networks. Significant excess
inventories and capacity continued to exist in this portion of the segment which also
resulted in ongoing pricing pressures. These declines were partially offset by an increase
in Wireless Networks revenues primarily due to new contracts with certain customers and
other customers upgrading and expanding their existing networks to meet increased
subscriber demand on our GSM and CDMA solutions;
    
    4% decline in revenues in Asia Pacific due in part to ongoing pricing pressures and
reductions in capital spending for optical products. In addition, a substantial portion of
the decline in Asia Pacific was a result of a cumulative correction of approximately $80
made in the third quarter of 2004 for revenues previously recognized primarily in 2001 and
2002 relating to the delivery of future contractual PCS and other services, as described
under Optical Networks revenues. Further, CDMA revenues declined substantially primarily
due to the completion of certain customer network deployments during the first half of
2003. These declines were partially offset by a substantial increase of GSM revenues due
to increased subscriber demand; and
    
    3% decline in revenues in Canada primarily due to a significant decrease in Wireline
Networks revenues as our customers continued to reduce capital expenditures on our
traditional circuit switching products. Further, CDMA revenues declined substantially
primarily due to the completion of certain customer network deployments during the first
half of 2003; partially offset by
    
    9% increase in revenues in EMEA primarily due to GSM and UMTS network expansion related
to increased subscriber demand partially offset by continued reductions in capital
expenditures on our traditional circuit switching products by our wireline service provider
customers; and
    
    17% increase in revenues in CALA primarily from new GSM and CDMA contracts with certain
wireless service provider customers and other customers upgrading and expanding their
existing networks to meet increased subscriber demand. In addition, the increase was due
to an increase in our packet voice solutions as wireline service provider customers
transitioned to these next-generation products from our traditional circuit switching
products.  2003 vs. 2002 From a geographic perspective, the 7% decline in revenues in 2003 compared to 2002 was due to
a:  
    
    7% decline in revenues in the U.S. primarily due to capital spending
restrictions experienced by our wireline service provider customers and their focus on
capital and cash flow management in 2003 as well as tightened capital
markets mainly during the first half of 2003. This was partially offset by the release of
certain software including the general availability of Succession 3.0 60




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in the fourth quarter
of 2003 which triggered the recognition of associated Enterprise Networks revenues deferred
from prior periods resulting in a net increase in revenues of $150 in
2003 ($300 in the fourth quarter of 2003). In addition,
Enterprise Networks revenues increased due to the recognition of deferred revenues of
approximately $60 associated with certain data switch upgrades in 2003. Further, Wireless
Networks revenues increased as GSM and CDMA customers upgraded and expanded their existing
networks in the second half of 2003;
    
    12% decline in revenues in Asia Pacific primarily due to a substantial decline
in optical long-haul revenues primarily due to the completion of network build-outs for
certain customers in 2002 that were not repeated in 2003. In addition, significant excess
inventories continued to exist in the optical long-haul market which resulted in ongoing
pricing pressures. In addition, the decline was due to capital spending restrictions by
our wireline service provider customers;
    
    5% decline in revenues in EMEA primarily due to a substantial decline in
optical long-haul revenues as customers continued to focus on maximizing return on invested
capital by increasing the capacity utilization rates and efficiency of existing networks.
The decline was also due to capital spending restrictions by our wireline service provider
and enterprise customers and tightened capital markets mainly during the first half of
2003. This decline was partially offset by increases in revenue related to new GSM
contracts with certain service providers and the impact of favorable foreign exchange
effects associated with the euro;
    
    9% decline in revenues in Canada primarily due to a substantial decline in
optical long-haul revenues as customers continued to focus on maximizing return on invested
capital by increasing the capacity utilization rates and efficiency of existing networks.
The decline was also due to capital spending restrictions experienced by our wireless
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, which was partially offset
by the impact of favorable foreign exchange effects associated with the Canadian dollar;
and
    
    8% decline in revenues in CALA primarily due to the completion of a major
Wireline Networks contract in the first quarter of 2002 and continued capital spending
restrictions experienced by our wireline service provider customers, which was partially
offset by increases in revenues related to new GSM contracts with certain wireless service
provider customers. Consolidated gross profit and gross margin For the years ended December 31,
    
    
    2004 vs 2003
    
    
    2003 vs 20022004
    
    
    2003
    
    
    2002
    
    
    Change
    
    
    % Change
    
    
    Change
    
    
    % ChangeGross profit
    
    $
    4,093
    
    
    $
    4,332
    
    
    $
    3,855
    
    
    $
    (239
    )
    
    
    (6
    )
    
    $
    477
    
    
    
    12Gross margin
    
    
    41.6%
    
    
    
    42.5%
    
    
    
    35.1%
    
    
    (0.9 pts
    )
    
    
    
    
    
    7.4 pts
 Gross profit decreased $239 and gross margin decreased 0.9 percentage points in 2004 compared
to 2003 primarily due to:  
    
    a decrease of approximately $540 primarily as a result of (i) pricing
pressures on certain of our products due to increased competition for service provider and
enterprise customers; (ii) unfavorable product mix associated with increased sales of our
next generation products which typically have lower gross margins in the early stages of
product evolution; and (iii) lower sales volumes of network expansion products and software
upgrades that typically have higher margins;
    
    an estimated project loss of approximately $160 related to a contract with
BSNL in India recognized in 2004. For further information related to the BSNL contract,
see Developments in 2004 and 2005  Other business developments  Bharat Sanchar Nigram
Limited;
    
    a decrease of approximately $200 due to overall lower sales volumes; and
    
    a one-time reduction in accruals of $53 associated with a certain customer
bankruptcy settlement in the third quarter of 2003 not repeated in 2004; partially offset
by
    
    an estimated increase of approximately $400 due to continued improvements in
our cost structure primarily as a result of lower material pricing;
    
    an increase of approximately $205 primarily due to (i) an absence of
significant inventory provision costs that were incurred in prior years as a result of
excess inventories due to a decline in revenues in the Optical Networks segment of our
business; and (ii) lower warranty costs as a result of improved product quality; and
    
    an approximate $85 decrease in expenses related to our employee return to
profitability, or RTP, and regular bonus
plans which were not incurred in 2004. 61




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Gross profit increased $477 and gross margin increased 7.4 percentage points in 2003 compared to
2002 primarily due to:  
    
    an estimated increase of approximately $760 due to continued improvements in
our cost structure primarily as a result of lower material pricing and the continued impact
of our workforce reductions;
    
    an increase of approximately $195 primarily due to (i) absence of significant
inventory provision costs that were incurred in prior years as a result of excess
inventories due to a decline in revenues in the Optical Networks segment of our business;
partially offset by (ii) an increase in warranty costs associated with certain product
defects identified in 2003; and
    
    a one-time reduction in accruals of $53 associated with a certain customer
bankruptcy settlement in the third quarter of 2003; partially offset by
    
    reductions of $415 due to overall lower sales volumes;
    
    an approximate $85 increase in expenses related to our employee RTP and
regular bonus plans incurred in 2003 which were not incurred in 2002; and
    
    a decrease of approximately $72 primarily as a result of (i) pricing pressures
on certain of our products due to increased competition for service provider and enterprise
customers; and (ii) unfavorable product mix associated with increased sales of our next
generation products which typically have lower gross margins in the early stages of product
evolution; partially offset by higher sales volumes of network expansion products and
software upgrades that typically have higher margins. While we cannot predict the extent to which changes in product mix and pricing pressures will
continue to impact our gross margin, we continue to see the effects of improvements in our product
costs primarily due to favorable supplier pricing. Considering the impacts of our strategic plan
described under Business overview  Our strategic plan and outlook and the higher costs
associated with initial customer deployments in emerging markets, we expect that gross margin will
trend in the range of 40% to 44% of revenue for the full year 2005. See Risk factors/forward looking statements for
factors that may affect our gross margins. See Segment Management EBT for a discussion of our
gross margins by segment. Consolidated operating expenses  Selling, general and administrative expense For the years ended December 31,
    
    
    2004 vs 2003
    
    
    2003 vs 20022004
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeSG&A expense
    
    $
    2,124
    
    
    $
    1,931
    
    
    $
    2,532
    
    
    $
    193
    
    
    
    10
    
    
    $
    (601
    )
    
    
    (24
    )As % of revenues
    
    
    21.6
    %
    
    
    18.9
    %
    
    
    23.0
    %
    
    2.7 pts
    
    
    
    
    
    
    (4.1 pts
    )
 SG&A expense increased $193 and increased from 18.9% to 21.6% as a percentage of revenues in
2004 compared to 2003 primarily due to:  
    
    costs related to our restatement activities of approximately $115 in 2004;
    
    significant unfavorable foreign exchange impacts associated with the
strengthening of the Canadian dollar, euro and British pound against the U.S. dollar;
    
    an increase in expense related to our stock-based compensation plans,
including restricted stock unit and stock option programs; and
    
    net trade and customer financing receivable recoveries totaling $127 in 2004
compared to a recovery of $179 in 2003. Recoveries were higher in 2003 as a result of
favorable settlements related to the sale or restructuring of various receivables and net
recoveries on other trade and customer financing receivables due to subsequent collections
for amounts exceeding our original estimates of net recovery; partially offset by
    
    a decrease of approximately $120 related to our RTP and regular bonus plans in
2004 compared to 2003. SG&A expense declined $601 and decreased from 23.0% to 18.9% as a percentage of revenues in 2003
compared to 2002 primarily due to:  
    
    the continued impact of our workforce reductions and associated reductions in
other related costs such as information services and real estate; and 62




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
    
    a net decrease of $471 (recovery of $179 in 2003 and expense of $292 in 2002)
related to increased net trade and customer financing receivable recoveries; partially
offset by
    
    an increase of approximately $120 related to our RTP and regular bonus plans
in 2003 compared to 2002;
    
    an increase due to significant foreign exchange impacts associated with the
strengthening of the Canadian dollar, euro and British pound against the U.S. dollar; and
    
    an increase related to our stock-based compensation, including restricted
stock unit and stock option programs, both of which are not allocated across all of our
reportable segments. See Segment Management EBT for a discussion of our SG&A expense by segment.  Research and development expense For the years ended December 31,
    
    
    2004 vs 2003
    
    
    2003 vs 20022004
    
    
    2003
    
    
    2002
    
    
    $Change
    
    
    % Change
    
    
    $Change
    
    
    % ChangeR&D expense
    
    $
    1,959
    
    
    $
    1,965
    
    
    $
    2,084
    
    
    $
    (6
    )
    
    
    (0
    )
    
    $
    (119
    )
    
    
    (6
    )As % of revenues
    
    
    19.9%
    
    
    
    19.3%
    
    
    
    19.0%
    
    
    0.6 pts
    
    
    
    
    
    
    0.3 pts
 R&D expense remained flat in 2004 compared to 2003 and decreased $119 in 2003 compared to 2002
primarily due to unfavorable foreign exchange impacts associated with the strengthening of the
Canadian dollar, euro and British pound against the U.S. dollar partially offset primarily by the
continued impact of our workforce reductions. Our continued strategic investments in R&D are aligned with technology leadership in anticipated
growth areas. In 2004, we maintained a technology focus and commitment to invest in new innovative
solutions where we believed we would achieve the greatest future benefit from this investment. As
a result, our R&D expense as a percentage of our consolidated revenues increased by 0.6 percentage
points to 19.9% in 2004 compared to 19.3% in 2003, both of which were up from 19.0% in 2002. We expect to 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 R&D efforts are
currently focused on secure and reliable converged networks including:  
    
    packetization of voice and multimedia IP telephony solutions services;
    
    services edge capability to realize simplification of customer network
operations and broadband access technologies, including wireless and wireline; and
    
    enhanced network security to ensure the level of reliability and performance
that has traditionally existed in carrier networks. We expect that our R&D expense as a percentage of revenue in 2005 will be lower than 2004 as we
seek to achieve ongoing cost reductions in R&D as part of our strategic plan first announced in
August 2004. See Segment Management EBT for a discussion of our R&D expense by segment. We expect operating expenses
(both SG&A expense and R&D expense) as a percent of revenue
to trend towards the low 30s by the end of 2005 primarily driven
by benefits from our previously announced restructuring work plan and reduction in restatement, accounting and reporting costs. See Business overview  Our strategic
plan and outlook.  Special charges We implemented our work plan to streamline our operations and activities around our core
markets and leadership strategies during 2001, or the 2001 Restructuring Plan, in light of the
significant downturn in both the telecommunications industry and the economic environment, and
capital market trends impacting our operations and expected future growth rates. In addition, we initiated activities in 2003 to exit certain leased facilities and leases for
assets no longer used across all segments. In 2004 and into 2005, our focus is on managing each of our businesses based on financial
performance, the market and customer priorities. In the third quarter of 2004, we announced a
strategic plan that includes a work plan involving focused workforce reductions, including a
voluntary retirement program, of approximately 3,250 employees, real
estate optimization and other
cost containment actions such as 63




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reductions in information services costs, outsourced services and
other discretionary spending across all segments but primarily in Wireline Networks and Optical
Networks, or the 2004 Restructuring Plan. Approximately 64% of employee actions related to the
focused workforce reduction were completed by the end of 2004, including approximately 55% who were
notified of termination or acceptance of voluntary retirement, with the remainder comprised of
voluntary attrition of employees who were not replaced. The remainder of employee actions is
expected to be completed by June 30, 2005. This workforce reduction is in addition to the workforce
reduction that will result from our agreement with Flextronics. For more information, see
Developments in 2004 and 2005  Evolution of our supply chain strategy. We expect the real
estate actions to be completed by the end of 2005. We estimate charges to earnings associated with the 2004 Restructuring Plan in the aggregate of
approximately $450 comprised of approximately $220 with respect to the workforce reductions and
approximately $230 with respect to the real estate actions. No charges are expected to be recorded
with respect to the other cost containment actions. We incurred aggregate charges of $160 in 2004
with the remainder expected to be incurred in 2005. The associated cash costs of the 2004 Restructuring Plan of approximately $430 are expected to be
split approximately equally between the workforce reductions and real estate actions.
Approximately 10% of these cash costs were incurred in 2004 and approximately 40% are expected to
be incurred in 2005. The remaining 50% of the cash costs relate to the real estate actions and are
expected to be incurred in 2006 through to 2022 for ongoing lease costs related to impacted real
estate facilities. In addition to the above, we also expect to incur capital cash costs of
approximately $50 in 2005 for facility improvements related to the real estate actions. We anticipate cost savings from the implementation of the 2004 Restructuring Plan of approximately
$500 in 2005 primarily due to reductions to cost of revenues, SG&A, and R&D of approximately 20%,
40% and 40%, respectively, across all segments but primarily in Wireline Networks and Optical
Networks. The majority of the cost reductions are expected to be substantially realized in the
results of operations in the second half of 2005 and will be partially offset by the costs
associated with new hires added throughout 2005. We expect that this work plan will primarily be
funded with cash from operations. 64




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During the years ended December 31, 2004, 2003 and 2002, we continued to implement these
restructuring work plans. Special charges recorded from January 1, 2002 to December 31, 2004 were
as follows: Contract
    
    
    
    
    
    
    
    
    
    
    Intangiblesettlement
    
    
    Plant and
    
    
    
    
    
    
    assetWorkforce
    
    
    and lease
    
    
    equipment
    
    
    
    
    
    
    impair-reduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    ments
    
    
    Total2001 Restructuring PlanProvision balance as of January 1, 2002
    
    $
    279
    
    
    $
    677
    
    
    $
    
    
    
    $
    29
    
    
    $
    
    
    
    $
    985Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    264
    
    
    
    264Other special charges
    
    
    928
    
    
    
    210
    
    
    
    383
    
    
    
    
    
    
    
    
    
    
    
    1,521Revisions to prior accruals
    
    
    (126
    )
    
    
    18
    
    
    
    (55
    )
    
    
    
    
    
    
    
    
    
    
    (163
    )Cash drawdowns
    
    
    (778
    )
    
    
    (286
    )
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    (1,084
    )Non-cash drawdowns
    
    
    (100
    )
    
    
    
    
    
    
    (328
    )
    
    
    
    
    
    
    (264
    )
    
    
    (692
    )Foreign exchange and other adjustments
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Provision balance as of December 31, 2002
    
    $
    204
    
    
    $
    620
    
    
    $
    
    
    
    $
    9
    
    
    $
    
    
    
    $
    833Other special charges
    
    
    198
    
    
    
    63
    
    
    
    74
    
    
    
    
    
    
    
    
    
    
    
    335Revisions to prior accruals
    
    
    (42
    )
    
    
    20
    
    
    
    (28
    )
    
    
    
    
    
    
    
    
    
    
    (50
    )Cash drawdowns
    
    
    (267
    )
    
    
    (275
    )
    
    
    
    
    
    
    (9
    )
    
    
    
    
    
    
    (551
    )Non-cash drawdowns
    
    
    (41
    )
    
    
    
    
    
    
    (46
    )
    
    
    
    
    
    
    
    
    
    
    (87
    )Foreign exchange and other adjustments
    
    
    12
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39Provision balance as of December 31, 2003(a)
    
    $
    64
    
    
    $
    455
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    519Other special charges
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Revisions to prior accruals
    
    
    (4
    )
    
    
    16
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    14Cash drawdowns
    
    
    (49
    )
    
    
    (167
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (216
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Foreign exchange and other adjustments
    
    
    (2
    )
    
    
    22
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20Provision balance as of December 31, 2004
    
    $
    15
    
    
    $
    326
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    3412004 Restructuring PlanOther special charges
    
    
    158
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    160Revisions to prior accruals
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cash drawdowns
    
    
    (38
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (38
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Foreign exchange and other adjustments
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Provision balance as of December 31, 2004
    
    $
    122
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    122Total
Provision balance as of December 31, 2004(a)
    
    $
    137
    
    
    $
    326
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    463
 (a)
    
    As of December 31, 2004 and 2003, the short-term provision balance was $254 and $205,
respectively, and the long-term provision balance was $209 and $314, respectively.
  2001 Restructuring Plan Year ended December 31, 2004 For the year ended December 31, 2004, we recorded total special charges of $20, which included
revisions of $14 related to prior accruals. Workforce reduction charges of $6 were related to severance and benefit costs associated with
approximately 80 employees notified of termination. The workforce
reduction occurred in Canada and
related entirely to Optical Networks. Offsetting these charges were revisions to prior accruals of
$4 which were primarily related to termination benefits where actual costs were lower than the
estimated amounts across all segments. During 2004, the workforce reduction provision balance was
drawn down by cash payments of $49. The remaining provision is expected to be substantially drawn
down by the end of 2005. No new contract settlement and lease costs were incurred during 2004. During 2004, we recorded
revisions to prior accruals of $16 resulting primarily from changes in estimates for sublease
income and costs to vacate certain properties, across all segments. During 2004, the provision
balance for contract settlement and lease costs was drawn down by cash payments of $167. The
remaining provision, net of approximately 65




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$248 in estimated sublease income, is expected to be
substantially drawn down by the end of 2013. No new plant and equipment charges were incurred during 2004. During 2004, we recorded revisions
of $2 to prior write downs of assets held for sale related primarily to adjustments to original
plans or estimated amounts for certain facility closures. Year ended December 31, 2003 For the year ended December 31, 2003, we recorded special charges of $285 which were net of
revisions of $50 related to prior accruals. Workforce reduction charges of $198 were related to severance and benefits costs associated with
approximately 1,700 employees notified of termination. The workforce reduction was primarily in
the U.S., Canada and EMEA and extended across all segments. Net revisions of $42 to reduce prior
accruals primarily related to termination benefits where actual costs were lower than the estimated
amounts across all segments. During 2003, the workforce reduction provision balance was drawn down
by cash payments of $267 and by a non-cash pension settlement loss of $41. Contract settlement and lease costs of $63 consisted of negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities (comprised of office,
warehouse and manufacturing space) and leased furniture that were identified as no longer required
across all segments. These lease costs, net of anticipated sublease income, included
non-cancelable lease terms from the date leased facilities ceased to be used and termination
penalties. In addition to these charges were revisions to prior accruals of $20 resulting
primarily from changes in estimates for sublease income and costs to vacate
certain properties, across all segments. During 2003, the provision balance for contract
settlement and lease costs was drawn down by cash payments of $275. We recorded plant and equipment charges of $74 largely related to current period write downs to
fair value less costs to sell for various leasehold improvements and excess Optical Networks
equipment held for sale. Net revisions of $28 were recorded to reduce prior write downs of assets
held for sale related primarily to adjustments to our original plans or estimated amounts for
facility closures. Year ended December 31, 2002 For the year ended December 31, 2002, we recorded total special charges of $1,622 which were
net of revisions of $163 related to prior accruals. Workforce reduction charges of $928 were related to severance and benefit costs associated with
approximately 12,100 employees notified of termination. The workforce reduction was primarily in
the U.S., Canada and EMEA and extended across all segments. Offsetting these charges were
revisions to prior accruals of $126 which were primarily related to termination benefits where
actual costs were lower than the original estimated amounts across all segments. Workforce
reduction charges included $124 for pension and post-retirement benefits other than pension,
settlement and curtailment costs. During 2002, the workforce reduction provision balance was drawn
down by cash payments of $778 and by $100 of non-cash pension and post-retirement benefits other
than pension, settlement and curtailment costs attributable to the notified employee group charged
against the provision. Contract settlement and lease costs of $210 consisted of negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities (comprised of office,
warehouse and manufacturing space) and leased manufacturing equipment that were no longer required,
across all segments. In addition to these charges were revisions to prior accruals of $18
resulting primarily from changes in estimates for sublease income and costs to vacate certain
properties, across all segments. During the year ended December 31, 2002, the provision balance
for contract settlement and lease costs was drawn down by cash payments of $286. The remaining
provision balance was net of approximately $402 in estimated sublease income. Plant and equipment charges of $383 were related to current period write downs to fair value less
costs to sell for various owned facilities and plant and manufacturing related equipment. These
charges for facilities and equipment included $283 related to the Optical Networks segment with the
remaining charges arising across all segments. Within Optical Networks, we performed assessments
of certain plant and equipment due to the then current market conditions and the delay in the
anticipated recovery of that segment and concluded that the asset carrying values were not fully
recoverable from estimated
future cash flows. As a result, we recorded a charge to income of $266
to write down the value of 66




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specialized plant infrastructure and equipment within Optical Networks
to its fair value less costs to sell. Included in the $266 write down was $34 related to equipment
held for sale, which was part of the Bookham transaction. See Acquisitions, divestitures and
closures in note 9 of the accompanying consolidated financial statements. Fair value was determined using quoted market prices or the anticipated cash flows discounted at a
rate commensurate with the risks involved. Offsetting these charges were revisions of $55 to prior
write downs of assets held for sale related primarily to additional proceeds from disposals of
equipment from Optical Networks and other segments in excess of amounts previously expected and
adjustments to original plans or estimated amounts for certain facility closures across all
segments. Goodwill impairment charges were $264. As a result of the continued decline during 2002, in both
our overall market value generally and within Optical Networks specifically, we as part of our
review of financial results during the year ended December 31, 2002, 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 the businesses within Optical Networks
could no longer support the carrying value of the remaining goodwill associated with them. As a
result, we recorded a goodwill impairment charge of $264. Fair value was estimated using the then
expected present value of discounted future cash flows of the businesses within Optical Networks.
The discount rate used ranged from 12 to 16 percent and the terminal values were estimated based on
terminal growth rates ranging from 3 to 5 percent. The assumptions supporting the estimated future
cash flows, including the discount rate and estimated terminal values, reflected managements best
estimates.  2001 Restructuring Plan  by segment The following table outlines special charges incurred by segment for each of the three years
ended December 31: Contract
    
    
    
    
    
    
    Intangiblesettlement
    
    
    Plant and
    
    
    assetWorkforce
    
    
    and lease
    
    
    equipment
    
    
    impair-reduction
    
    
    costs
    
    
    write downs
    
    
    ments
    
    
    Total2001 Restructuring PlanWireless Networks
    
    $
    136
    
    
    $
    39
    
    
    $
    11
    
    
    $
    
    
    
    $
    186Enterprise Networks
    
    
    144
    
    
    
    41
    
    
    
    11
    
    
    
    
    
    
    
    196Wireline Networks
    
    
    185
    
    
    
    52
    
    
    
    14
    
    
    
    
    
    
    
    251Optical Networks
    
    
    225
    
    
    
    64
    
    
    
    283
    
    
    
    264
    
    
    
    836Other
    
    
    112
    
    
    
    32
    
    
    
    9
    
    
    
    
    
    
    
    153Total special charges for the
year ended December 31, 2002
    
    $
    802
    
    
    $
    228
    
    
    $
    328
    
    
    $
    264
    
    
    $
    1,622Wireless Networks
    
    $
    48
    
    
    $
    26
    
    
    $
    9
    
    
    $
    
    
    
    $
    83Enterprise Networks
    
    
    31
    
    
    
    17
    
    
    
    6
    
    
    
    
    
    
    
    54Wireline Networks
    
    
    36
    
    
    
    19
    
    
    
    7
    
    
    
    
    
    
    
    62Optical Networks
    
    
    25
    
    
    
    13
    
    
    
    21
    
    
    
    
    
    
    
    59Other
    
    
    16
    
    
    
    8
    
    
    
    3
    
    
    
    
    
    
    
    27Total special charges for the
year ended December 31, 2003
    
    $
    156
    
    
    $
    83
    
    
    $
    46
    
    
    $
    
    
    
    $
    285Wireless Networks
    
    $
    (1
    )
    
    $
    5
    
    
    $
    1
    
    
    $
    
    
    
    $
    5Enterprise Networks
    
    
    (1
    )
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    2Wireline Networks
    
    
    (1
    )
    
    
    4
    
    
    
    1
    
    
    
    
    
    
    
    4Optical Networks
    
    
    5
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    8Other
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Total special charges for the
year ended December 31, 2004
    
    $
    2
    
    
    $
    16
    
    
    $
    2
    
    
    $
    
    
    
    $
    20
 As described under Segment Management EBT, segment management EBT does not include special
charges. A significant portion of our provisions for workforce reductions and contract settlement
and lease costs are associated with shared services. These costs have been allocated to the
segments in the table above based generally on headcount. 67




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2004 Restructuring Plan Year ended December 31, 2004 For the year ended December 31, 2004, we recorded total special charges of $160. Workforce reduction charges of $158 were related to severance and benefit costs associated with
approximately 1,850 employees, of which 1,800 had been notified of termination during the year. The
remaining charge related to termination benefits attributable to ongoing employee benefit
arrangements. The workforce reduction was primarily in the U.S., Canada, and EMEA and extended
across all segments as follows: For the year endedDecember 31, 2004Wireless Networks
    
    $
    35Enterprise Networks
    
    
    24Wireline Networks
    
    
    63Optical Networks
    
    
    17Other
    
    
    19Total workforce reduction charge
    
    $
    158
 During the year ended December 31, 2004, the workforce reduction provision balance was drawn
down by cash payments of $38. The remaining provision is expected to be substantially drawn down
by the end of 2005. Plant and equipment charges of $2 were related to current period write downs to fair value less
costs to sell for various leasehold improvements and excess equipment held for sale. For additional information related to our restructuring activities, see Special charges in note 6
of the accompanying consolidated financial statements. (Gain) loss on sale of businesses and assets In 2004, gain on sale of businesses and assets was $98 primarily due to a gain of $78 related
to the sale of certain assets in CALA for which we received $80 in proceeds and a gain of
approximately $30 related to the sale of our DOS business to VoltDelta. In 2003, gain on sale of businesses and assets of $4 was primarily due to the recognition of
the remaining unamortized deferred gain related to the sale of substantially all of the assets of
our Cogent Defence Systems, or CDS, business during the year ended December 31, 2001. The
remaining unamortized deferred gain of $23 was recognized as a result of the sale of our 41%
interest in EADS Telecom S.A.S. (formerly EADS Defence and Security Networks S.A.S.), or EADS
Telecom. 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., or
NNF, 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 Germany and France. At the same time, EADS increased its ownership in
EADS Telecom from 59% to 100% as a result of acquiring our equity ownership in that company. This
gain was partially offset by a loss due to retirement of fixed assets. In 2002, gain on sale of businesses and assets of $4 was primarily related to:  
    
    a gain of $29 on the sale of certain assets relating to our optical components business to Bookham;
    
    a gain of $41 related to a previously deferred gain associated with the sale of
substantially all of the assets of our CDS business to EADS Telecom as well as the
cancellation and replacement of a call option to acquire an additional approximate 7%
ownership interest in NNF which was originally included as part of the consideration
received on the sale of these assets; partially offset by
    
    a loss of $68 due to retirement of fixed assets. 68




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For additional information relating to these asset sales, see Acquisitions, divestitures and
closures in note 9 and Commitments in note 13 of the accompanying consolidated financial
statements. Other income (expense)  net The components of other income (expense) -net were as follows: 2004
    
    
    2003
    
    
    2002Interest income
    
    $
    62
    
    
    $
    75
    
    
    $
    88Gain (loss) on sale or write down of investments
    
    
    19
    
    
    
    143
    
    
    
    (39
    )Currency exchange gains (losses)
    
    
    98
    
    
    
    83
    
    
    
    (84
    )Other  net
    
    
    61
    
    
    
    132
    
    
    
    7Other income (expense)  net
    
    $
    240
    
    
    $
    433
    
    
    $
    (28
    )
 In 2004, other income  net was $240, which primarily included:  
    
    foreign exchange gains of $66 primarily related to day-to-day transactional activities;
    
    interest income of $62 and dividend income of $22 on our short-term investments;
    
    a gain of $53 resulting from a restructured customer financing arrangement;
    
    a foreign exchange gain of $32 resulting from a correction during 2004 related
to a cumulative error in functional currency designation of an entity in Brazil;
    
    a gain of $18 related to the sale of our remaining 7 million common shares of
Entrust for cash consideration of $33. In connection with this transaction, we no longer
hold any equity interest in Entrust;
    
    a gain of $13 related to the sale of Arris Group, Inc., or Arris Group shares.
For additional information on our investment in Arris Group see
Results of operations 
discontinued operations; and
    
    a gain of $7 related to a certain customer bankruptcy settlement; partially
offset by
    
    losses of $24 related to changes in fair value of derivative financial
instruments that did not meet the criteria for hedge accounting; and
    
    losses of $8 related to prepaid equity forward purchase contracts that were
entered into in connection with the issuance of restricted stock units. In 2003, other income  net was $433, which primarily included:  
    
    foreign exchange gains of $83 primarily related to day-to-day transactional activities;
    
    a gain of $96 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 of $75 and dividend income of $19 on our short-term
investments;
    
    gains of $31 related to the sale of Arris Group shares. For additional
information on our investment in Arris Group see Results of operations  discontinued
operations;
    
    a gain of $30 related to a certain customer bankruptcy settlement;
    
    a gain of $25 resulting from a settlement related to intellectual property use;
    
    gains of $22 related to changes in fair value of derivative financial
instruments that did not meet the criteria for hedge accounting;
    
    royalty income of $15 from patented technology;
    
    gains of $10 related to sale of certain minority investments; and
    
    a gain of $6 related to sale of our interest in Bookham. In 2002, other expense  net of $28 was primarily related to a foreign exchange loss of $84 and a
$39 loss on the sale or write down of certain minority investments, partially offset by interest
income of $88 on our short-term investments. Interest expense Interest expense decreased $8 in 2004 compared to 2003 and decreased $66 in 2003 compared to
2002 primarily due to a reduction in the outstanding balances of our notes payable and long-term
debt. In 2004, we reduced our long term debt by
$133, from $2,210 as of 69




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December 31, 2003 to $2,077 as of December 31, 2004, primarily due to the purchase of land and two buildings for $87
that were previously leased by us and a decrease of $30 in the fair value adjustment attributable
to hedged debt obligations. For additional information, see Long-term debt in note 10 of the
accompanying consolidated financial statements. Interest rates on our outstanding notes payable and long-term debt remained relatively flat during
these periods. We expect that the quarterly interest expense in 2005 will remain at similar levels. Income tax benefit (expense) In 2004, we recorded a tax benefit of $29 on pre-tax earnings of $42 from continuing
operations before minority interests and
equity in net loss of associated companies. We recorded a tax expense against the earnings of
certain taxable entities and recorded additional valuation allowances against the tax benefit of
current period losses of other entities. The tax benefit is primarily a result of R&D related
incentives, favorable audit settlements, and a release of valuation allowances in certain
jurisdictions, partially offset by tax expense recorded against the earnings of certain taxable
entities and corporate minimum and other taxes. In 2003, we recorded a tax benefit of $33 on pre-tax earnings of $461 from continuing operations
before minority interests and equity in net loss of associated companies. This tax benefit
resulted from tax audit settlements and the benefit of various R&D related tax incentives. This
benefit was partially offset by income tax provisions in certain taxable jurisdictions and various
corporate minimum related income taxes. As of December 31, 2004, we have substantial loss carryforwards and valuation allowances in our
significant tax jurisdictions. These loss carryforwards will serve to minimize our future cash
income related taxes. 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. Given the magnitude of our valuation allowance, future adjustments to this
valuation allowance based on actual results could result in a significant adjustment to our
effective tax rate. For additional information, see Application of critical accounting policies
and estimates  Income Taxes  Tax asset valuation. Net earnings (loss) from continuing operations As a result of the items discussed above under Results of operations  continuing
operations, net earnings from continuing operations were $58 in 2004. This amount represented a
decline of $372 compared to our net earnings from continuing operations of $430 in 2003. Our net
earnings from continuing operations improved by $2,593 in 2003 compared to our net loss from
continuing operations of $2,163 in 2002. 70




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Segment Management EBT Management EBT is a measure that includes the cost of revenues, SG&A expense, R&D expense,
interest expense, other income (expense)  net, minority interests  net of tax and equity in net
loss of associated companies  net of tax. The following tables set forth information by segment for the years ended December 31: 2004 vs 2003
    
    
    2003 vs 20022004
    
    
    2003
    
    
    2002
    
    
    $Change
    
    
    % Change
    
    
    $Change
    
    
    % ChangeWireless Networks
    
    $
    554
    
    
    $
    695
    
    
    $
    256
    
    
    $
    (141
    )
    
    
    (20
    )
    
    $
    439
    
    
    
    171Enterprise Networks
    
    
    199
    
    
    
    317
    
    
    
    54
    
    
    
    (118
    )
    
    
    (37
    )
    
    
    263
    
    
    
    487Wireline Networks
    
    
    (31
    )
    
    
    170
    
    
    
    185
    
    
    
    (201
    )
    
    
    (118
    )
    
    
    (15
    )
    
    
    (8
    )Optical Networks
    
    
    (202
    )
    
    
    (258
    )
    
    
    (1,227
    )
    
    
    56
    
    
    
    22
    
    
    
    969
    
    
    
    79Other(a)
    
    
    (399
    )
    
    
    (243
    )
    
    
    (232
    )
    
    
    (156
    )
    
    
    (64
    )
    
    
    (11
    )
    
    
    (5
    )Total segment Management EBT
    
    $
    121
    
    
    $
    681
    
    
    $
    (964
    )
    
    $
    (560
    )
    
    
    (82
    )
    
    $
    1,645
    
    
    
    171Amortization of acquired technology and other
    
    
    (10
    )
    
    
    (3
    )
    
    
    (19
    )
    
    
    (7
    )
    
    
    (233
    )
    
    
    16
    
    
    
    84Special charges
    
    
    (180
    )
    
    
    (285
    )
    
    
    (1,622
    )
    
    
    105
    
    
    
    37
    
    
    
    1,337
    
    
    
    82Gain (loss) on sale of businesses and assets
    
    
    98
    
    
    
    4
    
    
    
    4
    
    
    
    94
    
    
    
    2,350
    
    
    
    
    
    
    
    Income tax benefit (expense)
    
    
    29
    
    
    
    33
    
    
    
    438
    
    
    
    (4
    )
    
    
    (12
    )
    
    
    (405
    )
    
    
    (92
    )Net earnings (loss) from continuing operations
    
    $
    58
    
    
    $
    430
    
    
    $
    (2,163
    )
    
    $
    (372
    )
    
    
    (87
    )
    
    $
    2,593
    
    
    
    120
 (a)
    
    Other represented miscellaneous business activities and corporate functions.
 The following table identifies the increases (decreases) in segment Management EBT from each of its
components for the years ended December 31: 2004 vs 2003
    
    
    2003 vs 2002Gross
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    Total
    
    
    Gross
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    TotalProfit
    
    
    SG&A
    
    
    R&D
    
    
    items(b)
    
    
    $ change
    
    
    Profit
    
    
    SG&A
    
    
    R&D
    
    
    items(b)
    
    
    $ changeWireless Networks
    
    $
    (33
    )
    
    $
    (52
    )
    
    $
    (68
    )
    
    $
    12
    
    
    $
    (141
    )
    
    $
    362
    
    
    $
    122
    
    
    $
    (22
    )
    
    $
    (23
    )
    
    $
    439Enterprise Networks
    
    
    (97
    )
    
    
    (27
    )
    
    
    9
    
    
    
    (3
    )
    
    
    (118
    )
    
    
    191
    
    
    
    69
    
    
    
    (15
    )
    
    
    18
    
    
    
    263Wireline Networks
    
    
    (186
    )
    
    
    20
    
    
    
    (24
    )
    
    
    (11
    )
    
    
    (201
    )
    
    
    (365
    )
    
    
    237
    
    
    
    110
    
    
    
    3
    
    
    
    (15
    )Optical Networks
    
    
    51
    
    
    
    (1
    )
    
    
    77
    
    
    
    (71
    )
    
    
    56
    
    
    
    330
    
    
    
    397
    
    
    
    203
    
    
    
    39
    
    
    
    969Other(a)
    
    
    26
    
    
    
    (133
    )
    
    
    12
    
    
    
    (61
    )
    
    
    (156
    )
    
    
    (41
    )
    
    
    (224
    )
    
    
    (157
    )
    
    
    411
    
    
    
    (11
    )Total
    
    $
    (239
    )
    
    $
    (193
    )
    
    $
    6
    
    
    $
    (134
    )
    
    $
    (560
    )
    
    $
    477
    
    
    $
    601
    
    
    $
    119
    
    
    $
    448
    
    
    $
    1,645
 (a)
    
    Other represented miscellaneous business activities and corporate functions.(b)
    
    Other items is comprised of interest expense, other income (expense)  net, minority
interests  net of tax and equity in net loss of associated companies  net of tax.
 The decrease in segment Management EBT of $560 in 2004 compared to 2003 and increase of $1,645 in
2003 compared to 2002 are a result of fluctuations in gross profit, SG&A expense, R&D expense and
other items as discussed below. Gross margin represents gross profit as a percentage of revenues. Wireless Networks  2004 vs. 2003 Wireless Networks gross margin decreased by approximately 5.0 percentage points (while gross
profit decreased $33) primarily due to:  
    
    an estimated project loss of approximately $160 related to a contract with
BSNL in India recognized in 2004. For further information related to the BSNL contract,
see Other business developments  Bharat Sanchar Nigram Limited;
    
    pricing pressures on certain of our products due to increased competition for
service provider customers; 71




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
    
    unfavorable product mix associated with increased sales of our next generation
products which typically have lower gross margins in the early stages of product evolution;
and
    
    lower sales volumes of network expansion products and software upgrades that
typically have higher margins; partially offset by
    
    continued improvements in our cost structure primarily as a result of lower material pricing. Wireless Networks SG&A expense increased $52 primarily due to:  
    
    increases in employee related expenses;
    
    net trade and customer financing receivable recoveries in 2003 not repeated in 2004; and
    
    unfavorable foreign exchange rate impacts associated with the strengthening of
the euro and British pound against the U.S. dollar. Wireless Networks R&D expense increased $68 primarily due to:  
    
    unfavorable foreign exchange rate impacts associated with the strengthening of
the Canadian dollar and euro against the U.S. dollar;
    
    continued investment in the development of new CDMA and UMTS products; and
    
    acceleration of programs to increase the feature content in our GSM product offering.  2003 vs. 2002 Wireless Networks gross margin increased by approximately 6.2 percentage points (while gross
profit increased $362) primarily due to:  
    
    favorable changes in product mix mainly related to increased volumes of
certain products with higher margins;
    
    continued improvements in our cost structure primarily as a result of lower
material pricing and the continued impact of our workforce reductions; partially offset by
    
    pricing pressures on certain of our products due to increased competition for service provider customers; and
    
    an increase in contract-related costs including customer trials. Wireless Networks SG&A expense decreased $122 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. Wireless Networks R&D expense increased $22 primarily due to:  
    
    significant unfavorable foreign exchange impacts associated with the
strengthening of the Canadian dollar and euro against the U.S. dollar; partially offset by
    
    the continued impact of our workforce reductions;
    
    transitioning R&D activities into lower cost markets; and
    
    focused cost-savings initiatives. Enterprise Networks  2004 vs. 2003 Enterprise Networks gross margin increased by approximately 0.6 percentage points (while gross
profit decreased $97) primarily due to:  
    
    continued improvements in our cost structure primarily as a result of lower material pricing; and
    
    lower warranty costs as a result of improved product quality; partially offset by 72




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
    
    pricing pressures on certain of our products due to increased competition for enterprise customers; and
    
    lower sales volumes of software upgrades that typically have higher margins. Enterprise Networks SG&A expense increased $27 primarily due to:  
    
    increases in sales and marketing expenses; and
    
    increases in employee related expenses; partially offset by
    
    the continued impact of our workforce reductions. Enterprise Networks R&D expense decreased $9 primarily due to:  
    
    effectively prioritizing investment in data products and increased outsourcing activity; partially offset by
    
    acceleration of IP portfolio R&D programs.  2003 vs. 2002 Enterprise Networks gross margin increased by approximately 4.5 percentage points (while gross
profit increased $191) primarily due to:  
    
    continued improvements in our cost structure primarily as a result of lower material pricing;
    
    higher sales volumes of software upgrades that typically have higher margins;
    
    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; partially offset by
    
    pricing pressures on certain of our products due to increased competition for
enterprise customers. Enterprise Networks SG&A expense decreased $69 primarily due to:  
    
    the continued impact of our workforce reductions, primarily in the U.S. and
Canada, and associated reductions in other related costs such as information services and
real estate; and
    
    a decrease in provisioning for trade receivables. Enterprise Networks R&D expense increased $15 primarily due to:  
    
    unfavorable foreign exchange impacts associated with the Canadian dollar; partially offset by
    
    the continued impact of our workforce reductions that targeted a level of R&D
that was more representative of the volume of our business. Wireline Networks  2004 vs. 2003 Wireline Networks gross margin decreased by approximately 3.1 percentage points (while gross
profit decreased $186) primarily due to:  
    
    unfavorable product mix associated with increased sales of our next generation
products which typically have lower gross margins in the early stages of product evolution;
and
    
    lower sales volumes of network expansion products and software upgrades that
typically have higher margins; partially offset by
    
    continued improvements in our cost structure primarily as a result of lower material pricing. Wireline Networks SG&A expense decreased $20 primarily due to:  
    
    increase in net trade and customer financing recoveries; and 73




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
    
    the continued impact of our workforce reductions; partially offset by
    
    planned investment in strategic businesses. Wireline Networks R&D expense increased $24 primarily due to:  
    
    continued investment in the development of new voice and data products;
    
    accelerated development of certain new products; and
    
    unfavorable foreign exchange rate impacts associated with the strengthening of
the Canadian dollar against the U.S. dollar.  2003 vs. 2002 Wireline Networks gross margin decreased by approximately 3.8 percentage points (while gross
profit decreased $365) primarily due to:  
    
    unfavorable changes in product mix mainly related to decreased volumes of
certain products with higher margins; partially offset by
    
    continued improvements in our cost structure primarily as a result of lower material pricing;
    
    continued impact of our workforce reductions, mainly in the U.S. and Canada; and
    
    reduced inventory provisioning as a result of our inventory levels being better aligned to customer demand. Wireline Networks SG&A expense decreased $237 primarily due to:  
    
    a decrease in provisioning for trade and customer financing receivables; and
    
    the continued impact of our workforce reductions, primarily in the U.S. and
Canada, and associated reductions in other related costs such as information services and
real estate. Wireline Networks R&D expense decreased $110 primarily due to:  
    
    the continued impact of our workforce reductions that targeted a level of R&D
expense that was more representative of the volume of our business; and
    
    effectively prioritizing investment in data products and increased outsourcing
activity. Optical Networks  2004 vs. 2003 Optical Networks gross margin increased by approximately 10.2 percentage points (while gross
profit increased $51) primarily due to:  
    
    increased volume of higher margin sales contracts;
    
    continued improvements in our cost structure primarily as a result of lower
material pricing in both the long-haul portion and metro optical portion of this segment;
    
    absence of significant inventory provision costs that were incurred in prior
years as a result of excess inventories due to a decline in revenues of our business; and
    
    lower warranty costs as a result of improved product quality; partially offset
by
    
    a one-time reduction in accruals of $53 associated with a certain customer
bankruptcy settlement in the third quarter of 2003 not repeated in 2004; and
    
    continued pricing pressures on the certain of our products due to increased
competition. Optical Networks SG&A expense increased $1 primarily due to:  
    
    unfavorable foreign exchange rate impacts associated with the strengthening of
the Canadian dollar against the U.S. dollar; and 74




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
    
    lower net trade and customer financing receivable recoveries in 2004;
partially offset by
    
    the continued impact of our workforce reductions across all regions and
associated reductions in other related costs such as information services and real estate. Optical Networks R&D expense decreased $77 primarily due to:  
    
    the continued impact of our workforce reductions that targeted a level of R&D
expense that was more representative of the volume of our business; partially offset by
    
    unfavorable foreign exchange rate impacts associated with the strengthening of
the Canadian dollar against the U.S. dollar. Optical Networks other items expense increased by $71 in 2004 compared to 2003 primarily due to:  
    
    release of accruals of $30 from a certain customer bankruptcy settlement in 2003 not repeated in 2004; and
    
    a gain of $25 in 2003 resulting from a settlement related to intellectual property use not repeated in 2004.  2003 vs. 2002 Optical Networks gross margin increased by approximately 23.5 percentage points (while gross
profit increased $330) primarily due to:  
    
    reduced inventory provisioning and other contract and customer settlement
costs throughout 2003 including a reduction in accruals of $53 associated with a certain
customer bankruptcy settlement;
    
    continued improvements in our cost structure primarily as a result of lower
material pricing; partially offset by
    
    pricing pressures on certain of our products due to increased competition for
service provider and enterprise customers;
    
    the sale of certain optical components assets to Bookham and, as a result, our
2003 gross margin excluded the impact of excess capacity of those optical components
assets; and
    
    reduced warranty charges in 2003. Optical Networks SG&A expense decreased $397 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;
    
    reduction in accruals of approximately $4 associated with a certain customer bankruptcy settlement; and
    
    a decrease in provisioning for trade and customer financing receivables. Optical Networks R&D expense decreased $203 primarily due to the continued impact of our workforce
reductions that targeted a level of R&D expense that was more representative of the volume of our
business. Other  2004 vs. 2003 Other segment SG&A expense increased $133 primarily due to:  
    
    costs associated with our restatement activities and additional investment in our finance organization;
    
    unfavorable foreign exchange rate impacts associated with the strengthening of the
Canadian dollar and euro against the U.S. dollar; and
    
    an increase in stock based compensation in 2004 which was not allocated to our segments; partially offset by
    
    a reduction in our RTP and regular bonus plans. Other segment R&D expense decreased by $12 primarily due to a reduction in our employee bonus
programs, partially offset by an increase in stock based compensation. 75




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Other segment other items expense increased by $61 primarily due to:  
    
    gains related to the sale of our interest in EADS Telecom in conjunction with the
changes in ownership of our French and German operations in 2003 not repeated in 2004;
    
    losses related to changes in fair value of derivative financial instruments that do not
meet the criteria for hedge accounting compared to a gain in 2003; and
    
    a decrease in interest income.  2003 vs. 2002 Other segment SG&A expense increased $224 primarily due to:  
    
    a significant reduction in net trade and customer financing recoveries that were not
allocated to our segments; and
    
    an increase related to our RTP and regular bonus plans in 2003 compared to 2002. Other segment R&D expense increased $157 primarily due to:  
    
    an increase in our employee bonus programs; and
    
    a sales tax refund related to the purchase of equipment and supplies used in the
development of software in 2002 not repeated in 2003. Other segment other items expense decreased by $411 primarily due to:  
    
    gains related to the sale of our interest in EADS Telecom in conjunction with the
changes in ownership of our French and German operations;
    
    gains related to changes in fair value of derivative financial instruments that do not
meet the criteria for hedge accounting;
    
    favorable currency exchange gains; and
    
    a decrease in interest expense in 2003; partially offset by
    
    a decrease in interest and customer financing income. Results of operations  discontinued operations In 2001, our Board of Directors approved a plan to discontinue our access solutions operations
consisting of all of our narrowband and broadband access solutions, including copper, cable and
fixed wireless solutions, as well as our then consolidated membership interest in Arris Group and
equity investment in Elastic Networks. Also affected by the decision were our prior acquisitions of
Sonoma Systems, Promatory Communications, Inc., Aptis Communications, Inc. and Broadband Networks
Inc. Certain disposal activities were delayed beyond the originally planned timeframe of one year due to
the prolonged deterioration in industry and market conditions during 2003 and 2002. Accordingly,
during the years ended December 31, 2003 and 2002, we continued to wind down our access solutions
operations, and as of December 31, 2003, we had substantially completed the wind down of these
operations. In 2004, we recorded net earnings from discontinued operations (net of tax) of $49. The
significant items included in net earnings are summarized below:  
    
    a gain of $32 related to the revaluation of a receivable. On December 23, 2004, a
customer financing arrangement was restructured. The notes receivable that were
restructured had a net carrying amount of $1, net of a provision of $63. The arrangement
increased the net carrying amount of the receivable to $33. On January 25, 2005, we sold
this receivable for cash proceeds; and
    
    a net gain of $17 related to our reassessment of our remaining provisions for
discontinued operations consisting of changes in estimates of $13 for liabilities, and $4
for both short-term and long-term receivables. In 2003, we recorded net earnings from discontinued operations of $184 (net of tax) primarily
related to a number of transactions in 2003 76




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as follows, as well as gains of $68 associated with
provision reassessments:  
    
    a gain of $14 on the sale of certain assets related to our fixed wireless access
operations to Airspan Networks, Inc. for cash consideration of $13 on December 23, 2003;
    
    a gain of $17 in the fourth quarter of 2003 associated with a cash settlement of $17
related to a certain note receivable which had been previously provisioned;
    
    a gain of $12 on March 24, 2003 from the sale of 8 million common shares of Arris Group,
back to Arris Group for cash consideration of $28 pursuant to a March 11, 2003 agreement.
In addition, on March 18, 2003, we assigned our membership interest in Arris Interactive
LLC, or Arris, to ANTEC Corporation, an Arris Group company, for cash consideration of $88,
resulting in a loss of $2. Also in connection with these transactions, we received $11
upon the settlement of a sales representation agreement with Arris Group and recorded a
gain of $11; and
    
    a gain of $66 in the first quarter of 2003 from the settlement of certain trade and
customer financing receivables, the majority of which was previously provisioned. Following the March 2003 Arris Group transactions, we reduced our interest in Arris Group to 18.8%,
and ceased equity accounting for the investment. As a result, we reclassified our remaining
ownership interest in Arris Group as an available-for-sale investment within continuing operations
effective in the second quarter of 2003. We continued to dispose of our interest in Arris Group in
2004 and 2003 and the gain or loss on the sale of shares subsequent to the first quarter of 2003
was included in other income (expense)  net. We sold 9 million common shares of Arris Group on
November 24, 2003 and 1.8 million shares on March 10, 2004. As of December 31, 2004, we owned
approximately 3.2 million common shares of Arris,
or approximately 4.2% of Arris Groups outstanding common shares, as compared to approximately 6.6%
as of December 31, 2003. For additional information, see Discontinued operations in note 18 of the accompanying
consolidated financial statements and Other income (expense)-net. Liquidity and capital resources In 2004, we continued to maintain our strong liquidity position. As of December 31, 2004, our
primary source of liquidity was cash. At December 31, 2004, we had cash and cash equivalents
excluding restricted cash, or cash, of $3,607 compared to $3,928 as of December 31, 2003. The
decrease was primarily due to the payments of employee bonuses and stock compensation programs
based on our 2003 performance, higher accounts receivables, higher inventory, the reduction of long
term debt and expenditures for plant and equipment. This decrease was partially offset by the sale
of customer financing assets and investments, favorable foreign exchange rate impacts associated
primarily with the euro and British pound against the U.S. dollar and a customer contract
settlement of $80. Cash flows The following table summarizes our cash flows by activity and cash on hand as of December 31: 2004
    
    
    2003Net cash from (used in) operating activities of continuing operations
    
    $
    (164
    )
    
    $
    78Net cash from (used in) investing activities of continuing operations
    
    
    (126
    )
    
    
    (85
    )Net cash from (used in) financing activities of continuing operations
    
    
    (141
    )
    
    
    (362
    )Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    88
    
    
    
    176Net cash from (used in) continuing operations
    
    
    (343
    )
    
    
    (193
    )Net cash from (used in) discontinued operations
    
    
    22
    
    
    
    379Net increase (decrease) in cash and cash equivalents
    
    
    (321
    )
    
    
    186Cash and cash equivalents at beginning of period
    
    
    3,928
    
    
    
    3,742Cash and cash equivalents at end of period
    
    $
    3,607
    
    
    $
    3,928
 77




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Operating activities In 2004, our cash flows used in operating activities were $164 due to net earnings from
continuing operations of $58, plus adjustments of $675 for non-cash and other items less $897
related to the change in our operating assets and liabilities. In 2003, our cash flows from operating activities were $78 due to net earnings from continuing
operations of $430, plus adjustments of $514 for non-cash and other items less $866 related to the
change in our operating assets and liabilities. In 2004, the primary
adjustments to our net earnings from continuing operations for non-cash and other
items were amortization and depreciation of $362, substantially all of which was depreciation, and
stock option expense of $76. In 2005, amortization and depreciation is expected to be slightly
lower and stock option expense is expected to be higher than in 2004 due to the planned issuance of
stock options in 2005 as part of our employee stock option plans. In addition, other adjustments
included deferred income taxes, gain on sale of businesses and assets and other items offset by
foreign exchange impacts on long term assets and liabilities that accounted for the remaining $237. In 2003, the primary adjustments to net earnings from continuing operations for non-cash and other
items were amortization and depreciation of $434, substantially all of which was depreciation, and
stock option expense of $26. In addition, other adjustments included deferred income taxes, gain
on sale of businesses and assets and other items offset by foreign exchange impacts on long term
assets and liabilities and a reduction in long term deferred revenue that accounted for the
remaining $54.  Changes in operating assets and liabilities In 2004, the use of cash of $897 relating to the change in our operating assets and liabilities was
primarily due to changes in accounts receivable, inventories and accounts payable, restructuring
outflows, supplemental pension funding and other changes in assets and liabilities partially offset
by collection of long term or customer financing receivables. This included a $664 reduction in
cash flows associated with accounts receivable, inventories and
accounts payable as discussed further under working capital metrics below. In 2004, we received cash proceeds of approximately $147 from the sale of certain customer
financing notes receivable and convertible notes receivable. We had cash outflows for
restructuring activities of $254 primarily related to our 2001 restructuring plan and approximately
$140 in supplemental pension funding cash outflows to contribute to the reduction of our pension
deficit. Other significant operating items included payments of approximately $280 in the first
quarter of 2004 associated with our employee bonus plan and restricted stock unit program based on
2003 performance. Other trends in other operating assets and liabilities included the following:  
    
    our restricted cash balance increased by $17 in 2004 compared to a $200 reduction in
2003 and is expected to increase in 2005 due to requirements associated with customer
contracts primarily in Asia;
    
    income tax payments of $40 in 2004 compared to income tax payments of $2 in 2003
primarily due to previously incurred tax losses and tax credits. We do not expect
significant cash income tax payments in the foreseeable future; and
    
    an increase of $351 in cash from other changes in operating assets and liabilities primarily
due to an increase in deferred revenue, partially offset by a reduction in other
liabilities. In 2003, the use of cash of $866 relating to the change in our operating assets and liabilities was
primarily due to changes in accounts receivable, inventories and accounts payable, restructuring
outflows, supplemental pension funding and other changes in assets and liabilities partially offset
by collection of long term or customer financing receivables. The increase in cash flows
associated with accounts receivable, inventories and accounts payable was $193. In 2003, we received cash proceeds of approximately $230 from the sale of certain customer
financing notes receivable and convertible notes receivable. We had cash outflows for
restructuring activities of $551 related to our 2001 restructuring plan and approximately $165 in
supplemental pension funding cash outflows to contribute to the reduction of our pension deficit. In 2003, we had a decrease in
cash of $771 from other changes in operating assets and liabilities
primarily due to a decrease in contractual liabilities and deferred revenue. 78




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In the first quarter of 2005 we received proceeds of $110 from the sale of a customer financing
notes receivable. This was our last significant customer financing asset and we do not expect
additional significant proceeds from customer financing receivables in 2005. We expect cash
outflows of approximately $280 in 2005 related to both our 2001 restructuring plan and our 2004
work plan. Our pension funding in 2005 is expected to be $92. We do not expect to have
significant payments related to our employee bonus program in 2005 based on 2004 performance and
our 2003 restricted stock unit program has been terminated.  Working capital metrics The $664 reduction in cash flows associated with our working capital performance in 2004 was due to
changes in accounts receivable of $182 and inventories of $592, partially offset by an increase due
to changes in accounts payable of $110, as further described below.  Accounts Receivable  net Days sales outstanding in accounts receivables, or DSO, measures the average number of days our
accounts receivables are outstanding. DSO is a metric that approximates the measure of the average
number of days from when we recognize revenue until we collect cash from our customers. The following table shows our quarterly DSO (a): (BAR CHART) a)
    
    DSO for each quarter is calculated by dividing the quarter end accounts receivable-net
balance by revenues for the quarter, in each case as determined in accordance with GAAP, and
multiplying by 90 days.
 DSO increased as of December 31, 2004 compared to December 31, 2003 primarily due to:  
    
    reduced accounts receivable securitization;
    
    increase of deferred revenues primarily in the fourth quarter of 2004;
    
    one-time recognition of $300 of deferred revenue in our Enterprise Networks segment
in the fourth quarter of 2003; and
    
    reduced focus on collection activities, particularly in the first half of 2004, due
to our restatement activities. Also contributing to the average increase of DSO was increased Wireless Networks revenues from a
large number of contracts involving progress billing, due to significant portions of collections
occurring upon project completion. In 2005, we will continue to
focus on improving our collections process. Offsetting this expected
improvement is an expected increase in the number of contracts involving progress billing. We
expect to experience fluctuations in collections performance in individual quarters. 79




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Inventories  net Net inventory days, or NID, is a metric that approximates the average number of days from
procurement to sale of our product. The following table shows our quarterly NID (a): (BAR CHART) a)
    
    NID for each quarter is calculated by dividing the average of the current quarter and prior
quarter inventories  net by the cost of revenues for the quarter, in each case as determined in
accordance with U.S. GAAP, and multiplying by 90 days. Finished goods inventory includes certain
direct and incremental costs associated with arrangements where title and risk of loss was
transferred to the customer but revenue was deferred due to other revenue recognition criteria not
being met. As of December 31, 2004 and 2003, these deferred costs totaled $829 and $432,
respectively.
 NID increased as of December 31, 2004 compared to December 31, 2003 primarily due to the
increased deferred costs associated with deferred revenues as described in note (a) of the table
above, and an increase in inventory to meet new contract requirements, particularly in Asia for
Wireless projects, including BSNL. NID is normally highest in the third quarter as inventory is held to support sales in the fourth
quarter, which is typically our strongest quarter of the year in terms of revenues. However, in
2004, NID in the third quarter was reduced due to the impact of the project loss related to BSNL.
In addition, while NID decreased overall between the third quarter of 2003 and the second quarter
of 2004, it increased through the third quarter and particularly in the fourth quarter of 2004 as a
result of increases associated with deferred revenues across all of our segments. In 2005, we expect that NID will fluctuate from quarter to quarter and will normally be highest in
the third quarter as inventory is held to support sales in the fourth quarter, which is typically
our strongest quarter of the year in terms of revenues. Inventory management continues to be an area of focus as we balance the need to maintain strategic
inventory levels to ensure competitive delivery performance to our customers against the risk of
inventory obsolescence due to rapidly changing technology and customer spending requirements. 80




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Days of purchases outstanding in accounts payable Days of purchases outstanding in accounts payable, or DPO, is a metric that approximates the
average number of days from when we receive purchased goods and services until we pay our
suppliers. The following table shows the quarterly DPO (a): (BAR CHART) a)
    
    DPO for each quarter is calculated by dividing the quarter end Trade and other accounts
payable by the cost of revenues for the quarter, in each case, as determined in accordance with
GAAP, and multiplying by 90 days.
 DPO increased to 61 days
as of December 31, 2004 from 42 days as of December 31, 2003 as we placed additional focus on
establishing competitive payment terms with our suppliers and improving the processing of payments
to match payment terms. DPO will normally be highest in the third quarter and lowest in the fourth quarter due to the
impact of purchasing inventory in the third quarter to support sales in the fourth quarter, which
is generally our strongest quarter of the year in terms of revenue. However, the lower DPO in the
third and the higher DPO in the fourth quarter of 2004 did not reflect this trend primarily due to
the impact of the project loss related to the BSNL project and the deferred cost increases in the
fourth quarter as described above. While we will continue our focus on managing our DPO, we expect that DPO will continue to fluctuate
on a quarter by quarter basis.  Investing activities In 2004, cash flows used in investing activities were $126 and were primarily due to net
expenditures of $271 in plant and equipment and $5 associated with acquisitions of certain
investments and businesses. These amounts were partially offset by proceeds of $150 from the sale
of certain investments and businesses which we no longer considered strategic, including $80 from
the sale of certain assets in CALA, $17 related to the sale of the common shares of Arris Group and
$33 related to the sale of the common shares of Entrust. In 2003, cash flows used in investing activities were $85 and were primarily due to net
expenditures of $134 in plant and equipment and $58 associated with acquisitions of certain
investments and businesses including the ownership adjustment in our French and German operations.
These amounts were partially offset by proceeds of $107 from the sale of certain investments and
businesses which we no longer considered strategic.  Financing activities In 2004, cash flows used in financing activities were $141 and were primarily due to $107 used
to reduce our long-term debt, a repayment of capital leases payable of $9 and dividends of $33 paid
by us related to our outstanding preferred shares. The reduction of our long-term debt was
primarily due to the extinguishment of debt of $87 related to the purchase of land and two
buildings in the U.S. that were previously leased by us. In 2003, cash flows used in financing activities were $362 and were primarily due to $270 used to
reduce our long-term debt, a reduction of our notes payable by a net amount of $45, a repayment of
capital leases payable of $12 and dividends of $35 paid by us related to our outstanding preferred
shares. In 2004, our cash increased $88 compared to $176 in 2003 due to favorable effects of changes in
foreign exchange rates. Approximately $75 ($150 in 2003) of the favorable impact was the result of favorable changes in the
euro and the British pound against the U.S. dollar. 81




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In 2004, our discontinued operations generated net cash of $22 related to the continued wind-down
of our discontinued operations. In 2003, our discontinued operations generated net cash of $379 related to certain investing and
operating activities. We generated $241 of cash from investing activities primarily related to
proceeds from the sale of the common shares of Arris and the settlement of certain customer
financing receivables. The remaining cash of $138 was generated from operating activities related
to the continued wind down of our discontinued operations. Uses of liquidity As of December 31, 2004, our cash requirements for the next 12 months are primarily expected
to fund operations, including our investments in R&D and the following items:  
    
    investments in certain businesses, including planned joint ventures in Asia and our planned acquisition of PEC;
    
    costs relating to workforce reduction and other restructuring activities;
    
    capital expenditures;
    
    pension and post-retirement benefits;
    
    debt service; and
    
    costs in relation to the restatement activities, matters related to the
Revenue Independent Review and other related matters, including regulatory and other legal
proceedings. We believe that we have sufficient cash to repay our long term debt of $1,275 due in February 2006.
However, we continue to routinely monitor the capital markets for opportunities to improve our
capital structure and financial flexibility. We are subject to significant pending civil litigation actions and regulatory and
criminal investigations which could materially adversely affect our results of operations,
financial condition and liquidity by requiring us to pay substantial judgments, settlements, fines
or other penalties. See Risk factors/forward looking statements. Considerable effort and
resources have been expended on our restatement activities in 2004, including the dedicated effort
of hundreds of employees and numerous external consultants and advisors. The costs of our
restatement activities in 2004 are approximately $115, which amount has been included in SG&A
expense in our consolidated statements of operations. 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. As well, we expect to be required to fund some portion of our aggregate
undrawn customer financing commitments as further described below. 82




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Contractual cash obligations Payments dueTotalContractual cash obligations (a)
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    obligationsLong-term debt (b)
    
    $
    15
    
    
    $
    1,470
    
    
    $
    15
    
    
    $
    16
    
    
    $
    17
    
    
    $
    544
    
    
    $
    2,077Operating leases (c)
    
    
    94
    
    
    
    106
    
    
    
    94
    
    
    
    72
    
    
    
    57
    
    
    
    390
    
    
    
    813Purchase obligations
    
    
    1,132
    
    
    
    111
    
    
    
    9
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    1,254Outsourcing contracts
    
    
    96
    
    
    
    94
    
    
    
    92
    
    
    
    91
    
    
    
    90
    
    
    
    
    
    
    
    463Obligations under special charges
    
    
    118
    
    
    
    63
    
    
    
    53
    
    
    
    45
    
    
    
    35
    
    
    
    185
    
    
    
    499Pension, post-retirement and
post-employment obligations
    
    
    142
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142Other long-term liabilities reflected
on the balance sheet
    
    
    18
    
    
    
    8
    
    
    
    7
    
    
    
    8
    
    
    
    5
    
    
    
    46
    
    
    
    92Total contractual cash obligations
    
    $
    1,615
    
    
    $
    1,852
    
    
    $
    270
    
    
    $
    234
    
    
    $
    204
    
    
    $
    1,165
    
    
    $
    5,340
 (a)
    
    Amounts represent our known, undiscounted, minimum contractual payment obligations under our
long-term obligations and include amounts identified as contractual obligations in current
liabilities of the accompanying consolidated financial statements.(b)
    
    Includes principal payments due on long term debt and $176 of capital lease obligations. As
described in note 11 to the accompanying consolidated financial statements, we have entered
into certain interest rate swap contracts which swap fixed rate payments for floating rate
payments and therefore, interest payments are not included in the above table. For additional
information, also see note 10 Long-term debt, credit and support facilities to the
accompanying consolidated financial statements.(c)
    
    For additional information, see note 13 Commitments to the accompanying consolidated
financial statements.
  Purchase obligations Purchase obligation amounts in the above table represent the minimum obligation under our supply
arrangements related to product and/or services entered into in the normal course of our business.
Where the arrangement specifies quantity, pricing and timing information, we have included that
arrangement in the amounts presented above. In certain cases, these arrangements define an end
date of the contract, but do not specify timing of payments between December 31, 2004 and the end
date of the agreement. In those cases, we have estimated the timing of the payments based on
forecasted usage rates. 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 with 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. The remaining minimum purchase obligation has been
reflected in the contractual cash obligations table above.  Outsourcing contracts Outsourcing contract amounts in the table above represent our minimum contractual obligation for
services provided to us for a portion of our information services function. The amount payable
under our outsourcing contracts is variable to the extent that our hardware volumes and workforce
fluctuates from the baseline levels contained in the contracts and our contractual obligation could
increase above such baseline amount. If our hardware volumes or workforce were to fall below the
baseline levels in the contracts, we would be required to make the minimum payments included above.  Obligations under special charges Obligations under special charges in the above table reflect undiscounted amounts related to
contract settlement and lease costs and are expected to be substantially drawn down by the end of
2013. Balance sheet provisions of $137 for workforce reduction costs, included in restructuring in
current liabilities in the accompanying consolidated financial statements, have not been reflected
in the contractual cash obligations table above. 83




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Pension, post-retirement and post-employment obligations During 2004, we made cash contributions to our defined benefit pension plans of approximately $202,
which excludes $78 of deferred contributions for 2004 which were made in 2003, and approximately
$31 to our post-retirement benefit plans. In 2005, we expect to make cash contributions of
approximately $92 to the defined benefit plans, approximately $29 to the post-retirement benefit
plans and approximately $21 for post-employment obligations.  Other long-term liabilities reflected on the balance sheets Other long-term liabilities reflected on the balance sheet relate to asset retirement obligations
and deferred compensation accruals. Payment information related to our asset retirement
obligations has been presented based on the termination date after the first renewal period of the
associated lease contracts. Payment information related to our deferred compensation accruals has
been presented based on the anticipated retirement dates of the employees participating in the
programs.  Customer financing Generally, customer financing arrangements may include financing with deferred payment terms
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 to our customers for working capital purposes and equity financing. The following
table provides information related to our customer financing commitments, excluding our
discontinued operations as of: December 31,2004
    
    
    2003Drawn and outstanding  gross
    
    $
    118
    
    
    $
    401Provisions for doubtful accounts
    
    
    (38
    )
    
    
    (281
    )Drawn and outstanding  net(a)
    
    
    80
    
    
    
    120Undrawn commitments
    
    
    69
    
    
    
    180Total customer financing
    
    $
    149
    
    
    $
    300
 (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 years ended December 31, 2004 and 2003, we recorded net customer financing bad debt
recoveries of $54 and $113 as a result of settlements and adjustments to other existing provisions.
The recoveries and expense were included in the consolidated statements of operations within SG&A
expense. During the years ended December 31, 2004 and 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 $147 and $230 to settle outstanding
receivables of approximately $254 and $610 (with a net carrying value of $75 and $120), for the
years ended December 31, 2004 and 2003, respectively. Additional non-cash consideration received
under one such restructuring agreement in 2003 included a five year equipment and services supply
agreement and the mutual release of all other claims between the parties. On December 10, 2004, we entered into an agreement to restructure and/or settle customer financing
receivables with a certain customer. As a result of these transactions, we received cash
consideration of approximately $16 and a deferred senior unsecured note of $33 (net carrying value
of nil) to settle the outstanding receivables of approximately $118 with a net carrying value of
nil. On December 15 and 16, 2004, we sold certain notes receivable and convertible notes receivable that
had been received as a result of the restructuring of a customer financing arrangement for cash
proceeds of $116. The net carrying amount of the notes receivable and convertible notes receivable
was $61. We recorded a gain of $53, net of transaction costs of $2,
in other income (expense)  net for the year ended December 31, 2004. On December 23, 2004, a customer financing arrangement was restructured. The notes receivable and
other accounts receivable that were restructured had a net carrying amount of $12 ($1 of the net
carrying amount was included in discontinued operations), net of provisions for doubtful accounts
of $182 ($63 of the provision was included in discontinued operations). The restructured notes were valued at $100 as of 84




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December 31, 2004 and a gain of $88 ($32 of the gain was included in
discontinued operations) was recorded in the fourth quarter of 2004. On January 25, 2005, we sold
this receivable, including rights to accrued interest, for cash proceeds of $110. During 2004, we reduced undrawn customer financing commitments by $111 primarily as a result of the
expiration or cancellation of commitments and changing customer business plans. As of December 31,
2004, all of the $69 in undrawn commitments was available for funding under the terms of our
financing agreements. 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. Commitments to extend future financing generally have
conditions for funding, fixed expiration or termination dates and specific interest rates and
purposes. 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. We are currently directly supporting most outstanding balances and expect to
initially fund any future commitments in the normal course of business from our working capital.
We expect to fund substantially all of our current remaining undrawn commitments of $69 in 2005.
However, we also expect that we will be able to arrange for third party lenders to assume these
obligations in the same timeframe. Acquisitions On April 26, 2005, we announced that Nortel Networks Inc., a wholly owned subsidiary of NNL
had entered into an agreement with PEC, providing for the acquisition of all of the outstanding
shares of PEC for $15.50 per share in cash, or approximately $448 million (net of cash acquired) in
the aggregate, plus transaction costs and expenses. The acquisition is subject to certain
conditions, including the successful completion of a tender offer and regulatory approvals. We
currently expect to complete the acquisition during the second quarter of 2005. Sources of liquidity In 2004, we continued to maintain our strong liquidity position. As of December 31, 2004, our
primary source of liquidity was cash. At December 31, 2004, we had cash of $3,607 excluding $80 of
restricted cash and cash equivalents. We believe this cash will be sufficient to fund the changes
to our business model in accordance with the strategic plan (see Business overview  Our strategic
plan and outlook), fund 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. In the
future, we may seek additional funds from liquidity generating transactions and other sources of
external financing. We continue to routinely monitor the capital markets for opportunities to
improve our capital structure and financial flexibility. Our ability and willingness to access the
capital markets is based on many factors including market conditions and overall financial
objectives. Currently, our ability is limited due to the impact of the delay in filing the Reports
and the findings of the Independent Review and related matters. We cannot provide any assurance
that our net cash requirements will be as we currently expect, that we will continue to have access
to the EDC Support Facility when and as needed or that liquidity generating transactions or
financings will be available to us on acceptable terms. In addition, we have not assumed the need
to make any payments in respect of judgments, settlements, fines or other penalties in connection
with our pending civil litigation or investigations related to the First Restatement and Second
Restatement, which could have a material adverse effect on our financial condition or liquidity,
other than anticipated professional fees and expenses. See Risk factors/forward looking
statements. As of the first quarter of 2005, we have received proceeds of approximately $85. For the remainder of 2005, we expect to receive an additional portion of the total expected net proceeds of $675 to $725 from the
Flextronics arrangement which is expected to be partially offset by cash outflows attributable to direct transaction costs and other costs
associated with the arrangement. Asset sales of investments and customer financing receivables in
both continuing and discontinued operations have resulted in significant cash inflows in 2003 and
2004. In 2005, we expect the contribution to cash flow from investments and customer financing
asset sales to be substantially lower. The sale of a customer financing receivable for cash
consideration of $110 in the first quarter of 2005 is expected to be the only significant customer
financing asset sale in 2005. Although, we do not have any significant debt repayments planned
in 2005, our $1,275 long term debt matures in February 2006. We believe that we have sufficient
cash to repay our long term debt of $1,275 due in February 2006. However, we continue to routinely
monitor the capital markets for opportunities to improve our capital structure and financial
flexibility. 85




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Credit facilities On April 28, 2004, we notified the lenders under the Five Year Facilities that we were
terminating these facilities. Due to our failure to file our 2003 Annual Report on Form 10-K by
April 29, 2004, the banks under the Five Year Facilities would have otherwise been permitted to,
upon 30 days notice, terminate their commitments under the Five Year Facilities. Upon termination,
we were in compliance with that financial covenant and the Five Year Facilities were undrawn. As
of December 31, 2004, we had no material credit facilities in place. For additional information
relating to the Five Year Facilities and the impact of the termination of these facilities under
the related security agreements, see Developments in 2004 and 2005  Nortel Audit Committee
Independent Review; restatements; related matters  Credit facilities and security agreements and
Risk factors/forward looking statements.  Available support facility On February 14, 2003, we entered into the EDC Support Facility. As of December 31, 2004, the
facility provided for up to $750 in support including:  
    
    $300 of uncommitted revolving support for performance bonds or similar instruments,
of which $207 was outstanding;
    
    $150 of uncommitted support for receivables sales and/or securitizations, of which
none was utilized; and
    
    $300 of uncommitted support for performance bonds and/or receivables sales and/or
securitizations, of which $84 was outstanding. For additional information relating to the EDC Support Facility subsequent to December 31, 2004 and
waivers obtained in connection with certain defaults arising under the EDC Support Facility from
the delay in filing the Reports, see Developments in 2004 and 2005  Nortel Audit Committee
Independent Review; restatements; related matters  EDC Support Facility and Risk factors/forward
looking statements. On March 29, 2004, we and EDC amended the EDC Support Facility to provide that EDC may suspend its
obligation to issue us any additional support if events occur that would have a material adverse
effect on our business, financial position or results of operation. As a result of an amendment on
December 10, 2004, the EDC Support Facility will expire on December 31, 2006. The EDC Support Facility 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 its currently outstanding
debt. The EDC Support Facility can be suspended or terminated if our senior long-term debt rating
by Moodys has been downgraded to less than B3 or if our debt rating by S&P has been downgraded to
less than B. As of December 31, 2004, our obligations under the EDC Support Facility were secured on an equal
and ratable basis under the security agreements entered into by us and various of our subsidiaries
that pledged substantially all of our and NNCs subsidiaries assets in favor of the holders of our
public debt securities and the holders of NNCs 4.25% Convertible Senior Notes. As of December
31, 2004, the security provided under the security agreements was comprised of:  
    
    pledges of substantially all of our assets and those of most of our U.S. and
Canadian subsidiaries; and
    
    guarantees by certain of our wholly owned subsidiaries organized in the U.S.,
Canada, England, Ireland and Hong Kong. If our senior long-term debt rating by Moodys returns to Baa2 (with a stable outlook) and its
rating by S&P returns to BBB (with a stable outlook), the security and guarantees will be released
in full. If the EDC Support Facility is terminated, or expires, the security and guarantees will
also be released in full. We may provide EDC with cash collateral in an amount equal to the total
amount of its outstanding obligations and undrawn commitments and expenses under this facility (or
any other alternative collateral or arrangements 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 or arrangements acceptable to EDC, the security and guarantees
will also be released in full. For information related to our outstanding public debt, see Long-term debt, credit and support
facilities in note 10 of the accompanying consolidated financial statements. For additional
financial information related to those subsidiaries providing guarantees as of December 31, 2004,
see Supplemental consolidating financial information in
note 23 of the accompanying consolidated
financial statements. For 86




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information related to the security pledged, those subsidiaries
providing guarantees and the impact of the termination of the Five Year Facilities on the related
security agreements, subsequent to December 31, 2004, see Developments in 2004 and 2005  Nortel
Audit Committee Independent Review; restatements; related matters  Credit facilities and security
agreements. For information related to our debt ratings, see Credit ratings below. See Risk
factors/forward looking statements for factors that may affect our ability to comply with
covenants and conditions in our EDC Support Facility in the future.  Shelf registration statement and base shelf prospectus In 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 the potential sale of up to $2,500 of
various types of securities in the U.S. and/or Canada. The qualifying securities include common
shares, preferred shares, debt securities, warrants to purchase equity or debt securities, share
purchase contracts and share purchase or equity units (subject to certain approvals). As of
December 31, 2004, approximately $1,700 under the shelf registration statement and base shelf
prospectus has been utilized. As of June 6, 2004, the Canadian base shelf prospectus expired.
Owing to matters described above in Developments in 2004 and 2005  Nortel Audit Committee
Independent Review; restatements; related matters with respect to the delayed filing of the
Reports and the 2005 First Quarter Reports, we are currently unable to utilize, in its current
form, approximately $800 of the remaining capacity under the SEC shelf registration statement.
After we become current and timely with our SEC filings for a period of twelve months, we will
again become eligible for short form shelf registration with the SEC. Credit ratings Rating on long-term debt
    
    
    Rating onissued or guaranteed by
    
    
    preferred sharesNortel Networks
    
    
    issued byLimited/Nortel Networks
    
    
    Nortel NetworksRating agency
    
    Corporation
    
    
    Limited
    
    
    Last changeStandard & Poors Ratings Service
    
    
    B
    
    
    CCC
    
    
    April 28, 2004Moodys Investors Service, Inc.
    
    
    B3
    
    
    Caa3
    
    
    November 1, 2002
 On April 28, 2004, S&P downgraded its ratings on us, including its long-term corporate credit
rating from B to B and its preferred shares
rating from CCC to CCC. At the same time, it
revised its outlook to developing from negative. Moodys outlook changed to review for potential
downgrade from uncertain on April 28, 2004. 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 EDC Support
Facility and/or enter into normal course derivative or hedging transactions. Preferred Shares NNC, as the sole holder of the common shares of Nortel Networks Limited, approved reductions
in the legal stated capital of the common shares of Nortel Networks Limited in the amount of nil in
2004 and 2003, and $3,187 in 2002. Among other things, these reductions enhance our ability to
continue to declare and pay dividends on our outstanding preferred shares under applicable Canadian
corporate law. Beginning December 1, 2001, the holders of our Cumulative Redeemable Class A Preferred Shares
Series 5, or Series 5 preferred shares, are entitled (if declared) to a monthly floating cumulative
preferential cash dividend based on the average prime rate of two Canadian banks. 87




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Prior to that
time, the holders were entitled to an annual fixed cumulative preferential cash dividend of
Canadian $1.275 per share (5.1%), which was payable on a quarterly basis up to November 30, 2001.
Also, as of December 1, 2001, the holders of the Series 5 preferred shares had the right to convert
their shares into Cumulative Redeemable Class A Preferred Shares Series 6, or Series 6 preferred
shares, provided that a minimum number of Series 5 preferred shares were tendered for conversion.
This condition was not satisfied and, as a result, no Series 6 preferred shares were issued.
Holders of Series 6 preferred shares would have been entitled to an annual fixed cumulative
preferential cash dividend of Canadian $0.821 per share (3.284%), payable (if declared) on a
quarterly basis. The Series 5 preferred shares are redeemable at our option any time after
December 1, 2001, at Canadian $25.50 per share, plus any declared and unpaid
dividends. The next opportunity for conversion of Series 5 preferred shares into Series 6
preferred shares will be as of December 1, 2006. Beginning December 1, 2002, the holders of our Non-cumulative Redeemable Class A Preferred Shares
Series 7, or Series 7 preferred shares, are entitled (if declared) to a monthly floating
non-cumulative preferential cash dividend based on the average prime rate of two Canadian banks.
Prior to that time, the holders were entitled to an annual fixed non-cumulative preferential cash
dividend of Canadian $1.225 per share (4.9%), which was payable on a quarterly basis up to November
30, 2002. Also, as of December 1, 2002, the holders of Series 7 preferred shares had the right to
convert their shares into Non-cumulative Redeemable Class A Preferred Shares Series 8, or Series 8
preferred shares, provided that a minimum number of Series 7 preferred shares were tendered for
conversion. This condition was not satisfied and, as a result, no Series 8 preferred shares were
issued. Holders of Series 8 preferred shares would have been entitled to an annual fixed
non-cumulative preferential cash dividend of Canadian $0.84725 per share (3.389%), payable (if
declared) on a quarterly basis. The Series 7 Shares are redeemable at our option any time after
December 1, 2002, at Canadian $25.50 per share, plus any declared and unpaid dividends. The next
opportunity for conversion of Series 7 preferred shares into Series 8 preferred shares will be as
of December 1, 2007. For additional information about our preferred shares, see Capital stock in note 15 of the
accompanying consolidated financial statements. Off-balance sheet arrangements Bid, performance related and other bonds We have entered 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 and other bonds generally have a
term of twelve months and are typically renewed, as required, over the term of the applicable
contract. 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 of: December 31,2004
    
    
    2003Bid and performance related bonds(a)
    
    $
    362
    
    
    $
    427Other bonds(b)
    
    
    68
    
    
    
    53Total bid, performance related and other bonds
    
    $
    430
    
    
    $
    480
 (a)
    
    Net of restricted cash and cash equivalents of $36 as of December 31, 2004 and $14 as of
December 31, 2003.(b)
    
    Net of restricted cash and cash equivalents of $28 as of December 31, 2004 and $31 as of
December 31, 2003.
 The criteria under which bid, performance related and other bonds can be obtained changed due
to the industry environment primarily in 2002 and 2001. During that timeframe, in addition to the
payment of higher fees, we experienced significant cash collateral requirements in connection with
obtaining new bid, performance related and other bonds. Given that the EDC Support Facility is
used to support bid and performance bonds with varying terms, including those with at least 365 day
terms, we will likely need to increase our use of cash collateral to support these obligations
beginning on January 1, 2006 absent a further extension of the facility. The EDC Support Facility provides support for certain obligations under bid and performance related
bonds and has reduced the 88




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requirement to provide cash collateral to support these obligations. As
of December 31, 2004, the EDC Support Facility provided for up to $750 in support, of which $300
was uncommitted support for performance bonds of which $207 was outstanding. The remainder was
uncommitted support, subject to certain limitations, for performance bonds, receivables sales
and/or securitizations of which $84 was outstanding as of December 31, 2004. Any bid or
performance related bonds with terms that extend beyond December 31, 2006 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 equally and ratably 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 the EDC Support Facility and the security
agreements and see Developments in 2004 and 2005  Nortel Audit Committee Independent Review;
restatements; related matters  EDC Support Facility for additional information in connection with
amendments to the EDC Support Facility and developments in connection with the EDC Support Facility
and related security agreements subsequent to December 31, 2004. Receivables securitization and certain lease financing transactions In January 2003, the Financial Accounting Standards Board, or FASB, issued FASB
Interpretation, or FIN, No. 46, Consolidation of Variable Interest Entities  an Interpretation of
Accounting Research Bulletin No. 51, Consolidated
Financial Statements, or FIN 46, and in
December 2003, the FASB issued a revision of FIN 46 
FIN 46 (Revised 2003), or FIN 46R. FIN 46R
provides guidance with respect to the consolidation of variable interest entities, or VIEs. VIEs
are characterized as 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. Reporting entities which
have a variable interest in such an entity and are deemed to be the primary beneficiary must
consolidate the variable interest entity. Certain of our lease financing transactions were structured through single transaction VIEs that
did not have sufficient equity at risk as defined in FIN 46R. Effective July 1, 2003, we
prospectively began consolidating two VIEs for which we were considered the primary beneficiary
following the guidance of FIN 46, on the basis that we retained certain risks associated with
guaranteeing recovery of the unamortized principal balance of the VIEs debt, which represented the
majority of the risks associated with the respective VIEs activities. The amount of the guarantees
will be adjusted over time as the underlying debt matures. During 2004, the debt related to one of
the VIEs was extinguished and as a result consolidation of this VIE was no longer required. As of
December 31, 2004, our consolidated balance sheet included $100 of long-term debt and $100 of plant
and equipment  net related to these VIEs. These amounts represented both the collateral and
maximum exposure to loss as a result of our involvement with these VIEs. As of December 31, 2004, we did not have any variable interests related to transfers of financial
assets. We have other financial interests and contractual arrangements which would meet the
definition of a variable interest under FIN 46R, including investments in other companies and joint
ventures, customer financing arrangements, and guarantees and indemnification arrangements. As of
December 31, 2004, none of these interests or arrangements were considered significant variable
interests and, therefore, did not meet the requirements for consolidation under FIN 46R. We have also conducted certain receivable sales transactions 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, expected
future cash flows and appropriate discount rates as applicable. Where we have acted as the
servicing agent, we generally have not recorded an asset or liability related to servicing as the
annual servicing fees were equivalent to those that would have been paid to a third party servicing
agent. Also, we have not historically experienced significant credit losses with respect to
receivables sold with limited recourse. As of December 31, 2004, we were not required to, and did
not, consolidate or provide any of the additional disclosures set out
in FIN 46R with respect to
the variable interest entities involving receivable sales. Additionally, we have agreed to indemnify some of our counterparties in certain receivables
securitization transactions. The indemnifications provided to counterparties in these types of
transactions may require us 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 of December 31, 2004, we had approximately $266 of securitized receivables which were
subject to repurchase under this provision, in which case, we would assume all rights to collect
such receivables. The indemnification provisions generally expire upon expiration of the
securitization agreements, 89




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which extend through 2005, or collection of the receivable amount by the
counterparty. We are 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, we have not made any significant
indemnification payments or receivable repurchases under these agreements and no significant
liability has been accrued in the accompanying
consolidated financial statements with respect to the obligation associated with these guarantees. Other indemnifications or guarantees Through our normal course of business, we have also entered into other indemnifications or
guarantees that arise in various types of arrangements including:  
    
    third party debt agreements;
    
    business sale and business combination agreements;
    
    intellectual property indemnification obligations;
    
    lease agreements;
    
    indemnification of banks and agents under our credit and support facilities and security agreements; and
    
    other indemnification agreements. In 2004, we did not make 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 12 of the accompanying consolidated financial
statements. Application of critical accounting policies and estimates Our accompanying consolidated financial statements are based on the selection and application
of accounting policies, generally accepted in the U.S., which require us to make significant
estimates and assumptions. We believe that the following accounting policies involve a higher
degree of judgment and complexity in their application and require us to make significant
accounting estimates. The application of these estimates requires us to make subjective and
objective judgments. In general, any changes in estimates or assumptions relating to revenue recognition, provisions for
doubtful accounts, provisions for inventory and other contingencies (excluding legal contingencies)
are directly reflected in the results of our reportable operating segments. Changes in estimates
or assumptions pertaining to our tax asset valuations, our pension and post-retirement benefits and
our legal contingencies are generally not reflected in our reportable operating segments, but are
reflected on a consolidated basis. We have discussed the application of these critical accounting policies and estimates with the
Audit Committee of our Board of Directors. Revenue recognition Our material revenue streams are the result of a wide range of activities, from custom design
and installation over a period of time to a single delivery of equipment to a customer. Our
networking solutions also cover a broad range of technologies and are offered on a global basis. As
a result, our revenue recognition policies can differ depending on the level of customization
within the solution and the contractual terms with the customer. Newer technologies within one of
our reporting segments may also have different revenue recognition policies, depending on, among
other factors, the specific performance and acceptance criteria within the applicable contract.
Therefore, management must use judgment in determining how to apply the current accounting
standards and interpretations, not only based on the networking solution, but also within
networking solutions based on reviewing the level of customization and contractual terms with the
customer. As a result, our revenues may fluctuate from period to period based on the mix of
solutions sold and the geographic region in which they are sold. When a sale involves multiple deliverables where the deliverables are governed by more than one
authoritative standard, we evaluate all deliverables to determine whether they represent separate
units of accounting based on the following criteria:  
    
    whether the delivered item has value to the customer on a stand-alone basis;
    
    whether there is objective and reliable evidence of the fair value of the undelivered item(s); and 90




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
    
    if the contract includes a general right of return relative to the delivered item,
delivery or performance of the undelivered item(s) is considered probable and is
substantially in our control. Our determination of whether deliverables within a multiple element arrangement can be treated
separately for revenue recognition purposes involves significant estimates and judgment, such as
whether fair value can be established on undelivered obligations and/or whether delivered elements
have standalone value to the customer. Changes to our assessment of the accounting units in an
arrangement and/or our ability to establish fair values could significantly change the timing of
revenue recognition. If objective and reliable evidence of fair value exists for all units of accounting in the
contract, revenue is allocated to each unit of accounting or element based on relative fair values.
In situations where there is objective and reliable evidence of fair value for all undelivered
elements, but not for delivered elements, the residual method is used to allocate the contract
consideration. Under the residual method, the amount of revenue allocated to delivered elements
equals the total arrangement consideration less the aggregate fair value of any undelivered
elements. Each unit of accounting is then accounted for under the applicable revenue recognition
guidance. If fair value does not exist for any undelivered element, revenue is not recognized
until the earlier of (i) the undelivered element is delivered or (ii) fair value of the undelivered
element exists, unless the undelivered element is a service, in which case revenue is recognized as
the service is performed once the service is the only undelivered element. Our assessment of which revenue recognition guidance is appropriate to account for a deliverable
also can involve significant judgment. For instance, the determination of whether software is more
than incidental to hardware can impact whether the hardware is accounted for under software revenue
recognition or general revenue recognition guidance. This assessment could impact the amount and
timing of revenue recognition. For accounting units related to customized network solutions and certain network build-outs,
revenues are recognized under AICPA Statement of Position 81-1 using the
percentage-of-completion method. In using the percentage-of-completion method, revenues are
generally recorded based on a measure of the percentage of costs incurred to date on a contract
relative to the estimated total expected contract costs. Profit estimates on long-term contracts
are revised periodically based on changes in circumstances and any losses on contracts are
recognized in the period that such losses become known. Generally, the terms of long-term
contracts provide for progress billing based on completion of certain phases of work. Contract
revenues recognized, based on costs incurred towards the completion of the project, that are
unbilled are accumulated in the contracts in progress account included in accounts receivable -
net. Billings in excess of revenues recognized to date on long-term contracts are recorded as
advance billings in excess of revenues recognized to date on
contracts within other accrued liabilities. Significant judgment is
often required when estimating total contract costs and progress to completion on these
arrangements, as well as whether a loss is expected to be incurred on the contract. Management uses
historical experience, project plans and an assessment of the risks and uncertainties inherent in
the arrangement to establish these estimates. Uncertainties include implementation delays or
performance issues that may or may not be within our control. Changes in these estimates could
result in a material impact on revenues and net earnings (loss). Revenue for hardware that does not require significant customization, and where any software is
considered incidental, is recognized under SEC Staff Accounting Bulletin 104, Revenue
Recognition, or SAB 104. Under SAB 104, revenue is recognized provided that persuasive evidence
of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or
determinable and collectibility is reasonably assured. For hardware, delivery is considered to have occurred upon shipment provided that risk of loss, and
title in certain jurisdictions, have been transferred to the customer. For arrangements where the
criteria for revenue recognition have not been met because legal title or risk of loss on products
did not transfer to the buyer until final payment had been received or where delivery had not
occurred, revenue is deferred to a later period when title or risk of
loss passes either on
delivery or on receipt of payment from the customer. For arrangements where the customer agrees to
purchase products but we retain possession until the customer
requests shipment, or bill
and hold arrangements, revenue is not recognized until delivery to the customer has occurred and
all other revenue recognition criteria have been met. We make certain sales through multiple distribution channels, primarily resellers and distributors.
These customers are generally given certain rights of return. For
products sold through these distribution channels, revenue is
recognized from product sale at the time of shipment to the
distribution channel when persuasive evidence of an arrangement
exists, delivery has occurred, the fee is fixed or determinable and
collection is reasonably assured. Accruals for estimated sales returns
and other allowances and deferrals are recorded as a reduction of revenue at the time of revenue
recognition. These provisions are based on contract terms and prior claims experience and involve
significant estimates. If these estimates are significantly different from actual results, our
revenue could be impacted. 91




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We provide extended payment terms on certain software contracts and may sell these receivables to
third parties. The fees on these contracts are considered fixed or determinable if the contracts
are similar to others for which we have a standard
business practice of providing extended payment terms and have a history of successfully collecting
under the original payment terms without making concessions. If fees are not considered fixed or
determinable at the outset of the arrangement, revenue for delivered products is deferred until the
fees become legally due and payable and therefore estimates and judgment in this area can impact
the timing of revenue recognition. The collectibility of trade and notes receivables is also critical in determining whether revenue
should be recognized. As part of the revenue recognition process, we determine whether trade or notes receivables are
reasonably assured of collection and whether there has been deterioration in the credit quality of
our customers that could result in our inability to collect the receivables. We will defer revenue
but recognize related costs if we are uncertain as to whether we will be able to collect the
receivable. As a result, our estimates and judgment regarding customer credit quality could
significantly impact the timing and amount of revenue recognition. For further information on our revenue recognition policies relating to our material revenue
streams, you should also refer to note 2(d) of the accompanying consolidated financial statements. Provisions for doubtful accounts In establishing the appropriate provisions for trade, notes and long-term receivables due from
customers, we make assumptions with respect to their future collectibility. Our assumptions are
based on an individual assessment of a customers credit quality as well as subjective factors and
trends, including the aging of receivable balances. Generally, these individual credit assessments
occur prior to the inception of the credit exposure and at regular reviews during the life of the
exposure and consider:  
    
    a customers ability to meet and sustain its financial commitments;
    
    a customers current and projected financial condition;
    
    the positive or negative effects of the current and projected industry outlook; and
    
    the economy in general. Once we consider all of these individual factors, we make a determination as to the probability of
default. An appropriate provision is then made, which takes into consideration the severity of the
likely loss on the outstanding receivable balance based on our experience in collecting these
amounts. In addition to these individual assessments, in general, outstanding trade accounts
receivable amounts for which recovery is not expected that are greater than 365 days are fully
provisioned for and amounts greater than 180 days are 50% provisioned for. As part of our review of the provision for doubtful accounts in 2004, our recent historical
experience as to lower bad debt write-offs was factored into the analysis so as to require a lesser
percentage of provisions for aged balances and, accordingly, we reduced our provision for doubtful
accounts by approximately $27. This was recorded as a reduction to SG&A expense in the third
quarter of 2004 and was in addition to any adjustments related to our ongoing provisioning process. In subsequent periods, we may be required to make adjustments once further information becomes
available or actual events occur. As a result, we may incur significant adjustments to our
provisions for trade, notes and long-term receivables. We recorded net trade and customer financing receivable recoveries related to continuing operations
of $127 in 2004. In 2003 and 2002, we recorded receivable recoveries related to continuing
operations of $179 and receivable provisions related to continuing operations of $292,
respectively. The net receivable recoveries of $127 in 2004 and $179 in 2003 primarily related to
trade and customer financing receivable recoveries as a result of favorable settlements related to
our sale or restructuring of various receivables as well as net recoveries on other trade and
customer financing receivables due to subsequent collections for amounts exceeding our original
estimates of net recovery. These recoveries were partially offset by receivable provisions
recorded during 2003 that related to our normal business activity. The receivable provisions
recorded in 2002 were primarily related to the financial difficulties of several of our service
provider and enterprise customers as a result of the significant industry adjustment. 92




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The following table summarizes our accounts receivable and long-term receivable balances and
related reserves of our continuing operations as of: December 31,2004
    
    
    2003Gross accounts receivable
    
    $
    2,909
    
    
    $
    2,853Provision for doubtful accounts
    
    
    (109
    )
    
    
    (194
    )Accounts receivable  net
    
    $
    2,800
    
    
    $
    2,659Accounts receivable provision as a percentage of gross accounts receivables
    
    
    4
    %
    
    
    7
    %Gross long-term receivables
    
    $
    159
    
    
    $
    386Provision for doubtful accounts
    
    
    (65
    )
    
    
    (297
    )Net long-term receivables
    
    $
    94
    
    
    $
    89Long-term receivable provision as a percentage of gross long-term receivables
    
    
    41
    %
    
    
    77
    %
 Provisions for inventory Management must make estimates about the future customer demand for our products when
establishing the appropriate provisions for inventory. When making these estimates, we consider
general economic conditions and growth prospects within our customers ultimate marketplace, and
the market acceptance of our current and pending products. These judgments must be made in the
context of our customers shifting technology needs and changes in the geographic mix of our
customers. With respect to our provisioning policy, in general, we fully reserve for surplus
inventory in excess of our 365 day demand forecast or that we deem to be obsolete. Generally, our
inventory provisions have an inverse relationship with the projected demand for our products. For
example, our provisions usually increase as projected demand decreases due to adverse changes in
the conditions mentioned above. We have experienced significant changes in required provisions in
recent periods due to changes in strategic direction, such as discontinuances of product lines, as
well as declining market conditions. A misinterpretation or misunderstanding of any of these
conditions could result in inventory losses in excess of the provisions determined to be
appropriate as of the balance sheet date. The following table summarizes our inventory balances and other related reserves of our continuing
operations as of: December 31,2004
    
    
    2003Gross inventory
    
    $
    2,923
    
    
    $
    2,311Inventory provisions
    
    
    (1,141
    )
    
    
    (1,121
    )Inventories  net (b)
    
    $
    1,782
    
    
    $
    1,190Inventory provisions as a percentage of gross inventory
    
    
    39
    %
    
    
    49
    %Other reserves for claims related to our contract manufacturers and suppliers(a)
    
    
    (57
    )
    
    
    (120
    )
 (a)
    
    This amount was included in other accrued liabilities and related to cancellation charges,
contracted for inventory in excess of future demand and the settlement of certain other
claims.(b)
    
    Includes long-term portion of inventory related to the deferred costs which is included in
other assets.
 As of December 31, 2004, our inventory provisions as a percentage of gross inventory was 39%.
We recorded inventory provisions related to continuing operations of $1,141 as of December 31, 2004
and $1,121 as of December 31, 2003. Inventory provisions increased due to $159 of additional
inventory provisions and $67 as a result of foreign exchange fluctuations, reclassifications and
other adjustments offset by $174 of scrapped inventory and $32 of reductions due to sale of
inventory. In the future, we may be required to make significant adjustments to these provisions
for the sale and/or disposition of inventory that was provided for in prior periods. Customers continued to be cautious with their capital expenditures in 2004. As a result, we will
continue to closely monitor our inventory provisions to ensure that they 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. 93




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Provisions for product warranties Provisions are recorded for estimated costs related to warranties given to customers on our
products to cover defects. These provisions are calculated based on historical return rates as well
as on estimates which take into consideration the historical material replacement costs and the
associated labor costs to correct the product defect. Known product defects are specifically
provided for as we become aware of such defects. Revisions are made when actual experience differs
materially from historical experience. These provisions for product warranties are part of the
cost of revenues and are accrued when the products are sold. They represent the best possible
estimate, at the time the sale is made, of the expenses to be incurred under the warranty granted.
Warranty terms generally range from one to six years from the date of sale depending upon the
product. We accrue for warranty costs as part of our cost of revenues based on associated material costs and
technical support labor costs. Material cost is estimated based primarily upon historical trends
in the volume of product returns within the warranty period and the cost to repair or replace the
equipment. Technical support labor cost is estimated based primarily upon historical trends in the
rate of customer warranty claims and projected claims within the warranty period. The following table summarizes the accrual for product warranties that was recorded as part of
other accrued liabilities in the consolidated balance sheets as of December 31: 2004
    
    
    2003Balance at the beginning of the year
    
    $
    382
    
    
    $
    404Payments
    
    
    (349
    )
    
    
    (347
    )Warranties issued
    
    
    229
    
    
    
    337Revisions
    
    
    9
    
    
    
    (12
    )Balance at the end of the year
    
    $
    271
    
    
    $
    382
 The decline in warranties issued in 2004 compared to 2003 is primarily due to improvements in
the quality of our products. Warranty provisions we have recorded in the past may not be reflective
of those in future periods. If we experience an increase in warranty claims compared with our
historical experience, or if the cost of servicing warranty claims is greater than the expectations
on which the accrual has been based, our gross margin could be adversely affected. We engage in extensive product quality programs and processes, including actively monitoring and
evaluating the quality of our component suppliers. Our estimated warranty obligation is based upon
warranty terms, ongoing product failure rates, historical material replacement costs and the
associated labor to correct the product defect. If actual product failure rates, material
replacement costs, service or labor costs differ from our estimates, revisions to the estimated
warranty provision would be required. Income taxes Tax asset valuation Our net deferred tax assets balance, excluding discontinued operations, was $3,848 at December
31, 2004 and $3,576 at December 31, 2003. The $272 increase was primarily due to the impact of
foreign exchange effects related primarily to the Canadian dollar and British pound, a release of
valuation allowance in certain jurisdictions, and a reclassification of a portion of our deferred
income tax liabilities to current income taxes payable. We currently have deferred tax assets
resulting from net operating loss carryforwards, tax credit carryforwards and deductible temporary
differences, all of which are available to reduce future taxes payable in our significant tax
jurisdictions. Generally, our loss carryforward periods range from seven years to an indefinite
period. As a result, we do not expect that a significant portion of these carryforwards will
expire in the near future. We assess the realization of these deferred tax assets quarterly to determine whether an income tax
valuation allowance is required. Based on available evidence, both positive and negative, we
determine whether it is more likely than not that all or a portion of the remaining net deferred
tax assets will be realized. The main factors that we consider include:  
    
    cumulative losses in recent years;
    
    history of loss carryforwards and other tax assets expiring; 94




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
    
    the carryforward period associated with the deferred tax assets;
    
    the nature of the income that can be used to realize the deferred tax assets;
    
    our net earnings/loss; and
    
    future earnings potential determined through the use of internal forecasts. 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 it is our belief that it
is more likely than not that some portion of these assets will not be realized, an income tax
valuation allowance is recorded. Primarily as a result of losses realized in 2001 and 2002, we concluded that it was more likely
than not that a portion of our deferred tax assets would not be realized. Accordingly, an income tax
valuation allowance has been recorded against these deferred income tax assets. However, due to
the fact that the majority of the carryforwards do not expire in the near future, our extended
history of earnings in our material tax jurisdictions exclusive of 2001 and 2002, and our future
expectations of earnings, we concluded that it is more likely than not that the remaining net
deferred income tax asset recorded as of December 31, 2004 will be realized. In 2004, our gross income tax valuation allowances increased to $3,395 as of December 31, 2004
compared to $3,108 as of December 31, 2003. The increase was primarily due to additional valuation
allowances recorded against current period losses in certain jurisdictions and the impacts of
foreign exchange. We assessed positive evidence including forecasts of future taxable income to
support realization of the net deferred tax assets, and negative evidence including our cumulative
loss position, and concluded that the valuation allowances as of December 31, 2004 were
appropriate. We continue to review all available positive and negative evidence on a jurisdictional basis and
our valuation allowance may need to be adjusted in the future as a result of this ongoing review.
Given the magnitude of our valuation allowance, future adjustments to this allowance based on
actual results could result in a significant adjustment to our net earnings. Tax contingencies We are subject to ongoing examinations by certain taxation authorities of the jurisdictions in
which we operate. We regularly assess the status of these examinations and the potential for
adverse outcomes to determine the adequacy of the provision for income and other taxes. We believe
that we have adequately provided for tax adjustments that we believe are probable as a result of
any ongoing or future examination. Specifically, the tax authorities in Brazil have recently completed an examination of a prior
taxation year and have issued an assessment in the amount of $56. We are currently in the process
of appealing this assessment and believe that we have adequately provided for tax adjustments that
are probable as a result of the outcome of the ongoing appeals process. In addition, tax authorities in France have recently begun an examination of a prior taxation year
and have issued a preliminary notice of proposed assessment for a material amount. No amount has
been provided for this assessment since we believe that this proposed assessment is without merit
and any potential tax adjustments that could result from this ongoing examination cannot be
quantified at this time. We had previously entered into Advance Pricing Arrangements, or APAs, with the taxation authorities
of the U.S. and Canada in connection with our intercompany transfer pricing and cost sharing
arrangements between Canada and the U.S. These arrangements expired in 1999 and 2000. In 2002, we
filed APA requests with the taxation authorities of the U.S. Canada and the United Kingdom, or the
U.K., that are expected to apply to the taxation years beginning in 2000. The APA requests are
currently under consideration but the tax authorities have not begun to negotiate the terms of the
arrangement. We have applied the transfer pricing methodology proposed in the APA requests since
2001. As part of the APA applications, we have requested that the methodology adopted in 2001 be
applied retroactively to the 2000 taxation year. If the retroactive application is accepted by the
taxation authorities, it would result in an increase in taxable income in certain jurisdictions
offset by an equal decrease in taxable income in the other jurisdictions. We have provided for any
taxes and interest that would be due as a result of retroactive application of the APAs. Although the outcome of the APA applications are uncertain, we do not believe it is probable that
the ultimate resolution of these negotiations will have a material adverse effect on our
consolidated financial position, results of operations or cash flows. Despite our current belief,
if this matter is resolved unfavorably, it could have a material adverse effect on our business,
results of operations, financial condition and liquidity. 95




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Goodwill valuation Commencing January 1, 2002, we test goodwill for possible impairment on an annual basis as of
October 1 of each year and at any other time if an event occurs or circumstances change that would
more likely than not reduce the fair value of a reporting unit below its carrying amount.
Circumstances that could trigger an impairment test between annual tests include, but are not
limited to:  
    
    a significant adverse change in the business climate or legal factors;
    
    an adverse action or assessment by a regulator;
    
    unanticipated competition;
    
    loss of key personnel;
    
    the likelihood that a reporting unit or a significant portion of a reporting unit will be sold or disposed of;
    
    a change in reportable segments;
    
    results of testing for recoverability of a significant asset group within a reporting unit; and/or
    
    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. These measures involve significant management judgment and as a result are subject
to change. 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). The fair value of each reporting unit is determined by allocating our total fair value among our
reporting units using an average of three valuation models; a discounted cash flow model, or the
DCF model, a model based on estimated 2005 revenue multiples, or the Revenue Multiple model, and a
model based on a multiple of estimated 2005 earnings before interest, taxes, depreciation and
amortization, or the EBITDA Multiple model. All of these valuation models involve significant
assumptions regarding our future operating performance. The following are the significant
assumptions involved in each model:  
    
    DCF model: assumptions regarding revenue growth rates, gross margin percentages,
discount rates and terminal growth rates;
    
    Revenue Multiple model: estimates of 2005 revenue growth and the selection of
comparable companies to determine an appropriate multiple; and
    
    EBITDA Multiple model: 2005 projected EBITDA and the selection of comparable companies
to determine an appropriate multiple. Of our total goodwill of $2,123 as of December 31, 2004, $1,558 was attributable to our Enterprise
Networks business. Accordingly, changes in our assumptions related to the fair value of our
Enterprise Networks business are most likely to result in an impairment charge in the future.
Based on a sensitivity analysis, we changed certain significant assumptions in order to assess the
impact on the value of our Enterprise Networks goodwill. We determined that a decrease as high as
20% in projected 2005 Enterprise revenues, coupled with the assumption of no future Enterprise
Networks revenue growth, would not trigger a goodwill impairment. Accordingly, a substantial
change in our assumptions would be required before a goodwill impairment would be triggered. In 2004 and 2003, we concluded that an impairment of our goodwill did not exist and no write down
was recorded. In the first quarter of 2005, we changed our reportable segments (see Business
Overview  Our Segments). We have determined that this change will trigger an interim impairment
test as of March 31, 2005. We have not yet completed this impairment test, and as such, have not
determined whether this change in our reportable segments will result in a goodwill impairment
charge. In 2002, we incurred a goodwill write down of $264. 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. 96




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The conclusion of those evaluations was that the fair value
associated with the businesses within Optical Networks could no longer support the carrying value
of the remaining goodwill associated with them. Fair value was estimated using the then expected
present value of discounted future cash flows of these businesses. The discount rate used ranged
from 12% to 16% and the terminal values were estimated based on terminal growth rates ranging from
3% to 5%. The carrying value of goodwill was $2,123 as of December 31, 2004 and $2,125 as of December 31,
2003. The decrease in goodwill primarily related to the contribution of a portion of our DOS
business to VoltDelta partially offset by our acquisition of the minority interests in our French
and German operations. For additional information on this transaction, including the allocation of
the purchase price, see Acquisitions, divestitures and closures  Nortel Networks Germany and
Nortel Networks France in note 9 of the accompanying consolidated financial statements. Pension and post-retirement benefits We maintain various pension and post-retirement benefit plans for our employees globally.
These plans include significant pension and post-retirement benefit obligations which are
calculated based on actuarial valuations. Key assumptions are made in determining these
obligations and related expenses, including expected rates of return on plan assets and discount
rates. For 2004, the expected long-term rate of return on plan assets used to estimate pension expenses
was 7.4% on a weighted average basis, which was the rate determined at September 30, 2003. The
expected long-term rate of return on plan assets decreased from 7.8% in 2003. The discount rates
used to estimate the net pension obligations and expenses for 2004 were 5.7% and 5.8%,
respectively, on a weighted average basis, compared to 5.8% and 6.3%, respectively, in 2003. The key assumptions used to estimate the post-retirement costs for 2004 were an expected long-term
rate of return on plan assets of 6.0% and a discount rate of 5.9% and 6.0% for the obligations and
costs, respectively, both on a weighted average basis. The expected long-term rate of return on
plan assets decreased from 8.0% in 2003. The discount rates for the obligations and costs
decreased in 2004 to 5.9% and 6.0%, respectively, from 6.0% and 6.8%, respectively, in 2003 due to
the decline experienced in global interest rates during 2002 through 2004. The difference between the expected long-term rate of return on plan assets and the discount rate
reported for the net pension obligations and expenses and those rates reported for the net
post-retirement benefit obligations and costs is due to the weighted-average calculation as a
result of the number of countries in which we offer either pension or pension and post-retirement
benefits. In developing these assumptions, we evaluated, among other things, input from our
actuaries, expected long-term market returns and current high-quality bond rates. Changes in net periodic pension and post retirement benefit expense may occur in the future due to
changes in our expected rate of return on plan assets and discount rate resulting from economic
events. The following table highlights the sensitivity of our pension and post retirement benefit
expense to changes in these assumptions, assuming all other assumptions remain constant: Effect on 2004Effect on 2004
    
    
    pre-taxpre-tax pension
    
    
    post-retirementChange in Assumption
    
    expense*
    
    
    benefit expenseIncrease/(decrease)
    
    Increase/(decrease)1 percentage point increase in the expected return on assets
    
    
    $(56
    )
    
    
    $     <11 percentage point decrease in the expected return on assets
    
    
    56
    
    
    
    <11 percentage point increase in the discount rate
    
    
    (74
    )
    
    
    <11 percentage point decrease in the discount rate
    
    
    77
    
    
    
    4
 *
    
    excludes settlement costs (lump sum and termination payments to participants which discharges our
obligations)
 Plan assets were primarily comprised of debt and equity securities. Included in the equity
securities of the defined benefit plan were common shares of Nortel Networks Corporation with an
aggregate market value of $11 (0.2% of total plan assets) as of December 31, 2004 and $13 (0.2% of
total plan assets) as of December 31, 2003. 97




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Unrecognized actuarial gains and losses are being recognized over approximately a 12 year period,
which represents the weighted-average expected remaining service life of the employee group.
Unrecognized actuarial gains and losses arise from several factors including experience and
assumption changes in the obligations and from the difference between expected returns and actual
returns on assets. At the end of 2004, we had unrecognized net actuarial losses related to the
defined benefit plans of $1,977 which could result in an increase to pension expenses in future
years depending on several factors, including whether such losses exceed the corridor in accordance
with SFAS No. 87, Employers Accounting for Pensions. The post-retirement benefit plans had
unrecognized actuarial losses of $50 at the end of 2004. The estimated accumulated benefit obligations for the defined benefit plans exceeded the fair value
of the plan assets at September 30, 2004 as a result of reductions in discount rates and changes in
foreign exchange rates which more than offset the favorable impacts of strong pension asset returns
and the voluntary contributions made by us during 2004. Accordingly, we recorded a non-cash charge
of $121 (before tax) to other comprehensive income for the minimum pension liability. A similar
charge may be required in the future as the impact of changes in global capital markets and
interest rates on the value of our pension plan assets and obligations are measured. During 2004, we made cash contributions to our defined benefit pension plans of $202, which
excludes $78 of deferred contributions for 2004 that were made in 2003, and $31 to our
post-retirement benefit plans. In 2005, we expect to make cash contributions of approximately $92
to our defined benefit pension plans, and approximately $29 to our post-retirement benefit plans. On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or
the MPDIM Act, was signed into law in the U.S. The MPDIM Act introduced a prescription drug benefit
under Medicare (specifically, Medicare Part D) as well as a federal subsidy to sponsors of retiree
health care benefit plans that provide a benefit that is at least actuarially equivalent to
Medicare Part D. As permitted by FSP Financial Accounting Standard, or FAS 106-1, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization
Act of 2003, we chose to make the one-time deferral election which remained in effect for our
plans in the U.S. until the earlier of the issuance of specific authoritative guidance by the FASB
on how to account for the federal subsidy to be provided to plan sponsors under the MPDIM Act or
the remeasurement of plan assets and obligations subsequent to January 31, 2004. On May 19, 2004,
FSP FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003, or FSP FAS 106-2, was issued by the FASB to provide
guidance relating to the prescription drug subsidy provided by the MPDIM Act. We expect that all
portions of our post-retirement benefit plans qualify as actuarially equivalent to the benefit
provided under the MPDIM Act, for which we expect to receive federal subsidies. We adopted FSP FAS
106-2 in the second quarter of 2004. The financial impact of the federal subsidies was determined
by remeasuring Nortel retiree life and medical obligations as of December 31, 2003, as provided
under the retroactive application provision of FSP FAS 106-2. As a result of adoption, the
accumulated post-retirement benefit obligation decreased by $31, and net periodic post-retirement
benefit costs decreased by $2 for the year ended December 31, 2004. For 2005, our expected rate of return on plan assets will remain at 7.4% for defined benefit
pension plans and will remain at 6.0% for 2005 for post-retirement benefit plans. Also for 2005,
we are lowering our discount rate on a weighted-average basis for pension expenses from 5.8% to
5.7% for the defined benefit pension plans and from 6.0% to 5.9% for post-retirement benefit plans
given the declining trend in current global interest rates. We will continue to evaluate our
expected long-term rates of return on plan assets and discount rates at least annually and make
adjustments as necessary, which could change the pension and post-retirement obligations and
expenses in the future. If the actual operation of the plans differs from the assumptions,
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. For additional information, see Employee benefit plans in note 8 of the accompanying consolidated
financial statements. 98




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Special charges In 2001, we entered into an unprecedented period of business realignment in response to a
significant adjustment in the industry. 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 plant and equipment, 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 December 31, 2003 and over the same time
period, we significantly reduced our facilities. Into 2005, our focus is on managing each of our businesses based on financial performance, the
market and customer priorities. In the third quarter of 2004, we announced a 2004 Restructuring
Plan that includes a work plan involving focused workforce reductions, including a voluntary
retirement program, of approximately 3,250 employees, real estate optimization and other cost
containment actions such as reductions in information services costs, outsourced services and other
discretionary spending across all segments but primarily in Wireline Networks and Optical Networks. We record provisions for workforce reduction costs and exit costs when they are probable and
estimable. Severance paid under ongoing benefit arrangements is recorded in accordance with SFAS
No. 112 Employers Accounting for Post-employment Benefits. One-time termination benefits and
contract settlement and lease costs are recorded in accordance with SFAS No. 146 Accounting for
Costs Associated with Exit or Disposal Activities. At each reporting date, we evaluate our accruals related to workforce reduction charges, contract
settlement and lease costs and plant and equipment write downs to ensure that these accruals are
still appropriate. As of December 31, 2004, we had $137 in accruals related to workforce reduction
charges and $326 in accruals related to contract settlement and lease costs, which included
significant estimates, primarily related to sublease income over the lease terms and other costs
for vacated properties. In certain instances, we may determine that these accruals are no longer
required because of efficiencies in carrying out our restructuring work plan. Adjustments to
workforce reduction accruals may also be required when employees previously identified for
separation do not receive severance payments because they are no longer employed by Nortel or were
redeployed due to circumstances not foreseen when the original plan was initiated. In these
cases, we reverse any related accrual to earnings when it is determined it is no longer required.
Alternatively, in certain circumstances, we may determine that certain accruals are insufficient as
new events occur or as additional information is obtained. In these cases, we would increase the
applicable existing accrual with the offset recorded against earnings. Increase or decreases to
the accruals for changes in estimates are classified within special charges in the statement of
operations. Other contingencies We are subject to the possibility of various loss contingencies arising in the ordinary course
of business. As a result, we consider the likelihood of loss or impairment of an asset or the
incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in
determining loss contingencies. We recognize a reserve for an estimated loss contingency when it
is probable that an asset has been impaired or a liability has been incurred and the amount of loss
can be reasonably estimated. We regularly evaluate current information available to us to
determine whether such accruals should be adjusted. We are also subject to proceedings, lawsuits, investigations and other claims (some of which may
involve substantial dollar amounts), including proceedings under laws and government regulations
related to securities, income and other taxes, environmental, labor, product and other matters. In
particular, our two restatements of our consolidated financial statements and related events have
caused us to be subject to ongoing regulatory and criminal investigations and significant pending
civil litigation actions in the U.S. and Canada. We are required to assess the likelihood of any
adverse judgments or outcomes in any of these matters, as well as potential ranges of probable
losses. A determination of the amount of reserves required, if any, for these contingencies is
based on an analysis of each individual issue. The required reserves may change in the future due
to new developments in each matter or changes in approach such as a change in settlement strategy
in dealing with these matters. We cannot determine whether these matters will, individually or
collectively, have a material adverse effect on our business, results of operations and financial
condition. See Risk factors/forward looking statements. For more information related to our outstanding legal and other proceedings, see Contingencies in
note 20 of the accompanying consolidated financial statements. 99




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Accounting changes and recent accounting pronouncements Accounting changes Our consolidated financial statements are based on the selection and application of accounting
policies, generally accepted in the U.S. For more information related to the accounting policies
that we adopted as a result of new accounting standards, see Accounting changes in note 3 of the
accompanying consolidated financial statements. The following summarizes the accounting changes
that we have adopted:  
    
    Guarantees   the adoption of FASB Interpretation FIN No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others  an Interpretation of FASB Statement Nos. 5, 57 and 107 and
Rescission of FIN No. 34 did not have a material impact on our results of operations
and financial condition. We adopted the disclosure requirements of FIN 45 effective
December 31, 2002 and the initial recognition and measurement provisions effective
January 1, 2003.
    
    Asset retirement obligations  the adoption of SFAS No. 143, Accounting for Asset
Retirement Obligations, or SFAS No. 143, resulted in a decrease to net earnings of $12
(net of tax of nil) which has been reported as a cumulative effect of accounting
changes  net of tax, an increase in plant and equipment  net of $4 and an asset
retirement obligation liability of $16 as of January 1, 2003. The adoption of SFAS No.
143 did not have a material impact on depreciation and accretion expense.
    
    Accounting for costs associated with exit or disposal activities  the adoption of
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities
effective January 1, 2003 did not have a material impact on our results of operations
and financial condition.
    
    Consolidation of VIEs  the adoption of new accounting guidance for VIEs resulted in
the inclusion of $100 in long-term debt and $104 of plant and equipment  net as of
December 31, 2004. These amounts represented both the collateral and maximum exposure
to loss as a result of our involvement with VIEs.
    
    Accounting for certain financial instruments with characteristics of both
liabilities and equity  the adoption of SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity in 2003 did
not have a material impact on our results of operations and financial condition.
    
    Accounting for revenue arrangements with multiple deliverables  the adoption of
EITF 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software
Deliverables in an Arrangement Containing More-Than-Incidental Software in 2003 did
not have a material impact on our results of operations and financial condition. Recent accounting pronouncements In March 2004, the Emerging Issues Task Force, or EITF, reached consensus on Issue No. 03-1,
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, or
EITF 03-1. EITF 03-1 provides guidance on determining when an investment is considered impaired,
whether that impairment is other than temporary and the measurement of an impairment loss. EITF
03-1 is applicable to marketable debt and equity securities within the scope of SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities, or SFAS 115, and SFAS No. 124,
Accounting for Certain Investments Held by Not-for-Profit Organizations, and equity securities
that are not subject to the scope of SFAS 115 and not accounted for under the equity method of
accounting. In September 2004, the FASB issued FSP EITF 03-1-1, Effective Date of Paragraphs
10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments, which delays the effective date for the measurement and recognition
criteria contained in EITF 03-1 until final application guidance is issued. The delay does not
suspend the requirement to recognize other-than-temporary impairments as required by existing
authoritative literature. The adoption of EITF 03-1 is not expected to have a material impact on
our results of operations and financial condition. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, or SFAS 151. SFAS 151 requires
that abnormal amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage) be recognized as current-period charges rather than capitalized as a component of
inventory costs. In addition, SFAS 151 requires that allocation of fixed production overheads to
inventory be based on the normal capacity of the production facilities. This statement is effective
for inventory costs incurred in fiscal periods beginning after June 15, 2005. The guidance should
be applied prospectively. We are currently assessing the impact of SFAS 151 on our results of
operations and financial condition. In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment, or SFAS 123R,
which requires all share-based payments to employees, including grants of employee stock options,
to be recognized as compensation expense in the consolidated financial statements based on their
fair values. SFAS 123R also modifies certain measurement and expense recognition provisions of SFAS No. 123, 100




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Accounting for Stock-Based Compensation, or
SFAS 123, that will impact us, including the requirement to estimate employee forfeitures each
period when recognizing compensation expense, and requiring that the initial and subsequent
measurement of the cost of liability-based service awards each period be based on the fair value
(instead of the intrinsic value) of the award. This statement is effective for us as of January 1,
2006. We had previously elected to expense employee stock-based compensation using the fair value
method prospectively for all awards granted or modified on or after January 1, 2003 in accordance
with SFAS 148. We are currently assessing the impact of SFAS 123R on its results of operations and
financial condition. In March 2005, the FASB issued FSP No. 46(R)-5, Implicit Variable Interests under FASB
Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, or FSP
FIN 46R-5. FSP FIN 46R-5 provides guidance for a reporting enterprise on whether it holds an
implicit variable interest in VIEs or potential VIEs when specific conditions exist. This FSP is
effective in the first period beginning after March 3, 2005 in accordance with the transition
provisions of FIN 46R. We are currently assessing the impact of the adoption of FSP FIN 46R-5 on
our results of operations and financial condition and do not expect it to have a material impact. Canadian supplement New Canadian securities regulations and, as of March 8, 2005, amendments to the regulations
under the Canada Business Corporations Act, allow issuers that are required to file reports with
the SEC, upon meeting certain conditions, to satisfy their Canadian continuous disclosure
obligations by using financial statements prepared in accordance with U.S. GAAP. We have provided
the following supplemental information to highlight the significant differences that would have
resulted in the MD&A had it been prepared using Canadian GAAP information. The principal continuing reconciling differences that affect consolidated net earnings (loss) under
Canadian GAAP are derivative accounting and goodwill impairment arising from historical differences
in carrying value. We adopted new Canadian accounting standards for asset retirement obligations
and for derivatives in 2004 and for VIEs in 2003 that are substantially consistent with U.S. GAAP.
Also in 2003, we elected to expense employee stock-based compensation using the fair value based
method for U.S. GAAP, which has resulted in no significant continuing reconciling difference for
stock-based compensation under Canadian GAAP. Other historical differences between U.S. GAAP and
Canadian GAAP were primarily due to facts and circumstances related to prior years that are not
expected to affect future earnings (loss) under Canadian GAAP, including business combinations. See note 22 of the accompanying consolidated financial statements for a reconciliation from U.S
GAAP to Canadian GAAP, including a description of the material differences affecting our
consolidated statements of operations and consolidated balance sheets. There were no significant
differences affecting the consolidated statements of cash flows. Accounting changes Under Canadian GAAP, we adopted the following accounting changes as more fully described in
note 22 (h) of the accompanying consolidated financial statements:  
    
    Derivative accounting  Effective January 1, 2004, we adopted Accounting Guideline 13,
Hedging Relationships, or AcG-13, which establishes specific criteria for derivatives to
qualify for hedge accounting. We had been previously applying these criteria under U.S.
GAAP, therefore, there was no impact on adoption of AcG-13. Concurrent with the adoption
of AcG-13, we also adopted the CICAs Emerging Issues Committee, or EIC, 128, Accounting
for Trading, Speculative or Non-Hedging Derivative Financial Instruments, or EIC 128. As
a result of the adoption of EIC 128, certain warrants, which had been previously recorded
at cost under Canadian GAAP, are required to be recorded at fair value consistent with U.S.
GAAP. The impact of this accounting change, which has been recorded prospectively as at
January 1, 2004, was an increase to investments and other income of $23 during the year
ended December 31, 2004.
    
    Revenue recognition  In December 2003, the EIC issued abstract 142, Accounting for
Revenue Arrangements with Multiple Deliverables, or EIC 142. EIC 142 was applicable to us
beginning January 1, 2004 and was applied prospectively. The application of EIC 142 did
not have a material impact on our results of operations and financial condition. In
December 2003, the EIC issued abstract 141, Revenue Recognition, or EIC 141. EIC 141 was
applicable to us beginning January 1, 2004 and was applied prospectively. The application
of EIC 141 did not have a material impact on our results of operations and financial
condition. 101




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
    
    Asset retirement obligations  Under U.S. GAAP, we adopted SFAS 143 effective January 1,
2003, and recorded a cumulative effect of accounting change, net of tax, within net
earnings (loss) on the date of adoption. We adopted similar Canadian guidance, CICA Handbook Section 3110, Asset Retirement Obligations,
effective January 1, 2004, with retroactive restatement of prior periods. Under Canadian
GAAP, the cumulative effect of adoption as of January 1, 2003 was recorded as an adjustment
to opening accumulated deficit, as opposed to an adjustment within net earnings (loss) under
U.S. GAAP, resulting in a difference of $12. The retroactive adjustment to earnings for the
year ended December 31, 2003 and 2002 under Canadian GAAP was not significant.
Plant and equipment  net, other liabilities and accumulated deficit as of December 31,
2003 have been increased by $4, $16 and $12, respectively, to reflect the retroactive
restatement.
    
    Stock-based compensation  In November 2001, the CICA issued Handbook Section 3870,
Stock-based Compensation and Other Stock-based Payments, or Section 3870, which was
revised in November 2003. Section 3870 outlines a fair value based method of accounting
required for certain stock-based transactions, effective January 1, 2002, and applied to
awards granted on or after that date. Prior to October 1, 2003, as permitted by Section
3870, we did not adopt the provisions in respect of the fair value based method of
accounting for our employee stock-based transactions. On October 1, 2003, we elected to
expense employee stock-based compensation using the fair value based method prospectively
for all awards granted, modified, or settled on or after January 1, 2003, in accordance
with the transitional provisions of Section 3870 and concurrent with the adoption of
expense recognition under the fair value based method for U.S. GAAP.
    
    Restructuring charges- Under U.S. GAAP, effective January 1, 2003, we adopted SFAS 146.
SFAS 146 requires that costs associated with an exit or disposal activity be recognized
when the liability is incurred. Under Canadian GAAP, EIC 134, Accounting for Severance
and Termination Benefits, or EIC 134, and EIC 135, Accounting for Costs Associated with
Exit and Disposal Activities (Including Costs Incurred in a Restructuring), or EIC 135,
were issued to harmonize the Canadian GAAP requirement with SFAS 146. Effective April 1,
2003, we adopted EIC 134 and EIC 135.
    
    Impairment and disposal of long-lived assets  In May 2003, the CICA issued an updated
Section 3475 Disposal of Long-Lived Assets and Discontinued operations, or Section 3475.
In April 2003, the CICA issued Handbook Section 3063, Impairment of Long-Lived Assets, or
Section 3063. The adoption of Sections 3475 and 3063, which are substantially consistent
with U.S. GAAP, did not have a material impact on our results of operations and financial
condition.
    
    Guarantees  In February 2003, the CICA issued AcG-14, Disclosure of Guarantees, or
AcG-14. AcG-14 expands on previously issued accounting guidance and requires additional
disclosure by a guarantor of information about each guarantee, or each group of similar
guarantees, even when the likelihood of the guarantor having to make any payments under the
guarantee is slight. AcG-14 does not address the recognition or measurement of a
guarantors liability for obligations under a guarantee. We adopted the requirements of
AcG-14 effective January 1, 2003 which are substantially consistent with the disclosure
requirements under U.S. GAAP for guarantees.
    
    Consolidation of VIEs  In June 2003, the CICA issued AcG-15, which is consistent with
FASB Interpretation No. 46, Consolidation of Variable Interest Entities. AcG-15
clarifies the application of consolidation guidance to those entities defined as VIEs
(which includes, but is not limited to, special purpose entities, trusts, partnerships,
certain joint ventures and other legal structures) 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. The requirements of AcG-15 were effective for all annual and interim periods
beginning on or after November 1, 2004. Earlier application was encouraged and effective
July 1, 2003, we adopted AcG-15 at the same time as equivalent guidance under U.S. GAAP and
prospectively began consolidating two VIEs for which we were considered the primary
beneficiary. Outstanding share data As of March 31, 2005, we had 1,460,978,638 outstanding common shares. 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 counterparty risks. These systems rely on analytical techniques including both
sensitivity analysis and value-at-risk estimations. We do not hold or issue financial instruments
for trading purposes. 102




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Additional disclosure of our financial instruments is included in Financial instruments and
hedging activities in note 11 of the accompanying consolidated financial statements. We manage foreign exchange exposures using forward and option contracts to hedge sale and purchase
commitments. Our most significant foreign exchange exposures are in the Canadian dollar, the
British pound and the euro. We enter into U.S. to Canadian dollar forward and option contracts
intended to hedge the U.S. to Canadian dollar exposure on future revenues and expenditure streams.
In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, we
recognize the gains and losses on the effective portion of these contracts in earnings when the
hedged transaction occurs. Any ineffective portion of these contracts is recognized in earnings
immediately. We expect to continue to expand our business globally and, as such, expect that an increasing
proportion of our business may be denominated in currencies other than U.S. 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 major currency exposures.
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 material foreign currency exposures. Our significant currency flows for the year ended
December 31, 2004 were in U.S. dollars, Canadian dollars, British pounds and euros. The net impact
of foreign exchange fluctuations resulted in a currency exchange gains of $98 in 2004, a gain of
$83 in 2003 and a loss of $84 in 2002. We cannot predict whether we will incur foreign exchange
gains or 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. We use sensitivity analysis to measure our foreign currency risk by computing the potential
decrease in cash flows that may result from adverse changes in foreign exchange rates. The balances
are segregated by source currency, and a hypothetical unfavorable variance in foreign exchange
rates of 10% is applied to each net source currency position using year-end rates, to determine the
potential decrease in cash flows over the next year. The sensitivity analysis includes all foreign
currency  denominated cash, short-term and long-term debt, and derivative instruments that will
impact cash flows over the next year that are held at December 31, 2004 and 2003, respectively. The
underlying cash flows that relate to the hedged firm commitments are not included in the analysis.
The analysis is performed at the reporting date and assumes no future changes in the balances or
timing of cash flows from the year-end position. Further, the model assumes no correlation in the
movement of foreign exchange rates. Based on a one-year time horizon, a 10% adverse change in
exchange rates would result in a potential decrease in after-tax cash flows of $184 as of December
31, 2004 and would have resulted in a potential decrease in after-tax cash flows of $195 as of
December 31, 2003. This potential decrease would result primarily from our exposure to the
Canadian dollar, the British pound and the euro. A portion of our long-term debt is subject to changes in fair value resulting from changes in
market interest rates. We have hedged a portion of this exposure to interest rate volatility using
fixed for floating interest rate swaps. The change in fair value of the swaps are recognized in
earnings with offsetting amounts related to the change in the fair value of the hedged debt
attributable to interest rate changes. Any ineffective portion of the swaps is recognized in
income immediately. We record net settlements on these swap instruments as adjustments to interest
expense. Historically, we have managed interest rate exposures, as they relate to interest expense, using a
diversified portfolio of fixed and floating rate instruments denominated in several major
currencies. We use sensitivity analysis to measure our interest rate risk. The sensitivity
analysis includes cash, our outstanding floating rate long-term debt and any outstanding
instruments that convert fixed rate long-term debt to floating rate. A 100 basis point adverse
change in interest rates would result in a potential decrease in cash flows of $47 as of December
31, 2004 and would have resulted in a potential decrease in cash flows of $51 as of December 31,
2003. Equity price risk The values of our equity investments in several publicly traded companies are subject to
market price volatility. These investments are generally in companies in the technology industry
sector and are classified as available for sale. We typically do not attempt to reduce or
eliminate the market exposure on these investment securities. We also hold certain derivative
instruments or warrants that are subject to market price volatility because their value is based on
the common share price of a publicly traded company. These derivative instruments are generally
acquired through business acquisitions or divestitures. In addition, derivative instruments may
also be purchased to hedge exposure to certain compensation obligations that vary based on future
Nortel Networks Corporation common share prices. We do not hold equity securities or derivative
instruments for trading purposes. As of December 31, 2004, a hypothetical 20% adverse change in
the stock prices of our publicly traded equity securities and the related underlying stock prices
of publicly traded equity securities for certain of our derivative instruments would result in a
loss in their aggregate fair value of $23. This includes a loss of $5 related to
derivative instruments that were purchased to hedge exposure to compensation obligations. As of
December 31, 2003, a hypothetical 20% adverse change in the stock prices of our publicly traded
equity securities and the related underlying stock prices of publicly traded equity securities for
certain of our derivative instruments would result in a loss in their aggregate fair value of $52.
This includes a loss of $12 related to derivative instruments that were purchased to hedge
exposure to compensation obligations. 103




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Environmental matters We are subject to numerous environmental protection laws and regulations in various
jurisdictions around the world, primarily due to our manufacturing operations. As a result, we are
exposed to liabilities and compliance costs arising from our past and current generation,
management and disposition of hazardous substances and wastes. We have remedial activities under way at twelve of our facilities which are either currently
occupied or were previously owned or occupied. We have also been listed as a potentially
responsible party at six Superfund sites in the U.S. An estimate of our anticipated remediation
costs associated with all such facilities and sites, to the extent probable and reasonably
estimable, is included in our environmental accruals in an approximate amount of $31. For a discussion of Environmental matters, see Contingencies in note 20 of the accompanying
consolidated financial statements. Legal proceedings Nortel and/or certain of our 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 are also a defendant 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, financial condition and liquidity.
We, and any of our named directors or officers, intend to vigorously defend these actions, suits,
claims, proceedings and investigations. We are also subject to significant pending civil
litigation and ongoing regulatory and criminal investigations in the U.S. and Canada which could
require us to pay substantial judgments, settlements, fines or other penalties. For additional
information related to our legal proceedings, see Contingencies in note 20 of the accompanying
consolidated financial statements, the Legal Proceedings section of this report and Risk
factors/forward looking statements. Risk factors/forward looking statements You should carefully consider the risks described below before investing in our securities.
The risks described below are not the only ones facing us. Additional risks not currently known to
us or that we currently believe are immaterial may also impair our business, results of operations,
financial condition and liquidity. 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. Certain statements in this Annual Report onForm 10-Kcontain words such as could, expects,
may, anticipates, believes, intends, estimates, plans, envisions, seeks 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. In particular, the risks described below could cause actual
events to differ materially from those contemplated in forward looking statements. 104




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Risks relating to our restatements and related matters Our two restatements of our consolidated financial statements and related events have had, and
will continue to have, a material adverse effect on us. In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to the Comprehensive Review, which resulted in the First Restatement.
In late October 2003, the Audit Committee initiated the Independent Review and engaged WCPHD to
advise it in connection with the Independent Review. The Audit Committee sought to gain a full
understanding of the events that caused significant excess liabilities to be maintained on the
balance sheet that needed to be restated, and to recommend that our Board of Directors adopt, and
direct management to implement, necessary remedial measures to address personnel, controls,
compliance and discipline. As the Independent Review progressed, the Audit Committee directed new
corporate management to examine in depth the concerns identified by WCPHD regarding provisioning
activity and to review certain provision releases. That examination, and other errors identified by
management, led to the Second Restatement and our revision of previously announced unaudited
results for the year ended December 31, 2003. The need for the Second Restatement resulted in
delays in filing the Reports. Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue recognition and undertook a process of
revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit
Committee has determined to review the facts and circumstances leading to the restatement of these
revenues for specific transactions identified in the Second Restatement. The review has a
particular emphasis on the underlying conduct that led to the initial recognition of these
revenues. The Audit Committee is seeking a full understanding of the historic events that required
the revenues for these specific transactions to be restated and will consider any appropriate
additional remedial measures, including those involving internal controls and processes. The Audit
Committee has engaged WCPHD to advise it in connection with this review. For more information on the Comprehensive Review, Independent Review, First Restatement, Second
Restatement and Revenue Independent Review, see the MD&A and Controls and Procedures sections
of this report. As a result of these events, we have become subject to the following key risks, each of which is
described in more detail below. Each of these risks could have a material adverse effect on our
business, results of operations, financial condition and liquidity.  
    
    We are subject to ongoing regulatory and criminal investigations in the
U.S. and Canada, which could require us to pay substantial fines or other penalties.
    
    We are subject to significant pending civil litigation, which if decided
against us, could require us to pay substantial judgments, settlements or other
penalties.
    
    Material adverse legal judgments, fines, penalties or settlements could
have a material adverse effect on our business, results of operations, financial
condition and liquidity, which could be very significant.
    
    We cannot predict the outcome of the Revenue Independent Review being
undertaken by our Audit Committee.
    
    We and our independent auditors have identified a number of material
weaknesses related to our internal control over financial reporting and concluded that
our internal control over financial reporting is ineffective, which could continue to
impact our ability to report our results of operations and financial condition
accurately and in a timely manner.
    
    The governing principles of the Independent Review particularly as they
relate to remedial measures may take time to implement.
    
    The delayed filing of our Reports and related matters caused us to breach
our public debt indentures and seek waivers from EDC under the EDC Support Facility,
which may affect our liquidity. As a result of the expected delay in filing the 2005
First Quarter Reports, we and NNC will not be in compliance with our obligations to
deliver the 2005 First Quarter Reports to the trustees under our and NNCs public debt
indentures if such reports are filed after May 25, 2005. In such event, it is possible
that the holders of our public debt will seek to accelerate the maturity of that debt.
In addition, it is possible that EDC will not grant us additional waivers.
    
    Our credit ratings have been downgraded, we are currently unable to access in its
current form, our shelf 105




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registration statement filed with the SEC and we terminated the Five Year Facilities,
each of which may affect our liquidity.
    
    The expected delay in filing of the 2005 First Quarter Reports could cause the TSX
and/or the NYSE to commence suspension or delisting procedures in respect of Nortel
Networks Corporations common shares or other of our or NNCs listed securities.
    
    Continuing negative publicity may adversely affect our business.
    
    We may not be able to attract or retain the personnel necessary to achieve our business objectives.
    
    Ongoing SEC review may require us to amend our public disclosures further. We are subject to ongoing regulatory and criminal investigations in the U.S. and Canada, which
could require us to pay substantial fines or other penalties. We are under investigation by the SEC and the OSC. On April 5, 2004, we announced that the SEC had
issued a formal order of investigation in connection with our previous restatement of financial
results for certain periods and our announcements in March 2004 regarding the likely need to revise
certain previously announced results and restate previously filed financial results for one or more
earlier periods. On April 13, 2004, we announced that we had received a letter from the staff of the OSC advising us
of an OSC Enforcement Staff investigation into the same matters that are the subject of the SEC
investigation. We have also received a U.S. federal grand jury subpoena for the production of certain documents
sought in connection with an ongoing criminal investigation being conducted by the U.S. Attorneys
Office for the Northern District of Texas, Dallas Division. Further, on August 16, 2004, we
received a letter from the Integrated Market Enforcement Team of the RCMP advising us that it would
be commencing a criminal investigation into our financial accounting situation. Our senior management and Board of Directors have been required to devote significant time to these
investigations and related matters. We cannot predict when these investigations will be completed,
nor can we predict what the results of these investigations may be. Expenses incurred in
connection with these investigations (which include substantial fees of lawyers and other
professional advisors and potential obligations to indemnify officers and directors who may be
parties to such actions) could adversely affect our cash position. We may be required to pay
material fines, consent to injunctions on future conduct or suffer other penalties, each of which
could have a material adverse effect on our business, results of operations, financial condition
and liquidity. The investigations may adversely affect our ability to obtain, and/or increase the
cost of obtaining, directors and officers liability insurance and/or other types of insurance,
which could have a material adverse affect on our business, results of operations and financial
condition. In addition, the findings and outcomes of the Independent Review, the Revenue
Independent Review and the regulatory and criminal investigations may affect the course of the
civil litigation pending against us, which are more fully described below. The effects and results of these or other investigations may have a material adverse effect on our
business, results of operations, financial condition and liquidity. We are subject to significant pending civil litigation, which if decided against us, could require
us to pay substantial judgments, settlements or other penalties. In addition to being subject to litigation in the ordinary course of business, we are currently,
and may in the future be, subject to class actions, other securities litigation and other actions
arising in relation to our accounting restatements. Subsequent to NNCs March 10, 2004
announcement of the likely need for the Second Restatement, numerous class action complaints,
including ERISA class action complaints and a derivative action complaint, have been filed against
Nortel and certain current and former officers and directors. We expect that this litigation will be time consuming, expensive and distracting from the conduct
of our daily business. The adverse resolution of any specific lawsuit could have a material adverse
effect on our ability to favorably resolve other lawsuits and on our financial condition and
liquidity. We are unable at this time to estimate what our ultimate liability in these matters may
be, and it is possible that we will be required to pay substantial judgments, settlements or other
penalties and incur expenses that could have a material adverse effect on our business, results of
operations, financial condition and liquidity, and such effects could be very significant.
Expenses incurred in connection with these matters (which include substantial fees of lawyers and
other professional advisors and potential obligations to indemnify officers and directors who 106




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may be parties to such actions) could adversely affect our cash position. Material adverse legal judgments, fines, penalties or settlements could have a material adverse
effect on our financial condition and liquidity, which could be very significant. We estimate that as of December 31, 2004 our available cash and our cash flow from operations will
be adequate to fund our operations and service our debt for at least the next twelve months. In
making this estimate, we have not assumed the need to make any payments in connection with our
pending civil litigation or investigations related to the First Restatement and Second Restatement,
other than our anticipated professional fees and expenses. We believe that we have sufficient cash
to repay our long term debt of $1,275 relating to our 6.125% notes due February 2006. However, we
continue to routinely monitor the capital markets for opportunities to improve our capital
structure and financial flexibility. We can provide no assurances that any capital markets
transactions will be completed on favorable terms, or at all. Any material adverse legal
judgments, fines, penalties or settlements arising from the pending civil litigation and
investigations could require additional funding which may not be available on commercially
reasonable terms, or at all. This could have a material adverse effect on our business, results of
operations, financial condition and liquidity, including by:  
    
    requiring us to dedicate a substantial portion of our cash and/or cash flow from
operations to payments of such judgments, fines, penalties or settlements, thereby reducing
the availability of our cash and/or cash flow to fund working capital, capital
expenditures, R&D efforts and other general corporate purposes, including debt reduction;
    
    making it more difficult for us to satisfy our payment obligations with respect to our outstanding indebtedness;
    
    increasing the difficulty and/or cost to us of refinancing our indebtedness;
    
    increasing our vulnerability to general adverse economic and industry conditions;
    
    limiting our flexibility in planning for, or reacting to, changes in our businesses and
the industries in which we operate;
    
    making it more difficult for us to make acquisitions and investments;
    
    limiting our ability to obtain, and/or increase the cost of obtaining, directors and
officers liability insurance and/or other types of insurance; and
    
    restricting our ability to introduce new technologies and products and/or exploit
business opportunities. We cannot predict the outcome of the Revenue Independent Review being undertaken by our Audit
Committee. As discussed in greater detail in the Controls and Procedures section of this report, our Audit
Committee initiated the Revenue Independent Review to achieve a full understanding of the historic
events that required revenues for certain specific transactions to be restated. The Revenue
Independent Review has a particular emphasis on the underlying conduct that led to the initial
recognition of these revenues. The review will also consider any appropriate additional remedial
measures, including those involving internal controls and processes. The Audit Committee has
engaged WCPHD to advise it in connection with this review. We cannot predict the outcome of the
Revenue Independent Review. We and our independent auditors have identified a number of material weaknesses related to our
internal control over financial reporting and concluded that our internal control over financial
reporting is ineffective, which could continue to impact our ability to report our results of
operations and financial condition accurately and in a timely manner. Two material weaknesses in our internal control over financial reporting were identified at the
time of the First Restatement. Over the course of Second Restatement, we and Deloitte identified a
number of additional material weaknesses in our internal control over financial reporting.
Deloitte confirmed to the Audit Committee these material weaknesses, listed below, on January 10,
2005:  
    
    lack of compliance with written Nortel procedures for monitoring and adjusting balances
related to certain accruals and provisions, including restructuring charges and contract
and customer accruals; 107




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
    
    lack of compliance with Nortel procedures for applying applicable GAAP to the initial
recording of certain liabilities, including those described in SFAS No. 5, and to foreign
currency translation as described in SFAS No. 52;
    
    lack of sufficient personnel with appropriate knowledge, experience and training in
U.S. GAAP and lack of sufficient analysis and documentation of the application of U.S.
GAAP to transactions, including, but not limited to, revenue transactions;
    
    lack of a clear organization and accountability structure within the accounting
function, including insufficient review and supervision, combined with financial reporting
systems that are not integrated and which require extensive manual interventions;
    
    lack of sufficient awareness of, and timely and appropriate remediation of, internal
control issues by Nortel personnel; and
    
    an inappropriate tone at the top, which contributed to the lack of a strong control
environment; as reported in the Independent Review Summary set forth in Item 9A of the
2003 Annual Reports, there was a Management tone at the top that conveyed the strong
leadership message that earnings targets could be met through application of accounting
practices that finance managers knew or ought to have known were not in compliance with
U.S. GAAP and that questioning these practices was not acceptable. Our management assessed the effectiveness of our internal control over financial reporting as of
December 31, 2004 pursuant to SOX 404 and the related SEC rules and concluded that our internal
control over financial reporting was not effective as of December 31, 2004. Specifically, they
concluded that the first five of these six material weaknesses continue to exist and existed as of
December 31, 2004. Deloitte has also assessed the effectiveness of our internal control over
financial reporting as of December 31, 2004 and has also concluded that our internal control over
financial reporting was not effective as of December 31, 2004. We continue to identify, develop
and implement remedial measures to address these material weaknesses. These material weaknesses,
if not fully addressed, could result in accounting errors such as those underlying the restatements
of our consolidated financial statements more fully discussed in Developments in 2004 and 2005 -
Nortel Audit Committee Independent Review; restatements; related matters in the MD&A and Controls
and Procedures section of this report. While our Board of Directors has approved the adoption of
all of the recommendations for remedial measures contained in the Summary of Findings and of
Recommended Remedial Measures of the Independent Review in the Controls and Procedures section
of our 2003 Annual Report on Form 10-K, and our management has adopted a number of measures to
strengthen our internal control over financial reporting and address the material weaknesses
identified above, we may be unable to address such material weaknesses in a timely manner, which
could adversely impact the accuracy and timeliness of future reports and filings we make with the
SEC and OSC. While we are implementing steps to ensure the effectiveness of our internal control over financial
reporting, failure to restore the effectiveness of our internal control over financial reporting
could continue to impact our ability to report our financial condition and results of operations
accurately and could have a material adverse effect on our business, results of operations,
financial condition and liquidity. The governing principles of the Independent Review for remedial measures may take time to
implement. As a result of the Independent Review, a number of significant remedial steps have been identified
as necessary to improve our process and procedures. These remedial steps may take time to
implement. In addition, the process of implementing the governing principles of the Independent
Review may be time consuming for our senior management and disrupt our business. The delayed filing of our Reports and related matters caused us to breach our public debt
indentures and seek waivers from EDC under the EDC Support Facility, which may affect our
liquidity. As a result of the expected delay in filing the 2005 First Quarter Reports, we and NNC
will not be in compliance with our obligations to deliver the 2005 First Quarter Reports to the
trustees under our and NNCs public debt indentures if such reports are filed after May 25, 2005.
In addition, the delay in filing the Reports and the expected delay in filing the 2005 First
Quarter Reports and related matters has resulted and we expect will result in a breach of our
obligations under the EDC Support Facility. It is possible that the holders of our public debt
will seek to accelerate the maturity of that debt and EDC will not grant us a further waiver. As a result of the delayed filing of the Reports, we and NNC breached our obligations to deliver
the Reports to the trustees under our and NNCs public debt indentures. With the filing of the
2004 Annual Reports with the SEC and the delivery of the 2004 Annual Reports to the trustees under
our and NNCs public debt indentures, we and NNC will be in compliance with our delivery
obligations under the public debt indentures. 108




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However, as a result of the expected delay in filing the 2005 First Quarter Reports, we and NNC may
not be in compliance with our obligations to deliver the 2005 First Quarter Reports to the trustees
under our and NNCs public debt indentures if such reports are filed after May 25, 2005. Any
non-compliance with the delivery obligations under the public debt indentures with respect to the
2005 First Quarter Reports will not result in an automatic event of default and acceleration of the
outstanding long-term debt and such default and acceleration could not occur unless notice of such
non-compliance from holders of 25% of the outstanding principal amount of any relevant series of
debt securities is provided to us or NNC, as applicable, and we or NNC, as applicable, failed to
deliver the 2005 First Quarter Reports within 90 days after such notice is provided, all in
accordance with the terms of the indentures. While such notice could have been given at any time
after March 30, 2004 as a result of the delayed filings of the Reports, neither we nor NNC has
received a notice to the date of this report. If notice were given with respect to the delayed
filing of the 2005 First Quarter Reports and acceleration of our and NNCs debt securities were to
occur, we may be unable to meet our payment obligations. If notice were given, we believe that it
is probable that we and NNC would file and deliver the 2005 First Quarter Reports within 90 days of
receipt of such a notice. As a result of the delayed filing of our Reports and the Related Breaches, we were also required to
seek waivers from EDC under the EDC Support Facility. On April 29, 2005, we obtained a new waiver
from EDC of certain defaults and related breaches by us under the EDC Support Facility. The new
waiver remains in effect until the earliest of certain events including the date on which we and
NNC have filed the 2004 Annual Reports and the 2005 First Quarter Reports, or May 31, 2005. If we
and NNC fail to file the 2005 First Quarter Reports by May 31, 2005, EDC will have the right
(absent a further waiver) to terminate the EDC Support Facility, exercise certain rights against
collateral or require us to cash collateralize all existing support. In addition, the Related
Breaches will continue beyond the filing of the 2004 Annual Reports and the 2005 First Quarter
Reports. Accordingly, beginning on the earlier of the date upon which we and NNC file the 2004
Annual Reports and the 2005 First Quarter Reports with the SEC and May 31, 2005, EDC will have the
right to terminate or suspend the EDC Support Facility notwithstanding the filing of the 2004
Annual Reports and the 2005 First Quarter Reports. While we intend to seek a permanent waiver from
EDC in connection with the Related Breaches, there can be no assurance that we will receive any
waiver or as to the terms of any such waiver. Any future delay in the filing of our periodic reports with the SEC would similarly result in a
breach of our public debt indentures and require us to seek additional waivers from EDC under the
EDC Support Facility, which could reduce our access to the EDC Support Facility and may adversely
affect our liquidity. EDC may not grant an additional waiver and the terms of such a waiver may be
unfavorable. Our credit ratings have been downgraded, we are currently unable to access our shelf registration
statement filed with the SEC and we terminated the Five Year Facilities, each of which may
adversely affect our liquidity. On April 28, 2004, S&P downgraded its ratings of us, including its long-term corporate credit
rating from B to B- and its preferred share rating from CCC to CCC-. At the same time, it
revised its outlook to developing from negative. Moodys current long-term debt rating for us is
B3 and its preferred share rating is Caa3. On April 28, 2004, Moodys changed its outlook to
potential downgrade from uncertain. These ratings are below investment grade. NNCs credit
ratings could be lowered or rating agencies could issue adverse commentaries in the future, which
could have a material adverse effect on our business, results of operations, financial condition
and liquidity. These ratings and our current credit condition affect, among other things, our
ability to raise debt, access the commercial paper market (which is currently closed to us), engage
in alternative financing arrangements, obtain bank financings and affect our ability, and the cost
to securitize receivables, obtain customer bid, performance-related and other bonds and contracts,
access the EDC Support Facility and/or enter into normal course derivative or hedging transactions
and also affect the price of our stock. As a result of a ratings downgrade in 2002, security agreements became effective under which
substantially all of our assets located in the U.S. and Canada and those of most of our U.S. and
Canadian subsidiaries, including the shares of certain of our U.S. and Canadian subsidiaries, were
pledged. In addition, certain of our wholly owned subsidiaries have guaranteed our obligations
under the EDC Support Facility and our and Nortels outstanding debt securities. These agreements
will continue to secure the EDC Support Facility and NNCs and our outstanding public debt until
the EDC Support Facility expires, alternative collateral is provided, or our public debt ratings
return to at least BBB ( with a stable outlook) by S&P and Baa2 (stable outlook) by Moodys. The
continued existence of these 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 under the EDC Support Facility if our senior long-term rating by Moodys
is downgraded to less than B3 or if its debt rating by S&P is downgraded to less than B-. In addition, in April 2004, we terminated the Five Year Facilities. Absent this termination, the
banks would have been permitted, upon 30 days notice, to terminate their commitments under the
Five Year Facilities as a result of our failure to file
our 2003 Annual Report on Form 10-K by April 29, 2004. Although the Five Year Facilities were
undrawn at termination, this termination may adversely affect our liquidity. 109




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Further, as a result of the delayed filing of the Reports and the expected delay in filing the 2005
First Quarter Reports, we are unable to use, in its current form, the remaining approximately $800
of capacity under our shelf registration statement filed with the SEC for various types of
securities. As a result, our ability to access the capital markets is constrained, which may
adversely affect our liquidity. The expected delay in filing of our 2005 First Quarter Reports could cause the Toronto Stock
Exchange and/or the New York Stock Exchange to commence suspension or delisting procedures in
respect of Nortel Networks Corporation common shares or other of our or NNCs listed securities. As a result of the delay in filing the Reports and the expected delay in filing the 2005 First
Quarter Reports, we were and expect to be, in breach of the continued listing requirements of the
NYSE and TSX. The expected delay in filing of our 2005 First Quarter Reports could cause the TSX
or NYSE to commence suspension or delisting procedures in respect of our or NNCs listed
securities. The commencement of any suspension or delisting procedures by either exchange remains,
at all times, at the discretion of such exchange and would be publicly announced by the exchange. If a suspension or delisting were to occur, there would be significantly less liquidity in the
suspended or delisted securities. In addition, our ability to raise additional necessary capital
through equity or debt financing, and attract and retain personnel by means of equity compensation,
would be greatly impaired. Furthermore, with respect to any suspended or delisted securities, we
would expect decreases in institutional and other investor demand, analyst coverage, market making
activity and information available concerning trading prices and volume, and fewer broker-dealers
would be willing to execute trades with respect to such securities. A suspension or delisting would
likely decrease the attractiveness of Nortel Networks Corporation common shares or other listed
securities of Nortel Networks Corporation and NNL to investors and cause the trading volume of
Nortel Networks Corporation common shares or other listed securities of Nortel Networks Corporation
and NNL to decline, which could result in a decline in the market price of such securities. Continuing negative publicity may adversely affect our business. As a result of the First Restatement and Second Restatement, we have been the subject of continuing
negative publicity. This negative publicity has contributed to significant declines in the prices
of our publicly traded securities. This negative publicity may have an effect on the terms under
which some customers and suppliers are willing to continue to do business with us and could affect
our financial performance or financial condition. We also believe that many of our employees are
operating under stressful conditions, which reduce morale and could lead to increased employee
turnover. Continuing negative publicity could have a material adverse effect on our business and
the market price of our publicly traded securities. As a result of the delay in the filing of the 2004 Annual Reports (containing our audited
consolidated financial statements for the year ended December 31, 2004), we were required to apply
to the Ontario Superior Court of Justice for an order permitting the postponement of our 2004
Annual Shareholders Meeting, or the Meeting. The Ontario Superior Court of Justice granted that
order, which permitted us to extend the time for calling the Meeting to a date not later than June
30, 2005. The order permits us to comply with a specific SEC rule which would require us, in our
circumstances, to provide to shareholders our 2004 audited financial statements either prior to or
concurrently with the mailing of proxy materials for the Meeting. This postponement has, among
other things, contributed to the continuing negative publicity related to us, which may adversely
affect our business and the market price of our publicly traded securities. We may not be able to attract or retain the personnel necessary to achieve our business objectives. Competition for certain key positions and specialized technical personnel in the high-technology
industry remains strong. Our future success depends in part on our continued ability to hire,
assimilate in a timely manner and retain qualified personnel, particularly in key senior management
positions and in our key areas of potential growth. An important factor in attracting and
retaining qualified employees is our ability to provide employees with the opportunity to
participate in the potential growth of our business through programs such as stock option plans,
restricted stock unit plans and employee investment and share purchase plans. The scope and value
of these programs will be adversely affected by the volatility or negative performance of the
market price for Nortel Networks Corporations common shares. In connection with the delay in filing our 2003 Annual Reports, as of March 10, 2004, NNC suspended
the purchase of Nortel Networks Corporation common shares under the stock purchase plans for
eligible employees in eligible countries that facilitate the acquisition of Nortel Networks
Corporation common shares; the exercise of outstanding options granted under
the 2000 Plan or the 1986 Plan, or the grant of any additional options under those plans, or the
exercise of outstanding options granted under employee stock option plans previously assumed by us
in connection with mergers and acquisitions; and the purchase of units in Nortels stock fund or
purchase of Nortel Networks Corporation common shares under our defined contribution and
investments plans until such time as, at the earliest, we are in compliance with U.S. and Canadian
regulatory securities filing requirements. On May 31, 2004, the OSC issued a final order
prohibiting all trading by our directors, officers and certain current and former employees in
Nortel Networks Corporations securities and those of us. This order will remain in effect until
two full business days following the receipt by the OSC of all filings required to be made by us
and NNC pursuant to Ontario securities law. Accordingly, our ability to provide employees with the
opportunity to participate in Nortel stock option plans, restricted stock unit plans and employee
investment and share purchase plans has been adversely affected and certain employees have not been
able to trade in NNCs securities. The current suspension of these programs and OSC trading order,
and any future suspension or OSC order, may have a material adverse effect on our ability to hire,
assimilate in a timely manner and retain qualified personnel. 110




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In addition, in 2004 we terminated for cause our former president and chief executive officer,
former chief financial officer, former controller and seven additional individuals with significant
responsibilities for financial reporting. We have also commenced litigation against our former
president and chief executive officer, former chief financial officer and former controller,
seeking the return of payments made to them under our bonus plan in 2003. In August and September
2004, as part of our new strategic plan, we announced an anticipated workforce reduction of
approximately 3,250 employees. Approximately 64% of employee actions related to the focused
workforce reduction were completed by the end of 2004, including approximately 55% that were
notified of termination or acceptance of voluntary retirement, with the remainder comprised of
voluntary attrition of employees that were not replaced. The remainder of employee actions are
expected to be completed by June 30, 2005. In addition, in 2001, 2002 and 2003, we implemented a
company-wide restructuring plan, which included a reduction of approximately two-thirds of our
workforce over the three-year period. We may find it more difficult to attract or retain qualified employees because of our recent
significant workforce reductions, business performance, management changes, restatement activities
and resulting negative publicity and the resulting impacts on our incentive programs and incentive
compensation plans. 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 workforce reductions. If we are not successful in attracting, recruiting
or retaining qualified employees, including members of senior management, we may not have the
personnel necessary to achieve our business objectives, including the implementation of our
remedial measures. Ongoing SEC review may require us to amend our public disclosures further. We have received comments on our periodic filings from the staff of the SECs Division of
Corporation Finance. As part of this comment process, we may receive further comments from the
staff of the SEC relating to this Annual Report on Form 10-K and our other periodic filings. As a
result, we may be required by the SEC to amend this Form 10-K or other reports filed with the SEC
in order to make adjustments or additional disclosures. Risks relating to our business We continue to restructure 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 continue to restructure our business to realign resources and achieve desired cost savings in an
increasingly competitive market. Our new strategic plan includes an anticipated further workforce
reduction of approximately 3,250 employees. We have based our restructuring efforts on certain
assumptions regarding the cost structure of our business. Our current assumptions may or may not
be correct and as a result, we may determine that further restructuring in the future will be
needed. Our restructuring efforts may not be sufficient for us to achieve improved results and
meet the changes in industry and market conditions, including increased competition. In
particular, we face increased competition from low cost competitors such as Huawei Technologies
Co., Ltd. and ZTE Corporation. We must manage the potentially higher growth areas of our business,
as well as the non-core areas, in order for us to achieve improved results. 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. 111




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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 improved results. As part of our review of restructured businesses, we 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 inventory, goodwill, net deferred taxes and other
intangible assets. We will continue to review our restructuring work plan based on our ongoing assessment of the
industry and the business environment. 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 execute our strategic plan, including the planned workforce
reductions, without negatively impacting our relationships with our customers, the
delivery of products based on new and developing technologies at competitive prices,
the effectiveness of our internal processes and organizations and the retention of
qualified personnel;
    
    our ability to focus on the day-to-day operation of our business while implementing
improvements in our internal controls and procedures, including our accounting systems,
and addressing the civil litigation actions and investigations related to our
restatements;
    
    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 successfully manage our manufacturing operations, which are
substantially outsourced to contract manufacturers;
    
    our ability to successfully comply with increased and complex regulations;
    
    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, including from
low cost competitors;
    
    our ability to compete with low cost competitors, including those offering
attractive customer financing arrangements;
    
    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;
    
    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;
    
    the overall trend toward industry consolidation and rationalization among our
customers, competitors and suppliers;
    
    our ability to make investments, including acquisitions, to strengthen our business;
    
    the ability of our customers and suppliers to obtain financing to fund capital expenditures;
    
    variations in sales channels, product costs and the mix of products sold;
    
    the size and timing of customer orders and shipments;
    
    our ability to obtain payment from customers on a timely basis;
    
    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; 112




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
    
    our ability to fund and sustain our research and development activities;
    
    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 as of
January 1, 2003 has caused 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 partially 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. 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. As a consequence, operating results for a particular future period are difficult to predict, and
therefore, prior results are not necessarily indicative of results to be expected in future
periods. Any of the foregoing factors, or any other factors described herein, could have a
material adverse effect on our business, results of operations and financial condition. Global economic conditions and other trends and factors affecting the telecommunications 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. These 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 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 converged networking solutions, which could lead to
reduced capital spending on multiple networks by our customers;
    
    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;
    
    increased price competition, particularly from low cost competitors;
    
    changes in legislation or accounting rules and governmental and environmental
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 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. Cautious capital spending in our industry has affected, and could affect, demand for, or pricing
pressures on, our products. 113




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Our gross margins may decline, which would reduce our operating results. Our gross margins may be negatively affected as a result of a number of factors, including:  
    
    increased price competition, particularly from low cost competitors;
    
    increased industry consolidation among our customers, which may lead to decreased
demand for, and downward pricing pressure on the prices of, our products;
    
    changes in product and geographic mix;
    
    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;
    
    excess capacity or excess fixed assets;
    
    accruals for employee incentive bonuses;
    
    further restructuring costs; and
    
    costs related to our restatements, including the possibility of substantial fines,
settlements and/or damages or other penalties, and/or remedial actions. Lower than expected gross margins would negatively affect our operating results. Cash flow fluctuations may affect our ability to fund our working capital requirements or achieve
our business objectives in a timely manner. Additional sources of funds may not be available or
may not be available on acceptable terms. 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, if the industry or our current condition deteriorates,
notwithstanding the EDC Support Facility, an increased portion of our cash and cash equivalents may
be restricted as cash collateral for customer performance bonds and contracts. As of December 31,
2004, 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. In making this
estimate, we have not made provision for any material payments in connection with our pending civil
litigation actions and investigations related to the First Restatement and Second Restatement,
other than our anticipated professional fees and expenses. We believe that we have sufficient cash
to repay our long term debt of $1,275 relating to our 6.125% notes due February 2006. However, we
continue to routinely monitor the capital markets for opportunities to improve our capital
structure and financial flexibility. We can provide no assurances that any capital markets
transactions will be completed on favorable terms, or at all. Any material adverse legal
judgments, fines, penalties or settlements arising from these pending civil litigation actions and
investigations could require additional funding which may not be available on commercially
reasonable terms, or at all. This could have a material adverse effect on our liquidity, which
could be very significant. In addition, 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 sources of external
financing (which may include a variety of debt, convertible debt and/or equity financings). We
cannot provide any assurance that our net cash requirements will be as we currently expect, that we
will continue to have access to the EDC Support Facility 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, expiry or termination of the EDC Support Facility 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. 114




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We may be materially and adversely affected by cautious capital spending by our customers.
Increased consolidation among our customers and the loss of customers in certain markets could have
a material adverse effect on our business, results of operations and financial condition. Our consolidated revenues in 2004 were slightly lower compared to 2003. Continued cautiousness in
capital spending by service providers and other customers may affect our revenues more than we
currently expect. Our revenues and operating results have been and may continue to be materially
and adversely affected by the continued cautiousness in capital spending by our customers. We have
focused on the larger customers in certain markets, which provide a substantial portion of our
revenues. Increased industry consolidation among our customers may lead to downward pressure on
the prices of our products, or reduced spending, a loss, reduction or delay in business from one or
more of these customers. Such increased industry consolidation among our customers, reduced
spending, a loss, 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 business may be materially and adversely affected by our high level of debt. In order to finance our business, we have incurred significant levels of debt compared to
historical levels, and we may need to obtain 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 covenants in
the EDC Support Facility and any significant reduction in, or access to, such facility, poor
business performance or lower than expected cash inflows could materially and adversely affect 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;
    
    a high debt level may affect our ability to refinance our existing debt, including
the $1,275 of long-term debt relating to our 6.125% Notes due February 2006;
    
    we may need to use a large portion of our cash flow from operations to pay principal
and interest on our indebtedness, which would reduce the amount of cash available to
finance our operations and other business activities;
    
    a high debt level, arduous or restrictive terms and conditions, or lower than
expected cash flows would make us more vulnerable to economic downturns and adverse
developments in our business; and
    
    if operating cash flows are not sufficient to meet our operating expenses, capital
expenditures and debt service requirements as they become due, we may be required, in
order to meet our debt service obligations, to delay or reduce capital expenditures or
the introduction of new products, sell assets and/or forego business opportunities
including acquisitions, research and development projects or product design
enhancements. An increased portion of our cash and cash equivalents may be restricted as cash collateral if we
are unable to secure alternative support for certain obligations arising out of our normal course
business activities. The EDC Support Facility may not provide all the support we require for certain of our obligations
arising out of our normal course of business activities. In particular, although this facility
provides for up to $750 in support, the $300 revolving small bond sub-facility will not become
committed support until the 2005 First Quarter Reports are filed with the SEC and we obtains a
permanent waiver of the Related Breaches. As of April 15, 2005, there was approximately $223 of outstanding support utilized under the EDC Support
Facility, approximately $155 of which was outstanding under the small bond sub-facility. In
addition, bid and performance related bonds with terms that extend beyond December 31, 2006, which,
absent any early termination of the EDC Support Facility, is the expiry date of this facility, are
currently not eligible for the support provided by the EDC Support Facility. Given that the EDC
Support Facility is used to support bid and performance bonds with varying terms, including those
with at least 365 days, we may need to increase our use of cash collateral to support these
obligations beginning on January 1, 2006 absent a further extension of the facility. Unless EDC
agrees to extend 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. Under the terms of the waiver
letter with EDC dated March 29, 2004, EDC may also suspend its obligation to issue us any
additional support if events occur that have a material adverse effect on our business, financial
position or results of operations. If we do not have access to sufficient support under the EDC
Support Facility, and if we are unable to secure alternative support, an increased portion of our
cash and cash equivalents may be restricted as cash collateral, which could adversely affect our
ability to fund some of our normal course business activities, capital expenditures, R&D and our
ability to borrow in the future. 115




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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 to pay interest and principal on outstanding public debt and
to pay corporate expenses. If our subsidiaries are unable to pay dividends or provide us with
loans or other forms of financing in sufficient amounts, it could adversely affect our ability to
meet our obligations. We may need to make larger contributions to our defined benefit plans in the future. We currently maintain various defined benefit plans in North America and the U.K. which cover
various categories of employees and retirees, which represent our major retirement plans. In
addition, we have smaller retirement plans in other countries. 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 experience differs from the assumptions, the amounts we are obligated to
contribute to the plans may increase. In particular, the performance of the financial markets is
difficult to predict, particularly in periods of high volatility in the equity markets. If the
financial markets perform lower than the assumptions, we may have to make larger contributions in
the future than we would otherwise have to make and expenses related to defined benefit plans could
increase. 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
interest rates are lower in the future than we assume they will be, then we would probably be
required to make larger contributions than we would otherwise have to make. In addition, the 2004 decision of the Supreme Court of Canada in Monsanto Canada Inc. v.
Superintendent of Financial Services has caused companies in Canada that sponsor defined benefit
plans, including us, to review certain of our past activities that may have triggered partial
wind-ups of such plans to determine whether a distribution of plan surplus, if any, should have
occurred at the time of any triggering event. Although the full impact of the decision remains
unclear and we have not yet made any determination regarding our plans, if it is determined that a
distribution of plan surplus should have occurred at the time of any triggering event, we may be
required to make a distribution out of our plan assets, which may lead to an increase in the amount
of future contributions that we are required to make. If market conditions deteriorate 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. If market conditions deteriorate 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 our 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 our 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, which will 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. We cannot be sure what the rate of this convergence of voice and data networks will be, due to the
dynamic and rapidly evolving nature of the communications business, the technology involved and the
availability of capital. Consequently, market discontinuities and the resulting demand for
IP-optimized networking solutions or 3G wireless networks may not continue. Alternatively, the pace of that development 116




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may be slower than currently anticipated.
On a regional basis, growth of our revenues from sales of our networking solutions in emerging
markets, such as China and India, may be less than we anticipate if current customer orders are not
indicative of future sales, strong growth in our UMTS technology does not occur, build-out of the
BSNL contract is slower than we expect, or those emerging markets experience slower growth or fewer
deployments of VoIP and wireless data networks than we anticipate. The market may also develop in
an unforeseen direction. Certain events, including the commercial availability and actual
implementation of new technologies, 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. Any such change in demand 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, and slower than anticipated revenue growth from
our network solutions such as WLAN and carrier routing. We also cannot be sure that the metro optical portion of our Optical Networks business will
continue to represent as large of a percentage of our overall Optical Networks revenues as we
expect, or that our current growth in carrier VoIP will continue, or that the continued decline in
sales of our traditional circuit switching solutions will not decline more rapidly than we
anticipate, any or all of which may materially and adversely affect our results of operations and
financial condition. We have made, and may continue to make, strategic acquisitions. 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 that we believed would enhance the expansion of our business and
products. We may make 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. Acquisitions involve significant risks and uncertainties, including:  
    
    the industry may develop in a different direction than anticipated and the
technologies we acquire may not prove to be those we need;
    
    the future valuations of acquired businesses may decrease from the market price we
paid for these acquisitions;
    
    the revenues of acquired businesses may not offset increased operating expenses
associated with these acquisitions;
    
    potential difficulties in completing in-process research and development projects
and delivering high quality products to our customers;
    
    potential difficulties in integrating new products, software, businesses and
operations in an efficient and effective manner;
    
    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;
    
    potential loss of key employees of the acquired businesses;
    
    diversion of the attention of our senior management from the operation of our daily business;
    
    entering new markets in which we have limited experience and where competitors may
have a stronger market presence;
    
    the potential adverse effect on our cash position as a result of all or a portion of
an acquisition purchase price being paid in cash; 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. Acquisitions are inherently risky, and no assurance can be given that our previous or future
acquisitions will be successful and will not materially adversely affect our business, operating
results, or financial condition. Failure to manage and successfully integrate acquisitions could
materially harm our business and operating results. 117




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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. Our success depends,
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
integrate, simplify and reduce the number of software programs used in our portfolio of products,
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 this development may result in our expenses growing at a faster rate than our
revenues, particularly since the initial investment to bring a product to market may be high. We
may not be successful in targeting new market opportunities, in developing and commercializing new
products in a timely manner or in achieving market acceptance for our new products. The success of new or enhanced products, including IP-optimized networking solutions and 3G
wireless networks, depends on a number of other factors, including the timely introduction of those
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 those
products and the availability of funding for those 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 those 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 separately or together with consolidation in the industry have a material adverse
effect on our gross margins. Since some of the markets in which we compete are characterized by the potential for rapid growth
and, in certain cases, low barriers to entry and rapid technological changes, smaller, specialized
companies and start-up ventures are now, or may in the future become, principal competitors. 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, we face the risk that certain of our
competitors may enter into additional business combinations, accelerate product development, or
engage in aggressive price reductions or other competitive practices, which make them 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. In particular, we
currently, and may in the future, face increased competition from low cost competitors such as
Huawei Technologies Co., Ltd. and ZTE Corporation. 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 could potentially lead to a loss of market share. 118




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We face certain barriers in our efforts to expand internationally. We intend to continue to pursue international and emerging market growth opportunities. In many
international markets, long-standing relationships between potential customers and their local
suppliers and protective regulations, including local content requirements and type approvals,
create barriers to entry. In addition, pursuing international opportunities may require
significant investments for an extended period before returns on such investments, if any, are
realized and such investments may result in expenses growing at a faster rate than revenues.
Furthermore, those 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. 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. Fluctuations in foreign currency exchange rates could negatively impact our business, results of
operations and financial condition. As an increasing proportion of our business may be denominated in currencies other than U.S.
dollars, fluctuations in foreign currency exchange rates may have an adverse impact on our
business, results of operations and financial condition. Our primary currency exposures are to
Canadian dollars, British 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 emerging
market currencies, such as, for example, the Indian rupee. These currencies may be affected by
internal factors and external developments in other countries. Also, our ability 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 rate fluctuations may have a material adverse effect on
our business, results of operations and financial condition. If we fail to protect our intellectual property rights, or if we are subject to adverse judgments
or settlements arising out of disputes regarding intellectual property rights, our business,
results of operations and financial condition could be materially and adversely affected. Our 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. Our business is
global and the level of protection of our proprietary technology provided by those laws varies by
jurisdiction. 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 of those claims may be uncertain. An unfavorable
outcome in such a claim could require us to cease offering for sale the products that are the
subject of such a claim, pay substantial monetary damages to a third party and/or make ongoing
royalty payments to a third party. In addition, any defense of claims
of intellectual property infringement 119




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or trade secret misappropriation may require extensive
participation by senior management and/or other key employees and may reduce their time and ability
to focus on other aspects of our business. 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 lead to increased competition and harm our
business. The industry has experienced consolidation and rationalization and we expect this trend to
continue. There have been adverse changes in the public and private equity and debt markets for
industry participants which have affected their ability to obtain financing or to fund capital
expenditures. Some operators have experienced financial difficulty and have, or may, file for
bankruptcy protection or be acquired by other operators. Other operators may merge and we and one
or more of our competitors may each supply products to the companies that have merged or will
merge. This rationalization and/or consolidation could result in our dependence on a smaller
number of customers, purchasing decision delays by the merged companies and/or our playing a lesser
role, or no longer playing a role, in the supply of communications products to the merged companies
and downward pressure on pricing of our products. This rationalization and/or consolidation,
including the acquisition by Cingular Wireless of AT&T Wireless, 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, 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 and harm our business. 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 or other
aspects of the industry 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. 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. In the U.S., on February 20, 2003, the FCC announced a decision in its triennial review proceeding
of the agencys rules regarding UNEs. The text of the FCCs order and reasons for the decision
were released on August 21, 2003. The uncertainty surrounding the impact of the FCCs decision,
judicial review of the decision, the adoption of interim rules, and the subsequent adoption of new
unbundling rules with an effective date of March 11, 2005 is affecting, and may continue to affect,
the decisions of certain of our U.S.-based service provider customers regarding investment in their
telecommunications infrastructure. These UNE rules and/or material changes in other
country-specific telecommunications or other regulations may affect capital spending by certain of
our service provider customers, which could have a material adverse effect on our business, results
of operations and financial condition. In Europe, we are subject to new product content laws and product takeback and recycling
requirements that will require full compliance by 2006. We expect that these laws will require us
to incur additional compliance costs. Although compliance costs relating to environmental matters
have not resulted in a material adverse effect on our business, results of operations and financial
condition in the past, they may result in a material adverse effect in the future. Industry concerns 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. 120




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We expect to continue to hold most current and future customer financing obligations for longer
periods prior to any possible placement with third-party lenders, due to, among other factors,
recent economic uncertainty in various countries, adverse capital market conditions, our current
credit condition, adverse changes in the credit quality of our customers and reduced demand for
telecommunications financing in capital and bank markets. In addition, risks generally associated
with customer financing, including the risks associated with new technologies, new network
construction, market demand and competition, customer business plan viability and funding risks,
may require us to hold certain customer financing obligations over a longer term. We may not be
able to place any of our current or future customer financing obligations with third-party lenders
on acceptable terms. Certain customers have been experiencing financial difficulties and have failed to meet their
financial obligations. As a result, we have incurred charges for increased provisions related to
certain trade and customer financing receivables. If there are further increases in the failure of
our customers to meet their customer financing and receivables obligations to us or if the
assumptions underlying the amount of provisions we have taken with respect to customer financing
and receivables obligations do not reflect actual future financial conditions and customer payment
levels, we could incur losses in excess of our provisions, which could have a material adverse
effect on our cash flow and operating results. Negative developments associated with our supply contracts and contract manufacturing agreements
including in our Optical Networks segment as a result of using a sole supplier for a key component
of our Optical Networks solutions 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 networks. Some of these supply 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 and/or the termination of the supply contract. Unexpected developments in these
supply contracts could have a material adverse effect on our revenues, cash flows and relationships
with our customers. In particular, we currently rely on a sole supplier for key components of our Optical Networks
solutions and our supply of such components used in our Optical Networks solutions could be
materially adversely affected by adverse developments in the supply
arrangement with that supplier. In February 2005, we agreed to waive for a period of time Bookhams obligation to maintain a
minimum cash balance under certain secured and unsecured notes and in
March 2005 to adjust the prepayment provisions under these notes
and to amend our
supply agreement with Bookham to provide certain product price increases and accelerated purchase
orders and invoice payment terms. The inability of such
supplier to meet its contractual obligations under our supply arrangements and of us to make
alternative arrangements 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, or are in the process of
outsourcing, substantially all of our manufacturing capacity to contract manufacturers, including
an agreement with Flextronics announced on June 29, 2004 regarding the divestiture of certain of
our manufacturing operations and related activities. The transfer to Flextronics of our optical
design operations and related assets in Ottawa, Canada and Monkstown, Northern Ireland was
completed in the fourth quarter of 2004. In the first quarter of 2005, we completed the portion of
the transaction relating to our manufacturing activities in Montreal, Canada. We and Flextronics
are currently discussing the timing of the closing of the balance of the remaining transaction in
order to optimize the business transition between the companies. As a result of these discussions,
it is now expected that the balance of the transaction relating to
the manufacturing operations in Chateaudun, Calgary and Monkstown
will close by the end of the first quarter of 2006. These
transitions are subject to customary conditions and regulatory approvals. Upon the completion of
the divestiture, a significant portion of our supply chain will be concentrated with Flextronics.
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 121




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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. There is no assurance that we will be able to complete, on a timely basis or otherwise, the
remaining portion of the transaction with Flextronics, which could materially and negatively impact
our cash flows and operating results and impede achievement of our strategic goal to improve our
business efficiency and operating cost performance. Many of our current and planned products are highly complex and may contain defects or errors that
are detected only after deployment in telecommunications networks, which could harm our reputation. Our products are highly complex, and some of them can be fully tested only when deployed in
telecommunications networks or with other equipment. From time to time, our products have
contained undetected defects, errors or failures. The occurrence of any defects, errors or
failures could result in cancellation of orders, product returns, diversion of our resources, legal
actions by our customers or our customers end users and other losses to us or to our customers or
end users. Any of these occurrences could also result in the loss of or delay in market acceptance
of our products and loss of sales, which would harm our business and adversely affect our business,
results of operations and financial condition. Our business may suffer if our strategic alliances 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. In addition to the investigations and litigation arising out of our restatements, we are also
subject to numerous class actions and other lawsuits as well as lawsuits in the ordinary course of
business. In addition to the investigations and litigation arising out of our restatements, we are currently
a defendant in numerous class actions and other lawsuits, including lawsuits initiated on behalf of
holders of Nortel Networks Corporation common shares, which seek damages of material and
indeterminate amounts, as well as lawsuits in the ordinary course of our business. In the future,
we may be subject to similar litigation. The defense of these lawsuits may divert our managements
attention, and we may incur significant expenses in defending these lawsuits (including substantial
fees of lawyers and other professional advisors and potential obligations to indemnify officers and
directors who may be parties to such actions). In addition, we may be required to pay judgments or
settlements that could have a material adverse effect on our results of operations, financial
condition and liquidity. 122




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ITEM 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk Refer to Market risk in Managements Discussion and Analysis of Financial Condition and
Results of Operations. 123




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ITEM 8. Consolidated Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGEReport of Independent Registered Chartered Accountants
    
    
    F-1Report of Independent Registered Chartered Accountants
    
    
    F-2Consolidated Statements of Operations
    
    
    F-4Consolidated Balance Sheets
    
    
    F-5Consolidated Statements of Changes in Equity and Comprehensive Income (Loss)
    
    
    F-6Consolidated Statements of Cash Flows
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8*********Quarterly Financial Data (Unaudited)
    
    
    F-89
 124




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REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS To the Shareholders and Board of Directors of Nortel Networks Limited We have audited the accompanying consolidated balance sheets of Nortel Networks Limited and its
subsidiaries (Nortel) as at December 31, 2004 and 2003 and the related consolidated statements
of operations, changes in equity and comprehensive income (loss) and cash flows for each of the
years in the three year period ended December 31, 2004. These financial statements are the
responsibility of Nortels management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and
the standards of the Public Company Accounting Oversight Board (United States). These standards
require that we plan and perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion. In our opinion, these consolidated financial statements present fairly, in all material
respects, the financial position of Nortel as at December 31, 2004 and 2003 and the results of
its operations and its cash flows for each of the years in the three year period ended December
31, 2004 in accordance with accounting principles generally accepted in the United States of
America. We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Nortels internal control over financial
reporting as at December 31, 2004, based on the criteria established in Internal Control 
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated April 29, 2005 expressed an
unqualified opinion on managements assessment of the
effectiveness of Nortels internal control over financial
reporting and an adverse opinion on the
effectiveness of Nortels internal control over financial reporting because of material
weaknesses. /s/ Deloitte & Touche LLP
Independent Registered Chartered Accountants Toronto, Canada
April 29, 2005 COMMENTS BY INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS ON CANADIAN-U.S. REPORTING DIFFERENCES The standards of the Public Company Accounting Oversight Board (United States) require the
addition of an explanatory paragraph (following the opinion paragraph) when there are changes in
accounting principles that have a material effect on the comparability of the companys
financial statements, such as the changes described in Note 3 to the financial statements. Our
report to the Shareholders and Board of Directors of Nortel dated
April 29, 2005, with respect
to the financial statements, is expressed in accordance with Canadian reporting standards which
would not include a reference to such changes in accounting principles in the auditors report
when the change is properly accounted for and adequately disclosed in the financial statements. /s/ Deloitte & Touche LLP
Independent Registered Chartered Accountants Toronto, Canada
April 29, 2005 F-1




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REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS To the Board of Directors and Shareholders of Nortel Networks Limited We have audited managements assessment, included in the accompanying Managements Report on
Internal Control over Financial Reporting, that Nortel Networks Limited and its subsidiaries (the Company) did not
maintain effective internal control over financial reporting as of December 31, 2004, because of
the effect of the material weaknesses identified in managements assessment based on criteria
established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Nortels management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility is to express an opinion on
managements assessment and an opinion on the effectiveness of Nortels internal control over
financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting
was maintained in all material respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating managements assessment, testing and
evaluating the design and operating effectiveness of internal control, and performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides
a reasonable basis for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due
to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate. A material weakness is a significant deficiency, or combination of significant deficiencies,
that results in more than a remote likelihood that a material misstatement of the annual or
interim financial statements will not be prevented or detected. The following material
weaknesses have been identified and included in managements assessment:  
    
    Lack of compliance with written Nortel procedures for monitoring and adjusting
balances relating to certain accruals and provisions, including restructuring charges
and contract and customer accruals; 
    
    Lack of compliance with Nortel procedures for appropriately applying generally
accepted accounting principles (GAAP) to the initial recording of certain liabilities
including those described in Statement of Financial Accounting Standards (SFAS) No.
5, Accounting for Contingencies, and to foreign currency translation as described in
SFAS No. 52, Foreign Currency Translation; 
    
    Lack of sufficient personnel with appropriate knowledge, experience and training in
U.S. GAAP and lack of sufficient analysis and documentation of the application of U.S.
GAAP to transactions including, but not limited to, revenue transactions; F-2




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
    
    Lack of a clear organization and accountability structure within the accounting
function, including insufficient review and supervision, combined with financial
reporting systems that are not integrated and which require extensive manual
interventions; 
    
    Lack of sufficient awareness of, and timely and appropriate remediation of, internal
control issues by Nortel personnel. These material weaknesses were considered in determining the nature, timing, and extent of audit
tests applied in our audit of the consolidated financial statements as of and for the year ended
December 31, 2004, of Nortel and this report does not affect our report on such financial
statements. In our opinion, managements assessment that Nortel did not maintain effective internal control
over financial reporting as of December 31, 2004, is fairly stated, in all material respects,
based on the criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, because
of the effect of the material weaknesses described above on the achievement of the objectives of
the control criteria, Nortel has not maintained effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. We have also audited, in accordance with Canadian generally accepted auditing standards and the
standards of the Public Company Accounting Oversight Board (United States), the consolidated
financial statements as of and for the year ended December 31, 2004, of the Company and our
report dated April 29, 2005 expressed an unqualified opinion on those financial statements and
includes a separate report titled Comments by Independent Registered Chartered Accountants on
Canadian-U.S. Reporting Differences referring to changes in accounting principles that have a
material effect on the comparability of the financial statements. /s/ Deloitte & Touche LLP
Independent Registered Chartered Accountants
 
Toronto, Ontario
April 29, 2005 F-3




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NORTEL NETWORKS LIMITED
Consolidated Statements of Operations for the years ended December 31 (millions of U.S. dollars)
    
    2004
    
    
    2003
    
    
    2002Revenues
    
    $
    9,828
    
    
    $
    10,193
    
    
    $
    10,994Cost of revenues
    
    
    5,735
    
    
    
    5,861
    
    
    
    7,139Gross profit
    
    
    4,093
    
    
    
    4,332
    
    
    
    3,855Selling, general and administrative expense
    
    
    2,124
    
    
    
    1,931
    
    
    
    2,532Research and development expense
    
    
    1,959
    
    
    
    1,965
    
    
    
    2,084Amortization of intangibles
    
    
    10
    
    
    
    3
    
    
    
    19Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    264Other special charges
    
    
    180
    
    
    
    285
    
    
    
    1,358(Gain) loss on sale of businesses and assets
    
    
    (98
    )
    
    
    (4
    )
    
    
    (4
    )Operating earnings (loss)
    
    
    (82
    )
    
    
    152
    
    
    
    (2,398
    )Other income (expense)  net
    
    
    240
    
    
    
    433
    
    
    
    (28
    )Interest expenseLong-term debt
    
    
    (108
    )
    
    
    (98
    )
    
    
    (135
    )Other
    
    
    (8
    )
    
    
    (26
    )
    
    
    (55
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    42
    
    
    
    461
    
    
    
    (2,616
    )Income tax benefit (expense)
    
    
    29
    
    
    
    33
    
    
    
    43871
    
    
    
    494
    
    
    
    (2,178
    )Minority interests  net of tax
    
    
    (13
    )
    
    
    (28
    )
    
    
    32Equity in net loss of associated companies  net of tax
    
    
    
    
    
    
    (36
    )
    
    
    (17
    )Net earnings (loss) from continuing operations
    
    
    58
    
    
    
    430
    
    
    
    (2,163
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    49
    
    
    
    184
    
    
    
    (101
    )Net earnings (loss) before cumulative effect of accounting change
    
    
    107
    
    
    
    614
    
    
    
    (2,264
    )Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    (12
    )
    
    
    Net earnings (loss)
    
    
    107
    
    
    
    602
    
    
    
    (2,264
    )Dividends on preferred shares
    
    
    33
    
    
    
    35
    
    
    
    26Net earnings (loss) applicable to common shares
    
    $
    74
    
    
    $
    567
    
    
    $
    (2,290
    )
 The accompanying notes are an integral part of these consolidated financial statements F-4




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NORTEL NETWORKS LIMITED
Consolidated Balance Sheets as of December 31 (millions of U.S. dollars, except for share amounts)
    
    2004
    
    
    2003ASSETSCurrent assetsCash and cash equivalents
    
    $
    3,607
    
    
    $
    3,928Restricted cash and cash equivalents
    
    
    80
    
    
    
    63Accounts receivable  net
    
    
    2,800
    
    
    
    2,659Inventories  net
    
    
    1,414
    
    
    
    967Deferred income taxes  net
    
    
    255
    
    
    
    369Other current assets
    
    
    355
    
    
    
    404Total current assets
    
    
    8,511
    
    
    
    8,390Investments
    
    
    159
    
    
    
    244Plant and equipment  net
    
    
    1,646
    
    
    
    1,654Goodwill
    
    
    2,123
    
    
    
    2,125Intangible assets  net
    
    
    78
    
    
    
    86Deferred income taxes  net
    
    
    3,736
    
    
    
    3,397Other assets
    
    
    691
    
    
    
    560Total assets
    
    $
    16,944
    
    
    $
    16,456LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesTrade and other accounts payable
    
    $
    995
    
    
    $
    877Payroll and benefit-related liabilities
    
    
    512
    
    
    
    764Contractual liabilities
    
    
    568
    
    
    
    529Restructuring liabilities
    
    
    254
    
    
    
    205Other accrued liabilities
    
    
    2,788
    
    
    
    2,467Long-term debt due within one year
    
    
    15
    
    
    
    119Total current liabilities
    
    
    5,132
    
    
    
    4,961Long-term debt
    
    
    2,062
    
    
    
    2,091Deferred income taxes  net
    
    
    143
    
    
    
    190Other liabilities
    
    
    3,189
    
    
    
    2,944Total liabilities
    
    
    10,526
    
    
    
    10,186Minority interests in subsidiary companies
    
    
    94
    
    
    
    80Guarantees, commitments and contingencies (notes 12, 13 and 20)SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited;Issued and outstanding shares: 30,000,000 for 2004 and 30,000,000 for 2003
    
    
    536
    
    
    
    536Common shares, without par value  Authorized shares: unlimited;Issued and outstanding shares: 1,460,978,638 for 2004 and 1,460,978,638 for 2003
    
    
    1,211
    
    
    
    1,211Additional paid-in capital
    
    
    22,107
    
    
    
    22,031Accumulated deficit
    
    
    (16,992
    )
    
    
    (17,066
    )Accumulated other comprehensive loss
    
    
    (538
    )
    
    
    (522
    )Total shareholders equity
    
    
    6,324
    
    
    
    6,190Total liabilities and shareholders equity
    
    $
    16,944
    
    
    $
    16,456
 The accompanying notes are an integral part of these consolidated financial statements F-5




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NORTEL NETWORKS LIMITED
Consolidated Statements of Changes in Equity and Comprehensive Income (Loss) (millions of U.S. dollars)
    
    2004
    
    
    2003
    
    
    2002Preferred sharesBalance at the beginning and end of the year
    
    $
    536
    
    
    $
    536
    
    
    $
    536Common sharesBalance at the beginning of the year
    
    
    1,211
    
    
    
    1,211
    
    
    
    2,111Common shares issued
    
    
    
    
    
    
    
    
    
    
    2,287Reduction of legal stated capital
    
    
    
    
    
    
    
    
    
    
    (3,187
    )Balance at the end of the year
    
    
    1,211
    
    
    
    1,211
    
    
    
    1,211Additional paid-in capitalBalance at the beginning of the year
    
    
    22,031
    
    
    
    22,007
    
    
    
    18,806Reduction of legal stated capital
    
    
    
    
    
    
    
    
    
    
    3,187Stock option compensation
    
    
    76
    
    
    
    26
    
    
    
    Tax benefit associated with stock options
    
    
    
    
    
    
    
    
    
    
    13Other
    
    
    
    
    
    
    (2
    )
    
    
    1Balance at the end of the year
    
    
    22,107
    
    
    
    22,031
    
    
    
    22,007Accumulated deficitBalance at the beginning of the year
    
    
    (17,066
    )
    
    
    (17,633
    )
    
    
    (14,818
    )Net earnings (loss)
    
    
    107
    
    
    
    602
    
    
    
    (2,264
    )Dividends on preferred shares
    
    
    (33
    )
    
    
    (35
    )
    
    
    (26
    )Stock option fair value increment
    
    
    
    
    
    
    
    
    
    
    (525
    )Balance at the end of the year
    
    
    (16,992
    )
    
    
    (17,066
    )
    
    
    (17,633
    )Accumulated other comprehensive lossBalance at the beginning of the year
    
    
    (522
    )
    
    
    (941
    )
    
    
    (587
    )Foreign currency translation adjustment
    
    
    159
    
    
    
    535
    
    
    
    173Unrealized gain (loss) on investments  net
    
    
    (66
    )
    
    
    57
    
    
    
    19Unrealized derivative gain on cash flow hedges  net
    
    
    6
    
    
    
    15
    
    
    
    11Minimum pension liability adjustment  net
    
    
    (115
    )
    
    
    (188
    )
    
    
    (557
    )Other comprehensive income (loss)
    
    
    (16
    )
    
    
    419
    
    
    
    (354
    )Balance at the end of the year
    
    
    (538
    )
    
    
    (522
    )
    
    
    (941
    )Total shareholders equity
    
    $
    6,324
    
    
    $
    6,190
    
    
    $
    5,180Total comprehensive income (loss) for the yearNet earnings (loss)
    
    $
    107
    
    
    $
    602
    
    
    $
    (2,264
    )Other comprehensive income (loss)
    
    
    (16
    )
    
    
    419
    
    
    
    (354
    )Total comprehensive income (loss) for the year
    
    $
    91
    
    
    $
    1,021
    
    
    $
    (2,618
    )
 The accompanying notes are an integral part of these consolidated financial statements F-6




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NORTEL NETWORKS LIMITED
Consolidated Statements of Cash Flows for the years ended December 31 (millions of U.S. dollars)
    
    2004
    
    
    2003
    
    
    2002Cash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    58
    
    
    $
    430
    
    
    $
    (2,163
    )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
    
    
    362
    
    
    
    434
    
    
    
    553Non-cash portion of special charges and related asset write downs
    
    
    4
    
    
    
    87
    
    
    
    692Equity in net loss of associated companies
    
    
    
    
    
    
    36
    
    
    
    17Stock option compensation
    
    
    76
    
    
    
    26
    
    
    
    Deferred income taxes
    
    
    (45
    )
    
    
    (8
    )
    
    
    (405
    )Other liabilities
    
    
    277
    
    
    
    161
    
    
    
    1(Gain) loss on repurchases of outstanding debt securities
    
    
    
    
    
    
    (4
    )
    
    
    (60
    )(Gain) loss on sale or write down of investments, businesses and assets
    
    
    (117
    )
    
    
    (147
    )
    
    
    35Other  net
    
    
    118
    
    
    
    (71
    )
    
    
    683Change in operating assets and liabilities
    
    
    (897
    )
    
    
    (866
    )
    
    
    (347
    )Net cash from (used in) operating activities of continuing operations
    
    
    (164
    )
    
    
    78
    
    
    
    (994
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (281
    )
    
    
    (172
    )
    
    
    (352
    )Proceeds on disposals of plant and equipment
    
    
    10
    
    
    
    38
    
    
    
    406Acquisitions of investments and businesses  net of cash acquired
    
    
    (5
    )
    
    
    (58
    )
    
    
    (29
    )Proceeds on sale of investments and businesses
    
    
    150
    
    
    
    107
    
    
    
    61Net cash from (used in) investing activities of continuing operations
    
    
    (126
    )
    
    
    (85
    )
    
    
    86Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (33
    )
    
    
    (35
    )
    
    
    (26
    )Increase (decrease) in notes payable  net
    
    
    8
    
    
    
    (45
    )
    
    
    (333
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    33Repayments of long-term debt
    
    
    (107
    )
    
    
    (270
    )
    
    
    (611
    )Repayments of capital leases payable
    
    
    (9
    )
    
    
    (12
    )
    
    
    (16
    )Issuance of common shares
    
    
    
    
    
    
    
    
    
    
    2,287Payment of stock option fair value increment
    
    
    
    
    
    
    
    
    
    
    (525
    )Net cash from (used in) financing activities of continuing operations
    
    
    (141
    )
    
    
    (362
    )
    
    
    809Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    88
    
    
    
    176
    
    
    
    74Net cash from (used in) continuing operations
    
    
    (343
    )
    
    
    (193
    )
    
    
    (25
    )Net cash from (used in) discontinued operations
    
    
    22
    
    
    
    379
    
    
    
    350Net increase (decrease) in cash and cash equivalents
    
    
    (321
    )
    
    
    186
    
    
    
    325Cash and cash equivalents at beginning of year
    
    
    3,928
    
    
    
    3,742
    
    
    
    3,417Cash and cash equivalents at end of year
    
    $
    3,607
    
    
    $
    3,928
    
    
    $
    3,742
 The accompanying notes are an integral part of these consolidated financial statements F-7




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NORTEL NETWORKS LIMITED
Notes to Consolidated Financial Statements
(millions of U.S. dollars, unless otherwise stated)  1.
    
    Nortel Networks Limited  Nortel Networks Limited (Nortel) is a recognized leader in delivering communications
capabilities, serving both service provider and enterprise customers. Nortel delivers
innovative technology solutions encompassing end-to-end broadband, Voice over IP, multimedia
services and applications, and wireless broadband solutions. Nortels business consists of the
design, development, manufacture, assembly, marketing, sale, licensing, installation, servicing
and support of these networking solutions. A substantial portion of Nortels business has a
technology focus and is dedicated to research and development.  Nortel is the principal direct operating subsidiary of Nortel Networks Corporation (NNC). NNC
holds all of Nortel Networks Limiteds outstanding common shares but none of Nortel Networks
Limiteds outstanding preferred shares. NNCs common shares are publicly traded on the New York
Stock Exchange (NYSE) and Toronto Stock Exchange (TSX) under the symbol NT. Nortel
Networks Limiteds Cumulative Redeemable Class A Preferred Shares Series 5 and Non-cumulative
Redeemable Class A Preferred Shares Series 7 are traded on the TSX under the symbols NTL.PR.F
and NTL.PR.G, respectively. Acquisitions involving any share consideration are completed by
NNC, while acquisitions involving only cash consideration are generally completed by Nortel.  2.
    
    Significant accounting policies  Basis of presentation  The consolidated financial statements of Nortel have been prepared in accordance with
accounting principles generally accepted in the United States (U.S.) (GAAP) and the rules
and regulations of the U.S. Securities and Exchange Commission (the SEC) for the preparation
of financial statements. Although Nortel is headquartered in Canada, the consolidated financial
statements are expressed in U.S. dollars as the greater part of the financial results and net
assets of Nortel are denominated in U.S. dollars.  (a)
    
    Principles of consolidation  The financial statements of entities which are controlled by Nortel through voting equity
interests, referred to as subsidiaries, are consolidated. Entities which are jointly
controlled, referred to as joint ventures, and entities which are not controlled but over
which Nortel has the ability to exercise significant influence, referred to as associated
companies, are accounted for using the equity method. Variable Interest Entities (VIEs)
(which include, but are not limited to, special purpose entities, trusts, partnerships,
certain joint ventures and other legal structures), as defined by the Financial Accounting
Standards Board (FASB) in FASB Interpretation No. (FIN) 46 (Revised 2003),
Consolidation of Variable Interest Entities  an Interpretation of Accounting Research
Bulletin No. 51 (FIN 46R), are 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. VIEs are consolidated by Nortel when it is determined that it will, as the primary
beneficiary, absorb the majority of the VIEs expected losses and/or expected residual
returns. Intercompany accounts and transactions are eliminated upon consolidation and
unrealized intercompany gains and losses are eliminated when accounting under the equity
method.  (b)
    
    Use of estimates  Nortel makes estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date of the
consolidated financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results may differ from those estimates. Estimates are used
when accounting for items and matters such as revenue recognition and accruals for losses on
contracts, allowances for uncollectible accounts receivable and customer financing,
receivables sales, inventory obsolescence, product warranty, amortization, asset valuations,
impairment assessments, employee benefits including pensions, taxes and related valuation allowance, restructuring and other provisions, stock-based
compensation and contingencies. F-8




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(c)
    
    Translation of foreign currencies  The consolidated financial statements of Nortel are presented in U.S. dollars. The financial
statements of Nortels operations whose functional currency is not the U.S. dollar (except
for highly inflationary economies as described below) are translated into U.S. dollars at
the exchange rates in effect at the balance sheet dates for assets and liabilities, and at
average rates for the period for revenues and expenses. The unrealized translation gains and
losses on Nortels net investment in these operations, including long-term intercompany
advances considered to form part of the net investment, are accumulated as a component of
other comprehensive income (loss) (OCI).  Transactions and financial statements for Nortels operations in countries considered to
have highly inflationary economies and whose functional currency is not the U.S. dollar are
translated into U.S. dollars at the exchange rates in effect at the balance sheet dates for
monetary assets and liabilities, and at historical exchange rates for non-monetary assets
and liabilities. Revenue and expenses are translated at average rates for the period,
except for amortization and depreciation which are translated on the same basis as the
related assets. Resulting translation gains or losses are reflected in net earnings (loss).  When appropriate, Nortel may hedge a designated portion of the exposure to foreign exchange
gains and losses incurred on the translation of specific foreign operations. Hedging
instruments used by Nortel can include foreign currency denominated debt, foreign currency
swaps and foreign currency forward contracts that are denominated in the same currency as
the hedged foreign operations. The translation gains and losses on the effective portion of
the hedging instruments that qualify for hedge accounting are recorded in OCI; other
translation gains and losses are recorded in net earnings (loss).  (d)
    
    Revenue recognition  Nortels products and services are generally sold as part of a contract and the terms of the
contracts, taken as a whole, determine the appropriate revenue recognition methods.  Depending upon the terms of the contract and types of products and services sold, Nortel
recognizes revenue under American Institute of Certified Public Accountants Statement of
Position (SOP) 81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts (SOP 81-1), SOP 97-2, Software Revenue Recognition (SOP
97-2), and SEC Staff Accounting Bulletin (SAB) 104, Revenue Recognition (SAB 104),
which was preceded by SAB 101, Revenue Recognition in Financial Statements (SAB 101).
Revenue is recognized net of cash discounts and allowances.  Effective July 1, 2003, for contracts involving multiple deliverables, where the
deliverables are governed by more than one authoritative accounting standard, Nortel
generally applies the FASB Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables, and evaluates each deliverable to determine
whether it represents a separate unit of accounting based on the following criteria: (a)
whether the delivered item has value to the customer on a standalone basis, (b) whether
there is objective and reliable evidence of the fair value of the undelivered item(s), and
(c) if the contract includes a general right of return relative to the delivered item,
delivery or performance of the undelivered item(s) is considered probable and substantially
in the control of Nortel. If objective and reliable evidence of fair value exists for all
units of accounting in the contract, revenue is allocated to each unit of accounting or
element based on relative fair values. In situations where there is objective and reliable
evidence of fair value for all undelivered elements, but not for delivered elements, the
residual method is used to allocate the contract consideration. Under the residual method,
the amount of revenue allocated to delivered elements equals the total arrangement
consideration less the aggregate fair value of any undelivered elements. Each unit of
accounting is then accounted for under the applicable revenue recognition guidance.  For arrangements that include hardware and software where software is considered more than
incidental to the hardware, provided that the software is not essential to the functionality
of the hardware and the hardware and software represent separate units of accounting,
revenue related to the software element is recognized under SOP 97-2 and revenue related to the hardware element is recognized under SOP 81-1 or SAB
104. For arrangements where the software is considered more than incidental and essential
to the functionality of the hardware, or where the hardware is not considered a separate
unit of accounting from the software deliverables, revenue is recognized for the software
and the hardware as a single unit of accounting pursuant to SOP 97-2 for off-the-shelf
products and pursuant to SOP 81-1 for customized products. F-9




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Prior to July 1, 2003, for contracts involving multiple elements, Nortel allocated revenue
to each element based on the relative fair value or the residual method, as applicable.
Provided none of the undelivered elements were essential to the functionality of the
delivered elements, revenue related to the software element was recognized under SOP 97-2
and revenue related to the hardware element was recognized under SOP 81-1 or SAB 101.  For accounting units related to customized network solutions
and certain network build-outs,
revenues are recognized under SOP 81-1 using the percentage-of-completion method. In using
the percentage-of-completion method, revenues are generally recorded based on a measure of
the percentage of costs incurred to date on a contract relative to the estimated total
expected contract costs. Profit estimates on long-term contracts are revised periodically
based on changes in circumstances and any losses on contracts are recognized in the period
that such losses become known. Generally, the terms of long-term contracts provide for
progress billing based on completion of certain phases of work. Contract revenues
recognized, based on costs incurred towards the completion of the project, that are unbilled
are accumulated in the contracts in progress account included in accounts receivable  net.
Billings in excess of revenues recognized to date on long-term contracts are recorded as
advance billings in excess of revenues recognized to date on
contracts within other accrued liabilities.  Revenue for hardware that does not require significant customization, and where any software
is considered incidental, is recognized under SAB 104. Under SAB 104, revenue is recognized
provided that persuasive evidence of an arrangement exists, delivery has occurred or
services have been rendered, the fee is fixed or determinable and collectibility is
reasonably assured.For hardware, delivery is considered to have occurred upon shipment provided that risk of
loss, and title in certain jurisdictions, have been transferred to the customer. For
arrangements where the criteria for revenue recognition have not been met because legal
title or risk of loss on products does not transfer to the customer until final payment has
been received or where delivery has not occurred, revenue is deferred to a later period when
title or risk of loss passes either on delivery or on receipt of payment from the customer.
For arrangements where the customer agrees to purchase products but Nortel retains
possession until the customer requests shipment (bill and hold arrangements), revenue is
not recognized until delivery to the customer has occurred and all other revenue recognition
criteria have been met.Engineering, installation and other service revenues are recognized as the services are
performed.Nortel makes certain sales through multiple distribution channels, primarily resellers and
distributors. These customers are generally given certain rights of return. For products
sold through these distribution channels, revenue is recognized from product sale at the
time of shipment to the distribution channel when persuasive evidence of an arrangement
exists, delivery has occurred, the fee is fixed or determinable and collection is reasonably
assured. Accruals for estimated sales returns and other allowances are recorded at the time
of revenue recognition and are based on contract terms and prior claims experience.Software revenue is generally recognized under SOP 97-2. For software arrangements
involving multiple elements, Nortel allocates revenue to each element based on the relative
fair value or the residual method, as applicable, and using vendor specific objective
evidence of fair values, which is based on prices charged when the element is sold
separately. Software revenue accounted for under SOP 97-2 is recognized when persuasive
evidence of an arrangement exists, the software is delivered in accordance with all terms
and conditions of the customer contracts, the fee is fixed or determinable and collection is
reasonably assured. Revenue related to post-contract support (PCS), including technical
support and unspecified when-and-if available software upgrades, is recognized ratably over
the PCS term. Nortel provides extended payment terms on certain software contracts and may
sell these receivables to third parties. The fees on these contracts are considered fixed
or determinable if the contracts are similar to others for which Nortel has a standard business practice of providing extended
payment terms and has a history of successfully collecting under the original payment terms
without making concessions. F-10




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Under SAB 104 or SOP 97-2, if fair value does not exist for any undelivered element, revenue
is not recognized until the earlier of (i) the undelivered element is delivered or (ii) fair
value of the undelivered element exists, unless the undelivered element is a service, in
which case revenue is recognized as the service is performed once the service is the only
undelivered element.  (e)
    
    Research and development  Research and development (R&D) costs are charged to net earnings (loss) in the periods in
which they are incurred. However, costs incurred pursuant to specific contracts with third
parties for which Nortel is obligated to deliver a product are charged to cost of revenues
in the same period as the related revenue is recognized. Related global investment tax
credits are deducted from the income tax provision.  (f)
    
    Income taxes  Nortel provides for income taxes using the asset and liability method. This approach
recognizes the amount of taxes payable or refundable for the current year as well as
deferred tax assets and liabilities for the future tax consequence of events recognized in
the consolidated financial statements and tax returns. Deferred income taxes are adjusted
to reflect the effects of changes in tax laws or enacted tax rates.In establishing the appropriate income tax valuation allowances, Nortel assesses the
realizability of its net deferred tax assets quarterly and based on all available evidence,
both positive and negative, determines whether it is more likely than not that the remaining
net deferred tax assets or a portion thereof will be realized.  (g)
    
    Earnings (loss) per common share  As all of Nortel Networks Limiteds common shares are held by NNC and are not publicly
traded, information concerning Nortel Networks Limiteds net earnings (loss) per common
share and weighted-average number of common shares outstanding has not been presented in the
consolidated financial statements. For information regarding NNCs earnings (loss) per
common share and weighted-average number of common shares outstanding, see NNCs
consolidated financial statements and notes thereto for the year ended December 31, 2004
contained in NNCs 2004 Annual Report on Form 10-K filed with the SEC.  (h)
    
    Cash and cash equivalents  Cash and cash equivalents consist of cash on hand, balances with banks and short-term
investments. All highly liquid investments with original maturities of three months or less
are classified as cash and cash equivalents. The fair value of cash and cash equivalents
approximates the amounts shown in the consolidated financial statements.  (i)
    
    Restricted cash and cash equivalents  Cash and cash equivalents are considered restricted when they are subject to contingent
rights of a third party customer under bid, performance related and other bonds associated
with contracts that Nortel is not able to unilaterally revoke. Cash and cash equivalents
collateral may be provided, often in addition to the payment of fees to the other party, as
a result of the general economic and industry environment and Nortels credit rating.  (j)
    
    Provision for doubtful accounts  The provision for doubtful accounts for trade, notes and long-term receivables due from
customers is established based on an assessment of a customers credit quality, as well as
subjective factors and trends, including the aging of receivable balances. Generally, these
credit assessments occur prior to the inception of the credit exposure and at regular
reviews during the life of the exposure.  Customer financing receivables include receivables from customers with deferred payment
terms. Customer financing receivables are considered impaired when they are classified as
non-performing, payment arrears exceed 90 days or a major credit event such as a material
default has occurred, and management determines that collection of amounts due according to
the contractual terms is doubtful. Provisions for impaired customer financing receivables are recorded based on the expected recovery of defaulted customer obligations, being the
present value of expected cash flows, or the realizable value of the collateral if recovery
of the receivables is dependent upon a liquidation of the assets. Interest income on
impaired customer finance receivables is recognized as the cash payments are collected. F-11




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(k)
    
    Inventories  Inventories are valued at the lower of cost (calculated generally on a first-in, first-out
basis) or market. The cost of finished goods and work in process is comprised of material,
labor and manufacturing overhead. Provisions for inventory are based on estimates of future
customer demand for products, including general economic conditions, growth prospects within
the customers ultimate marketplaces and market acceptance of current and pending products.
In addition, full provisions are generally recorded for surplus inventory in excess of one
years forecast demand or inventory deemed obsolete.  (l)
    
    Receivables sales  Transfers of accounts receivable that meet the criteria for surrender of control under FASB
Statement of Financial Accounting Standard (SFAS) No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, are accounted for as
sales. Generally, Nortel retains servicing rights and, in some cases, provides limited
recourse when it sells receivables. A gain or loss is recorded in other income (expense) 
net at the date of the receivables sale and is based upon, in part, the previous carrying
amount of the receivables involved in the transfer allocated between the assets sold and the
retained interests based on their relative fair values at the date of the transfer. Fair
value is generally estimated based on the present value of the estimated future cash flows
expected under managements assumptions, including discount rates assigned commensurate with
risks. Retained interests are classified as available-for-sale securities.Nortel, when acting as the servicing agent, generally does not record an asset or liability
related to servicing as the annual servicing fees are equivalent to those that would be paid
to a third party servicing agent. Certain transactions will enable Nortel, when acting as
the servicing agent, to receive a servicing bonus at the maturity of the transaction if
certain performance criteria are met. The ultimate collection of servicing bonuses is based
primarily on the collectibility and credit experience of the receivables sold and is
sometimes paid at the discretion of the transferee. Nortel initially records the
non-discretionary servicing bonus at fair value which is the discounted value of the
estimated future cash flows taking into consideration future estimated interest rates and
credit losses. Generally, the discretionary servicing bonus is initially recorded at a fair
value of nil due to the fact that it is paid at the discretion of the transferee and based
on the determination that future credit losses will offset any such servicing bonus.Nortel reviews the fair value assigned to retained interests, including the servicing bonus,
at each reporting date subsequent to the date of the transfer to determine if there is an
other than temporary impairment. Fair value is reviewed using similar valuation techniques
as those used to initially measure the retained interest and, if a change in events or
circumstances warrants, the fair value is adjusted and any other than temporary impairments
are recorded in other income (expense)  net.  (m)
    
    Investments  Investments in publicly traded equity securities of companies over which Nortel does not
exert significant influence are accounted for at fair value and are classified as available
for sale. Unrealized holding gains and losses related to these securities are excluded from
net earnings (loss) and are included in OCI until such gains or losses are realized or an
other than temporary impairment is determined to have occurred.  Investments in equity securities of private companies over which Nortel does not exert
significant influence are accounted for using the cost method. Investments in associated
companies and joint ventures are accounted for
using the equity method. An impairment loss is recorded when there has been a loss in value
of the investment that is other than temporary.  Nortel monitors its investments for factors indicating other than temporary impairment and
records a charge to net earnings (loss) when appropriate. F-12




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(n)
    
    Plant and equipment  Plant and equipment are stated at cost less accumulated depreciation. Depreciation is
generally calculated on a straight-line basis over the expected useful lives of the plant
and equipment. The expected useful lives of buildings are twenty to forty years, and of
machinery and equipment are five to ten years. Capitalized software is amortized over three
years.  (o)
    
    Impairment or disposal of long-lived assets (plant and equipment and acquired
technology)  Long-lived assets held and used  Nortel tests long-lived assets or asset groups held and used for recoverability when events
or changes in circumstances indicate that their carrying amount may not be recoverable.
Circumstances which could trigger a review include, but are not limited to: significant
decreases in the market price of the asset; significant adverse changes in the business
climate or legal factors; the accumulation of costs significantly in excess of the amount
originally expected for the acquisition or construction of the asset; current period cash
flow or operating losses combined with a history of losses or a forecast of continuing
losses associated with the use of the asset; and a current expectation that the asset will
more likely than not be sold or disposed of significantly before the end of its previously
estimated useful life.  Recoverability is assessed based on the carrying amount of the asset and the sum of the
undiscounted cash flows expected to result from the use and the eventual disposal of the
asset or asset group. An impairment loss is recognized when the carrying amount is not
recoverable and exceeds the fair value of the asset or asset group. The impairment loss is
measured as the amount by which the carrying amount exceeds fair value.  Long-lived assets held for sale  Long-lived assets are classified as held for sale when certain criteria are met, which
include: managements commitment to a plan to sell the assets; the assets are available for
immediate sale in their present condition; an active program to locate buyers and other
actions to sell the assets have been initiated; the sale of the assets is probable and their
transfer is expected to qualify for recognition as a completed sale within one year; the
assets are being actively marketed at reasonable prices in relation to their fair value; and
it is unlikely that significant changes will be made to the plan to sell the assets or that
the plan will be withdrawn.Nortel measures long-lived assets to be disposed of by sale at the lower of carrying amount
or fair value less cost to sell. These assets are not depreciated.  Long-lived assets to be disposed of other than by sale  Nortel classifies assets that will be disposed of other than by sale as held and used until
the disposal transaction occurs. The assets continue to be depreciated based on revisions
to their estimated useful lives until the date of disposal or abandonment.Recoverability is assessed based on the carrying amount of the asset and the sum of the
undiscounted cash flows expected to result from the remaining period of use and the eventual
disposal of the asset or asset group. An impairment loss is recognized when the carrying
amount is not recoverable and exceeds the fair value of the asset or asset group. The
impairment loss is measured as the amount by which the carrying amount exceeds fair value.  Fair value for the purposes of measuring an impairment or planned disposal of long-lived
assets is determined using quoted market prices or the anticipated cash flows discounted at
a rate commensurate with the risk involved. F-13




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(p)
    
    Goodwill  Goodwill represents the excess of the purchase price of an acquired business over the fair
value of the identifiable assets acquired and liabilities assumed. Nortel tests for
impairment of goodwill on an annual basis as of October 1 and at any other time if events
occur or circumstances change that would indicate that it is more likely than not that the
fair value of the reporting unit has been reduced 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; the loss of key personnel; change in reportable segments; the
likelihood that a reporting unit or significant portion of a reporting unit will be sold or
otherwise disposed of; the results of testing for recoverability of a significant asset
group within a reporting unit; and the 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 present value techniques of estimated future
cash flows and estimated amounts at which the unit as a whole could be bought or sold in a
current transaction between willing parties. Nortel 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).  (q)
    
    Intangible assets  Intangible assets consist of acquired technology and other intangible assets. Acquired
technology represents the value of the proprietary know-how which was technologically
feasible as of the acquisition date, and is charged to net earnings (loss) on a
straight-line basis over its estimated useful life of two to three years. Other intangible
assets are amortized into net earnings (loss) based on their expected pattern of benefit to
future periods using estimates of undiscounted cash flows.  (r)
    
    Warranty costs  As part of the normal sale of product, Nortel provides its customers with product warranties
that extend for periods generally ranging from one to six years from the date of sale. A
liability for the expected cost of warranty-related claims is established when products are
sold. In estimating warranty liability, historical material replacement costs and the
associated labor costs to correct the product defect are considered. Revisions are made
when actual experience differs materially from historical experience. Known product defects
are specifically accrued for as Nortel becomes aware of such defects.  (s)
    
    Pension, post-retirement and post-employment benefits  Pension expense, based on managements assumptions, consists of: actuarially computed costs
of pension benefits in respect of the current years service; imputed returns on plan assets
and imputed interest on pension obligations; and straight-line amortization under the
corridor approach of experience gains and losses, assumption changes and plan amendments
over the expected average remaining service life of the employee group.The expected costs of post-retirement and certain post-employment benefits, other than
pensions, for active employees are accrued in the consolidated financial statements during
the years employees provide service to Nortel. These costs are recorded based on actuarial
methods and assumptions. Other post-employment benefits are recognized when the event
triggering the obligation occurs. F-14




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(t)
    
    Derivative financial instruments  Nortels net earnings (loss) and cash flows may be negatively impacted by fluctuating
interest rates, foreign exchange rates and equity prices. To effectively manage these
market risks, Nortel enters into foreign currency forward contracts, foreign currency swaps,
foreign currency option contracts, interest rate swaps and equity forward contracts. Nortel
does not hold or issue derivative instruments for trading purposes. Nortels policy is to
formally document all relationships between hedging instruments and hedged items, as well as
its risk management objectives and strategy for undertaking various hedge transactions.
Where hedge accounting will be applied, this process includes linking all derivatives to
specific assets and liabilities on the consolidated balance sheet or to specific firm
commitments or forecasted transactions. Nortel also formally assesses, both at the hedges
inception and on an ongoing basis, as applicable, whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in fair values or cash flows
of hedged items.For a derivative designated as a fair value hedge, changes in the fair value of the
derivative and of the hedged item attributable to the hedged risk are recognized in net
earnings (loss). For a derivative designated as a cash flow hedge, the effective portions
of changes in the fair value of the derivative are recorded in OCI and are recognized in net
earnings (loss) when the hedged item affects net earnings (loss). Ineffective portions of
changes in the fair value of cash flow hedges are recognized in other income (expense) 
net. If the derivative used in an economic hedging relationship is not designated in an
accounting hedging relationship or if it has become ineffective, changes in the fair value
of the derivative are recognized in net earnings (loss).When a cash flow or fair value hedging relationship is terminated because the derivative is
sold, terminated or de-designated as a hedge, the accumulated OCI balance to the termination
date or the fair value basis adjustment recorded on the hedged item is amortized into other
income (expense)  net or interest expense on an effective yield basis over the original
term of the hedging relationship. If a cash flow or fair value hedging relationship is
terminated because the underlying hedged item is repaid or is sold, or it is no longer
probable that the hedged forecasted transaction will occur, the accumulated balance in OCI
or the fair value basis adjustment recorded on the hedged item is recorded immediately in
net earnings (loss).Nortel generally classifies cash flows resulting from its derivative financial instruments
in the same manner as the cash flows from the item that the derivative is hedging.
Typically, this is within cash flows from (used in) operating activities in the consolidated
statements of cash flows, or, for derivatives designated as hedges relating to the cash
flows associated with settlement of the principal component of long-term debt, within cash
flows from (used in) financing activities.Nortel may also invest in warrants to purchase securities of other companies as a strategic
investment or receive warrants in various transactions. Warrants that relate to publicly
traded companies or that can be net share settled are deemed to be derivative financial
instruments. Such warrants, however, are generally not eligible to be designated as hedging
instruments as there is no corresponding underlying exposure. In addition, Nortel may enter
into certain commercial contracts containing embedded derivative financial instruments.
Generally, for these embedded derivatives, for which the economic characteristics and risks
are not clearly and closely related to the economic characteristics and risks of the host
contract, the changes in fair value are recorded in net earnings (loss).In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities (SFAS 149). SFAS 149 amends and clarifies the
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, SFAS 149 clarifies under
what circumstances a contract with an initial net investment meets the characteristic of a
derivative as discussed in SFAS 133, when a derivative contains a financing component,
amends the definition of an underlying to conform it to the language used in FIN 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Others  an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34 (FIN 45), and 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. F-15




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The provisions of SFAS 149 that relate to guidance in SFAS 133 that have been effective for
fiscal quarters which began prior to June 15, 2003 continue to be applied in accordance with
their respective effective dates. In addition, certain provisions relating to forward
purchases or sales of when-issued securities or other securities that do not yet exist are
applied to both existing contracts as well as new contracts entered into after June 30,
2003.Effective July 1, 2003, Nortel 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s results of operations and financial condition.  (u)
    
    Stock-based compensation  Nortel employees and directors participate in a number of stock-based compensation plans
that are described in note 17 to the consolidated financial statements.In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation
Transition and Disclosure  an Amendment of FASB Statement No. 123 (SFAS 148), which
amended the transitional provisions of SFAS No. 123, Accounting for Stock-based
Compensation (SFAS 123), for companies electing to recognize employee stock-based
compensation using the fair value based method.Prior to January 1, 2003, Nortel, as permitted under SFAS 123, applied the intrinsic value
method under Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock
Issued to Employees (APB 25), and related interpretations in accounting for its employee
stock-based compensation plans.Effective January 1, 2003, Nortel elected to adopt the fair value based method for
measurement and recognition of all stock-based compensation prospectively for all awards
granted, modified, or settled on or after January 1, 2003. The impact of the adoption of
the fair value based method for expense recognition of employee awards resulted in $26 (net
of tax of nil) of stock option expense during 2003.The accounting for Nortels stock-based compensation plans under the fair value based method
is as follows:  Stock Options  The fair value at grant date of stock options is estimated using the Black-Scholes-Merton
option-pricing model. Compensation expense is recognized on a straight-line basis over the
stock option vesting period. Adjustments to compensation expense due to not meeting
employment vesting requirements are accounted for in the period when they occur.  Restricted Stock Units (RSUs), Deferred Stock Units (DSUs) and Stock Appreciation Rights
(SARs)  RSUs that are only settled in equity are valued using the grant date market price of the
underlying stock. This valuation is not subsequently adjusted for changes in the market
price of the stock prior to settlement of the award. Compensation expense is recognized on
a straight-line basis over the vesting period based on the estimated number of RSU awards
that are expected to vest. If there are performance vesting criteria, such as achievement
of earnings or revenue targets, this estimate is updated each period for changes in
estimates or as actual results become known. Adjustments to compensation expense for
employment vesting requirements are accounted for in the period when they occur.Grants of RSUs, DSUs or SARs that are settled or may be settled in cash or stock purchased on the open
market at the option of employees or directors are accounted for as liabilities. The value
of the liability is remeasured each period based on the cumulative compensation expense
recognized for the awards at each period end. Prior to vesting, this is determined based on
the current market price of the underlying stock at period end, the estimated number of RSU,
DSU or SAR awards that are expected to vest calculated in the same manner as equity settled
RSUs and the portion of the vesting period that has elapsed. Subsequent to vesting and
prior to settlement of the award, changes in Nortels payment obligations are based on changes in the stock price and are recorded as
compensation expense each period. F-16




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The payment obligation is established for RSUs on the vesting date of the award and for DSUs
on the later of the date of termination of employment and/or directorship, and for SARs on
the date of exercise of the award by the employee.Stock-based awards which are substantively discretionary in nature are measured and recorded
fully as compensation expense in the period that the issuance and settlement of the award is
approved.  Employee Stock Purchase Plans  Nortel has stock purchase plans for eligible employees in eligible countries, and a stock
purchase plan for eligible unionized employees in Canada (collectively, the ESPPs), to
facilitate the acquisition of common shares of Nortel Networks Corporation at a discount.
The discount is such that the plans are considered compensatory under the fair value based
method. Nortels contribution to the ESPPs is recorded as compensation expense on a
quarterly basis as the obligation to contribute is incurred.  Pro forma disclosures required due to change in accounting policy  Had Nortel applied the fair value based method to all stock-based awards in all periods,
reported net earnings (loss) and earnings (loss) per common share would have been adjusted
to the pro forma amounts indicated below for the following years ended December 31: 2004
    
    
    2003
    
    
    2002Net earnings (loss) applicable to common shares  as reported
    
    $
    74
    
    
    $
    567
    
    
    $
    (2,290
    )Stock-based compensation  reported (note 17)
    
    
    116
    
    
    
    54
    
    
    
    17Stock-based compensation  pro forma(a)
    
    
    (166
    )
    
    
    (308
    )
    
    
    (873
    )Net earnings (loss) applicable to common shares  pro forma
    
    $
    24
    
    
    $
    313
    
    
    $
    (3,146
    )
 (a)
    
    Stock-based compensation  pro forma expense for the years ended December 31,
2004, 2003 and 2002 was net of tax of nil, nil and $136, respectively.  (v)
    
    Recent accounting pronouncements
  (i)
    
    In March 2004, the EITF reached consensus on Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides guidance on determining when an investment is considered
impaired, whether that impairment is other than temporary and the measurement of an
impairment loss. EITF 03-1 is applicable to marketable debt and equity securities
within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities (SFAS 115), and SFAS No. 124, Accounting for Certain Investments
Held by Not-for-Profit Organizations, and equity securities that are not subject to
the scope of SFAS 115 and not accounted for under the equity method of accounting. In
September 2004, the FASB issued FASB Staff Position (FSP) EITF 03-1-1, Effective
Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments, which delays the effective
date for the measurement and recognition criteria contained in EITF 03-1 until final
application guidance is issued. The delay does not suspend the requirement to
recognize other-than-temporary impairments as required by existing authoritative
literature. The adoption of EITF 03-1 is not expected to have a material impact on
Nortels results of operations and financial condition.(ii)
    
    In November 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS
151). SFAS 151 requires that abnormal amounts of idle facility expense, freight,
handling costs and wasted material (spoilage) be recognized as current period charges
rather than capitalized as a component of inventory costs. In addition, SFAS 151
requires allocation of fixed production overheads to inventory based on the normal
capacity of the production facilities. This statement is effective for inventory costs incurred in fiscal periods
beginning after June 15, 2005. The guidance should be applied prospectively. Nortel is
currently assessing the impact of SFAS 151 on its results of operations and financial
condition. F-17




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(iii)
    
    In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based
Payment (SFAS 123R), which requires all share-based payments to employees, including
grants of employee stock options, to be recognized as compensation expense in the
consolidated financial statements based on their fair values. SFAS 123R also modifies
certain measurement and expense recognition provisions of SFAS 123, that will impact
Nortel, including the requirement to estimate employee forfeitures each period when
recognizing compensation expense, and requiring that the initial and subsequent
measurement of the cost of liability-based awards each period be based on the
fair value (instead of the intrinsic value) of the award. This statement is effective
for Nortel as of January 1, 2006. Nortel previously elected to expense employee
stock-based compensation using the fair value method prospectively for all awards
granted or modified on or after January 1, 2003 in accordance with SFAS 148. Nortel is
currently assessing the impact of SFAS 123R on its results of operations and financial
condition, as well as the impact of SAB 107, Share-based Payment (SAB107). SAB 107
was issued by the SEC in March 2005, and provides supplemental SFAS 123R application
guidance based on the views of the SEC.(iv)
    
    In March 2005, the FASB issued FSP No. 46 (R) -5, Implicit Variable Interests
under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable
Interest Entities (FSP FIN 46R-5). FSP FIN 46R-5 provides guidance for a reporting
enterprise on whether it holds an implicit variable interest in VIEs or potential VIEs
when specific conditions exist. This FSP is effective in the first period beginning
after March 3, 2005 in accordance with the transition provisions of FIN 46R. Nortel is
currently assessing the impact of the adoption of FSP FIN 46R-5 on its results of
operations and financial condition.  Comparative figures  Certain 2003 and 2002 figures in the consolidated financial statements have been
reclassified to conform to the 2004 presentation.  3.
    
    Accounting changes  (a)
    
    Guarantees  In November 2002, the FASB issued FIN 45, which defines a guarantee as a contract that
contingently requires a guarantor to pay a guaranteed party as a result of changes in an
underlying economic characteristic (such as interest rates or market value) that is related
to an asset, a liability or an equity security of the guaranteed party or a third partys
failure to perform under a specified agreement. 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 has entered into agreements that
contain features which meet the definition of a guarantee under FIN 45. Effective December
31, 2002, Nortel adopted the disclosure requirements of FIN 45. In addition, effective
January 1, 2003, Nortel 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 (see note 12). F-18




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(b)
    
    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 be 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 amount is
recognized as income or loss on settlement. Effective January 1, 2003, Nortel adopted the
initial recognition and measurement provisions of SFAS 143 and identified certain asset
retirement obligations to remediate leased premises and buildings and equipment situated on
leased land. The adoption of SFAS 143 resulted in a decrease to net earnings (loss) of $12
(net of tax of nil) which has been reported as a cumulative effect of accounting change 
net of tax, an increase in plant and equipment  net of $4 and an asset retirement
obligation liability of $16 as of January 1, 2003. The adoption of SFAS 143 did not have a
material impact on depreciation and accretion expense.  (c)
    
    Accounting for costs associated with exit or disposal activities  In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit
or Disposal Activities (SFAS 146), which is effective for exit or disposal activities
initiated after December 31, 2002. SFAS 146 supersedes EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a 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 was to change
the timing of recognition and the basis for measuring certain liabilities and therefore
created 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
adopted the requirements of SFAS 146 effective January 1, 2003. The adoption of SFAS 146
did not have a material impact on Nortels results of operations and financial condition.  (d)
    
    Consolidation of variable interest entities  In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities 
an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial
Statements (FIN 46). FIN 46 clarifies the application of consolidation guidance to
those entities defined as VIEs (which include, but are not limited to, special purpose
entities, trusts, partnerships, certain joint ventures and other legal structures) 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. FIN 46 applied immediately to all VIEs created
after January 31, 2003 and by the beginning of the first interim or annual reporting period
commencing after June 15, 2003 for VIEs created prior to February 1, 2003. In October 2003,
the FASB issued FSP FIN 46-6, Effective Date of FASB Interpretation No. 46, deferring the
effective date for applying the provisions of FIN 46 for VIEs 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 elected early application of FIN 46 (see note
14).In December 2003, the FASB issued FIN 46R which amends and supersedes the original FIN 46.
Effective December 2003, Nortel adopted FIN 46R. Any impacts of applying FIN 46R to an
entity to which FIN 46 had previously been applied are considered immaterial to Nortels
results of operations and financial condition and Nortels accounting treatment of VIEs.  (e)
    
    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, including mandatorily redeemable
non-controlling interests, and requires that those instruments be F-19




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##### Table of Contents



classified as liabilities on 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. In November 2003, the FASB issued FSP FAS 150-3, Effective Date, Disclosures, and
Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities
and Certain Mandatorily Redeemable Non-controlling Interests under FASB Statement No. 150,
Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity (FSP FAS 150-3), which deferred indefinitely the effective date for applying the
specific provisions within SFAS 150 related to the classification and measurement of
mandatorily redeemable non-controlling interests.Nortel continues to consolidate two enterprises with limited lives. Upon liquidation in
2024, the net assets of these entities will be distributed to the owners based on their
relative interests at that time. The minority interests included in the consolidated
balance sheets related to these entities were a total of $50 and $45 as of December 31, 2004
and 2003, respectively. Nortel has not yet determined the fair value of these minority
interests as of December 31, 2004. The adoption of SFAS 150, as amended by FSP FAS 150-3,
did not have a material impact on Nortels results of operations and financial condition.  (f)
    
    Accounting for revenue arrangements with multiple deliverables  On October 1, 2003, Nortel adopted the guidance contained in EITF 03-5, Applicability
of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement
Containing More-Than-Incidental Software (EITF 03-5), which addresses whether
non-software deliverables included in an arrangement that contains software that is more
than incidental to the products or services as a whole are included within the scope of SOP
97-2. The adoption of EITF 03-5 did not have a material impact on Nortels results of
operations and financial condition.  4.
    
    Consolidated financial statement details  The following consolidated financial statement details are presented as of December 31,
2004 and 2003 for the consolidated balance sheets and for each of the three years ended December
31, 2004 for the consolidated statements of operations and consolidated statements of cash
flows.In preparing the 2004 financial statements Nortel recorded
adjustments that relate to prior periods. These adjustments resulted
in a net reduction of approximately $60 to net earnings (loss). The
aggregate impact of the adjustments to the 2004 results was not
material to the financial statements or to any individual segment or
geographic region. These adjustments were also immaterial to the
2003, 2002 and prior years results.  Consolidated statements of operations  Revenues:  During the year ended December 31, 2004, Nortel reduced revenue by approximately $80 to correct
for previously recognized revenue relating to past sales of Optical Networks equipment, which
Nortel subsequently determined should have been deferred and recognized with the delivery of
future contractual PCS and other services over the term of the PCS. The associated costs of
revenues were also deferred resulting in no significant impact on Nortels gross margin for the
year ended December 31, 2004.  Cost of revenues:  In August 2004, Nortel entered into a contract with Bharat Sanchar Nigram Limited (BSNL) to
establish a wireless network in India. Nortels commitments to date for orders received as of
December 31, 2004 under this contract have resulted in an estimated project loss of
approximately $160, which has been recorded as a charge to cost of revenues and accrued within
contractual liabilities in the year ended December 31, 2004.During the year ended December 31, 2003, reversals of provisions of $87 relating to a customer
bankruptcy settlement reduced cost of revenues and selling, general and administrative (SG&A)
expense by $53 and $4, respectively, and increased other income (expense)  net by $30. F-20




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##### Table of Contents



Selling, general and administrative expense:  SG&A expense included bad debt recoveries of $127 and $179 and expense of $292 in the years
ended December 31, 2004, 2003 and 2002, respectively.  Research and development expense: 2004
    
    
    2003
    
    
    2002R&D expense
    
    $
    1,959
    
    
    $
    1,965
    
    
    $
    2,084R&D costs incurred on behalf of others (a)
    
    
    40
    
    
    
    72
    
    
    
    49Total
    
    $
    1,999
    
    
    $
    2,037
    
    
    $
    2,133
 (a)
    
    These costs included R&D costs charged to customers of Nortel pursuant to contracts
that provided for full recovery of the estimated cost of development, material,
engineering, installation and other applicable costs, which were accounted for as contract
costs.
  Other income (expense)  net: 2004
    
    
    2003
    
    
    2002Interest income
    
    $
    62
    
    
    $
    75
    
    
    $
    88Gain (loss) on sale or write down of investments
    
    
    19
    
    
    
    143
    
    
    
    (39
    )Currency exchange gains (losses)(a)
    
    
    98
    
    
    
    83
    
    
    
    (84
    )Other  net
    
    
    61
    
    
    
    132
    
    
    
    7Other income (expense)  net
    
    $
    240
    
    
    $
    433
    
    
    $
    (28
    )
 (a)
    
    Currency exchange gains (losses) included a gain of $32 resulting from a correction
during 2004 related to a cumulative error in functional currency designation of an entity.
 F-21




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##### Table of Contents



Consolidated balance sheets  Accounts receivable  net: 2004
    
    
    2003Trade receivables
    
    $
    2,301
    
    
    $
    2,271Contracts in process
    
    
    608
    
    
    
    5822,909
    
    
    
    2,853Less: provision for doubtful accounts
    
    
    (109
    )
    
    
    (194
    )Accounts receivable  net
    
    $
    2,800
    
    
    $
    2,659
  Inventories  net: 2004
    
    
    2003Raw materials
    
    $
    935
    
    
    $
    945Work in process
    
    
    125
    
    
    
    132Finished goods
    
    
    1,863
    
    
    
    1,2342,923
    
    
    
    2,311Less: provision for inventory
    
    
    (1,141
    )
    
    
    (1,121
    )Inventories  net
    
    
    1,782
    
    
    
    1,190Less: long-term inventory (a)
    
    
    368
    
    
    
    223Current inventories  net
    
    $
    1,414
    
    
    $
    967
 (a)
    
    Includes long-term portion of inventory related to deferred costs discussed below which
is included in other assets.
  Finished goods inventory includes certain direct and incremental costs associated with
arrangements where title and risk of loss was transferred to the customer but revenue
was deferred due to other revenue recognition criteria not being met. As of December 31, 2004
and 2003, these deferred costs totalled $829 and $432, respectively.  Other current assets: 2004
    
    
    2003Prepaid expenses
    
    $
    175
    
    
    $
    176Income taxes recoverable
    
    
    38
    
    
    
    90Current assets of discontinued operations (note 18)
    
    
    14
    
    
    
    28Other
    
    
    128
    
    
    
    110Other current assets
    
    $
    355
    
    
    $
    404
 F-22




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Plant and equipment  net: 2004
    
    
    2003Cost:Land
    
    $
    63
    
    
    $
    63Buildings
    
    
    1,514
    
    
    
    1,483Machinery and equipment
    
    
    2,481
    
    
    
    2,7054,058
    
    
    
    4,251Less accumulated depreciation:Buildings
    
    
    (502
    )
    
    
    (457
    )Machinery and equipment
    
    
    (1,910
    )
    
    
    (2,140
    )(2,412
    )
    
    
    (2,597
    )Plant and equipment  net (a)
    
    $
    1,646
    
    
    $
    1,654
 (a)
    
    Included assets held for sale with a carrying value of $29 and $30 as of December 31,
2004 and 2003, 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 downs were included in special charges. Nortel expects to
dispose of all of these facilities during 2005.
  Goodwill:  The following table outlines goodwill by reportable segment: Wireless
    
    
    Enterprise
    
    
    Wireline
    
    
    OpticalNetworks
    
    
    Networks
    
    
    Networks
    
    
    Networks
    
    
    Other
    
    
    TotalBalance  net as of December 31, 2002
    
    $
    21
    
    
    $
    1,519
    
    
    $
    479
    
    
    $
    
    
    
    $
    
    
    
    $
    2,019Change:Additions (note 9)
    
    
    13
    
    
    
    31
    
    
    
    43
    
    
    
    9
    
    
    
    
    
    
    
    96Foreign exchange
    
    
    1
    
    
    
    5
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    10Balance  net as of December 31, 2003
    
    
    35
    
    
    
    1,555
    
    
    
    526
    
    
    
    9
    
    
    
    
    
    
    
    2,125Change:Disposal
    
    
    
    
    
    
    
    
    
    
    (13
    )
    
    
    
    
    
    
    
    
    
    
    (13
    )Foreign exchange
    
    
    2
    
    
    
    3
    
    
    
    5
    
    
    
    1
    
    
    
    
    
    
    
    11Balance  net as of December 31, 2004
    
    $
    37
    
    
    $
    1,558
    
    
    $
    518
    
    
    $
    10
    
    
    $
    
    
    
    $
    2,123
  During each of the years ended December 31, 2004 and 2003, Nortel performed its annual
goodwill impairment test in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets (SFAS 142) and concluded that there was no impairment.  Intangible assets  net: 2004
    
    
    2003Other intangible assets (a)
    
    $
    38
    
    
    $
    44Pension intangible assets (note 8)
    
    
    40
    
    
    
    42Intangible assets  net (a)
    
    $
    78
    
    
    $
    86
 (a)
    
    Other intangible assets are being amortized over a ten year period ending in 2013.
Amortization expense for the next five years commencing in 2005 is expected to be $6, $5,
$5, $4 and $4, respectively. The amortization expense is denominated in a foreign currency
and may fluctuate due to changes in foreign exchange rates.
 F-23




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Other accrued liabilities: 2004
    
    
    2003Outsourcing and selling, general and administrative related provisions
    
    $
    321
    
    
    $
    298Customer deposits
    
    
    28
    
    
    
    73Product related provisions
    
    
    57
    
    
    
    120Warranty provisions (note 12)
    
    
    271
    
    
    
    382Deferred revenue
    
    
    1,210
    
    
    
    761Miscellaneous taxes
    
    
    52
    
    
    
    75Income taxes payable
    
    
    110
    
    
    
    110Current liabilities of discontinued operations (note 18)
    
    
    
    
    
    
    6Interest payable
    
    
    40
    
    
    
    37Advance billings in excess of revenues recognized to date on contracts
    
    
    581
    
    
    
    509Other
    
    
    118
    
    
    
    96Other accrued liabilities
    
    $
    2,788
    
    
    $
    2,467
  Other liabilities: 2004
    
    
    2003Pension,
post-employment and post-retirement benefits liabilities
    
    $
    2,208
    
    
    $
    1,973Restructuring liabilities (note 6)
    
    
    209
    
    
    
    314Deferred revenue
    
    
    573
    
    
    
    482Other long-term provisions
    
    
    199
    
    
    
    175Other liabilities
    
    $
    3,189
    
    
    $
    2,944
  Consolidated statements of cash flows  Change in operating assets and liabilities: 2004
    
    
    2003
    
    
    2002Restricted cash and cash equivalents
    
    $
    (17
    )
    
    $
    200
    
    
    $
    (231
    )Accounts receivable  net
    
    
    (182
    )
    
    
    (302
    )
    
    
    937Inventories  net
    
    
    (592
    )
    
    
    437
    
    
    
    969Income taxes
    
    
    (63
    )
    
    
    25
    
    
    
    1,249Restructuring liabilities
    
    
    (254
    )
    
    
    (551
    )
    
    
    (1,084
    )Accounts payable, payroll and contractual liabilities
    
    
    223
    
    
    
    (479
    )
    
    
    (1,591
    )Other operating assets and liabilities
    
    
    (12
    )
    
    
    (196
    )
    
    
    (596
    )Change in operating assets and liabilities
    
    $
    (897
    )
    
    $
    (866
    )
    
    $
    (347
    )
  Cash and cash equivalents: 2004
    
    
    2003
    
    
    2002Cash on hand and balances with banks
    
    $
    733
    
    
    $
    729
    
    
    $
    902Short-term investments
    
    
    2,874
    
    
    
    3,199
    
    
    
    2,840Cash and cash equivalents at end of year
    
    $
    3,607
    
    
    $
    3,928
    
    
    $
    3,742
 F-24




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Acquisitions of investments and businesses  net of cash acquired: 2004
    
    
    2003
    
    
    2002Cash acquired
    
    $
    (6
    )
    
    $
    (12
    )
    
    $
    Total net assets acquired other than cash
    
    
    (5
    )
    
    
    (163
    )
    
    
    (29
    )Total purchase price
    
    
    (11
    )
    
    
    (175
    )
    
    
    (29
    )Less:Cash acquired
    
    
    6
    
    
    
    12
    
    
    
    Non-cash consideration paid other than common share options
and contingent consideration
    
    
    
    
    
    
    105
    
    
    
    Acquisitions of investments and businesses  net of cash acquired
    
    $
    (5
    )
    
    $
    (58
    )
    
    $
    (29
    )
  Interest and taxes paid (recovered): 2004
    
    
    2003
    
    
    2002Cash interest paid
    
    $
    110
    
    
    $
    110
    
    
    $
    201Cash taxes paid (recovered)  net (a)
    
    $
    40
    
    
    $
    2
    
    
    $
    (1,218
    )
 (a)
    
    During the year ended December 31, 2004, Nortel paid Canadian tax on preferred
dividends of $12. This amount is included in the $33 of dividends on preferred shares in
the consolidated statement of cash flows.
  5.
    
    Segment information  General description  During 2004, Nortels operations were organized into four reportable segments consisting of
Wireless Networks, Enterprise Networks, Wireline Networks and Optical Networks. Wireless
Networks included 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 and related professional services. Enterprise Networks included circuit and
packet voice solutions, data networking and security solutions and the related professional
services used by enterprise customers. Wireline Networks included circuit and packet voice
solutions, data networking and security solutions and the related professional services used by
service provider customers. Optical Networks included metropolitan, regional and long-haul
optical transport and switching solutions and managed broadband services and related
professional services for both service provider and enterprise customers.Other represented miscellaneous business activities and corporate functions. None of these
activities meet the quantitative criteria to be disclosed as reportable segments. As described
in note 18, Nortels access solutions operations were discontinued during the year ended
December 31, 2001. These operations were previously included as a separate business activity
within other. The data below excludes amounts related to the access solutions operations.Effective October 1, 2004, Nortel established a new streamlined organizational structure that
included, among other things, combining the businesses of Nortels four reportable segments into
two business organizations: (i) Carrier Networks and Global Operations, and (ii) Enterprise
Networks. Nortel has reviewed the impact of these changes on its reportable segments and
concluded that, although certain structural changes were made to reflect this reorganization
effective October 1, 2004, Nortel did not meet the criteria to change its reportable segments
under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information for the
2004 fiscal year. Nortels operating results on a segmented basis for the new business
organizations were not available for review by the chief operating decision maker (CODM), as a
significant amount of Nortels finance resources were allocated to the restatement activity that
was completed during January 2005.Nortels two business organizations include four operating segments. The four operating
segments are Carrier Packet Networks, which is substantially an amalgamation of Nortels
previous Wireline Networks and Optical Networks businesses; CDMA Networks, which was previously
part of Wireless Networks; GSM and UMTS Networks which was also previously part of Wireless
Networks; and Enterprise Networks, which remains substantially
unchanged from the previous organization. For the first quarter of 2005 these four operating segments will become Nortels
reportable segments. F-25




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##### Table of Contents



Nortels chief executive officer (the CEO) has been identified as the CODM in assessing the
performance of the segments and the allocation of resources to the segments. In 2004, each
reportable segment was managed separately with each segment manager reporting directly or
indirectly to the CEO. The CEO relies on the information derived directly from Nortels
management reporting system. Commencing in the second quarter of 2004, in conjunction with the
appointment of William A. Owens as Nortels president and CEO, the primary financial measure
used by the CEO in assessing performance and allocating resources to the segments is management
earnings (loss) before income taxes (Management EBT), a measure that includes the cost of
revenues and SG&A expense, R&D expense, interest expense, other income (expense)  net, minority
interests  net of tax and equity in net loss of associated companies  net of tax. This
primary financial measure replaced contribution margin, the previously disclosed primary
financial measure used for earlier periods. Contribution margin differs from Management EBT in
that it excludes R&D expense, interest expense, other income (expense)  net, minority interests
  net of tax and equity in net loss of associated companies  net of tax.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s 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. The accounting policies of the
reportable segments are the same as those applied to the consolidated financial statements.  Segments  The following tables set forth information by segment for the years ended December 31: 2004
    
    
    2003
    
    
    2002RevenuesWireless Networks
    
    $
    4,839
    
    
    $
    4,389
    
    
    $
    4,161Enterprise Networks
    
    
    2,354
    
    
    
    2,589
    
    
    
    2,415Wireline Networks
    
    
    1,723
    
    
    
    2,005
    
    
    
    2,572Optical Networks
    
    
    906
    
    
    
    1,179
    
    
    
    1,815Other
    
    
    6
    
    
    
    31
    
    
    
    31Total
    
    $
    9,828
    
    
    $
    10,193
    
    
    $
    10,994Management EBTWireless Networks
    
    $
    554
    
    
    $
    695
    
    
    $
    256Enterprise Networks
    
    
    199
    
    
    
    317
    
    
    
    54Wireline Networks
    
    
    (31
    )
    
    
    170
    
    
    
    185Optical Networks
    
    
    (202
    )
    
    
    (258
    )
    
    
    (1,227
    )Other
    
    
    (399
    )
    
    
    (243
    )
    
    
    (232
    )Total
    
    
    121
    
    
    
    681
    
    
    
    (964
    )Amortization of intangibles
    
    
    (10
    )
    
    
    (3
    )
    
    
    (19
    )Special charges
    
    
    (180
    )
    
    
    (285
    )
    
    
    (1,622
    )Gain (loss) on sale of businesses and assets
    
    
    98
    
    
    
    4
    
    
    
    4Income tax benefit (expense)
    
    
    29
    
    
    
    33
    
    
    
    438Net earnings (loss) from continuing operations
    
    $
    58
    
    
    $
    430
    
    
    $
    (2,163
    )
 F-26




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##### Table of Contents



Product revenues  The following table sets forth external revenues by product for the years ended December
31: 2004
    
    
    2003
    
    
    2002Wireless solutions
    
    $
    4,839
    
    
    $
    4,389
    
    
    $
    4,161Circuit and packet voice solutions
    
    
    2,657
    
    
    
    3,044
    
    
    
    3,193Optical solutions
    
    
    906
    
    
    
    1,179
    
    
    
    1,815Data networking and security solutions
    
    
    1,420
    
    
    
    1,550
    
    
    
    1,794Other
    
    
    6
    
    
    
    31
    
    
    
    31Total
    
    $
    9,828
    
    
    $
    10,193
    
    
    $
    10,994
  During the years ended December 31, 2004, 2003 and 2002, no customers had revenues greater
than 10 percent of consolidated revenues.  Geographic information  The following table sets forth external revenues by geographic region based on the location
of the customer for the years ended December 31: 2004
    
    
    2003
    
    
    2002U.S.
    
    $
    4,833
    
    
    $
    5,424
    
    
    $
    5,809Europe, Middle East and Africa (EMEA)
    
    
    2,580
    
    
    
    2,366
    
    
    
    2,500Canada
    
    
    568
    
    
    
    587
    
    
    
    648Other regions (a)
    
    
    1,847
    
    
    
    1,816
    
    
    
    2,037Total
    
    $
    9,828
    
    
    $
    10,193
    
    
    $
    10,994
 (a)
    
    The Asia Pacific, and Caribbean and Latin America (CALA) regions.
  Long-lived assets  The following table sets forth long-lived assets representing plant and equipment  net,
goodwill and other intangible assets  net by geographic region as of December 31: 2004
    
    
    2003U.S.
    
    $
    2,404
    
    
    $
    2,466EMEA
    
    
    613
    
    
    
    616Canada
    
    
    743
    
    
    
    683Other regions (a)
    
    
    87
    
    
    
    100Total
    
    $
    3,847
    
    
    $
    3,865
 (a)
    
    The Asia Pacific and CALA regions.
  6.
    
    Special charges  During 2001, Nortel implemented a work plan to streamline operations and activities around
core markets and leadership strategies in light of the significant downturn in both the
telecommunications industry and the economic environment, and capital market trends impacting
operations and expected future growth rates (the 2001 Restructuring Plan).  In addition, as described below, activities were initiated in 2003 to exit certain leased
facilities and leases for assets no longer used across all segments. The liabilities associated
with these activities were measured at fair value and recognized under SFAS 146. F-27




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##### Table of Contents



In 2004 and into 2005, Nortels focus is on managing each of its businesses based on financial
performance, the market and customer priorities. In the third quarter of 2004, Nortel announced
a strategic plan that includes a work plan involving focused workforce reductions, including a
voluntary retirement program, of approximately 3,250 employees, real estate optimization and
other cost containment actions such as reductions in information services costs, outsourced
services and other discretionary spending across all segments, but primarily in Wireline
Networks and Optical Networks (the 2004 Restructuring Plan). Nortel estimates charges to
earnings associated with the 2004 Restructuring Plan in the aggregate of approximately $450
comprised of approximately $220 with respect to the workforce reductions and approximately $230
with respect to the real estate actions. No charges are expected to be recorded with respect to
the other cost containment actions. Approximately one-third of the aggregate charges were
incurred in 2004 with the remainder expected to be incurred in 2005.During the years ended December 31, 2004, 2003 and 2002, Nortel continued to implement these
restructuring work plans. Special charges recorded from January 1, 2002 to December 31, 2004
were as follows: Contract
    
    
    
    
    
    
    
    
    
    
    Intangiblesettlement
    
    
    Plant and
    
    
    
    
    
    
    assetWorkforce
    
    
    and lease
    
    
    equipment
    
    
    
    
    
    
    impair-reduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    ments
    
    
    Total2001 Restructuring PlanProvision balance as of January 1, 2002
    
    $
    279
    
    
    $
    677
    
    
    $
    
    
    
    $
    29
    
    
    $
    
    
    
    $
    985Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    264
    
    
    
    264Other special charges
    
    
    928
    
    
    
    210
    
    
    
    383
    
    
    
    
    
    
    
    
    
    
    
    1,521Revisions to prior accruals
    
    
    (126
    )
    
    
    18
    
    
    
    (55
    )
    
    
    
    
    
    
    
    
    
    
    (163
    )Cash drawdowns
    
    
    (778
    )
    
    
    (286
    )
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    (1,084
    )Non-cash drawdowns
    
    
    (100
    )
    
    
    
    
    
    
    (328
    )
    
    
    
    
    
    
    (264
    )
    
    
    (692
    )Foreign exchange and other adjustments
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Provision balance as of December 31, 2002
    
    $
    204
    
    
    $
    620
    
    
    $
    
    
    
    $
    9
    
    
    $
    
    
    
    $
    833Other special charges
    
    
    198
    
    
    
    63
    
    
    
    74
    
    
    
    
    
    
    
    
    
    
    
    335Revisions to prior accruals
    
    
    (42
    )
    
    
    20
    
    
    
    (28
    )
    
    
    
    
    
    
    
    
    
    
    (50
    )Cash drawdowns
    
    
    (267
    )
    
    
    (275
    )
    
    
    
    
    
    
    (9
    )
    
    
    
    
    
    
    (551
    )Non-cash drawdowns
    
    
    (41
    )
    
    
    
    
    
    
    (46
    )
    
    
    
    
    
    
    
    
    
    
    (87
    )Foreign exchange and other adjustments
    
    
    12
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39Provision balance as of December 31, 2003
    
    $
    64
    
    
    $
    455
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    519Other special charges
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Revisions to prior accruals
    
    
    (4
    )
    
    
    16
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    14Cash drawdowns
    
    
    (49
    )
    
    
    (167
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (216
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Foreign exchange and other adjustments
    
    
    (2
    )
    
    
    22
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20Provision balance as of December 31, 2004
    
    $
    15
    
    
    $
    326
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    3412004 Restructuring PlanOther special charges
    
    
    158
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    160Cash drawdowns
    
    
    (38
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (38
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Foreign exchange and other adjustments
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Provision balance as of December 31, 2004
    
    $
    122
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    122Total provision balance as of December 31, 2004(a)
    
    $
    137
    
    
    $
    326
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    463
 (a)
    
    As of December 31, 2004 and 2003, the short-term provision balance was $254 and $205,
respectively, and the long-term provision balance was $209 and $314, respectively.
 F-28




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##### Table of Contents



Regular full-time (RFT) employee notifications resulting in special charges for both
restructuring plans were as follows: Employees (approximate)Direct(a)
    
    
    Indirect(b)
    
    
    TotalRFT employee notifications by period:During 2002
    
    
    3,300
    
    
    
    8,800
    
    
    
    12,100During 2003
    
    
    400
    
    
    
    1,300
    
    
    
    1,700During 2004
    
    
    200
    
    
    
    1,700
    
    
    
    1,900RFT employee notifications for the three years ended December 31, 2004
    
    
    3,900
    
    
    
    11,800
    
    
    
    15,700
 (a)
    
    Direct employees included employees performing manufacturing, assembly, test and
inspection activities associated with the production of Nortels products.(b)
    
    Indirect employees included employees performing manufacturing, management, sales,
marketing, research and development and administrative activities.
  2001 Restructuring PlanYear ended December 31, 2004For the year ended December 31, 2004, Nortel recorded total special charges of $20, which
included revisions of $14 related to prior accruals.Workforce reduction charges of $6 were related to severance and benefit costs associated
with approximately 80 employees notified of termination. The workforce reduction occurred in
Canada and related entirely to Optical Networks. Offsetting these charges were revisions to
prior accruals of $4 which were primarily related to termination benefits where actual costs
were lower than the estimated amounts across all segments. During 2004, the workforce reduction
provision balance was drawn down by cash payments of $49. The remaining provision is expected
to be substantially drawn down by the end of 2005.No new contract settlement and lease costs were incurred during 2004. Revisions to prior
accruals of $16 resulted primarily from changes in estimates for sublease income and costs to
vacate certain properties, across all segments. During 2004, the provision balance for contract
settlement and lease costs was drawn down by cash payments of $167. The remaining provision,
net of approximately $248 in estimated sublease income, is expected to be substantially drawn
down by the end of 2013.No new plant and equipment charges were incurred during 2004. Revisions of $2 to prior write
downs of assets held for sale related primarily to adjustments to original plans or estimated
amounts for certain facility closures.The table below summarizes the total costs estimated to be incurred as a result of the exit
activities initiated in 2003, which have met the criteria described in SFAS 146, the balance of
these accrued expenses as of December 31, 2004 and the movement in the accrual for the year
ended December 31, 2004. These costs are included in the provision balance above for the 2001
Restructuring Plan as of December 31, 2004. Accrued
    
    
    Costs
    
    
    Payments
    
    
    Adjustments
    
    
    Accruedbalance as
    
    
    incurred
    
    
    made
    
    
    made
    
    
    balance as ofof December 31,
    
    
    during
    
    
    during
    
    
    during
    
    
    December 31,2003
    
    
    2004
    
    
    2004
    
    
    2004
    
    
    2004Lease costs (a)
    
    $
    36
    
    
    $
    
    
    
    $
    (13
    )
    
    $
    8
    
    
    $
    31
 (a)
    
    Total estimated costs, net of estimated sublease income, associated with these accruals
are $69, of which $14 was drawn down by cash payments of $8 and non-cash adjustments of $6
prior to January 1, 2004.
 F-29




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##### Table of Contents



Year ended December 31, 2003For the year ended December 31, 2003, Nortel recorded total special charges of $285, which
were net of revisions of $50 related to prior accruals.Workforce reduction charges of $198 were related to severance and benefit costs associated
with approximately 1,700 employees notified of termination. The workforce reduction was
primarily in the U.S., Canada and EMEA and extended across all segments. Offsetting these
charges were revisions to prior accruals of $42 which were primarily related to termination
benefits where actual costs were lower than the estimated amounts across all segments. During
2003, the workforce reduction provision balance was drawn down by cash payments of $267 and by a
non-cash pension settlement loss of $41.Contract settlement and lease costs of $63 consisted of negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities (comprised of office,
warehouse and manufacturing space) and leased furniture that were identified as no longer
required across all segments. These lease costs, net of anticipated sublease income, included
non-cancelable lease terms from the date leased facilities ceased to be used and termination
penalties. In addition to these charges were revisions to prior accruals of $20 resulting
primarily from changes in estimates for sublease income and costs to vacate certain properties,
across all segments. During 2003, the provision balance for contract settlement and lease costs
was drawn down by cash payments of $275.Plant and equipment charges of $74 were largely related to current period write downs to fair
value less costs to sell for various leasehold improvements and excess Optical Networks
equipment held for sale. Offsetting these charges were revisions of $28 to prior write downs of
assets held for sale related primarily to adjustments to original plans or estimated amounts for
certain facility closures.Year ended December 31, 2002For the year ended December 31, 2002, Nortel recorded total special charges of $1,622,
which were net of revisions of $163 related to prior accruals.Workforce reduction charges of $928 were related to severance and benefit costs associated with
approximately 12,100 employees notified of termination. The workforce reduction was primarily
in the U.S., Canada and EMEA and extended across all segments. Offsetting these charges were
revisions to prior accruals of $126 which were primarily related to termination benefits where
actual costs were lower than the estimated amounts across all segments. Workforce reduction
charges included $124 for pension and post-retirement benefits other than pension, settlement
and curtailment costs. During 2002, the workforce reduction provision balance was drawn down by
cash payments of $778 and by $100 of non-cash pension and post-retirement benefits other than
pension, settlement and curtailment costs attributable to the notified employee group charged
against the provision.Contract settlement and lease costs of $210 consisted of negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities (comprised of office,
warehouse and manufacturing space) and leased manufacturing equipment that were no longer
required, across all segments. In addition to these charges were revisions to prior accruals of
$18 resulting primarily from changes in estimates for sublease income and costs to vacate
certain properties, across all segments. During the year ended December 31, 2002, the provision
balance for contract settlement and lease costs was drawn down by cash payments of $286. The
remaining provision balance was net of approximately $402 in estimated sublease income.Plant and equipment charges of $383 were related to current period write downs to fair value
less costs to sell for various owned facilities and plant and manufacturing related equipment.
These charges for facilities and equipment included $283 related to the Optical Networks segment
with the remaining charges arising across all segments. Within Optical Networks, Nortel
performed assessments of certain plant and equipment due to the then current market conditions
and the delay in the anticipated recovery of that segment and concluded that the asset carrying
values were not fully recoverable from estimated future cash flows. As a result, Nortel recorded
a charge to income of $266 to write down the value of specialized plant infrastructure and
equipment within Optical Networks to its fair value less costs to sell. Included in the $266
write down was $34 related to equipment held for sale, which was part of the Bookham Technology
plc (Bookham) transaction (see note 9). F-30




---



##### Table of Contents



Fair value was determined using quoted market prices or the anticipated cash flows discounted at
a rate commensurate with the risks involved. Offsetting these charges were revisions of $55 to
prior write downs of assets held for sale related primarily to additional proceeds from
disposals of equipment from Optical Networks and other segments in excess of amounts previously
expected and adjustments to original plans or estimated amounts for certain facility closures
across all segments.Goodwill impairment charges were $264. As a result of the continued decline during 2002, in
both Nortels overall market value generally and within Optical Networks specifically, Nortel as
part of its review of financial results during the year ended December 31, 2002, 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 the businesses within
Optical Networks could no longer support the carrying value of the remaining goodwill associated
with them. As a result, Nortel recorded a goodwill impairment charge of $264. Fair value was
estimated using the then expected present value of discounted future cash flows of the
businesses within Optical Networks. The discount rate used ranged from 12 to 16 percent and the
terminal values were estimated based on terminal growth rates ranging from 3 to 5 percent. The
assumptions supporting the estimated future cash flows, including the discount rate and
estimated terminal values, reflected managements best estimates.2001 Restructuring Plan by SegmentThe following table outlines special charges incurred by segment for each of the three
years ended December 31: Contract
    
    
    
    
    
    
    Intangiblesettlement
    
    
    Plant and
    
    
    assetWorkforce
    
    
    and lease
    
    
    equipment
    
    
    impair-reduction
    
    
    costs
    
    
    write downs
    
    
    ments
    
    
    Total2001 Restructuring PlanWireless Networks
    
    $
    136
    
    
    $
    39
    
    
    $
    11
    
    
    $
    
    
    
    $
    186Enterprise Networks
    
    
    144
    
    
    
    41
    
    
    
    11
    
    
    
    
    
    
    
    196Wireline Networks
    
    
    185
    
    
    
    52
    
    
    
    14
    
    
    
    
    
    
    
    251Optical Networks
    
    
    225
    
    
    
    64
    
    
    
    283
    
    
    
    264
    
    
    
    836Other
    
    
    112
    
    
    
    32
    
    
    
    9
    
    
    
    
    
    
    
    153Total special charges for the
year ended December 31, 2002
    
    $
    802
    
    
    $
    228
    
    
    $
    328
    
    
    $
    264
    
    
    $
    1,622Wireless Networks
    
    $
    48
    
    
    $
    26
    
    
    $
    9
    
    
    $
    
    
    
    $
    83Enterprise Networks
    
    
    31
    
    
    
    17
    
    
    
    6
    
    
    
    
    
    
    
    54Wireline Networks
    
    
    36
    
    
    
    19
    
    
    
    7
    
    
    
    
    
    
    
    62Optical Networks
    
    
    25
    
    
    
    13
    
    
    
    21
    
    
    
    
    
    
    
    59Other
    
    
    16
    
    
    
    8
    
    
    
    3
    
    
    
    
    
    
    
    27Total special charges for the
year ended December 31, 2003
    
    $
    156
    
    
    $
    83
    
    
    $
    46
    
    
    $
    
    
    
    $
    285Wireless Networks
    
    $
    (1
    )
    
    $
    5
    
    
    $
    1
    
    
    $
    
    
    
    $
    5Enterprise Networks
    
    
    (1
    )
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    2Wireline Networks
    
    
    (1
    )
    
    
    4
    
    
    
    1
    
    
    
    
    
    
    
    4Optical Networks
    
    
    5
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    8Other
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Total special charges for the
year ended December 31, 2004
    
    $
    2
    
    
    $
    16
    
    
    $
    2
    
    
    $
    
    
    
    $
    20
  As described in note 5, segment management EBT does not include special charges. A
significant portion of Nortels provisions for workforce reductions and contract settlement and
lease costs are associated with shared services. These costs have been allocated to the segments
in the table above based generally on headcount. F-31




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##### Table of Contents



2004 Restructuring PlanYear ended December 31, 2004For the year ended December 31, 2004, Nortel recorded total special charges of $160.Workforce reduction charges of $158 were related to severance and benefit costs associated with
approximately 1,850 employees, of which 1,800 had been notified of termination during the year.
The remaining charge related to termination benefits attributable to ongoing employee benefit
arrangements. The workforce reduction was primarily in the U.S., Canada and EMEA and extended
across all segments as follows: Year endedDecember 31,2004Wireless Networks
    
    $
    35Enterprise Networks
    
    
    24Wireline Networks
    
    
    63Optical Networks
    
    
    17Other
    
    
    19Total workforce reduction charge
    
    $
    158
  During the year ended December 31, 2004, the workforce reduction provision balance was
drawn down by cash payments of $38. The remaining provision is expected to be substantially
drawn down by the end of 2005.Plant and equipment charges of $2 were related to current period write downs to fair value less
costs to sell for various leasehold improvements and excess equipment held for sale.7.
    
    Income taxesAs of December 31, 2004, Nortels net deferred tax assets, excluding discontinued
operations, were $3,848, reflecting temporary differences between the financial reporting and
tax treatment of certain current assets and liabilities and non-current assets and liabilities,
in addition to the tax benefit of net operating and capital loss carryforwards and tax credit
carryforwards.In accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109), Nortel reviews all
available positive and negative evidence to evaluate the recoverability of the deferred tax
assets. This includes a review of such evidence as the carryforward periods of the significant
tax assets, Nortels history of generating taxable income in its material tax jurisdictions and
Nortels cumulative consolidated loss position.Based on this review, Nortel concluded that it was more likely than not that the remaining net
deferred tax assets would be realized. Nortel continues to review all available positive and
negative evidence on a jurisdictional basis and Nortels valuation allowance may need to be
adjusted in the future as a result of this ongoing review.Nortel is subject to ongoing examinations by certain taxation authorities of the
jurisdictions in which it operates. Nortel regularly assesses the status of these examinations
and the potential for adverse outcomes to determine the adequacy of the provision for income and
other taxes. Nortel believes that it has adequately provided for tax adjustments that are
probable as a result of any ongoing or future examination.Specifically, the tax authorities in Brazil have recently completed an examination of a prior
taxation year and have issued an assessment in the amount of $56. Nortel is currently in the
process of appealing this assessment and believes that it has adequately provided for tax
adjustments that are probable as a result of the outcome of the ongoing appeals process.In addition, tax authorities in France have recently begun examinations of a prior taxation year
and have issued a preliminary notice of proposed assessment for a material amount. No amount
has been provided for this assessment since Nortel believes that this proposed assessment is without merit and any potential tax
adjustments that could result from this ongoing examination cannot be quantified at this time. F-32




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##### Table of Contents



Nortel had previously entered into Advance Pricing Arrangements (APAs) with the taxation
authorities of the U.S. and Canada in connection with its intercompany transfer pricing and cost
sharing arrangements between Canada and the U.S. These arrangements expired in 1999 and 2000.
In 2002, Nortel filed APA requests with the taxation authorities of the U.S., Canada and the
United Kingdom (U.K.) that are expected to apply to the taxation years beginning in 2000. The
APA requests are currently under consideration but the tax authorities have not begun to
negotiate the terms of the arrangements. Nortel has applied the transfer pricing methodology
proposed in the APA requests since 2001. As part of the APA applications, Nortel has requested
that the methodology adopted in 2001 be applied retroactively to the 2000 taxation year. If the
retroactive application is accepted by the taxation authorities, it would result in an increase
in taxable income in certain jurisdictions offset by an equal decrease in taxable income in the
other jurisdictions. Nortel has provided for any taxes and interest that would be due as a
result of retroactive application of the APAs.Although the outcome of the APA applications are uncertain, Nortel does not believe it is
probable that the ultimate resolution of these negotiations will have a material adverse effect
on its consolidated financial position, results of operations or cash flows. Despite Nortels
current belief, if this matter is resolved unfavorably, it could have a material adverse effect
on Nortels consolidated financial position, results of operations or cash flows. F-33




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##### Table of Contents



The following is a reconciliation of income taxes, calculated at the Canadian combined federal
and provincial income tax rate, to the income tax benefit (expense) included in the consolidated
statements of operations for each of the years ended December 31: 2004
    
    
    2003
    
    
    2002Income taxes
at Canadian rates (2004  33.3%, 2003  35.8%, 2002  39.4%)
    
    $
    (14
    )
    
    $
    (165
    )
    
    $
    1,031Reduction of Canadian taxes applicable to manufacturing profits
    
    
    
    
    
    
    
    
    
    
    (55
    )Difference between Canadian rate and rates applicable to subsidiaries in the U.S. and other jurisdictions
    
    
    (4
    )
    
    
    (25
    )
    
    
    (30
    )Difference between basic Canadian rate and rates applicable to gain (loss) on sale of businesses
    
    
    
    
    
    
    
    
    
    
    2Non-deductible amortization of acquired intangibles
    
    
    
    
    
    
    
    
    
    
    (90
    )Valuation allowances on tax benefits
    
    
    (127
    )
    
    
    68
    
    
    
    (511
    )Utilization of losses
    
    
    2
    
    
    
    86
    
    
    
    65Tax benefit of investment tax credits, net of valuation allowance
    
    
    43
    
    
    
    41
    
    
    
    76Adjustments to provisions and reserves
    
    
    25
    
    
    
    29
    
    
    
    23Foreign witholding and other taxes
    
    
    (14
    )
    
    
    (13
    )
    
    
    (2
    )Corporate minimum taxes
    
    
    (8
    )
    
    
    (8
    )
    
    
    (14
    )Impact of non-taxable/(non-deductible) items and other differences
    
    
    126
    
    
    
    20
    
    
    
    (57
    )Income tax benefit (expense)
    
    $
    29
    
    
    $
    33
    
    
    $
    438Details of Nortels income (loss):Earnings (loss) from continuing operations before income taxes, minority
interests and equity in net loss of associated companies:Canadian, excluding gain (loss) on sale of businesses and assets
    
    $
    (136
    )
    
    $
    (82
    )
    
    $
    (1,050
    )U.S. and other, excluding gain (loss) on sale of businesses and assets
    
    
    80
    
    
    
    539
    
    
    
    (1,570
    )Gain (loss) on sale of businesses and assets
    
    
    98
    
    
    
    4
    
    
    
    4$
    42
    
    
    $
    461
    
    
    $
    (2,616
    )Income tax benefit (expense):Canadian, excluding gain (loss) on sale of businesses and assets
    
    $
    16
    
    
    $
    184
    
    
    $
    121U.S. and other, excluding gain (loss) on sale of businesses and assets
    
    
    13
    
    
    
    (151
    )
    
    
    318Gain (loss) on sale of businesses and assets
    
    
    
    
    
    
    
    
    
    
    (1
    )$
    29
    
    
    $
    33
    
    
    $
    438Income tax benefit (expense):Current
    
    $
    (16
    )
    
    $
    25
    
    
    $
    33Deferred
    
    
    45
    
    
    
    8
    
    
    
    405Income tax benefit (expense)
    
    $
    29
    
    
    $
    33
    
    
    $
    438
 F-34




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##### Table of Contents



The following table shows the significant components included in deferred income taxes as
of December 31:Deferred income taxes 2004
    
    
    2003Assets:Tax benefit of loss carryforwards and tax credits
    
    $
    5,850
    
    
    $
    5,428Provisions and reserves
    
    
    606
    
    
    
    711Post-retirement benefits other than pensions
    
    
    255
    
    
    
    234Plant and equipment
    
    
    133
    
    
    
    122Pension plan liabilities
    
    
    442
    
    
    
    433Deferred compensation
    
    
    208
    
    
    
    2777,494
    
    
    
    7,205Valuation allowance
    
    
    (3,395
    )
    
    
    (3,108
    )4,099
    
    
    
    4,097Liabilities:Provisions and reserves
    
    
    156
    
    
    
    341Plant and equipment
    
    
    
    
    
    
    48Unrealized foreign exchange and other
    
    
    95
    
    
    
    132251
    
    
    
    521Net deferred income tax assets
    
    $
    3,848
    
    
    $
    3,576
  Nortel has not provided for foreign withholding taxes or deferred income tax liabilities
for temporary differences related to the undistributed earnings of foreign subsidiaries since
Nortel does not currently expect to repatriate these earnings. It is not practical to
reasonably estimate the amount of additional deferred income tax liabilities or foreign
withholding taxes that may be payable should these earnings be distributed in the future.As of December 31, 2004, Nortel had the following net operating and capital loss carryforwards
and tax credits which are scheduled to expire in the following years: Netoperating
    
    
    Capital
    
    
    Taxlosses
    
    
    losses(a)
    
    
    credits(b)
    
    
    Total2005 - 2007
    
    $
    103
    
    
    $
    
    
    
    $
    299
    
    
    $
    4022008 - 2010
    
    
    2,480
    
    
    
    
    
    
    
    551
    
    
    
    3,0312011 - 2017
    
    
    597
    
    
    
    50
    
    
    
    426
    
    
    
    1,0732018 - 2024
    
    
    3,011
    
    
    
    
    
    
    
    231
    
    
    
    3,242Indefinitely
    
    
    2,128
    
    
    
    4,933
    
    
    
    36
    
    
    
    7,097$
    8,319
    
    
    $
    4,983
    
    
    $
    1,543
    
    
    $
    14,845
 (a)
    
    The capital losses related primarily to the U.K. and may only be used to offset future
capital gains. Nortel has recorded a full valuation allowance against this future tax
benefit.(b)
    
    Global investment tax credits of $43, $41 and $76 have been applied against the income
tax provision in 2004, 2003 and 2002, respectively. Unused tax credits can be utilized to
offset deferred taxes payable primarily in Canada.
 F-35




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##### Table of Contents



8.
    
    Employee benefit plansNortel maintains various retirement programs covering substantially all of its employees,
consisting of defined benefit, defined contribution and investment plans.Nortel has four kinds of capital accumulation and retirement programs: balanced capital
accumulation and retirement programs (the Balanced Program) and investor capital accumulation
and retirement programs (the Investor Program) available to substantially all of its North
American employees; flexible benefits plan, which includes a group personal pension plan (the
Flexible Benefits Plan), available to substantially all of its employees in the U.K.; and
traditional capital accumulation and retirement programs that include defined benefit pension
plans (the Traditional Program) which are closed to new entrants in the U.K. and portions of
which are closed to new entrants in the U.S. and Canada. Although these four kinds of programs
represent Nortels major retirement programs and may be available to employees in combination
and/or as options within a program, Nortel also has smaller pension plan arrangements in other
countries.Nortel also provides other benefits, including post-retirement benefits and post-employment
benefits. Employees in the Traditional Program are eligible for their existing company
sponsored post-retirement benefits or a modified version of these benefits, depending on age or
years of service. Employees in the Balanced Program are eligible for post-retirement benefits
at reduced company contribution levels, while employees in the Investor Program have access to
post-retirement benefits by purchasing a Nortel-sponsored retiree health care plan at their own
cost.Nortels policy is to fund defined benefit pension and other benefits based on accepted
actuarial methods as permitted by regulatory authorities. The funded amounts reflect actuarial
assumptions regarding compensation, interest and other projections. Pension and other benefit
costs reflected in the consolidated statements of operations are based on the projected benefit
method of valuation. A measurement date of September 30 is used annually to determine pension
and other post-retirement benefit measurements for the pension plans and other post-retirement
benefit plans that make up the majority of plan assets and obligations.In 2004, the impact of reductions in discount rates and changes in foreign exchange rates more
than offset the favorable impacts of strong pension asset returns and the voluntary
contributions made by Nortel. As a result, Nortel was required to adjust the minimum pension
liability for certain plans, representing the amount by which the accumulated benefit obligation
less the fair value of the plan assets was greater than the recorded liability. The effect of
this adjustment and the related foreign currency translation adjustment was to increase
accumulated other comprehensive loss (before tax) by $121, decrease intangible assets by $2 and
increase pension liabilities by $119. F-36




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##### Table of Contents



The following details the unfunded status of the defined benefit plans and post-retirement
benefits other than pensions, and the associated amounts recognized in the consolidated balance
sheets as of December 31: Defined benefit plans
    
    
    Post-retirement benefits2004
    
    
    2003
    
    
    2004
    
    
    2003Change in benefit obligation:Benefit obligation  beginning
    
    $
    7,355
    
    
    $
    6,187
    
    
    $
    754
    
    
    $
    568Service cost
    
    
    119
    
    
    
    118
    
    
    
    9
    
    
    
    9Interest cost
    
    
    421
    
    
    
    401
    
    
    
    43
    
    
    
    40Plan participants contributions
    
    
    8
    
    
    
    7
    
    
    
    8
    
    
    
    3Plan amendments
    
    
    1
    
    
    
    5
    
    
    
    (22
    )
    
    
    Actuarial loss (gain)
    
    
    403
    
    
    
    362
    
    
    
    (57
    )
    
    
    106Divestitures/settlements
    
    
    
    
    
    
    (123
    )
    
    
    
    
    
    
    Special termination benefits
    
    
    2
    
    
    
    7
    
    
    
    
    
    
    
    Benefits paid
    
    
    (503
    )
    
    
    (459
    )
    
    
    (43
    )
    
    
    (37
    )Foreign exchange
    
    
    479
    
    
    
    850
    
    
    
    27
    
    
    
    65Benefit obligation  ending
    
    $
    8,285
    
    
    $
    7,355
    
    
    $
    719
    
    
    $
    754Change in plan assets:Fair value of plan assets  beginning
    
    $
    5,415
    
    
    $
    4,386
    
    
    $
    50
    
    
    $
    41Actual return on plan assets
    
    
    542
    
    
    
    626
    
    
    
    2
    
    
    
    3Employer contributions
    
    
    281
    
    
    
    392
    
    
    
    31
    
    
    
    31Plan participants contributions
    
    
    8
    
    
    
    7
    
    
    
    8
    
    
    
    3Divestitures/settlements
    
    
    
    
    
    
    (170
    )
    
    
    
    
    
    
    Special termination benefits
    
    
    2
    
    
    
    7
    
    
    
    
    
    
    
    Benefits paid
    
    
    (503
    )
    
    
    (459
    )
    
    
    (43
    )
    
    
    (37
    )Foreign exchange
    
    
    360
    
    
    
    626
    
    
    
    3
    
    
    
    9Fair value of plan assets  ending
    
    $
    6,105
    
    
    $
    5,415
    
    
    $
    51
    
    
    $
    50Unfunded status of the plans
    
    $
    (2,180
    )
    
    $
    (1,940
    )
    
    $
    (668
    )
    
    $
    (704
    )Unrecognized net plan benefits existing atJanuary 1, 1987
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    Unrecognized prior service cost (credit)
    
    
    18
    
    
    
    20
    
    
    
    (48
    )
    
    
    (29
    )Unrecognized net actuarial losses (gain)
    
    
    1,977
    
    
    
    1,664
    
    
    
    50
    
    
    
    119Contributions after measurement date
    
    
    34
    
    
    
    108
    
    
    
    8
    
    
    
    3Net amount recognized
    
    $
    (151
    )
    
    $
    (149
    )
    
    $
    (658
    )
    
    $
    (611
    )Amounts recognized in the accompanying
consolidated balance sheets consist of:Other liabilities  long-term
    
    $
    (1,472
    )
    
    $
    (1,290
    )
    
    $
    (629
    )
    
    $
    (581
    )Other liabilities  current
    
    
    (92
    )
    
    
    (72
    )
    
    
    (29
    )
    
    
    (30
    )Intangible assets  net
    
    
    40
    
    
    
    42
    
    
    
    
    
    
    
    Other assets
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency translation adjustment
    
    
    231
    
    
    
    151
    
    
    
    
    
    
    
    Accumulated other comprehensive loss
    
    
    1,141
    
    
    
    1,020
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    (151
    )
    
    $
    (149
    )
    
    $
    (658
    )
    
    $
    (611
    )
  The following details selected information for defined benefit plans, all of which have
accumulated benefit obligations in excess of the fair value of plan assets as of December 31: 2004
    
    
    2003Projected benefit obligation
    
    $
    8,267
    
    
    $
    7,355Accumulated benefit obligation
    
    $
    7,666
    
    
    $
    6,797Fair value of plan assets
    
    $
    6,086
    
    
    $
    5,415
 F-37




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##### Table of Contents



The following details the net pension expense, all related to continuing operations, and
the underlying assumptions for the defined benefit plans for the years ended December 31: 2004
    
    
    2003
    
    
    2002Pension expense:Service cost
    
    $
    119
    
    
    $
    118
    
    
    $
    158Interest cost
    
    
    421
    
    
    
    401
    
    
    
    402Expected return on plan assets
    
    
    (411
    )
    
    
    (395
    )
    
    
    (417
    )Amortization of prior service cost
    
    
    4
    
    
    
    9
    
    
    
    7Amortization of net losses (gains)
    
    
    77
    
    
    
    50
    
    
    
    17Settlement losses (gains)
    
    
    
    
    
    
    41
    
    
    
    94Curtailment losses (gains)
    
    
    
    
    
    
    
    
    
    
    40Special termination benefits
    
    
    2
    
    
    
    7
    
    
    
    Net pension expense
    
    $
    212
    
    
    $
    231
    
    
    $
    301Weighted-average assumptions used to determine
benefit obligations as at December 31:Discount rate
    
    
    5.7
    %
    
    
    5.8
    %
    
    
    6.3
    %Rate of compensation increase
    
    
    4.5
    %
    
    
    4.2
    %
    
    
    4.2
    %Weighted-average assumptions used to determine
net pension expense for years ended December 31:Discount rate
    
    
    5.8
    %
    
    
    6.3
    %
    
    
    6.7
    %Expected rate of return on plan assets
    
    
    7.4
    %
    
    
    7.8
    %
    
    
    7.8
    %Rate of compensation increase
    
    
    4.2
    %
    
    
    4.2
    %
    
    
    4.2
    %
  The following details the amounts included within other comprehensive income (loss) for the
years ended December 31: Defined benefit plans2004
    
    
    2003Increase in minimum pension liability adjustment included in
other comprehensive income (loss)
    
    $
    121
    
    
    $
    219
 F-38




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##### Table of Contents



The following details the net cost components, all related to continuing operations, and
underlying assumptions of post-retirement benefits other than pensions for the years ended
December 31: 2004
    
    
    2003
    
    
    2002Post-retirement benefit cost:Service cost
    
    $
    9
    
    
    $
    9
    
    
    $
    10Interest cost
    
    
    43
    
    
    
    40
    
    
    
    37Expected return on plan assets
    
    
    (2
    )
    
    
    (3
    )
    
    
    (3
    )Amortization of net losses (gains)
    
    
    (1
    )
    
    
    (3
    )
    
    
    (3
    )Settlement and curtailment losses (gains)
    
    
    
    
    
    
    
    
    
    
    (9
    )Net post-retirement benefit cost
    
    $
    49
    
    
    $
    43
    
    
    $
    32Weighted-average assumptions used to determine
benefit obligations as at December 31:Discount rate
    
    
    5.9
    %
    
    
    6.0
    %
    
    
    6.8
    %Weighted-average assumptions used to determine
net post-retirement benefit cost for years ended December 31:Discount rate
    
    
    6.0
    %
    
    
    6.8
    %
    
    
    7.0
    %Expected rate of return on plan assets
    
    
    6.0
    %
    
    
    8.0
    %
    
    
    8.0
    %Weighted-average health care cost trend rate
    
    
    8.3
    %
    
    
    8.5
    %
    
    
    8.0
    %Weighted-average ultimate health care cost trend rate
    
    
    4.8
    %
    
    
    4.8
    %
    
    
    4.7
    %Year in which ultimate health care cost trend rate will be achieved
    
    
    2011
    
    
    2010
    
    
    2009
  Assumed health care cost trend rates have a significant effect on the amounts reported for
health care plans. A one percentage-point change in assumed health care cost trend rates would
have the following effects for the years ended December 31: 2004
    
    
    2003
    
    
    2002Effect on aggregate of service and interest costs1% increase
    
    $
    5
    
    
    $
    5
    
    
    $
    51% decrease
    
    $
    (4
    )
    
    $
    (4
    )
    
    $
    (4
    )Effect on accumulated post-retirement benefit obligations1% increase
    
    $
    67
    
    
    $
    66
    
    
    $
    571% decrease
    
    $
    (55
    )
    
    $
    (55
    )
    
    $
    (46
    )
  As of December 31, 2004, the expected benefit payments for the next ten years for the
defined benefit plans and the post-retirement benefits other than pensions are as follows, along
with the expected reimbursement amounts related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (the MPDIM Act): Expected MPDIM subsidyDefined benefit
    
    
    Post-retirement
    
    
    (post-retirementplans
    
    
    benefit plans
    
    
    benefit plans)2005
    
    $
    450
    
    
    $
    40
    
    
    $
    2006
    
    
    458
    
    
    
    42
    
    
    
    (1
    )2007
    
    
    471
    
    
    
    44
    
    
    
    (1
    )2008
    
    
    486
    
    
    
    45
    
    
    
    (1
    )2009
    
    
    501
    
    
    
    46
    
    
    
    (1
    )2010-2014
    
    
    2,805
    
    
    
    243
    
    
    
    (7
    )
 F-39




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##### Table of Contents



The target allocation percentages and the year-end percentages based on actual asset
balances of the defined benefit plans as of December 31 are as follows: 2004
    
    
    2003Target
    
    
    Actual
    
    
    Target
    
    
    ActualDebt instruments
    
    
    41
    %
    
    
    40
    %
    
    
    39
    %
    
    
    39
    %Equity securities
    
    
    59
    %
    
    
    59
    %
    
    
    61
    %
    
    
    61
    %Other
    
    
    0
    %
    
    
    1
    %
    
    
    0
    %
    
    
    0
    %
 The primary investment performance objective is to obtain competitive rates of return on
investments at or above their assigned benchmarks while minimizing risk and volatility by
maintaining an appropriately diversified portfolio. The benchmarks selected are
industry-standard and widely-accepted indices. The defined benefit plans maintain a long-term
perspective in regard to investment philosophy and return expectations which are reflective of
the fact that the liabilities of the defined benefit plans mature over an extended period of
time. The investments have risk characteristics consistent with underlying defined benefit plan
demographics and liquidity requirements, and are consistent and compliant with all regulatory
standards.The primary method of managing risk within the portfolio is through diversification among and
within asset categories, and through the utilization of a wide array of active and passive
investment managers. Broadly, the assets are allocated between debt and equity instruments.
Included within the debt instruments are government and corporate fixed income securities, money
market securities, mortgage-backed securities and inflation indexed securities. Generally,
these debt instruments are considered investment grade. Included in equity securities are
developed and emerging market stocks of companies at a variety of capitalization levels. The
securities are predominantly publicly traded. The amount of employer and related-party
securities that the defined benefit plans may hold is governed by the statutory limitations of
the jurisdictions of the applicable plans. Included in equity securities of the defined benefit
plans are common shares of Nortel Networks Corporation with an aggregate market value of $11
(0.2 percent of total plan assets) and $13 (0.2 percent of total plan assets) as of December 31,
2004 and 2003, respectively.As a policy, assets within the defined benefit plans are reviewed to the target allocations at
least on a quarterly basis and adjustments made as appropriate. The plans commission periodic
asset and liability studies to determine the optimal allocation of the portfolios assets.
These studies consider a variety of the plan characteristics, including membership, benefits,
and liquidity needs, and utilize mean-variance analysis of historic and projected investment
returns to develop a range of acceptable asset mixes among a variety of asset classes.To develop the expected long-term rate of return on assets assumption, Nortel considered the
weighted-average historical returns and the future expectations for returns for each asset
class.Nortel expects to make cash contributions of approximately $92 in 2005 to the defined benefit
plans and approximately $29 in 2005 to the post-retirement benefit plans.Under the terms of the Balanced Program, Investor Program and Traditional Program, eligible
employees may contribute a portion of their compensation to an investment plan. Based on the
specific program that the employee is enrolled in, Nortel matches a percentage of the employees
contributions up to a certain limit. The cost of these investment plans was $75, $73 and $89
for the years ended December 31, 2004, 2003 and 2002, respectively.Under the terms of the Balanced Program and Flexible Benefits Plan, Nortel contributes a fixed
percentage of employees eligible earnings to a defined contribution plan arrangement. The cost
of these plan arrangements was $20, $17 and $20 for the years ended December 31, 2004, 2003 and
2002, respectively.On December 8, 2003, the MPDIM Act was signed into law in the U.S. The MPDIM Act introduced a
prescription drug benefit under Medicare (specifically, Medicare Part D) as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least
actuarially equivalent to Medicare Part D. As permitted by FSP Financial Accounting Standard
(FAS) 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003, Nortel chose to make the one-time deferral
election which remained in effect for its plans in the U.S. until the earlier of the issuance of specific
authoritative guidance by the FASB on how to account for the federal subsidy to be provided to
plan sponsors under the F-40




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MPDIM Act or the remeasurement of plan assets and obligations subsequent
to January 31, 2004. On May 19, 2004, FSP FAS 106-2, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP FAS
106-2) was issued by the FASB to provide guidance relating to the prescription drug subsidy
provided by the MPDIM Act. Nortel expects that all portions of its post-retirement benefit
plans will qualify as actuarially equivalent to the benefit provided under the MPDIM Act, for
which it expects to receive federal subsidies. Nortel adopted FSP FAS 106-2 in the second
quarter of 2004. The financial impact of the federal subsidies was determined by remeasuring
Nortel retiree life and medical obligations as of December 31, 2003, as provided under the
retroactive application provision of FSP FAS 106-2. As a result of adoption, the accumulated
post-retirement benefit obligation decreased by $31, and net periodic post-retirement benefit
costs decreased by $2 for the year ended December 31, 2004.  9.
    
    Acquisitions, divestitures and closures Acquisitions Nortel Networks Germany and Nortel Networks France  On October 19, 2002, Nortel, 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. The written options were marked to fair value through the consolidated statements of
operations at each period end until they were exercised. At December 31, 2002, Nortel estimated
the fair value of the written options to be approximately $81, which was included within other
accrued liabilities, and the corresponding loss was recorded in other income (expense)  net
during the year ended December 31, 2002. A further mark to fair value adjustment and loss of $18
was recorded during the year ended December 31, 2003. The purchased options and the share
exchange were initially recorded at fair value and were assessed for impairment throughout their
term until they were exercised or expired. The estimated fair values of the options were based
on an estimate of the current fair values of the respective joint ventures using an
option-pricing model that is dependent on the assumptions used concerning the amount of
volatility and the discount rates that reflect varying degrees of risk.  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. On July 18, 2003, Nortel 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s 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.  During the three months ended September 30, 2003, Nortel recorded the acquisitions of the
minority interests of NNF and NNG based on preliminary valuation estimates totaling $241. The
purchase price of $241 included $58 of cash, an in-kind component of approximately $82
representing the return of a loan note that was owed to Nortel by EADS Telecom and the remaining
 shares of EADS Telecom held by Nortel. The allocation of the purchase price resulted in the
elimination of $23 of minority interest, settlement of a net liability of $94 related to the put
and call options and an increase of approximately $45 in intangible assets and $79 in goodwill.
The intangible assets of approximately $45 related primarily to customer contracts and customer
relationships and are being amortized based on their expected pattern of benefit to future
periods using estimates of undiscounted cash flows, and were included in intangible assets on
the consolidated balance sheet as of December 31, 2003. The sale of Nortels 41 percent
interest in EADS Telecom has resulted in the receipt of cash of $12 and a reduction in equity
investments of $23. As a result of this transaction, Nortel recognized a gain of $79 which is
included in other income (expense)  net for the year ended December 31, 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.  During the three months ended December 31, 2003, the valuation report for NNF and NNG was
completed by a third party appraiser. As a result of the finalization of this valuation, an
additional gain of $17 was recorded with a corresponding increase in goodwill on the transaction
(see note 4 for goodwill by reportable segment). F-41




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DivestituresManufacturing operationsOn June 29, 2004, Nortel announced an agreement with Flextronics International Ltd.
(Flextronics), regarding the divestiture of substantially all of Nortels remaining
manufacturing operations, including product integration, testing and repair operations carried
out in Calgary and Montreal, Canada and Campinas, Brazil, as well as certain activities related
to these locations, including the management of the supply chain, related suppliers, and
third-party logistics. In Europe, Flextronics has made an offer to purchase similar Nortel
operations at Monkstown, Northern Ireland and Chateaudun, France, subject to the completion of
the required information and consultation process.Under the terms of the agreement and offer, Flextronics will also acquire Nortels global repair
services, as well as certain design assets in Ottawa, Canada and Monkstown related to hardware
and embedded software design, and related product verification for certain established optical
products.Nortel and Flextronics have entered into a four year supply agreement for manufacturing services
(whereby Flextronics will manage approximately $2,500 of Nortels annual cost of revenues) and a
three year supply agreement for design services. The portion of the transaction related to the
optical design activities in Ottawa and Monkstown was completed on November 1, 2004. On
February 8, 2005, Nortel announced the completion of the portion of the transaction related to
the manufacturing activities in Montreal. Nortel previously reported that the portion of the
transaction related to the manufacturing activities in Calgary is expected to close in the
second quarter of 2005 and that the balance of the transaction is expected to close on separate
dates occurring during the first half of 2005. Nortel and Flextronics are currently discussing
the timing of the closing of the balance of the transaction in order to optimize the business
transition between the companies. As a result of these discussions, it is now expected that the
balance of the transaction, relating to the manufacturing operations in Chateaudun, Calgary and
Monkstown, will close by the end of the first quarter of 2006. As a result, Nortel and
Flextronics intend to enter into an amendment agreement to extend the term of the original
agreement and offer to reflect this updated schedule. These transactions are subject to
customary conditions and regulatory approvals.The successful completion of the agreement and offer with Flextronics will result in the
transfer of approximately 2,500 employees from Nortel to Flextronics. Nortel expects to receive
cash proceeds ranging from approximately $675 to $725, which will be allocated to each separate
closing. Nortel previously announced that the estimated cash proceeds would be received
substantially in 2005. Nortel and Flextronics are currently discussing the timing of the cash
payments based on the expected change to the original schedule. Such payments will be subject to
a number of adjustments, including potential post-closing date asset valuations and potential
post-closing indemnity payments. Flextronics also has the ability in certain cases to exercise
rights to sell back to Nortel certain inventory and equipment after the expiration of a
specified period (of up to fifteen months) following each respective closing date. Nortel does
not expect such rights to be exercised with respect to any material amount of inventory and/or
equipment. The allocation of proceeds related to this transaction will be subject to an
assessment of fair values related to the separate components included therein. Direct
transaction costs and other costs associated with transferring operations to Flextronics
(including transition, potential severance, information technology implementation and real
estate costs) are expected to be incurred. As at December 31, 2004, direct transaction costs of
$10 have been deferred as other assets and will be recognized as a cost of the ultimate
divestiture of the operations.Directory and operator services businessOn August 2, 2004, Nortel completed the contribution of certain fixed assets, intangible assets
including customer contracts, software and other licenses, and liabilities of its directory and
operator services (DOS) business to VoltDelta Resources LLC (VoltDelta), a wholly owned
subsidiary of Volt Information Sciences, Inc. (VIS), in return for a 24 percent interest in
VoltDelta which was valued at $57. After a period of two years, Nortel and VIS each have an
option to cause Nortel to sell its VoltDelta shares to VIS for proceeds ranging from $25 to $70.
As a result of this transaction, approximately 160 Nortel DOS employees in North America and
Mexico joined VoltDelta. This non-monetary exchange has been recorded at fair value, and Nortel
recorded a gain of $30 within sale of businesses and assets during 2004. The purchased option
was initially recorded at fair value of $4 and is being assessed for impairment throughout the
term until exercise or expiration occurs. The written option is being marked to market through
other income (expense)  net each period until exercise or expiration occurs. As of December 31, 2004, the estimated fair value of
the written option was $9, which has been F-42




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recorded in accrued liabilities. Nortel is providing
certain transitional services to VoltDelta over a ten year period and the expected proceeds of
$4 are being recognized on a straight-line basis over the service term into other income
(expense)  net. Nortel is accounting for its investment in VoltDelta under the equity method
and Nortels proportionate share of VoltDeltas net earnings of $3 since August 2, 2004, has
been included in equity in net earnings (loss) of associated companies during 2004.Sale of Arris Group, Inc. investmentIn March 2004, Nortel sold 1.8 million shares of Arris Group, Inc. (Arris Group) for cash
consideration of $17, which resulted in a gain of $13, which was recorded in other income
(expense)  net. Following this transaction, Nortel owned 3.2 million Arris Group common shares
or 4.2 percent of Arris Group outstanding common shares (see note 18).On November 24, 2003, Nortel sold 9 million shares of Arris Group for cash consideration of $49,
which resulted in a gain of $31 reported in other income (expense)
 net. Following this
transaction, Nortel owned 5 million Arris Group common shares or 6.6 percent of Arris Group
outstanding common shares (see note 18).High speed module operationsOn August 10, 2003, Nortel sold certain assets related to its high speed module operations to
BreconRidge Manufacturing Solutions Corporation (BreconRidge). Nortel received proceeds of $6
in the form of cash and a note receivable. As a result of this transaction, Nortel recorded a
loss of $1 during the year ended December 31, 2003. The transaction included a minimum purchase
commitment with BreconRidge requiring Nortel to purchase approximately $33 and $11 of products
during 2004 and 2003, respectively.Optical components operationsOn November 8, 2002, Nortel sold certain plant and equipment, inventory, patents and other
intellectual property and trademarks relating to its optical components business to Bookham.
Included in the sale was the transfer of Nortels transmitter and receiver, pump laser and
amplifier businesses located in Paignton, U.K., Harlow, U.K., Ottawa, Canada, Zurich,
Switzerland and Poughkeepsie, New York. Nortel also transferred approximately 1,200 employees
to Bookham in the transaction. Nortel received 61 million common shares of Bookham, 9 million
warrants with a strike price of one-third pence Sterling, notes receivable of $50 and cash of
$10. The transaction included a minimum purchase commitment with Bookham requiring Nortel to
purchase approximately $120 of product from Bookham between November 8, 2002 and March 31, 2004.During the three months ended September 30, 2002, Nortel classified the assets sold to Bookham
as held for sale and assigned an estimated fair value of $47 to them resulting in a charge of
$123 ($89 to cost of revenues and $34 to special charges). A subsequent increase in Bookhams
common share price prior to the November 8, 2002 close date resulted in an increase in the value
assigned to the consideration received. As a result, Nortel recorded a gain on sale of
businesses and assets of $29 during the year ended December 31, 2002.As a result of the transaction, Nortel received a 29.8 percent ownership interest in Bookham.
Due to restrictions on Nortels ability to vote the common shares, ability to appoint directors
to the board or otherwise exercise significant influence over Bookham, the investment has been
accounted for using the cost method.During 2003, Nortel sold 30 million shares of Bookham for cash proceeds of $32 and recorded a
gain of $6 which is included in other income (expense)  net for the year ended December 31,
2003. As a result of this transaction, Nortel reduced its ownership interest in Bookham to
approximately 14 percent.On December 2, 2004, Nortel and Bookham entered into a restructuring agreement which, among other
changes, extended the maturity date of a senior secured note (the Series B Note), by one year
from November 8, 2005 to November 8, 2006, and eliminated the conversion feature of a senior
unsecured note (the Series A Note). Bookham also agreed to secure the Series A Note, provide
additional collateral for the Series A Note and the Series B Note, and provide Nortel with other
debt protection covenants. F-43




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##### Table of Contents



Other  On February 3, 2004, Nortel sold approximately 7 million common shares of Entrust Inc.
(Entrust) for cash consideration of $33, and recorded a gain of $18 in other income (expense)
  net. As a result of this transaction, Nortel no longer holds any equity interest in Entrust.On May 7, 2004, Nortel received $80 in proceeds from the sale of certain assets in connection
with a customer contract settlement in Latin America. This resulted in a gain of $78, which was
included in (gain) loss on sale of businesses and assets for the year ended December 31, 2004.  10.
    
    Long-term debt, credit and support facilitiesLong-term debt  The following table shows the components of long-term debt as of December 31: 2004
    
    
    20036.125% Notes due February 15, 2006
    
    $
    1,275
    
    
    $
    1,2757.40% Notes due June 15, 2006 (a)
    
    
    150
    
    
    
    1506.875% Notes due September 1, 2023
    
    
    200
    
    
    
    2007.875% Notes due June 15, 2026 (a)
    
    
    150
    
    
    
    150Other long-term debt with various repayment terms and a weighted-average
interest rate of 5.65% for 2004 and 3.49% for 2003
    
    
    3
    
    
    
    20Fair value adjustment attributable to hedged debt obligations
    
    
    23
    
    
    
    53Obligations associated with consolidated VIEs with weighted-average
interest rate of 2.9% for 2004 and 5.7% for 2003
    
    
    100
    
    
    
    184Obligations under capital leases and sale leasebacks and a weighted-average
interest rate of 9.49% for each of the years 2004 and 2003
    
    
    176
    
    
    
    1782,077
    
    
    
    2,210Less: Long-term debt due within one year
    
    
    15
    
    
    
    119Long-term debt
    
    $
    2,062
    
    
    $
    2,091
 (a)
    
    Notes were issued by Nortel Networks Capital Corporation, an indirect wholly owned
finance subsidiary of Nortel, and are fully and unconditionally guaranteed by Nortel.
  As of December 31, 2004, the amounts of long-term debt payable for each of the years ending
December 31 consisted of: 2005
    
    $
    152006
    
    
    1,4702007
    
    
    152008
    
    
    162009
    
    
    17Thereafter
    
    
    544Total long-term debt payable
    
    $
    2,077
  On February 8, 2001, Nortel completed an offering of $1,500 of 6.125% Notes due on February
15, 2006 (the 6.125% Notes). The 6.125% Notes pay interest on a semi-annual basis on February
15 and August 15, which began on August 15, 2001. The 6.125% Notes are redeemable, at any time
at Nortels option, at a redemption price equal to the principal amount thereof plus accrued and
unpaid interest and a make-whole premium.During the year ended December 31, 2002, Nortel paid $162 to purchase a portion of its 6.00%
Notes due on September 1, 2003 and its 6.125% Notes with carrying values of $36 and $186,
respectively. The early extinguishment of debt resulted in a gain of $60 which was included in
the consolidated statement of operations within other income (expense)  net for the year ended
December 31, 2002. F-44




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During the year ended December 31, 2002, Nortel sold an office building for $24 and concurrent
with the sale Nortel leased the property back for a period of fifteen years at an average annual
rental of $3. The lease is renewable at Nortels option for four additional five-year terms.
The lease requires that a letter of credit for $1 be provided while Nortels bonds are rated
below investment grade. As a result of the letter of credit structure, the transaction has been
recorded as a financing transaction rather than a sale, and the building and related accounts
will continue to be recognized in the consolidated financial statements.During the year ended December 31, 2003, Nortel purchased a portion of its 6.125% Notes 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 year ended
December 31, 2003.As a result of the delay in the filing of Nortels and NNCs 2003 Annual Reports on Form 10-K
(the 2003 Annual Reports) and 2004 Quarterly Reports on Form 10-Q for the first, second and
third quarters of 2004 (the 2004 Quarterly Reports, and together with the 2004 Annual Reports,
the 2004 Reports), Nortel and NNC were not in compliance with their obligations to deliver
their respective SEC filings to the trustees under Nortels and NNCs public debt indentures as
of December 31, 2004. Approximately $1,800 of notes of Nortel (or its subsidiaries) and $1,800
of convertible debt securities of NNC were outstanding under such indentures as of December 31,
2004.These delays have not resulted in the automatic event of default and acceleration of the
long-term debt of Nortel or NNC and such default and acceleration could not occur unless notice
of such non-compliance from holders of 25% of the outstanding principal amount of any relevant
series of debt securities were provided to Nortel or NNC, as applicable, and Nortel or NNC, as
applicable, failed to deliver the relevant report within 90 days after such notice is provided,
all in accordance with the terms of the indentures. While such notice could have been given at
any time after March 30, 2004, as a result of the delayed filing of the Reports, neither Nortel
nor NNC had received a notice as of December 31, 2004. See note 21 for additional information
relating to the delayed filings.  Credit facilities  On April 28, 2004, Nortel notified the banks under the Nortel and Nortel Networks Inc.
(NNI) $750 April 2000 five year credit facilities (the Five Year Facilities) that it was
terminating these facilities. Absent such termination, the banks
would have been permitted, upon 30 days notice, to
terminate their commitments under the Five Year Facilities as a result of Nortels inability to
file its 2003 Annual Report on Form 10-K by April 29, 2004. Upon termination, the Five Year
Facilities were undrawn. For information relating to the impact of the termination of the Five
Year Facilities under the security agreements entered into by Nortel and various of its
subsidiaries, see note 23.  Support facility  On February 14, 2003, Nortel entered into an agreement with Export Development Canada
(EDC) regarding arrangements to provide for support, on a secured basis, of certain
performance related obligations arising out of normal course business activities for the benefit
of Nortel (the EDC Support Facility). On December 10, 2004, Nortel and EDC amended the terms
of the EDC Support Facility by extending the termination date of the EDC Support Facility to
December 31, 2006 from December 31, 2005.On February 14, 2003, Nortels obligations under the EDC Support Facility became secured on an
equal and ratable basis under the security agreements entered into by Nortel and various of its
subsidiaries that pledged substantially all of the assets of Nortel in favor of the banks under
the Five Year Facilities and the holders of Nortels and NNCs public debt securities. This
security became effective in favor of the banks and the public debt holders on April 4, 2002.
For additional information relating to the security agreements, see note 23.  The EDC Support Facility provides up to $750 in support, all presently on an uncommitted basis.
As of December 31, 2004, there was approximately $291 of outstanding support utilized under the
EDC Support Facility, approximately $207 of which was outstanding under the revolving small bond
sub-facility.The delayed filing of the Reports with the SEC, the trustees
under Nortels and NNCs public
debt indentures and EDC gave EDC the right to (i) terminate its commitments under the EDC
Support Facility, relating to certain of Nortels performance related obligations arising out of
normal course business activities, and (ii) exercise certain rights against the collateral
pledged under related security agreements or require Nortel to cash collateralize all existing
support. F-45




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Throughout 2004, Nortel obtained waivers from EDC with respect to these matters to permit
continued access to the EDC Support Facility in accordance with its terms while Nortel and NNC
worked to complete their filing obligations. The waivers also applied to certain related
breaches under the EDC Support Facility relating to the delayed filings and the restatements and
revisions to Nortels and NNCs prior financial results (the Related Breaches). In connection
with such waivers, EDC reclassified the previously committed $300 revolving small bond
sub-facility of the EDC Support Facility as uncommitted support during the applicable waiver
period. The $300 revolving small bond sub-facility will not become committed support until all
delayed filings have been filed with the SEC, the trustees under Nortels and NNCs public debt
indentures and EDC and NNC obtains a permanent waiver of the Related Breaches. See note 21 for
additional information relating to the delayed filings.  11.
    
    Financial instruments and hedging activitiesRisk management  Nortels net earnings (loss) and cash flows may be negatively impacted by fluctuating
interest rates, foreign exchange rates and equity prices. To effectively manage these market
risks, Nortel enters into foreign currency forwards, foreign currency swaps, foreign currency
option contracts, interest rate swaps and equity forward contracts. Nortel does not hold or
issue derivative financial instruments for trading purposes.Foreign currency riskNortel enters into option contracts to limit its exposure to exchange fluctuations on
future revenue or expenditure streams expected to occur within the next twelve months, and
forward contracts, which are denominated in various currencies, to limit its exposure to
exchange fluctuations on existing assets and liabilities and on future revenue or expenditure
streams expected to occur within the next twelve months. Option and forward contracts used to
hedge future revenue or expenditure streams are designated as cash flow hedges and hedge
specific exposures. Option and forward contracts that do not meet the criteria for hedge
accounting are also used to economically hedge the impact of fluctuations in exchange rates on
existing assets and liabilities and on future revenue and expenditure streams.The following table provides a summary of the total notional amounts of option and forward
contracts as of December 31: Currency
    
    2004(a)
    
    
    2003(b)Options:Canadian dollar
    
    $
    84
    
    
    $
    37Forwards:Canadian dollar
    
    
    286
    
    
    
    375British pound
    
    
    661
    
    
    
    435Euro
    
    
    233
    
    
    
    74Other
    
    
    4
    
    
    
    206$
    1,268
    
    
    $
    1,127
 (a)
    
    All notional amounts of option and forward contracts will mature no later than the end
of 2005.(b)
    
    All notional amounts of option and forward contracts matured no later than the end of
2004.
 F-46




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Interest rate risk  Nortel enters into interest rate swap contracts to minimize the impact of interest rate
fluctuations on the fair value of its long-term debt. These contracts swap fixed interest rate
payments for floating rate payments and certain swaps are designated as fair value hedges. The
fair value adjustment related to the effective portion of interest rate swaps and the
corresponding fair value adjustment to the hedged debt obligation included within long-term debt
are recorded to interest expense within the consolidated statements of operations. These swap
contracts have remaining terms to maturity between 1 and 1.5 years.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
consolidated statements of operations.Hedge ineffectiveness and the discontinuance of cash flow hedges and fair value hedges that were
accounted for in accordance with SFAS 133 had no material impact on the net earnings (loss) for
the years ended December 31, 2004, 2003 and 2002 and were reported within other income (expense)
  net in the consolidated statements of operations.The following table provides a summary of interest rate swap contracts and their aggregated
weighted-average rates as of December 31: 2004
    
    
    2003Interest rate swap contracts:Received-fixed swaps  notional amount
    
    $
    875
    
    
    $
    875Average fixed rate received
    
    
    6.3
    %
    
    
    6.3
    %Average floating rate paid
    
    
    2.5
    %
    
    
    2.6
    %
  Equity price risk  Nortel enters into equity forward contracts with terms from eight to fourteen months to
hedge the variability in future cash flows associated with certain compensation obligations that
vary based on future Nortel Networks Corporation common share prices. These contracts fix the
price of Nortel Networks Corporation common shares and are cash settled on maturity to offset
changes in the compensation liability based on changes in the share price from the inception of
the forward contract. Certain equity forward contracts are designated as cash flow hedges when
all criteria for hedge accounting are met. The changes in fair value of these equity forward
contracts are recorded in OCI and reclassified to SG&A expense when the underlying compensation
expense is recorded. Other equity forward contracts that are not designated in a hedging
relationship and are considered economic hedges of the compensation obligation are carried at
fair value with changes in fair value recorded in other income (expense)  net. The total
notional amount of these contracts as of December 31, 2004 and 2003 was $31 and $47,
respectively, and the average fixed Nortel Networks Corporation common share price was $4.52 and
$3.45, respectively. The fair value of these contracts as of December 31, 2004 and 2003 was
$(9) and $10, respectively.  Fair value  The estimated fair values approximate amounts at which financial instruments could be
exchanged in a current transaction between willing parties. The fair values are based on
estimates using present value and other valuation techniques that are significantly affected by
the assumptions used concerning the amount and timing of estimated future cash flows and
discount rates that reflect varying degrees of risk. Specifically, the fair value of interest
rate swaps and forward contracts reflected: the present value of the expected future cash flows
if settlement had taken place on December 31, 2004 and 2003; the fair value of option contracts
reflected the cash flows due to or by Nortel if settlement had taken place on December 31, 2004
and 2003; and the fair value of long-term debt instruments reflected a current yield valuation
based on observed market prices as of December 31, 2004 and 2003. Accordingly, the fair value
estimates are not necessarily indicative of the amounts that Nortel could potentially realize in
a current market exchange. F-47




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The following table provides the carrying amounts and fair values for financial assets and
liabilities for which fair value differed from the carrying amount and fair values recorded for
derivative financial instruments in accordance with SFAS 133 as of December 31: 2004
    
    
    2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    Fairamount
    
    
    value
    
    
    amount
    
    
    valueFinancial liabilities:Long-term debt due within one year
    
    $
    15
    
    
    $
    15
    
    
    $
    119
    
    
    $
    119Long-term debt
    
    $
    2,062
    
    
    $
    2,074
    
    
    $
    2,091
    
    
    $
    2,102Derivative financial instruments net asset
(liability) position:Interest rate swap contracts (a)
    
    $
    26
    
    
    $
    26
    
    
    $
    61
    
    
    $
    61Forward and option contracts (b)
    
    $
    5
    
    
    $
    5
    
    
    $
    19
    
    
    $
    19
 (a)
    
    Recorded in other assets.(b)
    
    Comprised of other assets of $31 and other liabilities of $26 as of December 31, 2004,
and other assets of $34 and other liabilities of $15 as of December 31, 2003.
  Credit risk  Credit risk on financial instruments arises from the potential for counterparties to
default on their contractual obligations to Nortel. Nortel is exposed to credit risk in the
event of non-performance, but does not anticipate non-performance by any of the counterparties.
Nortel limits its credit risk by dealing with counterparties that are considered to be of high
credit quality. The maximum potential loss on all financial instruments may exceed amounts
recognized in the consolidated financial statements. However, Nortels maximum exposure to
credit loss in the event of non-performance by the other party to the derivative contracts is
limited to those derivatives that had a positive fair value of $61 as of December 31, 2004.
Nortel is also exposed to credit risk from customers. However, Nortels global orientation has
resulted in a large number of diverse customers which minimizes concentrations of credit risk.  Other derivatives  Nortel may invest in warrants to purchase securities of other companies as a strategic
investment or receive warrants in various transactions. Warrants that relate to publicly traded
companies or that can be net share settled are deemed derivative financial instruments under
SFAS 133. Such warrants are generally not eligible to be designated as hedging instruments as
there is no corresponding underlying exposure. In addition, Nortel may enter into certain
commercial contracts containing derivative financial instruments.  Receivables sales  In 2004, 2003 and 2002, Nortel entered into various agreements to sell certain of its
receivables. These receivables were sold at a discount of $37, $20 and $25 from book value for
the years ended December 31, 2004, 2003 and 2002, respectively, at annualized discount rates of
approximately 2 percent to 6 percent, 2 percent to 6 percent and 3 percent to 5 percent for the
years ended December 31, 2004, 2003 and 2002, respectively. Certain receivables have been sold
with limited recourse, not exceeding 10 percent, of nil, $7 and $9 as of December 31, 2004, 2003
and 2002, respectively.Under certain agreements, Nortel has continued as servicing agent and/or has 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.
Generally, trade receivables that are sold do not experience prepayments. Nortel, when acting as
the servicing agent, generally does not record an asset or liability related to servicing as the
annual servicing fees are equivalent to those that would be paid to a third party servicing
agent. Also, Nortel has not historically experienced significant credit losses with respect to
receivables sold with limited recourse and, as such, no liability was recognized. F-48




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As of December 31, 2004 and 2003, total accounts receivable securitized and under Nortels
management were $266 and $359, respectively.There is a possibility that the actual performance of receivables or the cost of servicing the
receivables will differ from the assumptions used to determine fair values at the transfer date
and at each reporting date. Assuming hypothetical, simultaneous, unfavorable variations of up
to 20 percent in credit losses, discount rate used and cost of servicing the receivables, the
pre-tax impact on the value of the retained interests and servicing assets would not be
significant.Proceeds from receivable sales for the years ended December 31 were as follows: 2004
    
    
    2003
    
    
    2002Proceeds from new securitizations
    
    $
    137
    
    
    $
    651
    
    
    $
    562Proceeds from collections reinvested in revolving period securitizations
    
    $
    373
    
    
    $
    52
    
    
    $
    276
  12.
    
    Guarantees  Nortel 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 to make payments (either in cash, financial instruments, other assets, common shares of
Nortel Networks Corporation or through the provision of services) to a third party based on
changes in an underlying economic characteristic (such as interest rates or market value) that
is related to an asset, a liability or an equity security of the guaranteed party or a third
partys failure to perform under a specified agreement. A description of the major types of
Nortels outstanding guarantees as of December 31, 2004 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 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 generally indemnifies the purchaser of a Nortel business in
the event that a third party asserts a claim against the purchaser that relates to a
liability retained by Nortel. Some of these types of guarantees have indefinite terms while
others have specific terms extending to June 2008.Nortel 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 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 combinations and do not provide for
any limit on the maximum potential amount.Nortel 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 has not made any significant indemnification payments under such
agreements and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these guarantees.In conjunction with the sale of a subsidiary to a third party, Nortel guaranteed to the
purchaser that specified annual volume levels would be achieved by the business sold over a
ten year period ending December 31, 2007. The maximum amount that Nortel may be required to
pay under the volume guarantee as of December 31, 2004 is $9. A liability of $9 has been
accrued in the consolidated financial statements with respect to the obligation associated
with this guarantee as of December 31, 2004. F-49




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(b)
    
    Intellectual property indemnification obligations  Nortel 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 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 from making a reasonable estimate of the maximum potential amount it could be
required to pay to its customers and suppliers. Historically, Nortel has not made any
significant indemnification payments under such agreements. A liability of $6 has been
accrued in the consolidated financial statements with respect to the obligations associated
with these guarantees as of December 31, 2004.  (c)
    
    Lease agreements  Nortel has entered into agreements with certain of its lessors that guarantee the lease
payments of certain assignees of its facilities to lessors. Generally, these lease
agreements relate to facilities Nortel vacated prior to the end of the term of its lease.
These lease agreements require Nortel to make lease payments throughout the lease term if
the assignee fails to make scheduled payments. Most of these lease agreements also require
Nortel to pay for facility restoration costs at the end of the lease term if the assignee
fails to do so. These lease agreements have expiration dates through June 2015. The
maximum amount that Nortel may be required to pay under these types of agreements is $48 as
of December 31, 2004. Nortel generally has the ability to attempt to recover such lease
payments from the defaulting party through rights of subrogation.Historically, Nortel has not made any significant payments under these types of guarantees
and no significant liability has been accrued in the consolidated financial statements with
respect to the obligations associated with these guarantees.  (d)
    
    Debt agreements  Nortel has guaranteed the debt of certain customers. These third party debt agreements
require Nortel 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 may be required to
pay under these types of debt agreements is $7 as of December 31, 2004. Under most such
arrangements, the Nortel guarantee is secured, usually by the assets being purchased or
financed. No liability has been accrued in the consolidated financial statements with
respect to the obligations associated with these financial guarantees as of December 31,
2004.Nortel is a full and unconditional guarantor of NNCs $1,800 4.25% convertible Senior Notes
(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 may be required to pay under this guarantee is $1,800 plus the
premium, if any, and interest. No amount has been accrued in the consolidated financial
statements with respect to the obligation associated with this guarantee.  (e)
    
    Indemnification of banks and agents under credit facilities, EDC Support Facility and
security agreements  As of December 31, 2004, Nortel had 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 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
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 10 and 21). F-50




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Nortel is unable to estimate the maximum potential liability for these types of
indemnification guarantees as the agreements typically 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 has not made any significant indemnification payments under such
agreements and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these indemnification guarantees.Nortel has agreed to indemnify certain of its counterparties in certain receivables
securitization transactions. The indemnifications provided to counterparties in these types
of transactions may require Nortel 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 of December 31, 2004,
Nortel had approximately $266 of securitized receivables which were subject to repurchase
under this provision, in which case Nortel would assume all rights to collect such
receivables. The indemnification provisions generally expire upon expiration of the
securitization agreements, which extend through 2005, or collection of the receivable
amounts by the counterparty.Nortel 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 has not made any significant indemnification payments or receivable
repurchases under such agreements and no significant liability has been accrued in the
consolidated financial statements with respect to the obligations associated with these
guarantees.  (f)
    
    Other indemnification agreements  Nortel 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
asset sale agreements (other than the business sale agreements noted above). These
indemnification agreements generally require Nortel 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 typically provide for any limit on the maximum
potential payment amount.The nature of such agreements prevents Nortel 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 has not made any significant indemnification payments under such
agreements and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these guarantees. F-51




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Product warranties  The following summarizes the accrual for product warranties that was recorded as part of
other accrued liabilities in the consolidated balance sheets as of December 31: 2004
    
    
    2003Balance at the beginning of the year
    
    $
    382
    
    
    $
    404Payments
    
    
    (349
    )
    
    
    (347
    )Warranties issued
    
    
    229
    
    
    
    337Revisions
    
    
    9
    
    
    
    (12
    )Balance at the end of the year
    
    $
    271
    
    
    $
    382
  13.
    
    Commitments  Bid, performance related and other bonds  Nortel has entered into bid, performance related and other bonds associated with various
contracts. Bid bonds generally have a term of less than twelve months, depending on the length
of the bid period for the applicable contract. Other bonds primarily relate to warranty,
rental, real estate and customs contracts. Performance related and other bonds generally have a
term of twelve months and are typically renewed, as required, over the term of the applicable
contract. 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 Nortels non-performance under the applicable contract. Historically, Nortel has not
had to make material payments under these types of bonds and does not anticipate that any
material payments will be required in the future. The following table sets forth the maximum
potential amount of future payments under bid, performance related and other bonds, net of the
corresponding restricted cash and cash equivalents, as of December 31: 2004
    
    
    2003Bid and performance related bonds(a)
    
    $
    362
    
    
    $
    427Other bonds (b)
    
    
    68
    
    
    
    53Total bid, performance related and other bonds
    
    $
    430
    
    
    $
    480
 (a)
    
    Net of restricted cash and cash equivalent amounts of $36 and $14 as of December 31,
2004 and 2003, respectively.(b)
    
    Net of restricted cash and cash equivalent amounts of $28 and $31 as of December 31,
2004 and 2003, respectively.
  Venture capital financing  Nortel has entered into agreements with selected venture capital firms where the venture
capital firms make and manage investments in start-ups and emerging enterprises. The agreements
require Nortel to fund requests for additional capital up to its commitments when and if
requests for additional capital are solicited by the venture capital firm. Nortel had remaining
commitments, if requested, of $16 as of December 31, 2004. These commitments expire at various
dates through to 2012.  Purchase commitments  Nortel has entered into purchase commitments with certain suppliers under which it commits
to buy a minimum amount or percentage of designated products in exchange for price guarantees or
similar concessions. In certain of these agreements, Nortel may be required to acquire and pay
for such products up to the prescribed minimum or forecasted purchases. As of December 31,
2004, Nortel had aggregate purchase commitments of $1,254. Significant purchase commitments are
described below.During the third quarter of 2003, Nortel renegotiated a supply arrangement with a key supplier.
The renegotiated agreement requires that $2,800 in aggregate purchases with the supplier be made
between June 2003 and June 2009. As of December 31, 2004, the remaining purchase commitment
under the agreement was $1,200. The renegotiated agreement includes a graduated liquidated
damages remedy for the benefit of the supplier if the minimum purchase commitment is not met by
the end of the agreement in 2009. However, Nortel expects to meet the minimum purchase
commitment. F-52




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Operating leases and other commitments  As of December 31, 2004, the future minimum payments under operating leases, outsourcing
contracts, special charges related to lease commitments accrued for as part of restructuring
contract settlement and lease costs and related sublease recoveries under contractual agreements
consisted of: Operating
    
    
    Outsourcing
    
    
    Special
    
    
    Subleaseleases
    
    
    contracts
    
    
    charges
    
    
    income2005
    
    $
    94
    
    
    $
    96
    
    
    $
    118
    
    
    $
    (28
    )2006
    
    
    106
    
    
    
    94
    
    
    
    63
    
    
    
    (26
    )2007
    
    
    94
    
    
    
    92
    
    
    
    53
    
    
    
    (19
    )2008
    
    
    72
    
    
    
    91
    
    
    
    45
    
    
    
    (17
    )2009
    
    
    57
    
    
    
    90
    
    
    
    35
    
    
    
    (15
    )Thereafter
    
    
    390
    
    
    
    
    
    
    
    185
    
    
    
    (48
    )Total future minimum payments
    
    $
    813
    
    
    $
    463
    
    
    $
    499
    
    
    $
    (153
    )
  Rental expense on operating leases for the years ended December 31, 2004, 2003 and 2002,
net of applicable sublease income, amounted to $177, $257 and $465, respectively.During the years ended December 31, 2003 and 2002, Nortel entered into sale-leaseback
transactions for certain of its properties with carrying values of approximately $17 and $250,
respectively, which resulted in a loss on disposal of $6 and $7, respectively.Expenses related to outsourcing contracts for the years ended December 31, 2004, 2003 and 2002
amounted to $253, $308 and $364, respectively, and were for services provided to Nortel
primarily related to a portion of its information services function. The amount payable under
Nortels outsourcing contracts is variable to the extent that Nortels workforce fluctuates from
the baseline levels contained in the contracts. The table above shows the minimum commitment
contained in the outsourcing contracts.  14.
    
    Financing arrangements  Customer financing  Pursuant to certain financing agreements, Nortel is committed to provide future financing
in connection with purchases of Nortels 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 attempts to limit its financing credit risk by
utilizing an internal credit committee that monitors the credit exposure of Nortel. The
following table sets forth customer financing related information and commitments, excluding
discontinued operations, as of December 31: 2004
    
    
    2003Drawn and outstanding  gross
    
    $
    118
    
    
    $
    401Provisions for doubtful accounts
    
    
    (38
    )
    
    
    (281
    )Drawn and outstanding  net(a)
    
    
    80
    
    
    
    120Undrawn commitments
    
    
    69
    
    
    
    180Total customer financing
    
    $
    149
    
    
    $
    300
 (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 years ended December 31, 2004 and 2003, Nortel recorded net customer financing
bad debt recoveries of $54 and $113 as a result of settlements and adjustments to other existing
provisions. During the year ended December 31, 2002, Nortel recorded net customer financing bad
debt expense of $171. The recoveries and expense were included in the consolidated statements
of operations within SG&A expense. F-53




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During the years ended December 31, 2004 and 2003, Nortel entered into certain agreements to
restructure and/or settle various customer financing and related receivables. As a result of
these transactions, Nortel received cash consideration of approximately $147 and $230 to settle
outstanding receivables of approximately $254 and $610 (with a net carrying value of $75 and
$120), for the years ended December 31, 2004 and 2003, respectively. Additional non-cash
consideration received under one such restructuring agreement during the year ended December 31,
2003 included a five year equipment and services supply agreement and the mutual release of all
other claims between the parties.On December 10, 2004, Nortel entered into an agreement to settle customer financing receivables
with a certain customer. As a result of these transactions, Nortel received cash consideration
of approximately $16 and a deferred senior unsecured note of $33 (net carrying value of nil) to
settle the outstanding receivables of approximately $118 with the net carrying value of nil.On December 15 and 16, 2004, Nortel sold certain notes receivable and convertible notes
receivable that had been received as a result of the restructuring of a customer financing
arrangement for total cash proceeds of $116. The net carrying amount of the notes receivable
and convertible notes receivable was $61. Nortel recorded a gain of $53, net of transaction
costs of $2, in other income (expense)  net for the year ended December 31, 2004.On December 23, 2004, a customer financing arrangement was restructured. The notes receivable
and other accounts receivable that were restructured had a net carrying amount of $12 ($1 of the
net carrying amount was included in discontinued operations), net of provisions for doubtful
accounts of $182 ($63 of the provision was included in discontinued operations). The
restructured notes were valued at $100 as of December 31, 2004 and a gain of $88 ($32 of the
gain was included in discontinued operations) was recorded in the fourth quarter of 2004. On
January 25, 2005, Nortel sold this receivable, including rights to accrued interest, for cash
proceeds of $110.During the years ended December 31, 2004 and 2003, Nortel reduced undrawn customer financing
commitments by $111 and $651 as a result of the expiration or cancellation of commitments and
changing customer business plans. As of December 31, 2004, approximately $69 in undrawn
commitments was available for funding under the terms of the financing agreements.  Consolidation of variable interest entities  Certain lease financing transactions of Nortel were structured through single transaction
VIEs that did not have sufficient equity at risk as defined in FIN 46R. Effective July 1, 2003,
Nortel prospectively began consolidating two VIEs for which Nortel was considered the primary
beneficiary following the guidance of FIN 46, on the basis that Nortel retained certain risks
associated with guaranteeing recovery of the unamortized principal balance of the VIEs debt,
which represented the majority of the risks associated with the respective VIEs activities.
The amount of the guarantees will be adjusted over time as the underlying debt matures. During
2004, the debt related to one of the VIEs was extinguished and as a result consolidation of this
VIE was no longer required. As of December 31, 2004, Nortels consolidated balance sheet
included $100 of long-term debt (see note 10) and $100 of plant and equipment  net related to
the remaining VIE. These amounts represented both the collateral and maximum exposure to loss
as a result of Nortels involvement with the VIE.As of December 31, 2004, Nortel did not have any variable interests related to transfers of
financial assets. Nortel has other financial interests and contractual arrangements which would
meet the definition of a variable interest under FIN 46R, including investments in other
companies and joint ventures, customer financing arrangements, and guarantees and
indemnification arrangements. As of December 31, 2004, none of these interests or arrangements
were considered significant variable interests and, therefore, did not meet the requirements for
consolidation under FIN 46R. F-54




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15.
    
    Capital stock  Preferred shares  Nortel Networks Limited is authorized to issue an unlimited number of Class A preferred
 shares, which rank senior to the Class B preferred shares and the common shares upon a
distribution of capital or assets, and an unlimited number of Class B preferred shares, which
rank junior to the Class A preferred shares and senior to the common shares upon a distribution
of capital or assets, in each case without nominal or par value. Each of the Class A and Class
B preferred shares is issuable in one or more series, each series having such rights,
restrictions and provisions as determined by the Board of Directors of Nortel at the time of
issue. Class A preferred shares have been issued for consideration denominated in Canadian
dollars and are presented in U.S. dollars after translation at the exchange rate in effect at
the date of original issue. Each series of Class A preferred shares ranks in parity with every
other series of Class A preferred shares. As of December 31, 2004 and 2003, the following
outstanding Class A preferred shares were included in shareholders equity: Numberof shares(thousands)
    
    
    $Series 5, issued November 26, 1996 for consideration of Canadian (C) $400
    
    
    16,000
    
    
    $
    294Series 7, issued November 28, 1997 for consideration of C $350
    
    
    14,000
    
    
    $
    242
  In addition, as of December 31, 2000, 200 shares of Cumulative Redeemable Class A Preferred
Shares Series 4 (Series 4 Shares) were outstanding and included in shareholders equity at a
value of $73. During the year ended December 31, 2001, the holders of all 200 Series 4 Shares
of Nortel Networks Limited exercised their right to exchange their Series 4 Shares for common
 shares of Nortel Networks Corporation. Nortel Networks Corporation issued in aggregate
approximately 9,035,000 common shares to the former holders of Series 4 Shares. As a result,
pursuant to an agreement in respect of the Series 4 Shares exchange rights, Nortel Networks
Limited issued approximately 4,090,000 common shares to NNC.The Cumulative Redeemable Class A Preferred Shares Series 5 (Series 5 Shares) are presented
net of tax effected issue costs of approximately $4. Until November 30, 2001, holders of Series
5 Shares were entitled to an annual fixed cumulative preferential cash dividend of Canadian
$1.275 per share (5.1 percent), payable, if declared, quarterly. As of December 1, 2001,
holders of Series 5 Shares are entitled to, if declared, a monthly floating cumulative
preferential cash dividend, which will float in relation to the average of the prime commercial
lending rates of two designated Canadian chartered banks during the relevant month, as adjusted
by the weighted-average trading price of Series 5 Shares during such month, up to a maximum of
100 percent of such prime rate. Holders of Series 5 Shares will have the right to convert their
 shares into Cumulative Redeemable Class A Preferred Shares Series 6 (Series 6 Shares), subject
to certain conditions, on December 1, 2006, and on December 1 of every fifth year thereafter.
No Series 6 Shares have been issued. Holders of Series 6 Shares will have a similar right to
convert back into Series 5 Shares every 5 years. In certain circumstances, conversions may be
automatic and mandatory. Series 5 Shares are redeemable at any time after December 1, 2001, at
Nortels option, at Canadian $25.50 per share together with accrued and unpaid dividends up to,
but excluding, the date of redemption. If issued on December 1, 2006, the Series 6 Shares will
be redeemable at Nortels option at Canadian $25 per share, together with accrued and unpaid
dividends up to but excluding, the date of redemption, on December 1, 2011, and on December 1 of
every fifth year thereafter.The Non-cumulative Redeemable Class A Preferred Shares Series 7 (Series 7 Shares) are
presented net of tax effected issue costs of approximately $4. Holders of the Series 7 Shares
were, until November 30, 2002, entitled to an annual fixed non-cumulative preferential cash
dividend of Canadian $1.225 per share (4.9 percent), payable, if declared, quarterly on the
first day of March, June, September and December. From December 1, 2002, holders of the Series
7 Shares are entitled to, if declared, a monthly floating non-cumulative preferential cash
dividend. Holders of Series 7 Shares have the right to convert their shares into Non-cumulative
Redeemable Class A Preferred Shares Series 8 (Series 8 Shares), subject to certain conditions,
on December 1, 2007 and on December 1 of every fifth year thereafter. No Series 8 shares have
been issued. Holders of the Series 8 Shares will have a similar right to convert back into
Series 7 Shares every five years and, in certain circumstances conversions may be automatic and
mandatory. Series 7 Shares are F-55




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##### Table of Contents



redeemable at any time after December 1, 2002 at Nortels
option, at Canadian $25.50 per share together with declared and unpaid dividends up to, but
excluding, the date of redemption. If issued on December 1, 2007, Series 8 Shares will also be
redeemable at Nortels option at Canadian $25 per share, together with declared and unpaid
dividends up to, but excluding, the date of redemption, on December 1, 2012, and on December 1
of every fifth year thereafter.  Common shares  Nortel Networks Limited is authorized to issue an unlimited number of common shares without
nominal or par value. The outstanding number of common shares included in shareholders equity
consisted of the following as of December 31: 2004
    
    
    2003
    
    
    2002Number
    
    
    
    
    
    
    Number
    
    
    
    
    
    
    Number(number of shares in thousands)
    
    of shares
    
    
    $
    
    
    of shares
    
    
    $
    
    
    of shares
    
    
    $Balance at beginning of year
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    2,111Share issuance to parent (a)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,287Reduction of
legal stated capital(b)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,187
    )Balance at end of year
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    1,211
 (a)
    
    During the year ended December 31, 2002, Nortel Networks Limited issued four common
shares to NNC for cash consideration of $2,287.(b)
    
    On December 19, 2002, September 27, 2002, August 29, 2002 and June 28, 2002, NNC, as
the holder of all Nortel Networks Limited issued and outstanding common shares, approved a
reduction in Nortel Networks Limited legal stated capital for its common shares in the
amount of $1,190, $672, $525 and $800, respectively.
 F-56




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16.
    
    Accumulated other comprehensive loss  The components of accumulated other comprehensive loss, net of tax, were as follows: 2004
    
    
    2003
    
    
    2002Accumulated foreign currency translation adjustmentBalance at the beginning of the year
    
    $
    214
    
    
    $
    (321
    )
    
    $
    (494
    )Change in foreign currency translation adjustment(a)
    
    
    159
    
    
    
    535
    
    
    
    173Balance at the end of the year
    
    
    373
    
    
    
    214
    
    
    
    (321
    )Unrealized gain (loss) on investments  netBalance at the beginning of the year
    
    
    81
    
    
    
    24
    
    
    
    5Change in unrealized gain (loss) on investments
    
    
    (66
    )
    
    
    57
    
    
    
    19Balance at the end of the year (b)
    
    
    15
    
    
    
    81
    
    
    
    24Unrealized derivative gain (loss) on cash flow hedges  netBalance at the beginning of the year
    
    
    12
    
    
    
    (3
    )
    
    
    (14
    )Change in unrealized derivative gain (loss) on cash flow hedges (c)
    
    
    6
    
    
    
    15
    
    
    
    11Balance at the end of the year
    
    
    18
    
    
    
    12
    
    
    
    (3
    )Minimum pension liability(d)Balance at the beginning of the year
    
    
    (829
    )
    
    
    (641
    )
    
    
    (84
    )Change in minimum pension liability adjustment
    
    
    (115
    )
    
    
    (188
    )
    
    
    (557
    )Balance at the end of the year
    
    
    (944
    )
    
    
    (829
    )
    
    
    (641
    )Accumulated other comprehensive loss
    
    $
    (538
    )
    
    $
    (522
    )
    
    $
    (941
    )
 (a)
    
    The change in the foreign currency translation adjustment was not adjusted for income
taxes since it related to indefinite term investments in non-U.S. subsidiaries.(b)
    
    Certain securities deemed available-for-sale by Nortel were measured at fair value.
Unrealized holding gains (losses) related to these securities were excluded from net
earnings (loss) and were included in accumulated other comprehensive loss until realized.
Unrealized gain (loss) on investments was net of tax of nil, for each of the years ended
December 31, 2004, 2003 and 2002. During the years ended December 31, 2004, 2003 and 2002,
realized (gains) losses on investments of $(14) , $(6) and $(4), respectively,
were reclassified to other income (expense)  net in the consolidated statements of
operations.(c)
    
    During the years ended December 31, 2004, 2003 and 2002, net derivative gains of $14,
$32 and $18 were reclassified to other income (expense)  net. Unrealized
derivative gain (loss) on cash flow hedges is net of tax of nil, nil and $1 for the years
ended December 31, 2004, 2003 and 2002, respectively. Nortel estimates that $18 of net
derivative gains (losses) included in accumulated other comprehensive loss will be
reclassified into net earnings (loss) within the next 12 months.(d)
    
    Represents non-cash charges to shareholders equity related to the increase in the
minimum required recognizable liability associated with Nortels pension plans (see note
8). The change in minimum pension liability adjustment is presented net of tax of
$6, $31 and $133 for the years ended December 31, 2004, 2003 and 2002, respectively.
  17.
    
    Stock-based compensation plans  On March 10, 2004, NNC announced, among other things, that it was likely that NNC would
need to revise certain previously announced results and restate previously filed financial
results for one or more earlier periods. As a result of NNCs March 10, 2004 announcement, NNC
suspended as of March 10, 2004: the purchase of Nortel Networks Corporation common shares under
the ESPPs; the exercise of outstanding options granted under the Nortel Networks Corporation
2000 Stock Option Plan (the 2000 Plan) and Nortel Networks Corporation 1986 Stock Option Plan
As Amended and Restated (the 1986 Plan), and the grant of any additional options under those
plans, or the exercise of outstanding options granted under employee stock option plans
previously assumed by Nortel in connection with mergers and acquisitions; and the purchase of
units in a NNC stock fund or purchase of Nortel Networks Corporation common shares under NNCs
defined contribution and investment plans, until such time, at the earliest, that NNC and Nortel
are in compliance with U.S. and Canadian regulatory securities filing requirements. F-57




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Stock options  Nortel grants options to purchase Nortel Networks Corporation common shares under two
existing stock option plans, the 2000 Plan and the 1986 Plan. Under these two plans, options to
purchase Nortel Networks Corporation common shares may be granted to employees and under the
2000 Plan, options may be granted to directors of Nortel. The options under both plans entitle
the holders to purchase one common share at a subscription price of not less than 100 percent of
market value on the effective date of the grant. Subscription prices are stated and payable in
U.S. dollars for U.S. options and in Canadian dollars for Canadian options. Generally options
granted prior to 2003 vest 33 1/3 percent on the anniversary date of the
grant for three years. Commencing in 2003, options granted by NNC generally vest 25 percent each
year over a four year period on the anniversary date of the grant. The committee of the Board of
Directors of Nortel that administers both plans generally has the discretion to vary the period
during which the holder has the right to exercise options and, in certain circumstances, may
accelerate the right of the holder to exercise options, but in no case shall the exercise period
exceed ten years.Options granted under the 2000 Plan and 1986 Plan may be granted with or without a SAR. A SAR
entitles the holder to receive payment of an amount equivalent to the excess of the market value
of a common share at the time of exercise of the SAR over the subscription price of the common
share to which the option relates. Options with SARs may be granted on a cancellation basis, in
which case the exercise of one causes the cancellation of the other, or on a simultaneous basis,
in which case the exercise of one causes the exercise of the other. As of December 31, 2004 and
2003, there were no SARs outstanding.In January 1995, a key contributor stock option program (the Key Contributor Program) was
established that applies to both the 1986 Plan and the 2000 Plan. Under that program, a
participant is granted concurrently an equal number of initial options and replacement options.
The initial options and the replacement options expire ten years from the date of grant. The
initial options have an exercise price equal to the market value of common shares of Nortel
Networks Corporation on the date of grant and the replacement options have an exercise price
equal to the market value of common shares of Nortel Networks Corporation on the date all of the
initial options are fully exercised, provided that in no event will the exercise price be less
than the exercise price of the initial options. Replacement options are generally exercisable
commencing 36 months after the date all of the initial options are fully exercised, provided
that the participant beneficially owns a number of common shares of Nortel Networks Corporation
at least equal to the number of common shares subject to the initial options less any common
 shares sold to pay for options costs, applicable taxes, and brokerage costs associated with the
exercise of the initial options. No Key Contributor Program options were granted for the years
ended December 31, 2004 and 2003, respectively, under either stock option plan.NNC assumed stock options plans in connection with the acquisition of various companies. Common
 shares of Nortel Networks Corporation are issuable upon the exercise of options under the
assumed stock option plans, although no further options may be granted under the assumed plans.
The vesting periods for options granted under these assumed stock option plans may differ from
the 2000 Plan and 1986 Plan, but are not considered to be significant to Nortels overall use of
stock-based compensation.On June 20, 2001, NNC commenced a voluntary stock option exchange program (the Exchange
Program) for Nortels employees allowing employees to exchange certain outstanding stock
options for new stock options, based on a prescribed formula. The terms of the Exchange Program
required that the new grants of options would be made at least six months and a day from the
cancellation date of the options tendered for exchange, which was July 27, 2001. Nortels then
Board of Directors and its then board appointed officers were not eligible to participate in the
Exchange Program. F-58




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Restricted stock unit plan  The Nortel Networks Limited Restricted Stock Unit Plan is a long-term incentive plan that
generally provides executive officers and certain senior management with the opportunity to
receive RSUs over a specified period of time if assigned performance thresholds are achieved and
the joint leadership resources committee of the Boards of the Directors of Nortel and NNC (the
Committee) determines, in its discretion, to issue and settle all or a portion of the
allocated RSUs. Each RSU issued entitles the holder to receive one common share of Nortel
Networks Corporation purchased on the open market, or at the discretion of the Committee or at
the election of the holder in certain circumstances, cash in lieu of shares. As a result of
changes to the NYSE listing standards effective June 30, 2004, no further RSUs may be allocated
without shareholder approval.The number of RSUs (in millions) allocated as of December 31, 2004, 2003 and 2002 were
approximately 11, 20 and 2, respectively.The RSUs allocated in 2003 had a three year performance period ending December 31, 2005, which
included four performance thresholds. The performance criteria for each of the four performance
thresholds were distinct Return on Sales Before Tax percentage targets, calculated on a
rolling four-quarter basis. In order to receive a payout, the recipient must have continued
employment until the date the allocated RSUs were issued and settled. Once the Committee
determined that a threshold had been achieved, the Committee had the discretion to determine
whether additional factors should be considered in determining the number of allocated RSUs to
be issued and settled. Such additional factors included the performance of competitors and other
relevant business, financial, competitive, political and other criteria deemed appropriate by
the Committee. Nortel issued and settled approximately 13 million units of the RSUs allocated in
2003.On January 10, 2005, the Committee exercised the discretion reserved to it with respect to the
RSUs allocated in 2003 and determined, and the boards of directors of Nortel and NNC confirmed
and approved, that no additional RSUs allocated in 2003 will be issued (including in connection
with the achievement of the third and fourth Return on Sales Before Tax performance targets or
otherwise) and that all unissued RSUs relating to 2003 were immediately terminated and cancelled
in their entirety.The RSUs allocated in 2001 had a two year performance period, which included five performance
segments. At the end of the performance period, once the Committee determined whether the five
performance segments had been achieved, it used its discretion to consider the financial
performance and strategic business initiatives of NNC and its overall performance as compared to
key competitors during the two year performance period to determine the number of allocated RSUs
to be issued and settled. On May 29, 2003, Nortel issued and settled approximately 1.5 million
units in respect of the RSUs allocated in 2001.  Directors deferred share compensation plans  Under the Nortel Networks Corporation Directors Deferred Share Compensation Plan and the
Nortel Networks Limited Directors Deferred Share Compensation Plan, non-employee directors can
elect to receive all or a portion of their compensation for services rendered as a director of
Nortel or NNC, any committees thereof, and as board or committee chairperson, in the form of
share units, instead of cash. The share units are settled a specified number of trading days
following the release of NNCs financial results after the director ceases to be a member of the
applicable board, and each share unit entitles the holder to receive one common share of Nortel
Networks Corporation purchased on the open market. Certain new directors have been prevented
under applicable securities laws from participating in the Directors Deferred Share
Compensation Plans due to the delay in the filing of certain financial statements and related
periodic reports by Nortel and NNC. As of December 31, 2004 and 2003, the number of share units
issued (in millions) was 2 and 1, respectively.  Employee stock purchase plans  Nortel has ESPPs to facilitate the acquisition of common shares of Nortel Networks
Corporation by eligible employees. Effective March 10, 2004, purchases under the ESPPs were
suspended due to a delay in filing the 2003 Annual Reports. In addition, effective June 30,
2004, for purchases under the ESPPs to continue to meet the amended NYSE listing
standards NNC requires shareholder approval of the ESPPs. Prior to March 10, 2004, the ESPP
operated in the manner
described below. The ESPPs had four offering periods each year, with each offering period
beginning on the first day of each calendar quarter. Eligible employees were permitted to have
up to 10 percent of their eligible compensation deducted from their pay during each offering
period to contribute towards the purchase of Nortel Networks Corporation common shares. The
Nortel Networks Corporation common shares were purchased by an independent broker through the
facilities of the TSX and/or NYSE, and held by a custodian on behalf of the plan participants. F-59




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For North American eligible employees, Nortel Networks Corporation common shares were purchased
on the TSX and/or NYSE at fair market value but employees, effectively, paid only 85 percent of
that price as a result of Nortel contributing the remaining 15 percent of the price. For
non-North American eligible employees, common shares were purchased at a purchase price equal to
the greater of:  (i)
    
    85 percent of the average of the high and low prices of common shares on the
first trading day of the offering period; and(ii)
    
    71.5 percent of the market price of the common shares on the last trading day
of the offering period; or(iii)
    
    if the market price on the last trading day was equal to or less than the
average of the high and low on the first trading day, the purchase price was 85 percent
of the market price on the last trading day of the offering period.  The purchases under the ESPPs for the years ended December 31 are shown below: (number of shares in thousands)
    
    2004
    
    
    2003
    
    
    2002Nortel Networks Corporation common shares purchased (a)
    
    
    
    
    
    
    11,532
    
    
    
    38,824Weighted-average price of shares purchased
    
    $
    
    
    
    $
    3.10
    
    
    $
    1.31
 (a)
    
    Compensation expense was recognized for Nortels portion of the contributions. Nortel
contributed an amount equal to the difference between the market price and the purchase
price.
  Due to the suspensions of the purchase of Nortel Networks Corporation common shares under
the stock purchase plans as discussed above, in lieu of the employer portion of stock purchase
plan contributions Nortel made equivalent pre-tax payments to eligible employees during the year
ended December 31, 2004 totaling $7, which was recorded as compensation expense.  Stock-based compensation  Stock based compensation recorded during the years ended December 31 was as follows: 2004
    
    
    2003
    
    
    2002(a)Stock-based compensation:Stock option expense
    
    $
    76
    
    
    $
    26
    
    
    $
    Employer portion of ESPPs
    
    
    
    
    
    
    6
    
    
    
    6RSU expense
    
    
    41
    
    
    
    19
    
    
    
    5DSU expense
    
    
    (1
    )
    
    
    3
    
    
    
    6Total stock-based compensation reported  net of tax
    
    $
    116
    
    
    $
    54
    
    
    $
    17
 (a)
    
    In 2002, compensation related to employer portion of ESPPs, RSUs and DSUs was net of
tax of $2, $1, and $3, respectively. In 2004 and 2003, there was no tax effect for any of
the above noted plans.
 F-60




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The following weighted-average assumptions were used in computing the fair value of stock
options for purposes of expense recognition and pro forma disclosures, as applicable, for the
following periods: 2004
    
    
    2003
    
    
    2002Black-Scholes weighted-average assumptionsExpected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    94.47
    %
    
    
    92.49
    %
    
    
    71.33
    %Risk-free interest rate
    
    
    2.96
    %
    
    
    2.81
    %
    
    
    4.49
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4Weighted-average stock option fair value
per option granted
    
    $
    5.21
    
    
    $
    1.57
    
    
    $
    3.50
  18.
    
    Discontinued operations  In 2001, Nortels Board of Directors approved a plan to discontinue Nortels access
solutions operations consisting of all of Nortels narrowband and broadband access solutions,
including copper, cable and fixed wireless solutions, as well as Nortels then consolidated
membership interest in Arris Group and equity investment in Elastic Networks, Inc. (Elastic
Networks). Also affected by the decision were Nortels prior acquisitions of Sonoma Systems
(Sonoma), Promatory Communications, Inc. (Promatory), Aptis Communications, Inc. (Aptis)
and Broadband Networks Inc.Certain disposal activities were delayed beyond the original planned timeframe of one year due
to the prolonged deterioration in industry and market conditions during 2003 and 2002.
Accordingly, during the years ended December 31, 2003 and 2002, Nortel continued to wind down
its access solutions operations, and as of December 31, 2003, Nortel had substantially completed
the wind down of these operations.The following consolidated financial results for discontinued operations are presented as of
December 31 for the consolidated balance sheets and for the years ended December 31 for the
consolidated statements of operations and consolidated statements of cash flows:  Consolidated statements of operations: 2004
    
    
    2003
    
    
    2002Revenues
    
    $
    4
    
    
    $
    14
    
    
    $
    158Net earnings (loss) from discontinued operations  net of tax
    
    $
    
    
    
    $
    
    
    
    $
    Net gain (loss) on disposal of operations  net of tax (a)
    
    
    49
    
    
    
    184
    
    
    
    (101
    )Net earnings (loss) from discontinued operations  net of tax
    
    $
    49
    
    
    $
    184
    
    
    $
    (101
    )
 (a)
    
    Net gain (loss) on disposal of operations was net of an applicable income tax expense
(benefit) of nil, $1 and $(16) for the years ended December 31, 2004, 2003 and 2002,
respectively.
 F-61




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Consolidated balance sheets: 2004
    
    
    2003Deferred income taxes
    
    $
    14
    
    
    $
    26Other current assets (a)
    
    
    
    
    
    
    2Total current assets of discontinued operations (note 4)
    
    
    14
    
    
    
    28Other long-term assets (b)
    
    
    33
    
    
    
    4Total assets of discontinued operations
    
    $
    47
    
    
    $
    32Current liabilities (note 4)
    
    $
    
    
    
    $
    6Long-term liabilities
    
    
    
    
    
    
    1Total liabilities of discontinued operations
    
    $
    
    
    
    $
    7
 (a)
    
    Accounts receivable of $3 and $5 and inventories of $58 and $75, as of December 31,
2004 and 2003, respectively, were fully provided for.(b)
    
    Consisted of customer financing receivables which were net of provisions of nil and
$55, as of December 31, 2004 and 2003, respectively.
  Consolidated statements of cash flows: 2004
    
    
    2003
    
    
    2002Cash flows from (used in) discontinued operationsOperating activities
    
    $
    22
    
    
    $
    138
    
    
    $
    250Investing activities
    
    
    
    
    
    
    241
    
    
    
    100Net cash from (used in) discontinued operations
    
    $
    22
    
    
    $
    379
    
    
    $
    350
  2004 Activity  Nortel recorded net earnings from discontinued operations  net of tax, of $49 in 2004. The
significant items included in net earnings are summarized below.During the year ended December 31, 2004, Nortel reassessed its remaining provisions for
discontinued operations and recorded a net gain of $17, consisting of changes in estimates of
$13 for liabilities, and $4 for both short-term and long-term receivables.On December 23, 2004, a customer financing arrangement was restructured. The notes receivable
that were restructured had a net carrying amount of $1, net of a provision of $63. The
arrangement increased the net carrying amount of the receivable to $33 and resulted in a gain of
$32 due to the revaluation of the receivable. On January 25, 2005, Nortel sold this receivable for
cash proceeds (see note 14).  2003 Activity  Nortel recorded net earnings from discontinued operations  net of tax, of $184 in 2003.
The significant items included in net earnings are summarized below.During the year ended December 31, 2003, Nortel reassessed its remaining provisions for
discontinued operations and recorded a net gain of $68, consisting of changes in estimates of
$149 for liabilities, offset by additional provisions for both short-term and long-term
receivables of $81.On December 17, 2003, Nortel entered into an agreement to settle an outstanding $21 note
receivable from one of its customers, which was previously provisioned, for total cash proceeds
of approximately $17. A gain of $17 was recorded as a result of this transaction. F-62




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On December 23, 2003, Nortel sold certain plant and equipment, inventory, patent and other
intellectual property related to its fixed wireless access operations, to Airspan Networks Inc.
(Airspan). Nortel received cash proceeds of $13. The majority of the assets transferred to
Airspan had previously been written off by Nortel as part of its discontinued operations. As a
result of this transaction, Nortel recorded a gain of $14 during the year ended December 31,
2003.On March 24, 2003, Nortel sold 8 million common shares of Arris Group back to Arris Group for
cash consideration of $28 pursuant to a March 11, 2003 agreement, which resulted in a gain of
$12. Following this transaction, Nortels interest in Arris Group was reduced to 18.8 percent,
and it ceased equity accounting for the investment. As a result, Nortel now classifies its
remaining ownership interest in Arris Group as an available-for-sale investment within
continuing operations. Nortel has continued to dispose of its interest in Arris Group and the
gain or loss on the sale of shares subsequent to the first quarter of 2003 has been included in
other income (expense)  net (see note 9).On March 18, 2003, Nortel assigned its subordinated redeemable preferred interest (membership
interest) in Arris Interactive, L.L.C. (Arris Interactive) to ANTEC Corporation, an Arris
Group company, for cash consideration of $88. As a result of this transaction, Nortel recorded
a loss of $2. Also in connection with the March 2003 transactions, Nortel received $11 upon
settlement of a sales representation agreement with Arris Group and recorded a gain of $11.On March 20, 2003, Nortel entered into an agreement with a customer to restructure approximately
$465 of trade and customer financing receivables owed to Nortel, the majority of which was
previously provisioned. As a result of the restructuring agreement, Nortel 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
$66 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.2002 ActivityNortel recorded a net loss from discontinued operations  net of tax, of $101 in 2002. The
significant items included in this net loss are summarized below.During the year ended December 31, 2002, Nortel reassessed its remaining provisions for
discontinued operations and recorded a net additional loss of $97. The loss consisted of
additional provisions for both short-term and long-term receivables of $157, offset by gains of
$60 due to other changes in estimates.On June 25, 2002, Arris Group completed a secondary public offering of 15 million common shares
held by Nortel. Following the closing of the offering, Nortel owned 22 million shares, or
approximately 27 percent of Arris Groups common shares. The cash proceeds received were $67 and
a gain of approximately $17 was recorded as a result of this transaction. During the three
months ended March 31, 2002, Nortel recorded a gain of approximately $13 due to the reduction of
Nortels ownership interest in Arris Group, received for Nortels original interest in Arris
Group, from approximately 49 percent to approximately 46 percent as a result of Arris Groups
issuance of common shares in connection with its acquisition of another company.In addition, during the year, as a result of negotiation with Arris Group, Nortel reduced the
carrying value of its membership interest in Arris Interactive and recorded a loss of $14.On April 21, 2002, Nortel entered into an agreement with Aastra Technologies Limited to sell
certain assets, which were included in discontinued operations, associated with Nortels prior
acquisition of Aptis. The transaction was completed during the three months ended June 30, 2002.
The consideration primarily consisted of approximately $16 in cash, as well as contingent cash
consideration of up to $60 over four years based on the achievement of certain revenue targets
by the business. Nortel recorded a loss of approximately $44 on the transaction.On March 5, 2002, Nortel divested its approximately 46 percent ownership interest in Elastic
Networks to Paradyne Networks, Inc. (Paradyne) in exchange for an approximately 8 percent
ownership interest in Paradyne. Nortel recorded a gain of approximately $7 on the transaction.
The investment in Paradyne was classified within continuing operations. F-63




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On February 6, 2002, Nortel divested its 68.5 percent interest in Netgear, Inc. in exchange for
cash proceeds of $5, a subordinated, unsecured, convertible, promissory note receivable of $20,
and the assumption of certain liabilities. Nortel recorded a gain of approximately $7 on this
transaction. Subsequent to 2002, Nortel received cash of $20 relating to the repayment of the
subordinated, unsecured, convertible, promissory note receivable.  19.
    
    Related party transactions  In the ordinary course of business, Nortel engages in transactions with certain of its
equity-owned investees that are under or are subject to Nortels significant influence and with
joint ventures of NNC and with NNC and directly owned subsidiaries of NNC. These transactions
are sales and purchases of goods and services under usual trade terms and are measured at their
exchange amounts.Transactions with related parties for the years ended December 31 are summarized as follows: 2004
    
    
    2003
    
    
    2002Consolidated statements of operationsRevenues
    
    $
    2
    
    
    $
    3
    
    
    $
    15Purchases
    
    $
    73
    
    
    $
    99
    
    
    $
    52Research and development expense
    
    $
    20
    
    
    $
    30
    
    
    $
    19
  Balances with related parties as of December 31 were as follows: 2004
    
    
    2003Consolidated balance sheetsOwing from NNC
    
    $
    134
    
    
    $
    67Owing from NNC subsidiaries
    
    
    114
    
    
    
    87Other related parties (a)
    
    
    (5
    )
    
    
    (7
    )Related party receivables
    
    $
    243
    
    
    $
    147
 (a)
    
    Nortel purchases certain inventory for its Optical Networks segment from Bookham, a
related party due to Nortels equity interest in Bookham. Nortel has certain notes
receivable due from Bookham with a carrying amount of $20 and $19 as of December 31, 2004
and 2003, respectively. See note 9 for additional information on Bookham transactions.
  Bookham is a sole supplier of key components to Nortels Optical Networks business. In February
2005, Nortel agreed to waive until November 6, 2006 the requirement under the Series A Note and
Series B Note for Bookham to maintain a minimum cash balance. In March 2005, Nortel also agreed to
adjust the prepayment provisions of these notes and to amend its supply agreement with Bookham to include for a twelve month period price increases for
certain products and acceleration of certain planned purchase orders and invoice payment terms. These March amendments remain subject to completion of
definitive documentation and were agreed to by Nortel to provide Bookham with financial flexibility
to continue the supply of components for Nortels Optical Networks products. See note 9 for
additional information on the Bookham transactions.On August 29, 2002, a payment was made by a subsidiary of Nortel to NNC equal to $525
representing the difference between the market value of Nortel Networks Corporation common
 shares issued on option exercises and the exercise price of NNC stock options held and exercised
by employees of the subsidiary. This payment is referred to as stock option fair value
increment in the consolidated statements of shareholders equity and consolidated statement of
cash flows.In 2001, Nortel completed the sale of substantially all of the assets in the Cogent Defence
Systems (CDS) business to EADS Telecom. At that time, Nortel held a 41 percent ownership
interest in EADS Telecom and EADS held the
remaining 59 percent. Under the terms of the agreement, Nortel sold substantially all of its
assets in the CDS business including: fixed assets; accounts receivable; inventory;
intellectual property; and licenses (but excluding cash on hand as at the closing date) for
consideration of approximately $143, comprised of a loan note due in 2002 and a call option to
acquire an additional approximate 7 percent ownership interest in NNF beginning in 2004. Nortel
recorded a gain on the
sale of approximately $37 which was included in (gain) loss on sale of
businesses and assets, and a deferred gain of $26, which is amortized into (gain) loss on sale
of businesses and assets over the life of the assets sold to EADS Telecom. In 2002, in
connection with negotiations with EADS, the loan note and call option were cancelled and a new
loan note was issued to satisfy the remaining consideration owing in 2003. As a result, Nortel
recorded an additional gain on the sale of approximately $30, which was included in (gain) loss
on sale of businesses and assets and a further deferred gain of $21, which is amortized into
(gain) loss on sale of businesses and assets over the remaining life of the assets sold to EADS
Telecom in 2001. During the years ended December 31, 2003 and 2002, $13 and $11, respectively,
of the deferred gain was amortized into (gain) loss on sale of businesses and assets. On
September 18, 2003, as a result of the sale of Nortels 41 percent interest in EADS Telecom (see
note 9), the remaining unamortized deferred gain of $23 related to the sale of substantially all
of the assets in the CDS business during the year ended December 31, 2001, was recognized and
included in (gain) loss on sale of businesses and assets. F-64




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20.
    
    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 U.S. District Courts for the Eastern
District of New York, for the Southern District of New York and for the District of New Jersey
and the provinces of Ontario, Quebec and British Columbia in Canada, on behalf of shareholders
who acquired Nortel Networks Corporation securities as early as October 24, 2000 and as late as
February 15, 2001, allege, among other things, violations of U.S. 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 U.S. 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 grounds 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 U.S. District Court for the Southern
District of New York on behalf of shareholders who acquired the securities of JDS between
January 18, 2001 and February 15, 2001, alleging violations of the same U.S. federal securities
laws as the above-noted lawsuits.On April 1, 2002, NNC filed a motion to dismiss both the above consolidated U.S. shareholder
class action and the above JDS shareholder class action complaints on the grounds that they
failed to state a cause of action under U.S. 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 U.S. class action complaint. Plaintiffs appealed the dismissal of the JDS
shareholder class action complaint. On November 19, 2003, oral argument was held before the
U.S. Court of Appeals for the Second Circuit on the JDS shareholders appeal of the dismissal of
their complaint. On May 19, 2004, the Second Circuit issued an opinion affirming the dismissal
of the JDS shareholder class action complaint and on July 14, 2004 the Second Circuit denied
plaintiffs motion for rehearing. On October 12, 2004, the plaintiffs filed a petition for writ
of certiorari in the U.S. Supreme Court. On November 12, 2004, the defendants filed Brief for
the Respondents in Opposition, and on November 22, 2004, the plaintiffs filed Reply to Brief in
Opposition. On January 10, 2005, the U.S. Supreme Court
denied the petition for writ of certiorari. With respect to the consolidated U.S. shareholder
class action, the plaintiffs served a motion for class certification on March 21, 2003. On May
30, 2003, the defendants served an opposition to the motion for class certification. Plaintiffs
reply was served on August 1, 2003. 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 November 24, 2003, the Second Circuit denied the motion. On March 10, 2004, the District
Court approved the form of notice to the class which was published and mailed. F-65




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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 auditors as defendants. The factual allegations in the
Ontario Claim are substantially similar to the allegations in the consolidated amended complaint
filed in the U.S. District Court described above. The Ontario Claim is on behalf of all
Canadian residents who purchased Nortel Networks Corporation securities (including options on
Nortel Networks Corporation 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. On December 12, 2003, plaintiffs counsel requested an extension of time to January
21, 2004 to deliver class certification materials. On January 21, 2004, plaintiffs counsel
advised the Court that the two representative plaintiffs in the action no longer wished to
proceed, but counsel was prepared to deliver draft certification materials pending the
replacement of the representative plaintiffs. On February 19, 2004, the plaintiffs counsel
advised the Court of a potential new representative plaintiff. On February 26, 2004, the
defendants requested the Court to direct the plaintiffs counsel to bring a motion to permit the
withdrawal of the current representative plaintiffs and to substitute the proposed
representative plaintiff. On June 8, 2004, the Court signed an order allowing a Second Fresh as
Amended Statement of Claim that substituted one new representative plaintiff, but did not change
the substance of the prior claim.A purported class action lawsuit was filed in the U.S. District Court for the Middle District of
Tennessee on December 21, 2001, on behalf of participants and beneficiaries of the Nortel
Long-Term Investment Plan (the Plan) at any time during the period of March 7, 2000 through
the filing date and who made or maintained Plan investments in Nortel Networks Corporation
common shares, under the Employee Retirement Income Security Act (ERISA) for Plan-wide relief
and alleging, among other things, material misrepresentations and omissions to induce Plan
participants to continue to invest in and maintain investments in Nortel Networks Corporation
common shares in the Plan. A second purported class action lawsuit, on behalf of the Plan and
Plan participants for whose individual accounts the Plan purchased Nortel Networks Corporation
common shares during the period from October 27, 2000 to February 15, 2001 and making similar
allegations, was filed in the same court on March 12, 2002. A third purported class action
lawsuit, on behalf of persons who are or were Plan participants or beneficiaries at any time
since March 1, 1999 to the filing date and making similar allegations, was filed in the same
court on March 21, 2002. The first and second purported class action lawsuits were consolidated
by a new purported class action complaint, filed on May 15, 2002 in the same court and making
similar allegations, on behalf of Plan participants and beneficiaries who directed the Plan to
purchase or hold shares of certain funds, which held primarily Nortel Networks Corporation
common shares, during the period from March 7, 2000 through December 21, 2001. On September 24,
2002, plaintiffs in the consolidated action filed a motion to consolidate all the actions and to
transfer them to the U.S. District Court for the Southern District of New York. The plaintiffs
then filed a motion to withdraw the pending motion to consolidate and transfer. The withdrawal
was granted by the District Court on December 30, 2002. A fourth purported class action
lawsuit, on behalf of the Plan and Plan participants for whose individual accounts the Plan held
Nortel Networks Corporation common shares during the period from March 7, 2000 through March 31,
2001 and making similar allegations, was filed in the U.S. 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 U.S. District Court for 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 U.S. District Court for the Middle District of Tennessee (the
Consolidated ERISA Action). 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 30, 2004, the plaintiffs filed a motion for certification of a class
consisting of participants in, or beneficiaries of, the Plan who held shares of the NNC Stock Fund during the period from March 7,
2000 through March 31, 2001. On April 27, 2004, the Court granted the defendants motion to
stay discovery pending resolution of defendants motion to dismiss. On June 15, 2004, the
plaintiffs filed a First Amended Consolidated Class Action Complaint that added additional
current and former officers and employees as defendants and expanded the purported class period
to extend from March 7, 2000 through to June 15, 2004. F-66




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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 U.S. 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 U.S. Court of Appeals for the Ninth Circuit denied the
plaintiffs appeal of that decision. On April 18, 1997, a second lawsuit was filed in the
California Court, purportedly on behalf of a class of shareholders who acquired Bay Networks
common shares pursuant to the registration statement and prospectus that became effective on
November 15, 1995. The two actions in the California Court were consolidated in April 1998;
however, the California Court denied the plaintiffs motion for class certification. In January
2000, the California Court of Appeal rejected the plaintiffs appeal of the decision. A
petition for review was filed with the California Supreme Court by the plaintiffs and was
denied. In February 2000, new plaintiffs who allege to have been shareholders of Bay Networks
during the relevant periods, filed a motion for intervention in the California Court seeking to
become the representatives of a class of shareholders. The motion was granted on June 8, 2001
and the new plaintiffs filed their complaint-in-intervention on an individual and purported
class representative basis alleging misrepresentations made in connection with the purchase and
sale of securities of Bay Networks in violation of California statutory and common law. On March
11, 2002, the California Court granted the defendants motion to strike the class allegations.
The plaintiffs were permitted to proceed on their individual claims. The intervenor-plaintiffs
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. On December 22,
2003, the plaintiffs served their motion for certification of a class of purchasers of Bay
Networks common shares from July 25, 1995 through to October 14, 1996. Hearing of the
plaintiffs motion for class certification was held on May 4, 2004. On July 27, 2004, the Court
entered an Amended Order Denying Motion of Intervenor Plaintiffs for Class Certification and
Setting Further Hearing. On August 9, 2004, the intervenor-plaintiffs obtained Court approval
to dismiss their claims and this action and, on September 30, 2004, the Court entered dismissal
with prejudice of the entire action of all parties and all causes of action.Subsequent to the March 10, 2004 announcement in which NNC indicated it was likely that it and
Nortel would need to revise their previously announced unaudited results for the year ended
December 31, 2003, and the results reported in certain of their quarterly reports for 2003, and
to restate their previously filed financial results for one or more earlier periods, NNC and
certain of its then current and former officers and directors were named as defendants in 27
purported class action lawsuits. These lawsuits in the U.S. District Court for the Southern
District of New York on behalf of shareholders who acquired Nortel Networks Corporation
securities as early as February 16, 2001 and as late as May 15, 2004, allege, among other
things, violations of U.S. federal securities laws. These matters are also the subject of
investigations by Canadian and U.S. securities regulatory and criminal investigative
authorities. On June 30, 2004, the Court signed Orders consolidating the 27 class actions and
appointing lead plaintiffs and lead counsel. The plaintiffs filed a consolidated class action
complaint on September 10, 2004, alleging a class period of April 24, 2003 through and including
April 27, 2004. On November 5, 2004, Nortel Networks Corporation and the Audit Committee
Defendants filed a motion to dismiss the consolidated class action complaint. On January 18,
2005, the lead plaintiffs, NNC, and the Audit Committee Defendants reached an agreement in which
NNC would withdraw its motion to dismiss and plaintiffs would dismiss Count II of the complaint
which asserts a claim against the Audit Committee Defendants.On April 5, 2004, NNC announced that the SEC had issued a formal order of investigation in
connection with NNCs previous restatement of its financial results for certain periods, as
announced in October 2003, and NNC announcements in March 2004 regarding the likely need to
revise certain previously announced results and restate previously filed financial results for
one or more periods. The matter had been the subject of an informal SEC inquiry. On April 13,
2004, NNC announced that it had received a letter from the staff of the Ontario Securities
Commission (OSC) advising that there is an OSC Enforcement Staff investigation into the same
matters that are the subject of the SEC investigation.On May 14, 2004, NNC announced that it had received a federal grand jury subpoena for the
production of certain documents, including financial statements and corporate, personnel and
accounting records, in connection with an ongoing criminal investigation being conducted by the
U.S. Attorneys Office for the Northern District of Texas, Dallas Division. F-67




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On May 18, 2004, a purported class action lawsuit was filed in the U.S. District Court for the
Middle District of Tennessee on behalf of individuals who were participants and beneficiaries of
the Plan at any time during the period of December 23, 2003 through the filing date and who made
or maintained Plan investments in Nortel Networks Corporation common shares, under the ERISA for
Plan-wide relief and alleging, among other things, breaches of fiduciary duty. On September 3,
2004, the Court signed a stipulated order consolidating this action with the Consolidated ERISA
Action described above. On June 16, 2004, a second purported class action lawsuit, on behalf of
the Plan and Plan participants for whose individual accounts the Plan purchased Nortel Networks
Corporation common shares during the period from October 24, 2000 to June 16, 2004, and making
similar allegations, was filed in the U.S. District Court for the Southern District of New York.
On August 6, 2004, the Judicial Panel on Multidistrict Litigation issued a conditional transfer
order to transfer this action to the U.S. District Court for the Middle District of Tennessee
for coordinated or consolidated proceedings pursuant to 28 U.S.C. section 1407 with the
Consolidated ERISA Action described above. On August 20, 2004, plaintiffs filed a notice of
opposition to the conditional transfer order with the Judicial Panel. On December 6, 2004, the
Judicial Panel denied the opposition and ordered the action transferred to the U.S. District
Court for the Middle District of Tennessee for coordinated or consolidated proceedings with the
Consolidated ERISA Action described above. On January 3, 2005, this action was received in the
U.S. District Court for the Middle District of Tennessee and consolidated with the Consolidated
ERISA Action described above.On July 28, 2004, Nortel and NNC, and certain directors and officers, and certain former
directors and officers, of Nortel and NNC, were named as defendants in a purported class
proceeding in the Ontario Superior Court of Justice on behalf of shareholders who acquired
Nortel Networks Corporation securities as early as November 12, 2002 and as late as July 28,
2004. This lawsuit alleges, among other things, breaches of trust and fiduciary duty,
oppressive conduct and misappropriation of corporate assets and trust property in respect of the
payment of cash bonuses to executives, officers and employees in 2003 and 2004 under the NNC
Return to Profitability bonus program and seeks damages of Canadian $250 and an order under the
Canada Business Corporations Act directing that an investigation be made respecting these bonus
payments.On July 30, 2004, a shareholders derivative complaint was filed in the U.S. District Court for
the Southern District of New York against certain directors and officers, and certain former
directors and officers, of NNC alleging, among other things, breach of fiduciary duties owed to
NNC during the period from 2000 to 2003 including by causing NNC to engage in unlawful conduct
or failing to prevent such conduct; causing NNC to issue false statements; and violating the
law. On February 14, 2005, the defendants filed a motion to dismiss the derivative complaint.On August 16, 2004, NNC received a letter from the Integrated Market Enforcement Team of the
Royal Canadian Mounted Police (RCMP) advising NNC that the RCMP would be commencing a criminal
investigation into Nortels financial accounting situation.On February 16, 2005, a motion for authorization to institute a class action on behalf of
residents of Québec, who purchased NNC securities between January 29, 2004 and March 15, 2004,
was filed in the Québec Superior Court naming NNC as a defendant. The motion alleges that NNC
made misrepresentations about 2003 financial results.On March 9, 2005, Nortel and NNC, and certain of its current and former officers and directors
and its auditors were named as defendants in a purported class action proceeding filed in the
Ontario Superior Court of Justice, Commercial List, on behalf of all Canadian residents who
purchased Nortel Networks Corporation securities from April 24, 2003 to April 27, 2004. This
lawsuit alleges, among other things, negligence, misrepresentations, oppressive conduct, insider
trading and violations of Canadian corporation and competition laws in connection with NNCs
2003 financial results and seeks damages of Canadian $3,000, plus punitive damages in the amount
of Canadian $1,000, prejudgment and postjudgment interest and costs of the action.Except as otherwise described herein, in each of the matters described above, the plaintiffs are
seeking an unspecified amount of monetary damages.Nortel is also a defendant in various other suits, claims, proceedings and investigations which
arise in the normal course of business.Nortel is unable to ascertain the ultimate aggregate amount of monetary liability or financial
impact to Nortel of the above matters which, unless otherwise specified, seek damages from the
defendants of material or indeterminate amounts or could result in fines and penalties. F-68




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Nortel
cannot determine whether these actions, suits, claims and proceedings will, individually or
collectively, have a material adverse effect on the business, results of operations, financial
condition and liquidity of Nortel. Nortel or NNC, as applicable, and any named directors and
officers of Nortel or NNC, as applicable, intend to vigorously defend these actions, suits,
claims and proceedings. Nortel will continue to cooperate fully with all authorities in
connection with the regulatory and criminal investigations.Environmental mattersNortels operations are subject to a wide range of environmental laws in various
jurisdictions around the world. Nortel seeks to operate its business in compliance with such
laws. In 2004, Nortel became subject to new European product content laws and product takeback
and recycling requirements that will require full compliance by 2006. It is expected that these
laws will require Nortel to incur additional compliance costs. Although costs relating to
environmental matters have not resulted in a material adverse effect on the business, results of
operations, financial condition and liquidity in the past, there can be no assurance that Nortel
will not be required to incur such costs in the future. Nortel has a corporate environmental
management system standard and an environmental program to promote such compliance. Moreover,
Nortel has a periodic, risk-based, integrated environment, health and safety audit program.Nortels environmental program focuses its activities on design for the environment, supply
chain and packaging reduction issues. Nortel works with its suppliers and other external groups
to encourage the sharing of non-proprietary information on environmental research.Nortel is exposed to liabilities and compliance costs arising from its past and current
generation, management and disposal of hazardous substances and wastes. As of December 31,
2004, the accruals on the consolidated balance sheet for environmental matters were $31. Based
on information available as of December 31, 2004, management believes that the existing accruals
are sufficient to satisfy probable and reasonably estimable environmental liabilities related to
known environmental matters. Any additional liability that may result from these matters, and
any additional liabilities that may result in connection with other locations currently under
investigation, are not expected to have a material adverse effect on the business, results of
operations, financial condition and liquidity of Nortel.Nortel has remedial activities under way at 12 sites which are either currently or previously
owned or occupied facilities. An estimate of Nortels anticipated remediation costs associated
with all such sites, to the extent probable and reasonably estimable, is included in the
environmental accruals referred to above in an approximate amount of $31.Nortel is also listed as a potentially responsible party under the U.S. Comprehensive
Environmental Response, Compensation and Liability Act (CERCLA) at six Superfund sites in the
U.S. An estimate of Nortels share of the anticipated remediation costs associated with such
Superfund sites is expected to be de minimis and is included in the environmental accruals of
$31 referred to above.Liability under CERCLA may be imposed on a joint and several basis, without regard to the extent
of Nortels involvement. In addition, the accuracy of Nortels estimate of environmental
liability is affected by several uncertainties such as additional requirements which may be
identified in connection with remedial activities, the complexity and evolution of environmental
laws and regulations, and the identification of presently unknown remediation requirements.
Consequently, Nortels liability could be greater than its current estimate.  21.
    
    Subsequent events  Nortel Audit Committee Independent Review; restatements; related matters  In late October 2003, the Audit Committee of Nortel and NNCs Boards of Directors (the
Audit Committee) initiated the independent review of the facts and circumstances leading to
the restatement (effected in December 2003) of its consolidated financial statements for the
years ended December 31, 2002, 2001 and 2000 and for the quarters ended March 31, 2003 and June
30, 2003 (the First Restatement). The Audit Committee engaged the law firm now known as
Wilmer Cutler Pickering Hale & Dorr LLP (WCPHD) to advise it in connection with the
independent review of the facts and circumstances leading to the First Restatement (the
Independent Review). F-69




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In January 2005, the Audit Committee reported the findings of the Independent Review,
together with its recommendations for governing principles for remedial measures that were
developed for the Audit Committee by WCPHD. Each of Nortels and NNCs Boards of Directors has
adopted those recommendations in their entirety and directed management to develop a detailed
plan and timetable for their implementation, and will monitor their implementation.Also in January 2005, the Nortel Audit Committee determined to review the facts and
circumstances leading to the restatement of certain revenues for specific transactions
identified in the restatement effected in January 2005 of Nortels consolidated financial
statements for the years ended December 31, 2002 and 2001 and the quarters ended March 31, 2003
and 2002, June 30, 2003 and 2002, and September 30, 2003 and 2002 (the Second Restatement).
This review has a particular emphasis on the underlying conduct that led to the initial
recognition of these revenues. The Audit Committee will develop any appropriate additional
remedial measures, and has engaged WCPHD to advise it in connection with such review. EDC Support Facility  On January 14, 2005 and February 15, 2005, Nortel obtained waivers from EDC of certain defaults
and related breaches by NNC under the EDC Support Facility relating to the delayed filings of
Nortels and NNCs financial reports. Both of these waivers expired and, on March 15, 2005,
Nortel obtained a new waiver from EDC (the March Waiver).The March Waiver remains in effect until the earliest of certain events including the date on
which Nortel and NNC have filed their respective Quarterly Reports on Form 10-Q for the third
quarter of 2004 and the 2004 Annual Reports, or April 30, 2005. As previously announced, Nortel
and NNC have filed the 2004 Quarterly Reports. The March Waiver expires with the filing of the
2004 Reports with the SEC; however, the Related Breaches will continue beyond the filing of the
2004 Annual Reports.On April 14, 2005, Nortel and NNC announced that the filing of Nortels and NNCs Quarterly
Reports on Form 10-Q for the first quarter of 2005 (the 2005 First Quarter Reports) are
expected to be delayed and that, if necessary, Nortel intended to seek a new waiver from EDC in
connection with such delay.On April 29, 2005, NNC obtained a new waiver from EDC (the April Waiver) of certain defaults
and related breaches by NNL under the EDC Support Facility. The April Waiver remains in effect
until the earliest of certain events including the date on which Nortel and NNL have filed the
2004 Annual Reports and the 2005 First Quarter Reports, or May 31, 2005.If Nortel and NNC fail to file the 2005 First Quarter Reports by May 31, 2005, EDC will have the
right (absent a further waiver) to terminate the EDC Support Facility, exercise certain rights
against collateral or require NNC to cash collateralize all existing support. In addition, the
Related Breaches will continue beyond the filing of the 2004 Annual Reports and the 2005 First
Quarter Reports. Accordingly, beginning on the earlier of the date upon which Nortel and NNC
file the 2004 Annual Reports and the 2005 First Quarter Reports with the SEC and May 31, 2005,
EDC will have the right to terminate or suspend the EDC Support Facility notwithstanding the
filing of the 2004 Annual Reports and the 2005 First Quarter Reports. While NNC intends to seek
a permanent waiver from EDC in connection with the Related Breaches, there can be no assurance
that NNL will receive any waiver or as to the terms of any such waiver.As of April 15, 2005, there was approximately $223 of outstanding support utilized under the EDC
Support Facility, approximately $155 of which was outstanding under the small bond sub-facility. Debt securities  With the filing of the 2004 Annual Reports with the SEC and the delivery of the 2004 Annual
Reports to the trustees under Nortels and NNCs public debt indentures, Nortel and NNC will be
in compliance with their delivery obligations under the public debt indentures.However, as a result of the expected delay in filing the 2005 First Quarter Reports, Nortel and
NNC will not be in compliance with their obligations to deliver the 2005 First Quarter Reports
to the trustees under Nortels and NNCs public debt indentures if such reports are F-70




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filed after May 25, 2005. Any non-compliance with
the delivery obligations under the public debt indentures with respect to the 2005 First Quarter
Reports will not result in an automatic event of default and acceleration of the outstanding
long-term debt of Nortel and NNC and such default and acceleration could not occur unless notice
of such non-compliance from holders of 25% of the outstanding principal amount of any relevant
series of debt securities is provided to Nortel or NNC, as applicable, and Nortel or NNC, as
applicable, failed to deliver the 2005 First Quarter Reports within 90 days after such notice is
provided, all in accordance with the terms of the indentures. While such notice could have been
given at any time after March 30, 2004 as a result of the delayed filings of the Reports,
neither Nortel nor NNC has received a notice to the date of this report. If notice were given
and acceleration of Nortels and NNLs debt securities were to occur, Nortel may be unable to
meet its payment obligations. If notice were given, Nortel believes that it is probable that it
and NNC would file and deliver the 2005 First Quarter Reports within 90 days of receipt of such
a notice. Stock exchanges  As a result of the delay in filing the 2004 Reports and the expected delay in filing the 2005
First Quarter Reports, Nortel was and expects to be, in breach of the continued listing
requirements of the NYSE and TSX. Nortel and NNC continue to co-operate with the NYSE and the
TSX concerning Nortels and NNCs delayed filings. As of the date of this report, neither the
NYSE nor the TSX has commenced any suspension or delisting procedures in respect of NNCs common
 shares and other of Nortel Networks Corporation listed securities. The commencement of any
suspension or delisting procedures by either exchange remains, at all times, at the discretion
of such exchange. Other  On January 20, 2005, Nortel signed a Joint Venture Framework Agreement with China Putian
Corporation to establish a joint venture for R&D, manufacture and sale of third generation (3G)
mobile telecommunications equipment and products to customers in China. Nortel expects to have
a definitive joint venture agreement by June 30, 2005. Nortel anticipates that it will own 49%
of the joint venture and China Putian will own 51%.On January 23, 2005, Nortel signed a Memorandum of Understanding with LG Electronics to
establish a joint venture for providing high quality, leading edge telecommunications equipment
and networking solutions to Korea and other markets globally. The proposed joint venture is
subject to execution of a definitive agreement. Nortel expects to complete this transaction in
the second half of 2005. In the proposed joint venture, Nortel anticipates that it will have an
ownership interest of 50% plus one share.In connection with the BSNL contract, Nortel expects to record an additional loss of
approximately $35 to be recognized in the first half of 2005 as a result of additional
orders received in that period. In addition to the orders under the existing
contract, BSNL may increase the amounts purchased under the contract up to 50% of the existing contract level to
allow for business expansion. Nortel expect that there is the potential
for further product losses which will be determined by the product
mix and magnitude of any additional orders.On April 26, 2005, Nortel announced that Nortel Networks Inc., a wholly owned subsidiary of NNL
had entered into an agreement with PEC Solutions, Inc. (PEC) providing for the acquisition of
all of the outstanding shares of PEC for $15.50 per share in cash, or approximately $448 million
(net of cash acquired) in the aggregate, plus transaction costs and expenses. The acquisition is subject to certain conditions, including the successful
completion of a tender offer and regulatory approvals. Nortel currently expects to complete the
acquisition during the second quarter of 2005.As discussed in notes 9 and 19, Nortel amended certain
agreements with Bookham in 2004 and 2005.  22.
    
    Reconciliation from U.S. GAAP to Canadian GAAP  New Canadian regulations allow issuers that are required to file reports with the SEC, upon
meeting certain conditions, to satisfy their Canadian continuous disclosure obligations by using
financial statements prepared in accordance with U.S. GAAP. Accordingly, for fiscal 2004 and
2005, Nortel will include in the notes to its consolidated financial statements a reconciliation
highlighting the material differences between its financial statements prepared in accordance
with U.S. GAAP as compared to financial statements prepared in accordance with accounting
principles generally accepted in Canada (Canadian GAAP). Subsequent to 2005, no further
reconciliation will be required under current Canadian regulations. Prior to 2004, Nortel prepared financial statements (with accompanying
notes) and Managements Discussion and Analysis  Canadian Supplement in accordance with
Canadian GAAP, all of which were presented as a separate report and filed with the relevant
Canadian securities regulators in compliance with its Canadian continuous disclosure
obligations. F-71




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The consolidated financial statements of Nortel have been prepared in accordance with U.S. GAAP
and the accounting rules and regulations of the SEC which differ in certain material respects
from those principles and practices that Nortel would have followed had its consolidated
financial statements been prepared in accordance with Canadian GAAP. The following is a
reconciliation of the net earnings (loss) between U.S. GAAP and Canadian GAAP for the years
ended December 31, 2004, 2003 and 2002: 2004
    
    
    2003
    
    
    2002Net earnings (loss)U. S. GAAP
    
    $
    107
    
    
    $
    602
    
    
    $
    (2,264
    )Derivative
accounting (b) ((h)(i))
    
    
    31
    
    
    
    (22
    )
    
    
    (10
    )Cumulative effect of accounting
change  net of tax ((h)(iii))
    
    
    
    
    
    
    12
    
    
    
    Other
    
    
    (7
    )
    
    
    (44
    )
    
    
    42Canadian GAAP
    
    $
    131
    
    
    $
    548
    
    
    $
    (2,232
    )
  The following details the material differences between U.S. GAAP and Canadian GAAP for
balance sheet information as of December 31, 2004 and 2003: 2004
    
    
    2003(h)U.S.
    
    
    
    
    
    
    Canadian
    
    
    U.S.
    
    
    
    
    
    
    CanadianGAAP
    
    
    Adjustments
    
    
    GAAP
    
    
    GAAP
    
    
    Adjustments
    
    
    GAAPASSETSCurrent assets (f)
    
    $
    8,511
    
    
    $
    5
    
    
    $
    8,516
    
    
    $
    8,390
    
    
    $
    4
    
    
    $
    8,394Investments (c) (f)
    
    
    159
    
    
    
    (16
    )
    
    
    143
    
    
    
    244
    
    
    
    (105
    )
    
    
    139Plant and equipment  net
    
    
    1,646
    
    
    
    (1
    )
    
    
    1,645
    
    
    
    1,654
    
    
    
    (1
    )
    
    
    1,653Goodwill (a)
    
    
    2,123
    
    
    
    (910
    )
    
    
    1,213
    
    
    
    2,125
    
    
    
    (910
    )
    
    
    1,215Intangible assets  net (g)
    
    
    78
    
    
    
    (40
    )
    
    
    38
    
    
    
    86
    
    
    
    (42
    )
    
    
    44Deferred income taxes  net(g)
    
    
    3,736
    
    
    
    (220
    )
    
    
    3,516
    
    
    
    3,397
    
    
    
    (197
    )
    
    
    3,200Other assets (b) (g)
    
    
    691
    
    
    
    (20
    )
    
    
    671
    
    
    
    560
    
    
    
    25
    
    
    
    585Total assets
    
    $
    16,944
    
    
    $
    (1,202
    )
    
    $
    15,742
    
    
    $
    16,456
    
    
    $
    (1,226
    )
    
    $
    15,230LIABILITIES AND SHAREHOLDERS EQUITYCurrent
liabilities (f) ((h)(v))
    
    $
    5,132
    
    
    $
    (42
    )
    
    $
    5,090
    
    
    $
    4,961
    
    
    $
    5
    
    
    $
    4,966Long-term debt (b)
    
    
    2,062
    
    
    
    (26
    )
    
    
    2,036
    
    
    
    2,091
    
    
    
    (55
    )
    
    
    2,036Deferred income taxes  net (g)
    
    
    143
    
    
    
    14
    
    
    
    157
    
    
    
    190
    
    
    
    13
    
    
    
    203Other liabilities (b) (g)
    
    
    3,189
    
    
    
    (1,362
    )
    
    
    1,827
    
    
    
    2,944
    
    
    
    (1,139
    )
    
    
    1,805Total liabilities
    
    
    10,526
    
    
    
    (1,416
    )
    
    
    9,110
    
    
    
    10,186
    
    
    
    (1,176
    )
    
    
    9,010Minority interests in subsidiary companies
    
    
    94
    
    
    
    
    
    
    
    94
    
    
    
    80
    
    
    
    
    
    
    
    80Total shareholders equity(b) (c) (f) (g)
    
    
    6,324
    
    
    
    214
    
    
    
    6,538
    
    
    
    6,190
    
    
    
    (50
    )
    
    
    6,140Total liabilities and shareholders equity
    
    $
    16,944
    
    
    $
    (1,202
    )
    
    $
    15,742
    
    
    $
    16,456
    
    
    $
    (1,226
    )
    
    $
    15,230
  The significant differences between U.S. GAAP and Canadian GAAP that impact the
consolidated financial statements of Nortel include the following:  (a)
    
    Business combinations  All of Nortels business combinations have been accounted for using the purchase
method. Until June 30, 2001, under Canadian GAAP, when common share consideration was
involved, the purchase price of Nortel acquisitions was determined based on the F-72




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average
trading price per Nortel Networks Corporation common share for a reasonable period before
and after the date the transaction was closed. Under U.S. GAAP, when common share
consideration was involved, the purchase price of the acquisitions was determined based on the average
price per Nortel Networks Corporation common share for a reasonable period before and after
the date the acquisition was announced or the date on which the exchange ratio became fixed.
After June 30, 2001, treatment under Canadian GAAP was the same as under U.S. GAAP for
measurement of share consideration. As a result of the difference between Canadian GAAP and
U.S. GAAP until June 30, 2001, the value of purchase price consideration assigned to
acquisitions may have varied significantly depending on the length of time between the
announcement date and the closing date of the transaction and the volatility of Nortel
Networks Corporation common share price within that time frame.Stock options assumed on acquisitions were recorded at fair value for acquisitions on or
after July 1, 2000 under U.S. GAAP, and for acquisitions on or after July 1, 2001 under
Canadian GAAP. Beginning with acquisitions completed subsequent to July 1, 2000, U.S. GAAP
requires an allocation of a portion of the purchase price to deferred compensation related
to the intrinsic value of unvested options held by employees of the companies acquired. The
deferred compensation is amortized to net earnings (loss) based on the remaining vesting
period of the option awards. With the adoption of The Canadian Institute of Chartered
Accountants (CICA) Handbook Section 3870, Stock-based Compensation and Other Stock-based
Payments, on January 1, 2002, unearned compensation is recorded on unvested options held by
employees of acquired companies. Previously, there was no requirement to record deferred
compensation in respect of such unvested options under Canadian GAAP. Nortel has not
completed any acquisitions subsequent to January 1, 2002. The difference in accounting for
options assumed or issued to the value ascribed under U.S. GAAP, as part of acquisitions
discussed above, can result in a different balance being ascribed to goodwill under U.S.
GAAP.The potential differences in the initial measurement of goodwill in business combinations
under Canadian GAAP and U.S. GAAP may result in a difference in the amount of any subsequent
goodwill impairment charge. Effective January 1, 2002, under both U.S. GAAP and Canadian
GAAP, the method used in accounting for goodwill changed from an amortization method to an
impairment only method, thereby eliminating any impact on net earnings (loss) due to the
amortization of different amounts of goodwill during these periods.  (b)
    
    Derivative accounting  Under U.S. GAAP, effective January 1, 2001, Nortel adopted SFAS 133, which was
subsequently amended by SFAS No. 138, Accounting for Certain Derivative Instruments and
Certain Hedging Activities  an Amendment of SFAS No. 133, and SFAS 149. Under Canadian
GAAP, gains and losses on derivatives that are designated as hedges and that manage the
underlying risks of anticipated transactions are not recorded until the underlying hedged
item is recorded in net earnings (loss) and hedge ineffectiveness is not recorded until
settlement. Under U.S. GAAP, the accounting for changes in the fair value of a derivative depends on the intended use of
the derivative and the resulting designation. For fair value hedges, changes in the fair
value of the derivative and of the hedged item attributable to the hedged risk are reported
in net earnings (loss) from continuing operations immediately. For cash flow hedges, the
effective portion of the gains or losses is reported as a component of other comprehensive
income (loss) and the ineffective portion is reported in net earnings (loss) from continuing
operations immediately. Foreign currency hedges can fall into either fair value hedges or
cash flow hedges and are accounted for accordingly.Under U.S. GAAP, an embedded derivative is accounted for at fair value separate from the
host contract when certain specified conditions are met. Under Canadian GAAP, embedded
derivatives are not accounted for separately from the host contract.  (c)
    
    Investments  Under U.S. GAAP, certain investment securities deemed available-for-sale by Nortel are
remeasured to fair value each period, with unrealized holding gains (losses) included in
other comprehensive income (loss) until realized. Under Canadian GAAP, these investments
are recorded at historical cost unless a loss that is considered other than temporary
occurs. F-73




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(d)
    
    Other financial statement presentation differences  Under Canadian GAAP, global investment tax credits are required to be deducted from R&D
expense while under U.S. GAAP, these amounts are required to be deducted from the income tax
benefit (expense). The impact of this difference in the years ended December 31, 2004, 2003
and 2002 of $43, $41 and $76 respectively, was to increase or decrease net earnings
(loss) from continuing operations before income taxes, non-controlling interests and equity
in net loss of associated companies under Canadian GAAP, with a corresponding increase or
decrease in income tax benefit (expense).There are no significant differences between U.S. and Canadian GAAP that impact the
consolidated statement of cash flows.  (e)
    
    Other  Under U.S. GAAP, translation adjustments for self-sustaining subsidiaries are reported
as a component of other comprehensive income (loss), whereas, under Canadian GAAP, these
translation adjustments are classified as foreign currency translation adjustment, also a
component of shareholders equity.  (f)
    
    Joint ventures  Nortel has a number of joint ventures with other parties. Under U.S. GAAP, investments
in joint ventures are accounted for under the equity method, whereas under Canadian GAAP,
the proportionate consolidation method is used. The difference in accounting does not
impact net earnings (loss), but does impact certain other consolidated financial statement
items.  (g)
    
    Pension and other post-retirement benefits  Under U.S. GAAP, a minimum pension liability adjustment must be recognized in the
amount of the excess of the unfunded accumulated benefit obligation over the recorded
pension benefit liability. An offsetting intangible pension asset is recorded equal to the
unrecognized prior service costs, with any difference recorded in accumulated other
comprehensive loss. No such adjustments are required under Canadian GAAP.  (h)
    
    Accounting changes  (i)
    
    Derivative accounting  Effective January 1, 2004, Nortel adopted Accounting
Guideline (AcG) 13, Hedging
Relationships (AcG-13), which establishes specific criteria for derivatives to qualify
for hedge accounting. Nortel had been previously applying these criteria under U.S.
GAAP. Therefore, there was no impact on adoption of AcG-13.Concurrent with the adoption of AcG-13, Nortel also adopted the CICAs Emerging Issues
Committee (EIC) 128, Accounting for Trading, Speculative or Non-Hedging Derivative
Financial Instruments (EIC 128), which requires that certain freestanding derivative
instruments that give rise to a financial asset or liability, and do not qualify for
hedge accounting under AcG-13, be recognized on the balance sheet and measured at fair
value, with changes in fair value recognized in earnings (loss) in each period. As a
result of the adoption of EIC 128, certain warrants, which had been previously recorded
at cost under Canadian GAAP, are required to be recorded at fair value consistent with
U.S. GAAP. The impact of this accounting change, which has been recorded prospectively
as at January 1, 2004, was an increase to investments and other income of $23 during the
year ended December 31, 2004. F-74




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(ii)
    
    Revenue recognition  In December 2003, the EIC issued abstract 142, Accounting for Revenue Arrangements with
Multiple Deliverables (EIC 142). EIC 142 addresses how to determine whether an
arrangement involving multiple deliverables contains more than one unit of accounting.
EIC 142 also addresses how arrangement consideration should be measured and allocated to
the separate units of accounting in the arrangement. EIC 142 was applicable to Nortel
beginning January 1, 2004 and was applied prospectively. The application of EIC 142 did
not have a material impact on Nortels results of operations and financial condition.In December 2003, the EIC issued abstract 141, Revenue Recognition (EIC 141). EIC 141
summarizes the principles set forth in SAB 101, issued by the SEC. Under EIC 141,
performance is achieved in a transaction involving the sale of goods when all of the
following criteria are met: persuasive evidence of an arrangement exists; delivery has
occurred or services have been rendered; and the sellers price to the buyer is fixed or
determinable. EIC 141 was applicable to Nortel beginning January 1, 2004 and was applied
prospectively. The application of EIC 141 did not have a material impact on Nortels
results of operations and financial condition.  (iii)
    
    Asset retirement obligations  Under U.S. GAAP, Nortel adopted SFAS 143 effective January 1, 2003, and recorded a
cumulative effect of accounting change, net of tax, within net
earnings (loss) on the
date of adoption. Nortel adopted similar Canadian guidance, CICA Handbook Section 3110,
Asset Retirement Obligations, effective January 1, 2004, with retroactive restatement
of prior periods. Under Canadian GAAP, the cumulative effect of adoption as of January
1, 2003 was recorded as an adjustment to opening accumulated deficit, as opposed to an
adjustment within net earnings (loss) under U.S. GAAP, resulting in a difference of $12.
The retroactive adjustment to net earnings (loss) for the years ended December 31, 2003 and 2002
under Canadian GAAP was not significant. Plant and equipment  net, other
liabilities and accumulated deficit as of December 31, 2003 have been increased by $4,
$16 and $12, respectively, to reflect the retroactive restatement.  (iv)
    
    Stock-based compensation  In November 2001, the CICA issued Handbook Section 3870, Stock-based Compensation and
Other Stock-based Payments (Section 3870), which was revised in November 2003.
Section 3870 establishes standards for the recognition, measurement and disclosure of
stock-based compensation and other stock-based payments made in exchange for goods and
services and applies to transactions, including non-reciprocal transactions, in which an
enterprise grants common shares, stock options or other equity instruments, or incurs
liabilities based on the price of common shares or other equity instruments. Section
3870 outlines a fair value based method of accounting required for certain stock-based
transactions, effective January 1, 2002, and applied to awards granted on or after that
date.Prior to October 1, 2003, as permitted by Section 3870, Nortel did not adopt the
provisions in respect of the fair value based method of accounting for its employee
stock-based transactions. F-75




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On October 1, 2003, Nortel elected to expense employee stock-based compensation using the
fair value based method prospectively for all awards granted, modified, or settled on or
after January 1, 2003, in accordance with the transitional provisions of Section 3870 and
concurrent with the adoption of expense recognition under the fair value based method for
U.S. GAAP.  (v)
    
    Restructuring charges  Under U.S. GAAP, effective January 1, 2003, Nortel adopted SFAS 146. SFAS 146 requires
that costs associated with an exit or disposal activity be recognized when the liability
is incurred. Under Canadian GAAP, EIC 134, Accounting for Severance and Termination
Benefits (EIC 134), and EIC 135, Accounting for Costs Associated with Exit and
Disposal Activities (Including Costs Incurred in a Restructuring) (EIC 135) were
issued to harmonize Canadian GAAP requirement with SFAS 146. Effective April 1, 2003,
Nortel adopted EIC 134 and EIC 135.  (vi)
    
    Impairment and disposal of long-lived assets  In May 2003, the CICA issued an updated Section 3475 Disposal of Long-Lived Assets and
Discontinued operations (Section 3475). In April 2003, the CICA issued Handbook
Section 3063, Impairment of Long-Lived Assets (Section 3063).Section 3475 provides criteria for classifying long-lived assets as held for sale and
requires the measurement of such assets at the lower of their carrying amount and their
fair value less costs to sell. It also requires that long-lived assets that are
classified as held for sale are not amortized. Section 3475 also provides criteria for
classifying a disposal as a discontinued operation and specifies the presentation and
disclosure for discontinued operations and other disposals of long-lived assets.Section 3475 requires a long-lived asset which is to be disposed of other than by sale to
be classified as held and used until it is disposed of. Section 3475 replaces the
disposal provisions in the former Section 3475, Discontinued Operations and Section
3061, Property, Plant and Equipment (Section 3061).Section 3063 requires an impairment loss for a long-lived asset to be held and used to be
recognized when events or changes in circumstances cause its carrying value to exceed its
total undiscounted cash flows from its use and eventual disposition. The impairment loss
is calculated by deducting the fair value of the asset from its carrying value. Section
3063 replaces the write down provisions in Section 3061.Section 3475 is applicable for disposal activities initiated by a companys commitment to
a plan on or after May 1, 2003. Section 3063 is applicable for years beginning on or
after April 1, 2003; early adoption was permitted. Nortel adopted these standards
effective January 1, 2003. The adoption of Sections 3475 and 3063, which are
substantially consistent with U.S. GAAP, did not have a material impact on the results of
operations and financial condition of Nortel.Prior to the adoption of Section 3063, an impairment loss was recognized in an amount
equal to the excess of the carrying value of plant and equipment, net of related
provisions for future removal and site restoration costs and future income taxes, and the
anticipated net recoverable amount of the asset(s). Net recoverable amount is an amount
equal to the anticipated cash flows net of directly attributable general and
administrative costs, carrying costs, future removal and site restoration costs and
future income taxes, plus the expected residual value, if any.  (vii)
    
    Guarantees  In February 2003, the CICA issued AcG-14, Disclosure of Guarantees (AcG-14). AcG-14
expands on previously issued accounting guidance and requires additional disclosure by a
guarantor of information about each guarantee, or each group of similar guarantees, even
when the likelihood of the guarantor having to make any payments under the guarantee is
slight. AcG-14 does not address the recognition or measurement of a
guarantors liability for obligations under a guarantee. Nortel adopted the requirements
of AcG-14 effective January 1, 2003, which are substantially
consistent with the disclosure requirements under U.S. GAAP for guarantees. F-76




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(viii)
    
    Consolidation of variable interest entities  In June 2003, the CICA issued AcG-15, which is consistent with FASB Interpretation No.
46, Consolidation of Variable Interest Entities. AcG-15 clarifies the application of
consolidation guidance to those entities defined as VIEs (which includes, but is not
limited to, special purpose entities, trusts, partnerships, certain joint ventures and
other legal structures) 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. The
requirements of AcG-15 were effective for all annual and interim periods beginning on or
after November 1, 2004. Earlier application was encouraged and effective July 1, 2003,
Nortel adopted AcG-15 at the same time as equivalent guidance under U.S. GAAP and
prospectively began consolidating two VIEs for which Nortel was considered the primary
beneficiary.  (i)
    
    Recently issued accounting pronouncements  (i)
    
    In January 2004, the CICA issued amendments to CICA
Handbook Section 3860, Financial Instruments  Presentation and
Disclosure (Section 3860), to require obligations
that may be settled, at the issuer's option, by a variable number of
the issuer's own equity instruments to be presented as liabilities.
Thus, securities issued by an enterprise that give the issuer
unrestricted rights to settle the principal amount in cash or in the
equivalent value of its own equity instruments will no longer be
presented as equity. The amendments to Section 3860 are applicable to
Nortel beginning January 1, 2005 on a retroactive basis. Nortel
is currently assessing the impact of the amendments to Section 3860
on its results of operations and financial condition.  (ii)
    
    In December 2004, the EIC issued abstract 150, Determining Whether an Arrangement
Contains a Lease, (EIC 150). EIC 150 provides guidance on how to determine whether
an arrangement contains a lease that is within the scope of CICA Handbook Section 3065,
Leases. The guidance in EIC 150 is based on whether the arrangement conveys to the
purchaser the right to use a tangible asset, and is effective for Nortel for
arrangements entered into or modified after January 1, 2005. Equivalent guidance in
U.S. GAAP has already been adopted by Nortel. The impact of EIC 150 on Nortels future
results of operations and financial condition will depend on the terms contained in
contracts signed or contracts amended in the future.(iii)
    
    In January 2005, the EIC issued abstract 144, Accounting by a customer
(including a reseller) for certain consideration received from a vendor. The
consensus is effective retroactively for periods commencing on or after February 15,
2005. The consensus requires companies to recognize the benefit of non-discretionary
rebates for achieving specified cumulative purchasing levels as a reduction of the cost
of purchases over the relevant period, provided the rebate is probable and reasonably
estimable. Otherwise, the rebates would be recognized as purchasing milestones are
achieved. Nortel is assessing the impact of the new consensus but does not expect
adoption will have a material impact on its results of operations or financial
condition.(iv)
    
    In January 2005, the CICA issued Section 3855,
Financial Instruments  Recognition and Measurement, Section 1530, Comprehensive Income, and Section 3865,
Hedges. The new standards will be effective for interim and annual financial
statements commencing in 2007. Earlier adoption is permitted. Most significantly for
Nortel under Canadian GAAP, the new standards will introduce comprehensive income to
Canadian GAAP, a concept Nortel has been following under U.S. GAAP. Foreign exchange
gains and losses on the translation of the financial statements of self-sustaining
subsidiaries previously recorded in a separate section of shareholders equity will be
presented in comprehensive income. Also, mark to market adjustments on available for
sale investments will be recorded in comprehensive income. Derivative financial
instruments will be recorded in the balance sheet at fair value and the changes in fair
value of derivatives designated as cash flow hedges will be reported in comprehensive
income. F-77




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(j)
    
    Comparative information  The following tables present consolidated statements of
operations and cash flows under
Canadian GAAP for the years ended December 31, 2003 and 2002.Consolidated statements of operations for the years ended December 31: 2003
    
    
    2002Revenues
    
    $
    10,193
    
    
    $
    11,007Cost of revenues
    
    
    5,860
    
    
    
    7,148Gross profit
    
    
    4,333
    
    
    
    3,859Selling, general and administrative expense
    
    
    1,941
    
    
    
    2,538Research and development expense
    
    
    1,927
    
    
    
    2,011Amortization of intangibles
    
    
    3
    
    
    
    19Special chargesGoodwill impairment
    
    
    
    
    
    
    274Other special charges
    
    
    289
    
    
    
    1,359(Gain) loss on sale of businesses and assets
    
    
    (7
    )
    
    
    (1
    )Operating earnings (loss)
    
    
    180
    
    
    
    (2,341
    )Other income (expense)  net
    
    
    397
    
    
    
    (18
    )Interest expenseLong-term debt
    
    
    (98
    )
    
    
    (135
    )Other
    
    
    (26
    )
    
    
    (55
    )Earnings (loss) from continuing operations before income taxes,non-controlling interests and equity in net loss of associated companies
    
    
    453
    
    
    
    (2,549
    )Income tax benefit (expense)
    
    
    (24
    )
    
    
    404429
    
    
    
    (2,145
    )Non-controlling interests  net of tax
    
    
    (28
    )
    
    
    32Equity in net loss of associated companies  net of tax
    
    
    (37
    )
    
    
    (18
    )Net earnings (loss) from continuing operations
    
    
    364
    
    
    
    (2,131
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    184
    
    
    
    (101
    )Net earnings (loss)
    
    
    548
    
    
    
    (2,232
    )Dividends on preferred shares
    
    
    35
    
    
    
    19Net earnings (loss) applicable to common shares
    
    $
    513
    
    
    $
    (2,251
    )
 F-78




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Consolidated statements of cash flows for the years ended December 31: 2003
    
    
    2002Cash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    364
    
    
    $
    (2,131
    )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
    
    
    432
    
    
    
    553Non-cash portion of special charges and related asset write downs
    
    
    87
    
    
    
    702Equity in net loss of associated companies
    
    
    37
    
    
    
    18Stock option compensation
    
    
    26
    
    
    
    Future income taxes
    
    
    16
    
    
    
    (371
    )Other liabilities
    
    
    106
    
    
    
    42(Gain) loss on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    (60
    )(Gain) loss on sale or write down of investments, businesses and assets
    
    
    (150
    )
    
    
    38Other  net
    
    
    22
    
    
    
    652Change in operating assets and liabilities
    
    
    (837
    )
    
    
    (440
    )Net cash from (used in) operating activities of continuing operations
    
    
    99
    
    
    
    (997
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (170
    )
    
    
    (352
    )Proceeds on disposals of plant and equipment
    
    
    38
    
    
    
    406Acquisitions of investments and businesses  net of cash acquired
    
    
    (58
    )
    
    
    (29
    )Proceeds on sale of investments and businesses
    
    
    107
    
    
    
    61Net cash from (used in) investing activities of continuing operations
    
    
    (83
    )
    
    
    86Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (35
    )
    
    
    (19
    )Increase (decrease) in notes payable  net
    
    
    (45
    )
    
    
    (336
    )Proceeds from long-term debt
    
    
    
    
    
    
    35Repayments of long-term debt
    
    
    (270
    )
    
    
    (611
    )Repayments of capital leases payable
    
    
    (12
    )
    
    
    (18
    )Issuance of common shares
    
    
    
    
    
    
    2,287Payment of stock option fair value increment
    
    
    
    
    
    
    (525
    )Net cash from (used in) financing activities of continuing operations
    
    
    (362
    )
    
    
    813Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    176
    
    
    
    74Net cash from (used in) continuing operations
    
    
    (170
    )
    
    
    (24
    )Net cash from (used in) discontinued operations
    
    
    357
    
    
    
    342Net increase (decrease) in cash and cash equivalents
    
    
    187
    
    
    
    318Cash and cash equivalents at beginning of year
    
    
    3,745
    
    
    
    3,427Cash and cash equivalents at end of year
    
    $
    3,932
    
    
    $
    3,745
 F-79




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##### Table of Contents



23.
    
    Supplemental consolidating financial informationAs of December 31, 2004, and as a result of Nortels credit ratings, various liens, pledges
and guarantees were effective under security agreements entered into by Nortel and various of
its subsidiaries (see note 10).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 Service, Inc. (Moodys) downgrade of Nortels
senior long-term debt rating to below investment grade, in respect of the then existing credit
facilities including the Five Year Facilities. Consequently, on April 4, 2002 and in accordance
with the negative pledge covenants in the indentures for all Nortels 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s and NNIs then
existing credit facilities.Nortels obligations under the EDC Support Facility became secured on an equal and ratable basis
under the security agreements on February 14, 2003.As a result of Nortel terminating the Five Year Facilities (see note 10), certain foreign
security agreements entered into by Nortel and various of its subsidiaries under which shares of
certain subsidiaries of Nortel incorporated outside of the U.S. and Canada were pledged in favor
of the banks under the Five Year Facilities, EDC and the holders of Nortels and NNCs
outstanding public debt securities also terminated in accordance with their terms. In addition,
guarantees by certain subsidiaries of Nortel incorporated outside of the U.S. and Canada
terminated in accordance with their terms. As of December 31, 2004, the security agreements
pledge substantially all of the assets of Nortel located in the U.S. and Canada and those of
most of its U.S. and Canadian subsidiaries, including the shares of certain of Nortels U.S. and
Canadian subsidiaries, in favor of EDC and the holders of Nortels and NNCs outstanding public
debt securities ( see note 10 ). In addition, certain of Nortels wholly owned subsidiaries,
including NNI, most of Nortels Canadian subsidiaries, Nortel Networks (Asia) Limited, Nortel
Networks (Ireland) Limited and Nortel Networks U.K. Limited, have guaranteed Nortels
obligations under the EDC Support Facility and Nortels and NNCs outstanding public debt
securities (the Guarantor Subsidiaries). Non-guarantor subsidiaries (the Non-Guarantor
Subsidiaries) represented either wholly owned subsidiaries of Nortel whose shares were pledged,
or were the remaining subsidiaries of Nortel which did not provide liens, pledges or guarantees.The liens, pledges and guarantees described above also applied equally and ratably to NNCs
$1,800 Senior Notes due September 1, 2008 as well as Nortels guarantee of the Senior Notes.If Nortels 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. If the EDC Support Facility is terminated, or expires, the
security and guarantees will also be released in full. Nortel 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 or
arrangements 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 or
arrangements acceptable to EDC the security and guarantees will also be released in full.The following supplemental consolidating financial data illustrates, in separate columns, the
composition (as described below) of Nortel Networks Limited, the Guarantor Subsidiaries, the
Non-Guarantor Subsidiaries, eliminations and the consolidated total as of December 31, 2004 and
2003 and for the years ended December 31, 2004, 2003 and 2002.Investments in subsidiaries are accounted for using 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 earnings (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 operating as independent entities. F-80




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##### Table of Contents



Supplemental Consolidating Statements of Operations for the year ended December 31, 2004: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalRevenues
    
    $
    3,265
    
    
    $
    6,944
    
    
    $
    3,480
    
    
    $
    (3,861
    )
    
    $
    9,828Cost of revenues
    
    
    2,217
    
    
    
    4,752
    
    
    
    2,627
    
    
    
    (3,861
    )
    
    
    5,735Gross profit
    
    
    1,048
    
    
    
    2,192
    
    
    
    853
    
    
    
    
    
    
    
    4,093Selling, general and administrative expense
    
    
    430
    
    
    
    1,271
    
    
    
    423
    
    
    
    
    
    
    
    2,124Research and development expense
    
    
    822
    
    
    
    858
    
    
    
    279
    
    
    
    
    
    
    
    1,959Amortization of intangibles
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    10Special charges
    
    
    14
    
    
    
    122
    
    
    
    44
    
    
    
    
    
    
    
    180(Gain) loss on sale of businesses and assets
    
    
    (2
    )
    
    
    (25
    )
    
    
    (71
    )
    
    
    
    
    
    
    (98
    )Operating earnings (loss)
    
    
    (216
    )
    
    
    (34
    )
    
    
    168
    
    
    
    
    
    
    
    (82
    )Other income (expense)  net
    
    
    141
    
    
    
    132
    
    
    
    (33
    )
    
    
    
    
    
    
    240Interest expenseLong-term debt
    
    
    (67
    )
    
    
    (13
    )
    
    
    (28
    )
    
    
    
    
    
    
    (108
    )Other
    
    
    (5
    )
    
    
    (52
    )
    
    
    49
    
    
    
    
    
    
    
    (8
    )Earnings
(loss) from continuing operations before income taxes, minority
interests and equity in net earnings (loss) of associated companies
    
    
    (147
    )
    
    
    33
    
    
    
    156
    
    
    
    
    
    
    
    42Income tax benefit (expense)
    
    
    57
    
    
    
    14
    
    
    
    (42
    )
    
    
    
    
    
    
    29(90
    )
    
    
    47
    
    
    
    114
    
    
    
    
    
    
    
    71Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (13
    )
    
    
    
    
    
    
    (13
    )Equity in
net earnings (loss) of associated companies  net of tax
    
    
    148
    
    
    
    274
    
    
    
    (57
    )
    
    
    (365
    )
    
    
    Net earnings (loss) from continuing operations
    
    
    58
    
    
    
    321
    
    
    
    44
    
    
    
    (365
    )
    
    
    58Net earnings (loss) from discontinued
operations  net of tax
    
    
    49
    
    
    
    30
    
    
    
    
    
    
    
    (30
    )
    
    
    49Net earnings (loss)
    
    
    107
    
    
    
    351
    
    
    
    44
    
    
    
    (395
    )
    
    
    107Dividends on preferred shares
    
    
    33
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33Net earnings (loss) applicable to common shares
    
    $
    74
    
    
    $
    351
    
    
    $
    44
    
    
    $
    (395
    )
    
    $
    74
 F-81




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##### Table of Contents



Supplemental Consolidating Statements of Operations for the year ended December 31, 2003: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalRevenues
    
    $
    3,182
    
    
    $
    7,330
    
    
    $
    3,388
    
    
    $
    (3,707
    )
    
    $
    10,193Cost of revenues
    
    
    1,995
    
    
    
    5,007
    
    
    
    2,566
    
    
    
    (3,707
    )
    
    
    5,861Gross profit
    
    
    1,187
    
    
    
    2,323
    
    
    
    822
    
    
    
    
    
    
    
    4,332Selling, general and administrative expense
    
    
    430
    
    
    
    1,133
    
    
    
    368
    
    
    
    
    
    
    
    1,931Research and development expense
    
    
    814
    
    
    
    861
    
    
    
    290
    
    
    
    
    
    
    
    1,965Amortization of intangibles
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    3Special charges
    
    
    67
    
    
    
    250
    
    
    
    (32
    )
    
    
    
    
    
    
    285(Gain) loss on sale of businesses and assets
    
    
    4
    
    
    
    (5
    )
    
    
    (3
    )
    
    
    
    
    
    
    (4
    )Operating earnings (loss)
    
    
    (128
    )
    
    
    84
    
    
    
    196
    
    
    
    
    
    
    
    152Other income (expense)  net
    
    
    86
    
    
    
    350
    
    
    
    (3
    )
    
    
    
    
    
    
    433Interest expenseLong-term debt
    
    
    (68
    )
    
    
    (4
    )
    
    
    (26
    )
    
    
    
    
    
    
    (98
    )Other
    
    
    (3
    )
    
    
    (63
    )
    
    
    40
    
    
    
    
    
    
    
    (26
    )Earnings
(loss) from continuing operations before income taxes, minority
interests and equity in net earnings (loss) of associated companies
    
    
    (113
    )
    
    
    367
    
    
    
    207
    
    
    
    
    
    
    
    461Income tax benefit (expense)
    
    
    184
    
    
    
    (88
    )
    
    
    (63
    )
    
    
    
    
    
    
    3371
    
    
    
    279
    
    
    
    144
    
    
    
    
    
    
    
    494Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (28
    )
    
    
    
    
    
    
    (28
    )Equity in
net earnings (loss) of associated companies  net of tax
    
    
    351
    
    
    
    299
    
    
    
    (7
    )
    
    
    (679
    )
    
    
    (36
    )Net earnings (loss) from continuing operations
    
    
    422
    
    
    
    578
    
    
    
    109
    
    
    
    (679
    )
    
    
    430Net earnings
(loss) from discontinued operations  net of tax
    
    
    184
    
    
    
    118
    
    
    
    
    
    
    
    (118
    )
    
    
    184Net earnings (loss) before cumulative effect of
accounting
change
    
    
    606
    
    
    
    696
    
    
    
    109
    
    
    
    (797
    )
    
    
    614Cumulative effect of accounting change  net of tax
    
    
    (4
    )
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    (12
    )Net earnings (loss)
    
    
    602
    
    
    
    688
    
    
    
    109
    
    
    
    (797
    )
    
    
    602Dividends on preferred shares
    
    
    35
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35Net earnings (loss) applicable to common shares
    
    $
    567
    
    
    $
    688
    
    
    $
    109
    
    
    $
    (797
    )
    
    $
    567
 F-82




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##### Table of Contents



Supplemental Consolidating Statements of Operations for the year ended December 31, 2002: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalRevenues
    
    $
    3,028
    
    
    $
    7,895
    
    
    $
    3,370
    
    
    $
    (3,299
    )
    
    $
    10,994Cost of revenues
    
    
    2,719
    
    
    
    5,333
    
    
    
    2,386
    
    
    
    (3,299
    )
    
    
    7,139Gross profit
    
    
    309
    
    
    
    2,562
    
    
    
    984
    
    
    
    
    
    
    
    3,855Selling, general and administrative expense
    
    
    559
    
    
    
    1,515
    
    
    
    458
    
    
    
    
    
    
    
    2,532Research and development expense
    
    
    869
    
    
    
    905
    
    
    
    310
    
    
    
    
    
    
    
    2,084Amortization of intangibles
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    19Special chargesGoodwill impairment
    
    
    
    
    
    
    203
    
    
    
    61
    
    
    
    
    
    
    
    264Other special charges
    
    
    346
    
    
    
    653
    
    
    
    359
    
    
    
    
    
    
    
    1,358(Gain) loss on sale of businesses and assets
    
    
    134
    
    
    
    (101
    )
    
    
    (37
    )
    
    
    
    
    
    
    (4
    )Operating earnings (loss)
    
    
    (1,599
    )
    
    
    (632
    )
    
    
    (167
    )
    
    
    
    
    
    
    (2,398
    )Other income (expense)  net
    
    
    6
    
    
    
    427
    
    
    
    (461
    )
    
    
    
    
    
    
    (28
    )Interest expenseLong-term debt
    
    
    (105
    )
    
    
    
    
    
    
    (30
    )
    
    
    
    
    
    
    (135
    )Other
    
    
    (7
    )
    
    
    (16
    )
    
    
    (32
    )
    
    
    
    
    
    
    (55
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (1,705
    )
    
    
    (221
    )
    
    
    (690
    )
    
    
    
    
    
    
    (2,616
    )Income tax benefit (expense)
    
    
    330
    
    
    
    (38
    )
    
    
    146
    
    
    
    
    
    
    
    438(1,375
    )
    
    
    (259
    )
    
    
    (544
    )
    
    
    
    
    
    
    (2,178
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    32
    
    
    
    
    
    
    
    32Equity in
net earnings (loss) of associated companies  net of tax
    
    
    (788
    )
    
    
    1,404
    
    
    
    2
    
    
    
    (635
    )
    
    
    (17
    )Net earnings (loss) from continuing operations
    
    
    (2,163
    )
    
    
    1,145
    
    
    
    (510
    )
    
    
    (635
    )
    
    
    (2,163
    )Net earnings (loss) from discontinued
operations  net of tax
    
    
    (101
    )
    
    
    (68
    )
    
    
    
    
    
    
    68
    
    
    
    (101
    )Net earnings (loss)
    
    
    (2,264
    )
    
    
    1,077
    
    
    
    (510
    )
    
    
    (567
    )
    
    
    (2,264
    )Dividends on preferred shares
    
    
    26
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26Net earnings (loss) applicable to common shares
    
    $
    (2,290
    )
    
    $
    1,077
    
    
    $
    (510
    )
    
    $
    (567
    )
    
    $
    (2,290
    )
 F-83




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##### Table of Contents



Supplemental Consolidating Balance Sheets as of December 31, 2004: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    (2
    )
    
    $
    2,414
    
    
    $
    1,195
    
    
    $
    
    
    
    $
    3,607Restricted cash and cash equivalents
    
    
    52
    
    
    
    20
    
    
    
    8
    
    
    
    
    
    
    
    80Accounts receivable  net
    
    
    476
    
    
    
    1,244
    
    
    
    831
    
    
    
    
    
    
    
    2,551Intercompany/related party accounts receivable
    
    
    541
    
    
    
    1,135
    
    
    
    776
    
    
    
    (2,203
    )
    
    
    249Inventories  net
    
    
    298
    
    
    
    608
    
    
    
    508
    
    
    
    
    
    
    
    1,414Deferred income taxes  net
    
    
    45
    
    
    
    211
    
    
    
    (1
    )
    
    
    
    
    
    
    255Other current assets
    
    
    33
    
    
    
    166
    
    
    
    156
    
    
    
    
    
    
    
    355Total current assets
    
    
    1,443
    
    
    
    5,798
    
    
    
    3,473
    
    
    
    (2,203
    )
    
    
    8,511Investments
    
    
    2,222
    
    
    
    (6,772
    )
    
    
    508
    
    
    
    4,201
    
    
    
    159Intercompany advances
    
    
    346
    
    
    
    1,102
    
    
    
    2,066
    
    
    
    (3,514
    )
    
    
    Plant and equipment  net
    
    
    480
    
    
    
    771
    
    
    
    395
    
    
    
    
    
    
    
    1,646Goodwill
    
    
    
    
    
    
    1,946
    
    
    
    177
    
    
    
    
    
    
    
    2,123Intangible assets  net
    
    
    37
    
    
    
    1
    
    
    
    40
    
    
    
    
    
    
    
    78Deferred income taxes  net
    
    
    1,824
    
    
    
    1,814
    
    
    
    98
    
    
    
    
    
    
    
    3,736Other assets
    
    
    80
    
    
    
    288
    
    
    
    323
    
    
    
    
    
    
    
    691Total assets
    
    $
    6,432
    
    
    $
    4,948
    
    
    $
    7,080
    
    
    $
    (1,516
    )
    
    $
    16,944LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesTrade and other accounts payable
    
    $
    486
    
    
    $
    391
    
    
    $
    118
    
    
    $
    
    
    
    $
    995Intercompany/related party accounts payable
    
    
    (3,561
    )
    
    
    3,626
    
    
    
    2,138
    
    
    
    (2,203
    )
    
    
    Payroll and benefit-related liabilities
    
    
    68
    
    
    
    306
    
    
    
    138
    
    
    
    
    
    
    
    512Contractual liabilities
    
    
    175
    
    
    
    218
    
    
    
    175
    
    
    
    
    
    
    
    568Restructuring liabilities
    
    
    32
    
    
    
    184
    
    
    
    38
    
    
    
    
    
    
    
    254Other accrued liabilities
    
    
    380
    
    
    
    1,642
    
    
    
    766
    
    
    
    
    
    
    
    2,788Long-term debt due within one year
    
    
    13
    
    
    
    12
    
    
    
    (10
    )
    
    
    
    
    
    
    15Total current liabilities
    
    
    (2,407
    )
    
    
    6,379
    
    
    
    3,363
    
    
    
    (2,203
    )
    
    
    5,132Long-term debt
    
    
    1,520
    
    
    
    120
    
    
    
    422
    
    
    
    
    
    
    
    2,062Deferred income taxes  net
    
    
    
    
    
    
    108
    
    
    
    35
    
    
    
    
    
    
    
    143Other liabilities
    
    
    995
    
    
    
    1,928
    
    
    
    266
    
    
    
    
    
    
    
    3,189Intercompany advances
    
    
    
    
    
    
    297
    
    
    
    3,217
    
    
    
    (3,514
    )
    
    
    Total liabilities
    
    
    108
    
    
    
    8,832
    
    
    
    7,303
    
    
    
    (5,717
    )
    
    
    10,526Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    94
    
    
    
    
    
    
    
    94SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    237
    
    
    
    
    
    
    
    (237
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    5,417
    
    
    
    1,622
    
    
    
    (7,039
    )
    
    
    1,211Additional paid-in capital
    
    
    22,107
    
    
    
    775
    
    
    
    4,243
    
    
    
    (5,018
    )
    
    
    22,107Accumulated deficit
    
    
    (16,992
    )
    
    
    (10,931
    )
    
    
    (6,450
    )
    
    
    17,381
    
    
    
    (16,992
    )Accumulated other comprehensive income (loss)
    
    
    (538
    )
    
    
    618
    
    
    
    268
    
    
    
    (886
    )
    
    
    (538
    )Total shareholders equity
    
    
    6,324
    
    
    
    (3,884
    )
    
    
    (317
    )
    
    
    4,201
    
    
    
    6,324Total liabilities and shareholders equity
    
    $
    6,432
    
    
    $
    4,948
    
    
    $
    7,080
    
    
    $
    (1,516
    )
    
    $
    16,944
 F-84




---



##### Table of Contents



Supplemental Consolidating Balance Sheets as of December 31, 2003: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    (8
    )
    
    $
    2,963
    
    
    $
    973
    
    
    $
    
    
    
    $
    3,928Restricted cash and cash equivalents
    
    
    25
    
    
    
    19
    
    
    
    19
    
    
    
    
    
    
    
    63Accounts receivable  net
    
    
    314
    
    
    
    1,462
    
    
    
    729
    
    
    
    
    
    
    
    2,505Intercompany/related party accounts receivable
    
    
    345
    
    
    
    1,017
    
    
    
    870
    
    
    
    (2,078
    )
    
    
    154Inventories  net
    
    
    302
    
    
    
    405
    
    
    
    260
    
    
    
    
    
    
    
    967Deferred income taxes  net
    
    
    67
    
    
    
    302
    
    
    
    
    
    
    
    
    
    
    
    369Other current assets
    
    
    44
    
    
    
    188
    
    
    
    172
    
    
    
    
    
    
    
    404Total current assets
    
    
    1,089
    
    
    
    6,356
    
    
    
    3,023
    
    
    
    (2,078
    )
    
    
    8,390Investments
    
    
    1,995
    
    
    
    (6,801
    )
    
    
    758
    
    
    
    4,292
    
    
    
    244Intercompany advances
    
    
    166
    
    
    
    661
    
    
    
    1,963
    
    
    
    (2,790
    )
    
    
    Plant and equipment  net
    
    
    475
    
    
    
    775
    
    
    
    404
    
    
    
    
    
    
    
    1,654Goodwill
    
    
    
    
    
    
    1,956
    
    
    
    169
    
    
    
    
    
    
    
    2,125Intangible assets  net
    
    
    40
    
    
    
    1
    
    
    
    45
    
    
    
    
    
    
    
    86Deferred income taxes  net
    
    
    1,673
    
    
    
    1,655
    
    
    
    69
    
    
    
    
    
    
    
    3,397Other assets
    
    
    102
    
    
    
    161
    
    
    
    297
    
    
    
    
    
    
    
    560Total assets
    
    $
    5,540
    
    
    $
    4,764
    
    
    $
    6,728
    
    
    $
    (576
    )
    
    $
    16,456LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesTrade and other accounts payable
    
    $
    349
    
    
    $
    381
    
    
    $
    147
    
    
    $
    
    
    
    $
    877Intercompany/related party accounts payable
    
    
    (4,071
    )
    
    
    3,217
    
    
    
    2,932
    
    
    
    (2,078
    )
    
    
    Payroll and benefit-related liabilities
    
    
    137
    
    
    
    449
    
    
    
    178
    
    
    
    
    
    
    
    764Contractual liabilities
    
    
    26
    
    
    
    272
    
    
    
    231
    
    
    
    
    
    
    
    529Restructuring liabilities
    
    
    52
    
    
    
    129
    
    
    
    24
    
    
    
    
    
    
    
    205Other accrued liabilities
    
    
    356
    
    
    
    1,558
    
    
    
    553
    
    
    
    
    
    
    
    2,467Long-term debt due within one year
    
    
    11
    
    
    
    100
    
    
    
    8
    
    
    
    
    
    
    
    119Total current liabilities
    
    
    (3,140
    )
    
    
    6,106
    
    
    
    4,073
    
    
    
    (2,078
    )
    
    
    4,961Long-term debt
    
    
    1,549
    
    
    
    127
    
    
    
    415
    
    
    
    
    
    
    
    2,091Deferred income taxes  net
    
    
    
    
    
    
    143
    
    
    
    47
    
    
    
    
    
    
    
    190Other liabilities
    
    
    930
    
    
    
    1,774
    
    
    
    240
    
    
    
    
    
    
    
    2,944Intercompany advances
    
    
    11
    
    
    
    297
    
    
    
    2,482
    
    
    
    (2,790
    )
    
    
    Total liabilities
    
    
    (650
    )
    
    
    8,447
    
    
    
    7,257
    
    
    
    (4,868
    )
    
    
    10,186Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    80
    
    
    
    
    
    
    
    80SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    237
    
    
    
    
    
    
    
    (237
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    5,416
    
    
    
    1,621
    
    
    
    (7,037
    )
    
    
    1,211Additional paid-in capital
    
    
    22,031
    
    
    
    726
    
    
    
    4,228
    
    
    
    (4,954
    )
    
    
    22,031Accumulated deficit
    
    
    (17,066
    )
    
    
    (10,838
    )
    
    
    (6,684
    )
    
    
    17,522
    
    
    
    (17,066
    )Accumulated other comprehensive income (loss)
    
    
    (522
    )
    
    
    776
    
    
    
    226
    
    
    
    (1,002
    )
    
    
    (522
    )Total shareholders equity
    
    
    6,190
    
    
    
    (3,683
    )
    
    
    (609
    )
    
    
    4,292
    
    
    
    6,190Total liabilities and shareholders equity
    
    $
    5,540
    
    
    $
    4,764
    
    
    $
    6,728
    
    
    $
    (576
    )
    
    $
    16,456
 F-85




---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2004: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    58
    
    
    $
    321
    
    
    $
    44
    
    
    $
    (365
    )
    
    $
    58Adjustments 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
    
    
    41
    
    
    
    192
    
    
    
    129
    
    
    
    
    
    
    
    362Non-cash portion of special charges and related
asset write downs
    
    
    
    
    
    
    5
    
    
    
    (1
    )
    
    
    
    
    
    
    4Equity in net loss of associated companies
    
    
    (148
    )
    
    
    (274
    )
    
    
    57
    
    
    
    365
    
    
    
    Stock option compensation
    
    
    44
    
    
    
    17
    
    
    
    15
    
    
    
    
    
    
    
    76Deferred income taxes
    
    
    42
    
    
    
    (44
    )
    
    
    (43
    )
    
    
    
    
    
    
    (45
    )Other liabilities
    
    
    80
    
    
    
    169
    
    
    
    28
    
    
    
    
    
    
    
    277(Gain) loss on sale or write-down of investments,
businesses and assets
    
    
    12
    
    
    
    (60
    )
    
    
    (69
    )
    
    
    
    
    
    
    (117
    )Other  net
    
    
    74
    
    
    
    (120
    )
    
    
    164
    
    
    
    
    
    
    
    118Change in operating assets and liabilities
    
    
    (156
    )
    
    
    (771
    )
    
    
    30
    
    
    
    
    
    
    
    (897
    )Intercompany/related party activity
    
    
    (17
    )
    
    
    170
    
    
    
    (153
    )
    
    
    
    
    
    
    Net cash
from (used in) operating activities of continuing operations

    
    30
    
    
    
    (395
    )
    
    
    201
    
    
    
    
    
    
    
    (164
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (24
    )
    
    
    (177
    )
    
    
    (80
    )
    
    
    
    
    
    
    (281
    )Proceeds on disposals of plant and equipment
    
    
    4
    
    
    
    1
    
    
    
    5
    
    
    
    
    
    
    
    10Acquisitions of investments and businesses  net of cash acquired
    
    
    (1
    )
    
    
    (7
    )
    
    
    3
    
    
    
    
    
    
    
    (5
    )Proceeds on sale of investments and businesses
    
    
    6
    
    
    
    68
    
    
    
    76
    
    
    
    
    
    
    
    150Net cash from (used in) investing activities
of continuing operations
    
    
    (15
    )
    
    
    (115
    )
    
    
    4
    
    
    
    
    
    
    
    (126
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (33
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33
    )Increase (decrease) in notes payable  net
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    8Repayments of long-term debt
    
    
    
    
    
    
    (85
    )
    
    
    (22
    )
    
    
    
    
    
    
    (107
    )Repayments of capital leases payable
    
    
    (1
    )
    
    
    (11
    )
    
    
    3
    
    
    
    
    
    
    
    (9
    )Net cash from (used in) financing activities
of continuing operations
    
    
    (34
    )
    
    
    (96
    )
    
    
    (11
    )
    
    
    
    
    
    
    (141
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    59
    
    
    
    28
    
    
    
    
    
    
    
    88Net cash from (used in) continuing operations
    
    
    (18
    )
    
    
    (547
    )
    
    
    222
    
    
    
    
    
    
    
    (343
    )Net cash from (used in) discontinued operations
    
    
    24
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    22Net increase (decrease) in cash and cash equivalents
    
    
    6
    
    
    
    (549
    )
    
    
    222
    
    
    
    
    
    
    
    (321
    )Cash and cash equivalents at beginning of year
    
    
    (8
    )
    
    
    2,963
    
    
    
    973
    
    
    
    
    
    
    
    3,928Cash and cash equivalents at end of year
    
    $
    (2
    )
    
    $
    2,414
    
    
    $
    1,195
    
    
    $
    
    
    
    $
    3,607
 F-86




---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2003: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    422
    
    
    $
    578
    
    
    $
    109
    
    
    $
    (679
    )
    
    $
    430Adjustments 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
    
    
    75
    
    
    
    231
    
    
    
    128
    
    
    
    
    
    
    
    434Non-cash portion of special charges and related
asset write downs
    
    
    9
    
    
    
    73
    
    
    
    5
    
    
    
    
    
    
    
    87Equity in net loss of associated companies
    
    
    (351
    )
    
    
    (299
    )
    
    
    7
    
    
    
    679
    
    
    
    36Stock option compensation
    
    
    4
    
    
    
    314
    
    
    
    (292
    )
    
    
    
    
    
    
    26Deferred income taxes
    
    
    5
    
    
    
    (64
    )
    
    
    51
    
    
    
    
    
    
    
    (8
    )Other liabilities
    
    
    83
    
    
    
    74
    
    
    
    4
    
    
    
    
    
    
    
    161(Gain) loss on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )(Gain) loss on sale or write-down of investments,
businesses and assets
    
    
    (7
    )
    
    
    (126
    )
    
    
    (14
    )
    
    
    
    
    
    
    (147
    )Other  net
    
    
    292
    
    
    
    (372
    )
    
    
    9
    
    
    
    
    
    
    
    (71
    )Change in operating assets and liabilities
    
    
    189
    
    
    
    (1,092
    )
    
    
    37
    
    
    
    
    
    
    
    (866
    )Intercompany/related party activity
    
    
    (831
    )
    
    
    1,097
    
    
    
    (266
    )
    
    
    
    
    
    
    Net cash from (used in) operating activities
of continuing operations
    
    
    (114
    )
    
    
    414
    
    
    
    (222
    )
    
    
    
    
    
    
    78Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (41
    )
    
    
    (73
    )
    
    
    (58
    )
    
    
    
    
    
    
    (172
    )Proceeds on disposals of plant and equipment
    
    
    7
    
    
    
    28
    
    
    
    3
    
    
    
    
    
    
    
    38Acquisitions of investments and businesses  net of cash acquired
    
    
    (60
    )
    
    
    (6
    )
    
    
    8
    
    
    
    
    
    
    
    (58
    )Proceeds on sale of investments and businesses
    
    
    6
    
    
    
    101
    
    
    
    
    
    
    
    
    
    
    
    107Net cash from (used in) investing activities
of continuing operations
    
    
    (88
    )
    
    
    50
    
    
    
    (47
    )
    
    
    
    
    
    
    (85
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (35
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35
    )Increase (decrease) in notes payable  net
    
    
    
    
    
    
    4
    
    
    
    (49
    )
    
    
    
    
    
    
    (45
    )Repayments of long-term debt
    
    
    (199
    )
    
    
    1
    
    
    
    (72
    )
    
    
    
    
    
    
    (270
    )Repayments of capital leases payable
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    (12
    )Net cash from (used in) financing activities
of continuing operations
    
    
    (234
    )
    
    
    (7
    )
    
    
    (121
    )
    
    
    
    
    
    
    (362
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    2
    
    
    
    105
    
    
    
    69
    
    
    
    
    
    
    
    176Net cash from (used in) continuing operations
    
    
    (434
    )
    
    
    562
    
    
    
    (321
    )
    
    
    
    
    
    
    (193
    )Net cash from (used in) discontinued operations
    
    
    175
    
    
    
    224
    
    
    
    (20
    )
    
    
    
    
    
    
    379Net increase (decrease) in cash and cash equivalents
    
    
    (259
    )
    
    
    786
    
    
    
    (341
    )
    
    
    
    
    
    
    186Cash and cash equivalents at beginning of year
    
    
    251
    
    
    
    2,177
    
    
    
    1,314
    
    
    
    
    
    
    
    3,742Cash and cash equivalents at end of year
    
    $
    (8
    )
    
    $
    2,963
    
    
    $
    973
    
    
    $
    
    
    
    $
    3,928
 F-87




---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2002: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    (2,163
    )
    
    $
    1,145
    
    
    $
    (510
    )
    
    $
    (635
    )
    
    $
    (2,163
    )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
    
    
    87
    
    
    
    350
    
    
    
    116
    
    
    
    
    
    
    
    553Non-cash portion of special charges and related
asset write downs
    
    
    199
    
    
    
    464
    
    
    
    29
    
    
    
    
    
    
    
    692Equity in net loss of associated companies
    
    
    788
    
    
    
    (1,404
    )
    
    
    (2
    )
    
    
    635
    
    
    
    17Stock option compensation
    
    
    
    
    
    
    (7
    )
    
    
    7
    
    
    
    
    
    
    
    Deferred income taxes
    
    
    (417
    )
    
    
    (203
    )
    
    
    215
    
    
    
    
    
    
    
    (405
    )Other liabilities
    
    
    (4
    )
    
    
    15
    
    
    
    (10
    )
    
    
    
    
    
    
    1(Gain) loss on repurchases of outstanding debt securities
    
    
    (60
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (60
    )(Gain) loss on sale or write-down of investments,
businesses and assets
    
    
    17
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    35Other  net
    
    
    460
    
    
    
    162
    
    
    
    61
    
    
    
    
    
    
    
    683Change in operating assets and liabilities
    
    
    (590
    )
    
    
    187
    
    
    
    56
    
    
    
    
    
    
    
    (347
    )Intercompany/related party activity
    
    
    91
    
    
    
    (242
    )
    
    
    151
    
    
    
    
    
    
    
    Net cash from (used in) operating activities
of continuing operations
    
    
    (1,592
    )
    
    
    485
    
    
    
    113
    
    
    
    
    
    
    
    (994
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (65
    )
    
    
    (231
    )
    
    
    (56
    )
    
    
    
    
    
    
    (352
    )Proceeds on disposals of plant and equipment
    
    
    16
    
    
    
    359
    
    
    
    31
    
    
    
    
    
    
    
    406Acquisitions of investments and businesses  net of cash acquired
    
    
    (5
    )
    
    
    (16
    )
    
    
    (8
    )
    
    
    
    
    
    
    (29
    )Proceeds on sale of investments and businesses
    
    
    23
    
    
    
    33
    
    
    
    5
    
    
    
    
    
    
    
    61Net cash from (used in) investing activities
of continuing operations
    
    
    (31
    )
    
    
    145
    
    
    
    (28
    )
    
    
    
    
    
    
    86Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (26
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26
    )Decrease in notes payable  net
    
    
    
    
    
    
    (146
    )
    
    
    (187
    )
    
    
    
    
    
    
    (333
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    33
    
    
    
    
    
    
    
    33Repayments of long-term debt
    
    
    (460
    )
    
    
    (136
    )
    
    
    (15
    )
    
    
    
    
    
    
    (611
    )Repayments of capital leases payable
    
    
    (3
    )
    
    
    (13
    )
    
    
    
    
    
    
    
    
    
    
    (16
    )Issuance of common shares
    
    
    2,287
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,287Payment of stock option fair value increment
    
    
    
    
    
    
    (525
    )
    
    
    
    
    
    
    
    
    
    
    (525
    )Net cash from (used in) financing activities
of continuing operations
    
    
    1,798
    
    
    
    (820
    )
    
    
    (169
    )
    
    
    
    
    
    
    809Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    13
    
    
    
    38
    
    
    
    23
    
    
    
    
    
    
    
    74Net cash from (used in) continuing operations
    
    
    188
    
    
    
    (152
    )
    
    
    (61
    )
    
    
    
    
    
    
    (25
    )Net cash from (used in) discontinued operations
    
    
    104
    
    
    
    246
    
    
    
    
    
    
    
    
    
    
    
    350Net increase (decrease) in cash and cash equivalents
    
    
    292
    
    
    
    94
    
    
    
    (61
    )
    
    
    
    
    
    
    325Cash and cash equivalents at beginning of year
    
    
    (41
    )
    
    
    2,083
    
    
    
    1,375
    
    
    
    
    
    
    
    3,417Cash and cash equivalents at end of year
    
    $
    251
    
    
    $
    2,177
    
    
    $
    1,314
    
    
    $
    
    
    
    $
    3,742
 ********* F-88




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Quarterly Financial Data (Unaudited) 4th Quarter
    
    
    3rd Quarter
    
    
    2nd Quarter
    
    
    1st Quarter(millions of U.S. dollars)
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Revenues
    
    $
    2,615
    
    
    $
    3,266
    
    
    $
    2,179
    
    
    $
    2,344
    
    
    $
    2,590
    
    
    $
    2,288
    
    
    $
    2,444
    
    
    $
    2,295Gross profit
    
    
    1,181
    
    
    
    1,425
    
    
    
    788
    
    
    
    1,119
    
    
    
    1,052
    
    
    
    881
    
    
    
    1,072
    
    
    
    907Special charges
    
    
    81
    
    
    
    86
    
    
    
    93
    
    
    
    81
    
    
    
    (1
    )
    
    
    (22
    )
    
    
    7
    
    
    
    140Other income (expense)  net
    
    
    122
    
    
    
    137
    
    
    
    44
    
    
    
    144
    
    
    
    (14
    )
    
    
    57
    
    
    
    88
    
    
    
    95Net earnings (loss) from continuing operations
    
    
    117
    
    
    
    502
    
    
    
    (223
    )
    
    
    133
    
    
    
    48
    
    
    
    (32
    )
    
    
    116
    
    
    
    (173
    )Net earnings (loss) from discontinued
operations  net of tax
    
    
    37
    
    
    
    27
    
    
    
    5
    
    
    
    32
    
    
    
    6
    
    
    
    (8
    )
    
    
    1
    
    
    
    133Net earnings (loss) before cumulative effect of accounting change
    
    
    154
    
    
    
    529
    
    
    
    (218
    )
    
    
    165
    
    
    
    54
    
    
    
    (40
    )
    
    
    117
    
    
    
    (40
    )Cumulative
effect of accounting change  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )Net earnings (loss)
    
    
    154
    
    
    
    529
    
    
    
    (218
    )
    
    
    165
    
    
    
    54
    
    
    
    (40
    )
    
    
    117
    
    
    
    (52
    )Dividends on preferred shares
    
    
    (9
    )
    
    
    (9
    )
    
    
    (8
    )
    
    
    (9
    )
    
    
    (7
    )
    
    
    (9
    )
    
    
    (9
    )
    
    
    (8
    )Net earnings (loss) applicable
to common shares
    
    
    145
    
    
    
    520
    
    
    
    (226
    )
    
    
    156
    
    
    
    47
    
    
    
    (49
    )
    
    
    108
    
    
    
    (60
    )
 See notes 3, 6 and 9 to the accompanying consolidated financial statements for the impact of
accounting changes, special charges and acquisitions, divestitures and closures, respectively, that
affect the comparability of the above selected financial data. Additionally, the following
significant items were recorded in the fourth quarters of 2004 and 2003:  
    
    During the fourth quarter of 2004, bad debt recoveries of $80,
which related primarily to customer financing notes receivable
that were restructured and subsequently sold for cash proceeds in
the first quarter of 2005, were recorded as a reduction to SG&A
expense. Other income (expense) included foreign exchange gains
of $43 related to day-to-day transactional activities and a gain
of $53 related to the restructured customer financing arrangement
for which Nortel received cash proceeds in the fourth quarter of
2004.
    
    During the fourth quarter of 2003, revenue of $300 and gross
profit of $186 was recorded related to sales of Enterprise
Networks products that had been previously deferred until software
revenue recognition criteria were met. The gross profit impact
was partially offset by an incremental Optical Networks inventory
provision of $119. Also during the fourth quarter of 2003, bad
debt recoveries of $69 were recorded as a reduction to SG&A
expense. F-89




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REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS To the Shareholders and Board of Directors of Nortel Networks Limited We have audited the consolidated financial statements of Nortel Networks Limited and its
subsidiaries (Nortel) as at December 31, 2004 and 2003 and for each of the three years in the
period ended December 31, 2004, managements assessment of the effectiveness of Nortels internal
control over financial reporting as at December 31, 2004, and the effectiveness of Nortels
internal control over financial reporting as at December 31, 2004, and have issued our reports
thereon dated April 29, 2005 (which audit report on the
consolidated financial statements expressed
an unqualified opinion and includes a separate report titled Comments by Independent Registered
Chartered Accountants on Canadian-U.S. Reporting Differences referring to changes in accounting
principles that have a material effect on the comparability of the financial statements; and which
report on the effectiveness of Nortels internal control over financial reporting expressed an unqualified opinion on
management's assessment of the effectiveness of Nortel's internal control over financial reporting and an adverse opinion on the effectiveness of Nortels internal control over financial reporting
because of material weaknesses); such reports are included elsewhere in this Form 10-K. Our audits
also included the consolidated financial statement schedule of Nortel listed in Item 15. This
consolidated financial statement schedule is the responsibility of Nortels management. Our
responsibility is to express an opinion based on our audits. In our opinion, such consolidated
financial statement schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the information set forth
therein. /s/ Deloitte & Touche
LLP
Independent Registered Chartered Accountants Toronto, Canada
April 29, 2005 F-90




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##### Table of Contents



Schedule II
Consolidated NORTEL NETWORKS LIMITED
Valuation and Qualifying Accounts and Reserves Provision For Uncollectibles(a)(millions of U.S. dollars) Balance at
    
    
    Charged
    
    
    
    
    
    
    Balance atbeginning of
    
    
    to costs
    
    
    
    
    
    
    end ofU.S. GAAP
    
    year
    
    
    and expenses
    
    
    Deductions (b)
    
    
    year(c)Year 2004
    
    $
    491
    
    
    $
    (187
    )
    
    $
    130
    
    
    $
    174Year 2003
    
    $
    1,282
    
    
    $
    (179
    )
    
    $
    612
    
    
    $
    491Year 2002
    
    $
    1,537
    
    
    $
    292
    
    
    $
    547
    
    
    $
    1,282
 (a)
    
    Excludes Discontinued Operations.(b)
    
    Includes acquisitions and disposals of subsidiaries and divisions and amounts written off, and foreign exchange translation adjustments.(c)
    
    Includes provisions for uncollectibles on long-term accounts receivable of $65, $297 and $780 as of December 31, 2004, 2003
and 2002, respectively. F-91




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ITEM 9.
    
    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. 125




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##### Table of Contents



ITEM 9A.
    
    Controls and Procedures Management Conclusions Concerning Disclosure Controls and Procedures We carried out an evaluation under the supervision and with the participation of management,
including the current CEO and current CFO (William A. Owens and Peter W. Currie, respectively),
pursuant to Rule 13a-15 under the Exchange Act, of the effectiveness of our disclosure controls and
procedures as at December 31, 2004 (the end of the period covered by this report) and as at April
29, 2005. The CEO and CFO were appointed to such positions as at April 28, 2004 and February 14,
2005, respectively. In making this evaluation, the CEO and CFO considered, among other matters:  
    
    the Second Restatement and the revisions to our preliminary unaudited results for the
year ended December 31, 2003;  
    
    the findings of the Independent Review summarized in the Summary of Findings and of
Recommended Remedial Measures of the Independent Review, submitted to the Audit
Committee in January 2005 by WCPHD and Huron Consulting Services LLC, or the Independent
Review Summary, included in Item 9A of our 2003 Annual Report;  
    
    the terminations for cause of our former president and chief executive officer, former
chief financial officer, former controller and seven additional senior finance employees
during the course of the Independent Review and the reasons therefor as described in the
Independent Review Summary;  
    
    the material weaknesses in our internal control over financial reporting that we and our
external auditor, Deloitte, have identified (as more fully described below);  
    
    managements assessment of our internal control over financial reporting and conclusion
that our internal control over financial reporting is not effective, and Deloittes
attestation report with respect to that assessment and conclusion, each pursuant to the
requirements of SOX 404 (each as more fully described below);  
    
    the measures we have identified, developed and begun to implement, beginning in November
2003, to remedy those material weaknesses (as more fully described below);  
    
    our omission of certain 2000 selected financial data from this report (as more fully
described below); and  
    
    the decision of the Audit Committee to undertake the Revenue Independent Review (as more
fully described below). Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and
procedures as at December 31, 2004 and April 29, 2005 were not effective to provide reasonable
assurance that information required to be disclosed in the reports we file and submit under the
Exchange Act is recorded, processed, summarized and reported as and when required. In light of this conclusion and as part of the extensive work undertaken in connection with the
Second Restatement and the preparation of this report, we have applied compensating procedures and
processes as necessary to ensure the reliability of our financial reporting. Accordingly,
management believes, based on its knowledge, that (i) this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which they were made, not misleading with respect to the
period covered by this report and (ii) the financial statements, and other financial information
included in this report, fairly present in all material respects our financial condition, results
of operations and cash flows as at, and for, the periods presented in this report. We record any material
adjustments identified before the applicable financial statements are
published and consider the materiality of any adjustments relating to
prior periods both to the current period and to the prior periods.
In the course of the preparation of our 2004 financial statements,
and in part as a result of the application of our compensating
procedures and processes, we have recorded adjustments related to
prior periods which are included in our 2004 financial statements.
These adjustments include, among other items, an Asia Optical revenue
deferral of approximately $80 million and a Brazil foreign
exchange gain of approximately $32 million, both of which were
recorded in the third quarter of 2004. We also recorded a revenue
deferral of approximately $50 million in the fourth quarter of
2004 related to an EMEA Wireless Networks contract, which revenue was
previously recognized primarily in 2002 and 2003. We determined that
this revenue should have been deferred and recognized upon delivery of
the undelivered elements such as services and/or hardware. The
aggregate impact of the adjustments relating to prior periods to our
2004 results was not material to our financial statements or to any
individual segment or geographic region, and resulted in a net
reduction of approximately $60 million to our net income (loss),
or approximately $0.01 reduction in basic and diluted earnings (loss)
per common share,
primarily driven by a net reduction of approximately $60 million
in our 2004 gross profit of $4.1 billion. These adjustments were
immaterial to our 2003, 2002 and prior year results. 126




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* * * * * * Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial
reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control
over financial reporting is designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance
with applicable GAAP. Our internal control over financial reporting should include those policies
and procedures that:  
    
    pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of
our assets;  
    
    provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with applicable GAAP, and that receipts and
expenditures are being made only in accordance with authorizations
of management and the Board of Directors; and  
    
    provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our
assets that could have a material effect on the financial
statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. Management, including the current CEO and current CFO, assessed the effectiveness of our internal
control over financial reporting, and concluded that five material weaknesses in our internal
control over financial reporting existed, as at December 31, 2004. These material weaknesses are
the first five of six material weaknesses in our internal control over financial reporting that
existed as at December 31, 2003, as described in greater detail below under Background  Second
Restatement  Material Weaknesses in Internal Control over Financial Reporting Identified During
the Second Restatement. The material weaknesses in our internal control over financial reporting as at December 31, 2004 are:  
    
    lack of compliance with written Nortel procedures for monitoring and
adjusting balances related to certain accruals and provisions, including
restructuring charges and contract and customer accruals;  
    
    lack of compliance with Nortel procedures for appropriately applying
applicable GAAP to the initial recording of certain liabilities, including
those described in SFAS No. 5, and to foreign currency translation as
described in SFAS No. 52;  
    
    lack of sufficient personnel with appropriate knowledge, experience and
training in U.S. GAAP and lack of sufficient analysis and documentation of
the application of U.S. GAAP to transactions, including, but not limited
to, revenue transactions;  
    
    lack of a clear organization and accountability structure within the
accounting function, including insufficient review and supervision,
combined with financial reporting systems that are not integrated and which
require extensive manual interventions; and  
    
    lack of sufficient awareness of, and timely and appropriate remediation of,
internal control issues by Nortel personnel. For purposes of this Managements Report on Internal Control Over Financial Reporting, the
term material weakness means a significant deficiency (within the meaning of Public Company
Accounting Oversight Board Auditing Standard No. 2), or a combination of significant deficiencies,
that results in there being more than a remote likelihood that a material misstatement of our
annual or interim financial 127




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statements will not be prevented or detected on a timely basis by employees in the normal course of
their assigned functions. In making its assessment of internal control over financial reporting, management used the criteria
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework. Because of the material weaknesses described above, management
believes that, as at December 31, 2004, we did not maintain effective internal control over
financial reporting based on those criteria. Our independent registered Chartered accountants have issued an attestation report with respect to managements assessment
of our internal control over financial reporting
which expresses an adverse opinion on the effectiveness of Nortel's internal
control over financial reporting because of material weaknesses as at December 31, 2004.
That report appears on page F-2 of this report. * * * * * * Changes in Internal Control Over Financial Reporting and Remedial Measures We continue to identify, develop and begin to implement remedial measures to strengthen our
internal control over financial reporting and address the remaining material weaknesses in our
internal control over financial reporting. At the recommendation of the Audit Committee, the Board
of Directors adopted all of the recommendations for remedial measures contained in the summary of
the findings of the Independent Review. The Board of Directors has directed management to develop
a detailed plan and timetable for the implementation of these recommendations and will monitor
their implementation. Management has begun to address certain of these recommendations and is also
in the process of reviewing its other remedial measures in light of these recommendations. The
following is a summary of changes in internal control over financial reporting to address the
remaining material weaknesses.  Managements Report on the Elimination of a Material Weakness As noted above, management is responsible for establishing and maintaining adequate internal
control over financial reporting and used the COSO control criteria to make its annual assessment
of the effectiveness of our internal control over financial reporting. Over the course of the Second Restatement process, management, together with Deloitte, identified
six material weaknesses which were disclosed in our 2003 Annual Report, as further described below.
These six material weaknesses included the five material weaknesses listed above under
Managements Report on Internal Control Over Financial Reporting and the following material
weakness:  
    
    an inappropriate tone at the top, which contributed to the lack of a strong control
environment; as reported in the Independent Review Summary, there was a [m]anagement
tone at the top that conveyed the strong leadership message that earnings targets could
be met through application of accounting practices that finance managers knew or ought to
have known were not in compliance with U.S. GAAP and that questioning these practices was
not acceptable. In order to eliminate this identified material weakness related to tone at the top, new
management modified our internal control over financial reporting, implemented certain remedial
measures and took certain other actions to ensure that managements control objective to promote
honesty and ethical behavior was met as at December 31, 2004. Management recognizes that the
promotion of a culture of honesty and ethical behavior must be an ongoing process and has committed
to continue to promote such a culture. Prior to and since December 31, 2004, we have undertaken
the following key changes in internal control over financial reporting, remedial measures and other
actions to promote honesty and ethical behavior:  
    
    Appointment of New Senior Leadership with High Ethical and Moral Standards.  
    
    In April 2004, we terminated for cause our former president and chief executive
officer, former chief financial officer and former controller (the former chief
financial officer and former controller having been placed on paid leaves of absence in
March 2004), and in August 2004, we terminated for cause seven additional senior
finance employees with significant responsibilities for our financial reporting as a
whole or for their respective business units and geographic regions. 128




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
    
    We appointed new senior leadership with high ethical and moral standards: In April
2004, we appointed a new permanent CEO, and in March 2004, we appointed an interim CFO
and Controller, who each became permanent in April 2004.  
    
    Emphasis by New Senior Management of Honesty and Ethical Behavior.  
    
    In August 2004, we adopted a new strategic plan that includes a renewed commitment
to best corporate practices and ethical conduct, including the establishment of the
office of a chief ethics and compliance officer, which has now been filled with the
permanent appointment of Susan E. Shepard, effective February 21, 2005.  
    
    Emphasis on Reliable and Transparent Financial Reporting.  
    
    Over the course of and subsequent to the Second Restatement process, our current
CEO, William A. Owens, our CFO through the Second Restatement process, William R. Kerr,
and starting February 14, 2005, our current CFO, Peter Currie, have communicated to
employees the importance of the Second Restatement process and the ongoing need for
reliable and transparent financial reporting and ethical conduct. Those communications
included formal presentations as part of our annual executive conference in November
2004. Additionally, our CFO through the Second Restatement process and our current CFO
have encouraged finance personnel to bring matters of concern to managements attention
without fear of retribution.  
    
    Beginning in July 2004, we have emphasized the importance of internal control over
financial reporting throughout the organization, including through numerous education
sessions to various levels of management.  
    
    Beginning in September 2004, we implemented mandatory training procedures for senior
management with respect to our internal back-up certification process, with an
emphasis on the accountability of senior management both for their individual areas of
responsibility and for the business as a whole as members of the senior leadership
team.  
    
    Beginning in 2004, we implemented a process to increase visibility to management
after the close of a financial period of potential adjustments to the financial
statements.  
    
    Alignment of Leadership Compensation with Financial Accountability.  
    
    In June 2004, management recommended, the joint leadership resources committee
recommended and the Board of Directors subsequently approved the inclusion of financial
accountability as a key qualitative factor in the individual leadership performance
objectives for determination of incentive cash awards under our annual incentive plan.  
    
    In January 2005, we received notification from certain senior executives that they
would as a matter of corporate leadership and integrity pay an amount equal to their
Return to Profitability bonuses, conveying their deep disappointment over the
circumstances that led to the Second Restatement and their determination to make it
clear to employees, investors and others that such activities are unacceptable to them. As at and subsequent to December 31, 2004, management believes that the above changes in our
internal control over financial reporting, remedial measures and other actions taken achieve
managements control objective to promote a culture of honesty and ethical behavior and, as a
result, management believes the identified material weakness relating to tone at the top has been
eliminated as at December 31, 2004. 129




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Other Changes in Internal Control Over Financial Reporting and Remedial Measures At the recommendation of the Audit Committee, the Board of Directors adopted all of the
recommendations for remedial measures contained in the Independent Review Summary. The governing
principles of the recommendations developed by WCPHD and provided to the Audit Committee were the
following:  
    
    establishing standards of conduct to be enforced through appropriate discipline;  
    
    infusing strong technical skills and experience into the finance organization;  
    
    requiring comprehensive, on-going training on increasingly complex accounting standards;  
    
    strengthening and improving internal controls and processes;  
    
    establishing a compliance program throughout the Company which is appropriately staffed
and funded;  
    
    requiring management to provide clear and concise information, in a timely manner, to
the Board of Directors to facilitate its decision-making; and  
    
    implementing an information technology platform that improves the reliability of
financial reporting and reduces the opportunities for manipulation of results. See the Independent Review Summary for further information concerning these governing principles as
they translate into recommendations regarding three categories  people, processes and technology. The Board of Directors has directed management to develop a detailed plan and timetable for the
implementation of these recommendations and will monitor their implementation. Management has
begun to address certain of the recommendations, including through the measures set out above under
Changes in Internal Control Over Financial Reporting and Remedial Measures  Elimination of a
Material Weakness as they relate to our commitment to best corporate practices and ethical
conduct. In addition to those measures set forth above under Changes in Internal Control Over Financial
Reporting and Remedial Measures  Elimination of a Material Weakness, we have identified,
developed and begun to implement a number of measures to strengthen our internal control over
financial reporting and address the material weaknesses identified above, as discussed below.
These measures are in the process of being reviewed in light of the recommendations of the
Independent Review, and certain of these measures may be modified or superseded as managements
plan progresses, or as a result of the Revenue Independent Review.  
    
    Extended Balance Sheet Reviews. In March 2005, we implemented extended and
enhanced balance sheet review procedures for financial periods beginning with the third
quarter of 2004, as follows:  
    
    We have scheduled regular balance sheet reviews across all segments and major
statutory entities in advance of our periodic report filings; and  
    
    We clarified accountability within Nortel for review of significant balance sheet
accounts and required specific focus on accounts involving significant estimates and
judgments. 130




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
    
    Finance Department Organizational Structure. We announced, and have begun to
implement, plans to transform our finance organization, which include a renewed commitment
to transparency, accuracy, accountability and competency as fundamental goals. Measures we
have begun to implement include:  
    
    In the first quarter of 2004, we began to enhance our global technical accounting
group and established global revenue governance and global finance governance teams.  
    
    In March 2004, we began hiring additional full-time finance personnel (with a focus
on qualified accounting professionals) as part of an initiative introduced by the CFO
at that time, William R. Kerr, and the controller at that time, MaryAnne E. Pahapill.
This initiative is aimed at both strengthening the finance organizations technical
skills and experience, including at a senior level, and addressing employee attrition.  
    
    We established a global corporate finance Sarbanes-Oxley compliance group beginning
in the third quarter of 2004.  
    
    We engaged Accenture, a global management consulting and technology services firm,
in the third quarter of 2004 to assess the finance organizations structure, processes
and systems. The assessment was completed in February 2005. We appointed a global
finance transformation leader in the first quarter of 2005 and expect to begin the
detailed design phase of our finance transformation project in the second quarter of
2005. We expect the implementation of this project will continue into 2007 and will
include, among other things, implementing an information technology platform (SAP) to
provide an integrated global financial system.  
    
    In connection with our SOX 404 assessment of internal control over financial
reporting, we began to modify or enhance existing processes and implement new control
activities, including improved levels of documentation, and enhanced monitoring and
supervision of processes such as reconciliation of account balances and compliance with
internal policies.  
    
    Training Initiatives.  
    
    We re-established our formal training group (led by the global finance governance
team described above) to implement ongoing training programs for finance personnel
globally to strengthen the finance organizations technical skills and experience. The
groups focus includes training with respect to SFAS No. 5; accounting for hedging and
derivatives; revenue recognition, accruals and provisions; and SFAS No. 52.  
    
    Internal Audit.  
    
    In the first quarter of 2004, we modified the mandate of our internal audit function
to place a greater emphasis on the adequacy of, and compliance with, procedures
relating to internal control over financial reporting.  
    
    In October 2004, we engaged outside consultants to conduct a strategic performance
review of the internal audit function. The objective of this review is to ensure that
internal audit meets professional internal audit standards and moves towards audit best
practices. The strategic review has been completed and management has begun to
implement certain of the recommendations of the review.  
    
    Manual Journal Entry Processes.  
    
    We developed new procedures related to manual journal entries, which focus on
approvals, more stringent documentation processes and reduction of user access to
manual journal entry functions. We continue to work towards achieving full
implementation of these procedures. 131




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The above mentioned changes in internal control over financial reporting materially affected our
internal control over financial reporting, and these changes and expected changes as a result of
remedial measures to be developed and implemented are reasonably likely to materially affect and
strengthen our internal control over financial reporting in the future. We intend to continue to
make ongoing assessments of our internal controls and procedures periodically and as a result of
the recommendations of the Independent Review and any additional recommendations of the Revenue
Independent Review. * * * * * * Background This section provides information with respect to the material weaknesses and other deficiencies
identified at the time of the First Restatement and the Second Restatement, as well as certain
additional background information regarding the First Restatement and the Second Restatement. For
additional information, see Item 9A of our 2003 Annual Report, note 3 to the audited consolidated
financial statements accompanying our 2003 Annual Report and Developments in 2004Restatements
in the MD&A section of our 2003 Annual Report. In this report, when used with respect to dates and periods ending on or after December 31, 2004,
the term material weakness has the meaning set forth above under Managements Report on Internal
Control Over Financial Reporting. With respect to dates and periods ending before December 31,
2004, the terms material weakness and reportable condition have the meanings as formerly set
forth under standards established by the AICPA, which were applicable with respect to 2003. The
AICPA then defined a (i) reportable condition as 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 and (ii) material
weakness as 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.  First Restatement  Overview In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to the Comprehensive Review, which resulted in the First Restatement.
Each of the former members of management terminated for cause had responsibility for their
respective positions at the time of the Comprehensive Review and First Restatement. As disclosed
in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, the Comprehensive Review
was initiated [I]n light of a period of unprecedented industry adjustment and subsequent
restructuring actions, including workforce reductions and asset write-downs . . . . The amounts
under review were recorded when our balance sheet and income statement were much larger.
Specifically, what would have been relatively minor amounts in prior periods may be considered to
be material to current periods. As noted in the Independent Review Summary, Nortel posted
significant losses in 2001 and 2002 and downsized its work force by nearly two-thirds. The
remaining employees were asked to undertake significant additional responsibilities with no
additional increase in pay and no bonuses. The Companys former senior corporate management
asserted, at the start of the inquiry, that the Companys downturn, and concomitant downsizing of
operations and workforce, led to a loss of documentation and a decline in financial discipline.
Those factors, in their view, were primarily responsible for the significant excess provisions on
the balance sheet as at June 30, 2003, which resulted in the First Restatement. While that downturn surely played a
part in the circumstances leading to the First Restatement, the root causes ran far deeper. The
root causes of the First Restatement, as identified in the Independent Review, are more fully
discussed in the Independent Review Summary. 132




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The Comprehensive Review purported to (i) identify balance sheet accounts that, as at June 30,
2003, were not supportable and required adjustment; (ii) determine whether such adjustments related
to the third quarter of 2003 or prior periods; and (iii) document certain account balances in
accordance with our accounting policies and procedures. The Comprehensive Review, as supplemented
by additional procedures carried out between July 2003 and November 2003 to quantify the effects of
potential adjustments in the relevant periods and review the appropriateness of releases of certain
contractual liability and other related provisions (also called accruals, reserves or accrued
liabilities) in the six fiscal quarters ending with the fiscal quarter ended June 30, 2003, formed
the basis for the adjustments made to the financial statements in the First Restatement. On December 23, 2003, we filed with the SEC the 2002 Form 10-K/A and the 2003 Form 10-Q/As
reflecting the First Restatement. As disclosed in those reports, the net effect of the First
Restatement adjustments was a reduction in accumulated deficit of $486 million, $171 million and
$32 million as at December 31, 2002, 2001 and 2000, respectively. For additional information concerning adjustments made in the First Restatement, see Item 9A of our
2003 Annual Report, note 3 to the audited consolidated financial statements accompanying our 2003
Annual Report and Developments in 2004Restatements in the MD&A section of our 2003 Annual
Report.  Material Weaknesses and Other Deficiencies in Internal Control over Financial
Reporting Identified at the Time of the First Restatement In 2003, we, together with Deloitte, identified a number of deficiencies in our internal control
over financial reporting. On July 24, 2003, Deloitte first informed the Audit Committee that deficiencies in documentary
support for certain accruals and provisions on our balance sheet as at June 30, 2003 constituted a
reportable condition, but not a material weakness, in our internal control over financial
reporting. In particular, Deloitte concluded, in respect of this reportable condition, that it was
unclear, due to the lack of documentation regarding support for certain provisions and accruals,
the passage of time and the turnover of personnel, as to what adjustments, if any, should have been
made in prior years. Deloitte noted that its assessment was based on such information as was
available at the date of its communication to the Audit Committee and the materiality of the
underlying amounts in the context of 2003 reported results. This conclusion was initially
disclosed in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003. On November 18, 2003, as part of the communications by Deloitte to the Audit Committee with respect
to Deloittes interim audit procedures for the year ended December 31, 2003, Deloitte informed the
Audit Committee that there were two reportable conditions, each of which constituted a material
weakness in our internal control over financial reporting. No other reportable conditions were
communicated by Deloitte to the Audit Committee at the time of the First Restatement. These
reportable conditions were as follows:  
    
    lack of compliance with established Nortel procedures for
monitoring and adjusting balances related to certain accruals and
provisions, including restructuring charges; and 133




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
    
    lack of compliance with established Nortel procedures for
appropriately applying U.S. GAAP to the initial recording of
certain liabilities, including those described in SFAS No. 5, and
to foreign currency translation as described in SFAS No. 52. The foregoing material weaknesses contributed to the need for the First Restatement. As described
above, the foregoing material weaknesses continued to exist as at December 31, 2004, and we
continue to identify, develop and begin to implement remedial measures to address them, as
described above.  Second Restatement  Independent Review In late October 2003, the Audit Committee initiated the Independent Review in order to gain a full
understanding of the events that caused significant excess liabilities to be maintained on the
balance sheet that needed to be restated, and to recommend that the Board of Directors adopt, and
direct management to implement, necessary remedial measures to address personnel, controls,
compliance and discipline. The Independent Review focused initially on events relating to the
establishment and release of contractual liability and other related provisions in the second half
of 2002 and the first half of 2003, including the involvement of senior corporate leadership, but
as it evolved, its focus broadened to include specific provisioning activities in each of the
business units and geographic regions. In light of concerns raised in the initial phase of the
Independent Review, the Audit Committee expanded the review to include provisioning activities in
the third and fourth quarters of 2003. As discussed more fully in the Independent Review Summary, the Independent Review concluded that
certain former corporate management (now terminated for cause) and certain former finance
management (now terminated for cause) in the Companys finance organization endorsed, and employees
carried out, accounting practices relating to the recording and release of provisions that were not
in compliance with U.S. GAAP in at least four quarters, including the third and fourth quarters of
2002 and the first and second quarters of 2003. In three of those four quarters  when Nortel was
at, or close to, break even  these practices were undertaken to meet internally imposed pro-forma
earnings before taxes targets. While the dollar value of most of the individual provisions was
relatively small, the aggregate value of the provisions made the difference between a profit and a
reported loss, on a pro forma basis, in the fourth quarter of 2002 and the difference between a
loss and a reported profit, on a pro forma basis, in the first and second quarters of 2003.  Second Restatement Process and Principal Adjustments As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in-depth the concerns identified by WCPHD regarding provisioning activity and to review
provision releases in each of the four quarters of 2003, down to a low threshold. That
examination, and other errors identified by management, led to the Second Restatement. In addition to this examination of provisioning activity, management, including our CFO at that
time, William R. Kerr, undertook various initiatives aimed at ensuring the reliability and
integrity of the audited consolidated financial statements included in the 2003 Annual Report. As
a result of these initiatives, management, with the assistance of outside consultants, then
undertook further detailed reviews of our significant accounting policies, specific transactions
and communications and other documents relating to the identified issues. As a result, the Second
Restatement included adjustments to correct errors relating to a number of accounting issues other
than provisioning. 134




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The principal Second Restatement adjustments resulted in (i) an increase of $440 million in
previously reported revenues and a reduction of $456 million in previously reported net loss for
the year ended December 31, 2002 and (ii) an increase of $1,491 million in previously reported
revenues and a reduction of $917 million in previously reported net loss for the year ended
December 31, 2001. These adjustments primarily related to the following matters (each of which
reflects a number of related adjustments that have been aggregated for disclosure purposes):  
    
    Adjustments to revenues and cost of revenues to address various
aspects of our revenue recognition policies and practices
increased revenues by a total of $440 million in 2002 and $1,491
million in 2001, and increased cost of revenues by a total of $149
million in 2002 and $422 million in 2001. Of these adjustments
identified in the Second Restatement, approximately $1,200 million
of revenues has been deferred to the fourth quarter of 2003 and to
years after 2003, while approximately $250 million of revenues was
permanently reversed.  
    
    Foreign exchange adjustments increased our pre-tax loss by a total
of $57 million in 2002 and $113 million in 2001. These
adjustments resulted from the re-examination of the determination
of the functional currency for certain entities and the incorrect
treatment of significant long-term inter-company positions, and
the incorrect classification of certain foreign exchange gains and
losses.  
    
    Correction of certain inter-company balances that did not properly
eliminate upon consolidation and related provisions resulted in a
decrease of $36 million and an increase of $42 million to our
pre-tax loss for 2002 and 2001, respectively.  
    
    Adjustments to previously recorded special charges relating to
goodwill, inventory impairment, contract settlement costs and
other charges resulted in a total decrease to special charges of
$77 million in 2002 and $150 million in 2001.  
    
    Corrections to various accruals, provisions or other transactions,
primarily due to the incorrect application of U.S. GAAP to the
initial recording of such liabilities, or the failure to
subsequently adjust such liabilities in the correct period,
resulted in a decrease of $324 million and an increase of $47
million in our net loss in 2002 and 2001, respectively.  
    
    Adjustments to the accounting treatment of certain components of
discontinued operations, initially recorded by us in June 2001,
resulted in an increase of $122 million and a decrease of $493
million to the net loss from discontinued operations  net of tax
in 2002 and 2001, respectively. For additional information concerning adjustments made in the Second Restatement, see Item 9A of
our 2003 Annual Report, note 3 to the audited consolidated financial statements accompanying our
2003 Annual Report and Developments in 2004Restatements in the MD&A section of our 2003 Annual
Report.  Use of Estimates in Financial Reporting; Omission of 2000 Selected Financial Data As described above, two material weaknesses in our internal control over financial reporting were
identified at the time of the First Restatement. During the Second Restatement process, a number
of additional material weaknesses in our internal control over financial reporting were identified,
as described below. Due to, among other factors, these material weaknesses, the significant
turnover in our finance personnel, changes in accounting systems, documentation weaknesses and the
passage of time generally, the Second Restatement involved the efforts of hundreds of our finance
personnel and a number of outside consultants and advisors. The process required the review and
verification of a substantial number of documents and communications, and related accounting
entries, over multiple fiscal periods. In addition, the review of accruals and provisions and the application of accounting literature to
certain matters in the Second Restatement, including revenue recognition, foreign exchange, special
charges and discontinued operations, was complicated by the passage of time, the lack of
availability of supporting
records and the turnover of finance personnel noted above. As a result of this complexity,
estimates and assumptions that impact both the quantum of the various recorded adjustments and the
fiscal period to which they were attributed were required in the determination of certain of the
Second Restatement adjustments. We believe the procedures followed in determining such estimates
were appropriate and reasonable using the best available information. 135




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Also as a result of the above factors, as well as a likely inability to obtain third party
corroboration in certain cases due to the substantial industry adjustment in the telecommunications
industry beginning in 2001, we believe that extensive additional efforts over an extended period of
time would be required to restate our 2000 selected financial data. We also believe that selected
financial data for this period would not be meaningful to investors due to this industry
adjustment, which significantly impacted our financial results in 2001 and subsequent periods and
limits the relevance of financial results in periods prior to 2001 for purposes of analysis of
trends in subsequent periods. We believe that investor understanding would be better aided by the
dedication of our resources to the preparation of the current financial and other information
included in this and future reports. As a result, except for the selected balance sheet data as at
December 31, 2000, financial data for the year ended December 31, 2000 has not been restated or
presented in the Selected Financial Data section of this report. This omitted data
is normally required to be included in an Annual Report on Form 10-K. A number of our and NNLs past filings with the SEC remain subject to ongoing review by the SECs
Division of Corporation Finance (which could result in the need to amend this or our other
filings).  Material Weaknesses in Internal Control over Financial Reporting Identified During
the Second Restatement Over the course of the Second Restatement process, we, together with Deloitte, identified a number
of reportable conditions, each constituting a material weakness, in our internal control over
financial reporting as at December 31, 2003. In September 2004, management first notified the
Audit Committee of the possibility of additional material weaknesses. Over the remainder of the
Second Restatement process, management and Deloitte identified a total of six material weaknesses.
On January 10, 2005, Deloitte confirmed to the Audit Committee that it had identified these six
material weaknesses. No other reportable conditions were identified by us or Deloitte at the time
of the Second Restatement. The material weaknesses identified were:  
    
    lack of compliance with written Nortel procedures for monitoring
and adjusting balances related to certain accruals and provisions,
including restructuring charges and contract and customer
accruals;  
    
    lack of compliance with Nortel procedures for appropriately
applying applicable GAAP to the initial recording of certain
liabilities, including those described in SFAS No. 5, and to
foreign currency translation as described in SFAS No. 52;  
    
    lack of sufficient personnel with appropriate knowledge,
experience and training in U.S. GAAP and lack of sufficient
analysis and documentation of the application of U.S. GAAP to
transactions, including, but not limited to, revenue transactions;  
    
    lack of a clear organization and accountability structure within
the accounting function, including insufficient review and
supervision, combined with financial reporting systems that are
not integrated and which require extensive manual interventions;  
    
    lack of sufficient awareness of, and timely and appropriate
remediation of, internal control issues by Nortel personnel; and  
    
    an inappropriate tone at the top, which contributed to the lack
of a strong control environment. As reported in the Independent
Review Summary, there was a Management tone at the top that
conveyed the strong leadership message that earnings targets could
be met through application of
accounting practices that finance managers knew or ought to have known were not in compliance
with U.S. GAAP and that questioning these practices was not acceptable. 136




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The foregoing material weaknesses contributed to the need for the Second Restatement. As described
above, the first five of these six material weaknesses continued to exist as at December 31, 2004,
and we continue to identify, develop and begin to implement remedial measures to address them, as
described above. * * * * * * Revenue Independent Review As more fully described above, over the course of the Second Restatement process, management
identified certain accounting practices that it determined should be adjusted as part of the Second
Restatement. In particular, management identified certain errors related to revenue recognition
and undertook a process of revenue reviews. In light of the resulting adjustments to previously
reported revenues, the Audit Committee has determined to review the facts and circumstances leading
to the restatement of these revenues for specific transactions identified in the Second
Restatement. The Revenue Independent Review has a particular emphasis on the underlying conduct
that led to the initial recognition of these revenues. The Audit Committee is seeking a full
understanding of the historic events that required the revenues for these specific transactions to
be restated and will consider any appropriate additional remedial measures, including those
involving internal controls and processes. The Audit Committee has engaged WCPHD to advise it in
connection with the Revenue Independent Review. 137




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ITEM 9B.
    
    Other Information Not Applicable. 138




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PART III 
  ITEM 10.
    
    Directors and Executive Officers of the Registrant Directors of the registrant Directors are elected at the annual meeting of shareholders, except that we can appoint
directors in certain circumstances between annual meetings. Each person who is appointed or
elected to the board of directors will hold that position until the earliest of: (i) the close of
the next annual meeting of shareholders; (ii) the date he or she ceases to be a director by
operation of law; or (iii) the date he or she resigns. The committee on directors of Nortel Networks Corporation and the boards of directors of the
Company and Nortel Networks Corporation remain committed to ensuring an orderly succession,
continuity and renewal. This process was commenced in 2003 and resulted in the appointment of Dr.
Manfred Bischoff and The Hon. John P. Manley in the second quarter of 2004. On January 10, 2005,
the committee on directors of Nortel Networks Corporation advised the board of directors that five
of the current directors had decided not to stand for re-election to the board of directors of the
Company, and to the board of directors of Nortel Networks Corporation at the next annual Nortel
Networks Corporation shareholders meeting, or the Meeting. These directors and the year of their
initial election to the board of directors are: Lynton R. Wilson (1991), L. Yves Fortier (1992),
Sherwood H. Smith (1994), Guylaine Saucier (1997) and The Hon. James J. Blanchard (1997).
Additionally, on January 10, 2005, the board of directors of Nortel Networks Corporation appointed
Richard D. McCormick and Harry J. Pearce directors of Nortel Networks Corporation effective
immediately after the filing with the United States Securities and Exchange Commission, or SEC, of
the Annual Report on Form 10-K of Nortel Networks Corporation for the year ended December 31, 2003
(NNC 2003 Form 10-K). As a result of the filing of the NNC 2003 Form 10-K, the appointments of
Messrs. McCormick and Pearce became effective on January 11, 2005. The board of directors of the
Company, Nortel Networks Corporations principal operating subsidiary, also appointed Messrs.
McCormick and Pearce directors of the Company, effective immediately after the filing with the SEC
of the Annual Report on Form 10-K of the Company for the year ended December 31, 2003 (NNL 2003
Form 10-K). In addition, on January 17, 2005, the boards of directors of Nortel Networks
Corporation and the Company appointed Messrs. McCormick and Pearce to the joint leadership
resources committee of the Company and Nortel Networks Corporation, effective immediately after the
filing of the NNL 2003 Form 10-K. As a result of the filing of the NNL 2003 Form 10-K, the
appointment of Messrs. McCormick and Pearce as directors of the Company and as members of the joint
leadership resources committee of the Company and Nortel Networks Corporation became effective on
January 18, 2005. Set out below is certain information concerning the individuals who have been nominated to be
elected as directors of the Company and who have also been nominated for election as directors of
Nortel Networks Corporation at the meeting and certain information concerning the five of our
current directors who are not standing for re-election as directors of the Company, or as directors
of Nortel Networks Corporation at the Meeting. Name
    
    Age
    
    Position with the CompanyJalynn H. Bennett
    
    
    62
    
    
    NomineeDr. Manfred Bischoff
    
    
    63
    
    
    DirectorThe Hon. James Johnston Blanchard
    
    
    62
    
    
    Director (not standing for re-election)Robert Ellis Brown
    
    
    60
    
    
    DirectorJohn Edward Cleghorn
    
    
    63
    
    
    DirectorL. Yves Fortier
    
    
    69
    
    
    Director (not standing for re-election)The Hon. James B. Hunt, Jr.
    
    
    67
    
    
    NomineeRobert Alexander Ingram
    
    
    62
    
    
    DirectorJohn Alan MacNaughton
    
    
    60
    
    
    NomineeThe Hon. John Paul Manley
    
    
    55
    
    
    Director
 139




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Name
    
    Age
    
    Position with the CompanyRichard David McCormick
    
    
    64
    
    
    DirectorRonald Walter Osborne
    
    
    58
    
    
    NomineeWilliam Arthur Owens
    
    
    64
    
    
    Vice-Chairman and Chief Executive Officer and DirectorHarry Jonathan Pearce
    
    
    62
    
    
    DirectorGuylaine Saucier
    
    
    58
    
    
    Director (not standing for re-election)Sherwood Hubbard Smith, Jr.
    
    
    70
    
    
    Director (not standing for re-election)Lynton Ronald Wilson
    
    
    65
    
    
    Chairman (non-executive) and
Director (not standing
for re-election)
  (PHOTO)
 JALYNN H. BENNETT, C.M., 62, Toronto, Ontario, Canada, has been nominated for
election is a director of the Company and Nortel Networks Corporation for the
first time. Mrs. Bennett is President of Jalynn H. Bennett and Associates
Ltd., a consulting firm in strategic planning and organizational development in
both the public and private sectors. Prior to establishing that firm, Mrs.
Bennett was associated for nearly 25 years with The Manufacturers Life
Insurance Company. Mrs. Bennett is currently a director of the Canadian
Imperial Bank of Commerce, Cadillac Fairview Corporation Limited and Teck
Cominco Ltd. She is also a director of The Hospital for Sick Kids Foundation,
a member of the Lawrence National Centre for Policy and Management Advisory
Council, Richard Ivey School of Business and a Member of the Canada Millennium
Scholarship Foundation. She is a past Commissioner of the Ontario Securities
Commission and was a member of the Toronto Stock Exchange, Canadian Stock
Exchange and the Canadian Institute of Chartered Accountants Joint Committee
on Corporate Governance (The Saucier Committee).
    (PHOTO)
 DR. MANFRED BISCHOFF, 63, Starnberg, Federal Republic of Germany, has been a
director of the Company and Nortel Networks Corporation since April 29, 2004.
Dr. Bischoff has been Chairman of the Board of European Aeronautic Defence and
Space Company EADS N.V., an aerospace company, since July 2000, and Delegate
for Aerospace of DaimlerChrysler AG, an automotive company, since January 2004.
Previously, Dr. Bischoff was a member of the Board of Management of
DaimlerChrysler AG from May 1995 to December 2003 and President and Chief
Executive Officer of DaimlerChrysler Aerospace AG from May 1995 to March 2000.
He is also a member of the Supervisory Board of Bayerische Hypo-und Vereinsbank
AG, Fraport AG, Gerling-Konzern Versicherungs-Beteiligungs-AG, J.M. Voith AG,
Royal KPN N.V. and SMS GmbH.
    (PHOTO)
 ROBERT ELLIS BROWN, 60, Westmount, Québec, Canada, has been a director of the
Company since April 27, 2000 and of Nortel Networks Corporation since March 7,
2000. Mr. Brown has been President and Chief Executive Officer of CAE Inc., a
flight training, services and equipment company, since August 2004 and has been
a director of ACE Aviation Holdings Inc., the parent holding company under
which the reorganized Air Canada is held, since October 2004. After being
appointed a director of Air Canada, a commercial airline company, in March
2003, he served as Vice-Chairman of the Board from April 2003 to May 2003 and
Chairman of the Board from May 2003 to September 2004. On April 1, 2003, Air
Canada obtained an initial order from the Ontario Superior Court of Justice
providing creditor protection under the Companies Creditors Arrangement Act,
such order being subsequently amended in connection with the proceedings. On
April 1, 2003, Air Canada also made a concurrent petition for recognition and
ancillary relief under Section 304 of the United States Bankruptcy Code. Air
Canada successfully completed its restructuring process and emerged from
creditor protection in September 2004. Mr. Brown served as a Director and
Chairman of the Board of Air Canada during its restructuring. Mr.
Brown has been the Chairman of Vanguard Response Systems Inc. since November
2003. Mr. Brown was the President and Chief Executive Officer of Bombardier
Inc. from February 1999 to December 2002.
   140




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(PHOTO)
 JOHN EDWARD CLEGHORN, O.C., F.C.A., 63, Toronto, Ontario, Canada, has been a
director of the Company and of Nortel Networks Corporation since May 24, 2001.
Mr. Cleghorn was Chairman and Chief Executive Officer of the Royal Bank of
Canada from January 1995 to July 2001. He is also Chairman of the Board of
SNCLavalin Group Inc., an engineering and construction company, and a director
of Canadian Pacific Railway Company, Canadian Pacific Railway Limited, Finning
International Inc. and Molson Coors Brewing Company. He is Chancellor Emeritus
of Wilfrid Laurier University, Member of the Faculty of Management
International Advisory Board, McGill University and is the Immediate Past
Chairman and a director of the Historica Foundation of Canada.
    (PHOTO)
 THE HON. JAMES B. HUNT, JR.,67, Raleigh, North Carolina, United States has
been nominated for election is a director of the Company and Nortel Networks
Corporation for the first time. Mr. Hunt has been a member of the law firm of
Womble Carlyle Sandridge & Rice, PLLC, since 2001. Prior to that, he was
Governor of North Carolina for four terms, 1977 to 1985 and 1993 to 2001, where
he established the Microelectronics Center of North Carolina, the N.C.
Biotechnology Center and the N.C. School of Science and Mathematics. He
founded and chaired the National Board for Professional Teaching Standards and
currently chairs the National Center for Public Policy and Higher Education,
the Hunt Institute for Educational Leadership and Policy, and the Institute for
Emerging Issues. Mr. Hunt is a trustee of the Carnegie Corporation of New York
and is a director of BioSignia, Inc.
    (PHOTO)
 ROBERT ALEXANDER INGRAM, 62, Durham, North Carolina, United States, has been a
director of the Company since April 29, 1999 and of Nortel Networks Corporation
since March 7, 2000. Mr. Ingram has been Vice-Chairman Pharmaceuticals of
GlaxoSmithKline plc, a corporation involved in the research, development,
manufacturing and sale of pharmaceuticals, since January 2003. Mr. Ingram was
the Chief Operating Officer and President, Pharmaceutical Operations of
GlaxoSmithKline plc from January 2001 to January 2003. He was Chief Executive
of Glaxo Wellcome plc from October 1997 to December 2000 and Chairman of Glaxo
Wellcome Inc., Glaxo Wellcome plcs United States subsidiary, from January 1999
to December 2000. Mr. Ingram is also non-executive Chairman of the Board of
OSI Pharmaceuticals, Inc., a biotechnology company, and a director of Allergan,
Inc., Edwards Lifesciences Corporation, Lowes Companies, Inc., Misys plc,
VALEANT Pharmaceuticals International and Wachovia Corporation.
    (PHOTO)
 JOHN ALAN MacNAUGHTON, C.M., 60, Toronto, Ontario, Canada, has been nominated
for election as a director of the Company and Nortel Networks Corporation for
the first time. Mr. MacNaughton served as President and Chief Executive
Officer of the Canada Pension Plan Investment Board, a Crown Corporation
created by an Act of Parliament in 1997 to invest the assets of the Canada
Pension Plan, from September 1999 to January 2005. Prior to September 1999, he
served as President of Nesbitt Burns Inc., the investment banking arm of Bank
of Montreal, from September 1994 to March 1999. Mr. MacNaughton is a Trustee
of the University Health Network, an academic health science centre. He is a
Governor of CCAF-FCVI Inc., a research and education foundation focused on
governance, accountability, management and audit in the public sector.
    (PHOTO)
 THE HON. JOHN P. MANLEY, 55, Ottawa, Ontario, Canada, has been a director of
the Company and Nortel Networks Corporation since May 26, 2004. Mr. Manley has
been a senior counsel at the law firm of McCarthy Tétrault LLP since May 2004.
Mr. Manley was previously the Member of Parliament for Ottawa South from
November 1988 to June 2004 and Chairman of the Ontario Power Generation Review
Committee, which was responsible for reviewing the state of the energy system
of Ontario, from December 2003 to March 2004. As a Member of Parliament, Mr.
Manley also held various positions in the Canadian federal government,
including Deputy Prime Minister of Canada from January 2002 to December 2003,
Minister of Finance from June 2002 to December 2003, Chair of the Cabinet
Committee on Public Security and Anti-Terrorism from October 2001 to December
2003, Minister of Foreign Affairs from October 2000 to January 2002 and
Minister of Industry prior thereto. Mr. Manley is also a director of Canadian
Imperial Bank of Commerce.
   141




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(PHOTO)
 RICHARD DAVID McCORMICK, 64, Denver, Colorado, United States, has been director
of the Company since January 18, 2005 and a director of Nortel Networks
Corporation since January 11, 2005. He served as Chairman of US WEST, Inc., a
telecommunications company, from June 1998 until his retirement in May 1999. He
was chairman, president and chief executive officer of US WEST, Inc. from 1992
until 1998. He is also a director of HealthTrio Inc., United Technologies
Corporation, Unocal Corporation and Wells Fargo and Company. From 1994 to
2003, Mr. McCormick was also a director of UAL Corporation, the parent holding
company and sole shareholder of United Air Lines, Inc. On December 9, 2002,
UAL Corporation, United Air Lines, Inc. and 26 direct and indirect wholly owned
subsidiaries of UAL Corporation filed voluntary petitions to reorganize their
businesses under Chapter 11 of the United States Bankruptcy Code in the United
States Bankruptcy Court for the Northern District of Illinois, Eastern
Division.
    (PHOTO)
 RONALD WALTER OSBORNE, 58, of Toronto, Ontario, Canada, was a director of the
Company (formerly known as Northern Telecom Limited) from April 1996 to
September 1997. Mr. Osborne was President and Chief Executive Officer of
Ontario Power Generation, an electricity generating company, from 1998 to 2003.
Mr. Osborne held various positions with the BCE group, a group of
communications companies, from 1995 to 1998, including President and Chief
Executive Officer of Bell Canada. Mr. Osborne is also a director of
Massachusetts Financial Services Company, Torstar Corporation, Sun Life
Financial Inc., St. Lawrence Cement Group Inc. and Shell Canada Limited, and is
a member of the board of governors of Roy Thomson Hall and is a trustee of
RioCan (Real Estate Investment Trust). Mr. Osborne also served as a director
of Air Canada from 1999 until his resignation in September 2004. On April 1,
2003, Air Canada obtained an initial order from the Ontario Superior Court of
Justice providing creditor protection under the Companies Creditors Arrangement
Act, such order being subsequently amended in connection with the proceedings.
On April 1, 2003, Air Canada also made a concurrent petition for recognition
and ancillary relief under Section 304 of the United States Bankruptcy Code.
Air Canada successfully completed its restructuring process and emerged from
creditor protection in September 2004.
    (PHOTO)
 WILLIAM ARTHUR OWENS, 64, Kirkland, Washington, United States, has been a
director of the Company and of Nortel Networks Corporation since February 28,
2002. Mr. Owens became Vice-Chairman and Chief Executive Officer of the
Company and Nortel Networks Corporation on March 14, 2005 and, prior thereto,
had been President and Chief Executive Officer of the Company and of Nortel
Networks Corporation since April 2004. Mr. Owens was Chairman and Chief
Executive Officer of Teledesic LLC, a satellite communications company, from
December 2001 to April 2004, after having served as Vice Chairman and Co-Chief
Executive Officer from August 1998 to December 2001. Mr. Owens was
Vice-Chairman of the Board of Directors of Science Applications International
Corporation (or SAIC), a research and engineering firm representing the largest
employee-owned high technology company in the United States, from March 1996 to
August 1998, and served as SAICs President and Chief Operating Officer from
December 1996 to August 1998 and Vice-President from March 1996 to December
1996. Prior to joining SAIC, Mr. Owens was Vice Chairman of the Joint Chiefs
of Staff, the second-ranking military officer in the United States. As part of
his role with the Joint Chiefs of Staff, he had responsibility for the
reorganization and restructuring of the armed forces in the post-Cold War era.
Mr. Owens is also a director of DaimlerChrysler AG and a private investment
firm AEA Investments LLC. Mr. Owens also sits on three philanthropic boards.
Mr. Owens was the Chairman and founder of a private five-state wireless
telecommunication venture. Mr. Owens was also a director of IFusion Com
Corporation, a company involved in developing Internet services and systems,
for approximately one year, his tenure ending in March 1997. On March 28,
1997, IFusion Com Corporation filed a voluntary petition to reorganize its
businesses under Chapter 11 of the United States Bankruptcy Code in the United
States Bankruptcy Court for the Southern District of New York, United States.
    (PHOTO)
 HARRY JONATHAN PEARCE, 62, Bloomfield Hills, Michigan, United States, has been
a director of the Company since January 18, 2005 and a director of Nortel
Networks Corporation since January 11, 2005. He was Chairman of the Board of
Hughes Electronics Corporation (now The DIRECTV Group, Inc.), a company engaged
in digital television entertainment, broadband satellite and network services
as well as global video and data broadcasting, from June 2001 to January 2004.
He was a director and Vice-Chairman of General Motors Corporation from January
1996 to June 2001. Mr. Pearce is also a director of Marriott International,
Inc. and MDU Resources Group, Inc.
   142




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We would like to acknowledge the many years of contribution and service to the Company and
Nortel Networks Corporation by Messrs. Wilson, Fortier, Smith, Mrs. Saucier and Mr. Blanchard, each
of whom is not standing for re-election at the Meeting. The committee on directors recommended to
the board of the Company and of Nortel Networks Corporation, and on
April 22, 2005 the board of
directors of the Company and Nortel Networks Corporation determined that the honorary designation
of Chairman Emeritus be conferred on Mr. Wilson, effective upon the election of the directors at
the Meeting. Mr. Wilson has been a director of the Company since April 25, 1991 and of Nortel Networks
Corporation since March 7, 2000 and non-executive Chairman of the Board of the Company and of
Nortel Networks Corporation since February 2002. Mr. Wilson was executive Chairman of the Board of
the Company and of Nortel Networks Corporation from November 2001 to February 2002. He was
non-executive Chairman of the Board of the Company and of Nortel Networks Corporation from April
2001 to November 2001. Mr. Wilson also serves on the committee on directors of Nortel Networks
Corporation and on the joint leadership resources committee of the Company and Nortel Networks
Corporation. Mr. Wilson was Chairman of the Board of Directors of BCE Inc., a telecommunications
company, from May 1998 to April 2000, serving in a non-executive capacity from January 1999. He is
Chairman of the Board of CAE Inc., a flight training, services and equipment company, and a
director of DaimlerChrysler AG, DaimlerChrysler Canada Inc. and Mercedes-Benz Canada Inc. Mr.
Wilson is also the Chairman of the Board of Directors of AllerGen NCE
Inc., a new national Network of
Centres of Excellence. Mr. Fortier has been a director of the Company since April 30, 1992 and Nortel Networks
Corporation since March 7, 2000. He also serves on the pension fund policy committee of the
Company. He is a senior partner and Chairman of the law firm of Ogilvy Renault LLP. Mr. Fortier
was Canadas Ambassador to the United Nations from 1988 to 1992. Since 2001, he has been a Trustee
of the International Accounting Standards Committee Foundation. He is also Chairman of the Board
of Alcan Inc., Governor (Chairman of the Board) of Hudsons Bay Company, and a director of NOVA
Chemicals Corporation. Mr. Smith, having reached the age of retirement and the term limit under the Companys
corporate governance guidelines, will not be standing again for re-election as a director of the
Company, or as a director of Nortel Networks Corporation at the Meeting. Mr. Smith has been a
director of the Company since March 7, 2000 and of Nortel Networks Limited since April 28, 1994.
He serves on the audit committee and the joint leadership resources committee of the Company, and
on the audit committee, the joint leadership resources committee and the pension fund policy
committee (Chairman) of Nortel Networks Limited. Mr. Smith is Chairman Emeritus of the Board at
CP&L. He is also a trustee of Northwestern Mutual Life Insurance Company, Chairman of the Triangle
Universities Center for Advanced Studies and Vice-Chairman of the Research Triangle Foundation. Mrs. Saucier has been a director of the Company since May 1, 1997 and of Nortel Networks
Corporation since March 7, 2000. She also serves on the audit committees of the Company and Nortel
Networks Limited and the pension fund policy committee of the Company. Mrs. Saucier was Chair of the Joint Committee on Corporate Governance, which was
established by the Canadian Institute of Chartered Accountants, the Canadian Venture Exchange, and
the Toronto Stock Exchange in 2000 to review the state of corporate governance in Canada and make
recommendations thereon. She was also Chair of The Canadian Institute of Chartered Accountants
from June 1999 to June 2000. Mrs. Saucier was Chairman of the Board and a director of the Canadian
Broadcasting Corporation, a public broadcaster, from April 1995 to December 2000. She is also a
director of Altran Technologies SA, AXA Assurances Inc., Bank of Montreal, CHC Helicopters and
Petro-Canada. Mr. Blanchard has been a director of the Company since May 1, 1997 and of Nortel Networks
Corporation since March 7, 2000. He also serves on the pension fund policy committee of the
Company. Mr. Blanchard has been a partner in the law firm of Piper Rudnick LLP (now DLA Piper
Rudnick Gray Cary) since October 2002 and prior to October 2002 was a shareholder in the law firm
of Verner, Liipfert, Bernhard, McPherson and Hand, Chartered since April 1996. He was previously
United States Ambassador to Canada, Governor of the State of Michigan and a member of the United
States House of Representatives. Mr. Blanchard is also a director of Bennett Environmental, Inc.,
Brascan Corporation, Enbridge Inc., LDMI Communications, Inc. and Teknion Corporation. 
 Executive officers and certain other non-executive board appointed officers of the Registrant The executive officers and certain other non-executive board appointed officers of the
Company are appointed, and may be removed, by the board of directors of the Company. Generally,
executive officers and other non-executive officers hold their offices until a successor is
appointed or until the officer resigns. As of April 25, 2005, the names of the executive officers
and non-executive board appointed officers of the Company, their ages, offices currently held and
year of appointment thereto were as follows: 143




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##### Table of Contents



Year ofName and age
    
    Office and position currently held
    
    AppointmentMartha Helena Bejar (43)
    
    President, CALA
    
    
    2004Chahram Bolouri (50)
    
    President, Global Services
    
    
    2004Malcolm Kevin Collins (44)
    
    President, Enterprise Networks
    
    
    2002Tracy Sarah Jane Connelly McGilley (33)*
    
    Assistant Secretary
    
    
    2004Peter William Currie (54)
    
    Executive Vice-President and Chief Financial Officer
    
    
    2005Gary James Daichendt (53)
    
    President and Chief Operating Officer
    
    
    2005Gordon Allan Davies (43)*
    
    Assistant General Counsel  Securities and Corporate Secretary
    
    
    2004Pascal Debon (58)
    
    Senior Advisor
    
    
    2005Nicholas John DeRoma (59)
    
    Chief Legal Officer
    
    
    2000William John Donovan (48)
    
    Senior Vice-President, Human Resources
    
    
    2000John Marshall Doolittle (41)*
    
    Vice-President, Tax
    
    
    2002John Joseph Giamatteo (38)
    
    President, Asia Pacific
    
    
    2003Albert Roger Hitchcock (40)
    
    Chief Information Officer
    
    
    2002Dion Constandino Joannou (39)
    
    Chief Strategy Officer
    
    
    2004William Robert Kerr (51)
    
    Senior Advisor
    
    
    2005Gary Paul Kunis (52)
    
    Chief Technology Officer
    
    
    2005Richard Stephen Lowe (55)
    
    President, CDMA
    
    
    2004Pierre David MacKinnon (43)
    
    President, GSM/UMTS
    
    
    2004Robert Yu Lang Mao (61)
    
    President and Chief Executive Officer, Greater China
    
    
    2003Michael Walton McCorkle (52)*
    
    Assistant Treasurer
    
    
    2005Brian William McFadden (51)
    
    Chief Research Officer
    
    
    2004William Arthur Owens (64)
    
    Vice-Chairman and Chief Executive Officer
    
    
    2005Stephen Charles Pusey (43)
    
    President, Europe, Middle East and Africa
    
    
    2001Ralph Edward Clenton Richardson (43)
    
    Chief Marketing Officer
    
    
    2004Charles Raymond Saffell, Jr. (58)
    
    President, Federal Network Solutions
    
    
    2004Steven Leo Schilling (48)
    
    President, Enterprise Accounts
    
    
    2002Susan Engelke Shepard (61)
    
    Chief Ethics and Compliance Officer
    
    
    2005Stephen Francis Slattery (45)
    
    President, Wireline/Optical
    
    
    2004Karen Elizabeth Sledge (44)**
    
    Controller
    
    
    2005Susan Louise Spradley (44)
    
    President, Global Operations
    
    
    2004Katharine Berghuis Stevenson (42)
    
    Treasurer
    
    
    2000
  *
    
    Non-executive board appointed officers**
    
    Appointed on an interim basis All the above-named executive officers and non-executive board appointed officers of the
Company have been employed in their current position or other senior positions with Nortel during
the past five years, except as follows:  
    
    T.S.J. Connelly McGilley, prior to her appointment as Assistant
Secretary effective in December 2004, held the position of Counsel
  Securities in the Companys legal department;
    
    P.W. Currie, who was previously employed in various finance
positions at Nortel from 1979 to 1992, including general auditor,
controller and vice president, finance for different business
segments, and from 1994 to early 1997 as senior vice president and
chief financial officer, joined Royal Bank of Canada in 1997, most
recently holding the position of vice chairman and chief financial
officer of RBC Financial Group until September 2004;
    
    G.J. Daichendt was previously employed in the networking and
communications industry with Cisco Systems, Inc., or Cisco. At
Cisco, he held a number of senior positions. From 1998 to 2000,
he was Executive Vice-President, Worldwide Operations and, prior
to that, was Senior Vice-President, Worldwide Operations (1997 to
1998), Senior Vice-President, Worldwide Sales (1996 to 1997) andVice-President, Intercontinental Operations (1994 to 1996). Prior
to his tenure with Cisco, Mr. Daichendt held a number of other
senior positions with technology companies over a number of years,
including during his two years with System Software Associates,
Inc., eight years with Wang Laboratories, Inc. and ten years with
IBM Corporation. Since his departure from Cisco in 2000, Mr.
Daichendt has been primarily engaged in investing in private
commercial real estate ventures, a mega electronic game center and
board positions with technology start-up companies and non-profit
organizations; 144




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
    
    J.M. Doolittle was, prior to returning to Nortel in
September 1999, Vice President, Finance of The Bank of Montreal, a
Canadian chartered bank, from August 1997 and Director, Treasury,
Europe and Asia, Nortel Networks, prior thereto;
    
    W.R. Kerr, prior to returning to Nortel as Chief Financial Officer
in March 2004, held various senior finance positions with Nortel
from January 1999 (and prior thereto) until his retirement in
December 2001. Mr. Kerr served as Chief Financial Officer until
February 13, 2005, when he stepped down from the position to
become senior advisor to the Chief Executive Officer. He has also
served as a director of Bank of China (Canada) since June 1, 1997;
    
    G.P. Kunis, was previously employed in the networking and
communications industry with Cisco Systems, Inc., or Cisco. At
Cisco, he held a number of senior positions. Most recently, he
was Vice President, Chief Science Officer from September 1990
until October 2002. Mr. Kunis also served as the chief networking
engineer at Boeing Corporation from 1984 to 1990 where he was
involved in the design, implementation and operation of large
scale data and telecommunication networks for several U.S.
government agencies, including the Department of Defense,
U.S. Navy, U.S. Air Force and National Aeronautics and Space Administration
(NASA), as well as for various civilian agencies. Mr. Kunis was also a pioneer
of the Internet, leading numerous developments in Internet Protocol (IP)
standards and routing technology used to connect the worldwide web of networks
that make up the Internet. During the 1980s, he led a National Science
Foundation (NSF) project to develop and deploy NorthWest Net, the Internet
backbone for the Pacific Northwest region, the largest such undertaking in the
U.S. at that time;
    
    R.Y.L. Mao was, prior to returning to Nortel in
January 2003, Chairman and Chief Executive Officer of
Foxconn (Beijing) Precision Component Industries,
Ltd., a manufacturer of mobile communication terminal
devices, from November 2002 to December 2002, and
Chief Executive Officer, Nortel China, prior thereto;
    
    M.W. McCorkle, prior to his appointment as Assistant
Treasurer, held the position of Director and Team
Leader, Structured Finance EMEA, based in Nortels
United Kingdom operations. During his time with
Nortel, Mr. McCorkle has also held the position of
Director of Customer Finance, North America, where he
led the Wireless group within North American Customer
Finance. Prior to joining Nortel in 1997, Mr.
McCorkle had extensive experience in the banking
industry, having held various Vice-President
positions at the First National Bank of Chicago.
    
    W.A. Owens was, prior to his appointment as President
and Chief Executive Officer in April 2004, Chairman
and Chief Executive Officer of Teledesic LLC, a
satellite communications company, from December 2001
to April 2004, after having served as Vice Chairman
and Co-Chief Executive Officer from August 1998 to
December 2001. Mr. Owens was Vice-Chairman of the
Board of Directors of Science Applications
International Corporation (or SAIC), a research and
engineering firm representing the largest
employee-owned high technology company in the United
States, from March 1996 to August 1998, and served as
SAICs President and Chief Operating Officer from
December 1996 to August 1998 and Vice-President from
March 1996 to December 1996. Prior to joining SAIC,
Mr. Owens was Vice Chairman of the Joint Chiefs of
Staff, and the second-ranking military officer in the
United States. As part of his role with the Joint
Chiefs of Staff, he had responsibility for the
reorganization and restructuring of the armed forces
in the post-Cold War era. Mr. Owens is also a
director of DaimlerChrysler AG and a private
investment firm AEA Investments LLC. Mr. Owens also
sits on three philanthropic boards. Mr. Owens was
the Chairman and founder of a private five-state
wireless telecommunication venture. Mr. Owens has
been a director of the Company and Nortel Networks
Corporation since February 2002 and became
Vice-Chairman and Chief Executive Officer effective
March 14, 2005;
    
    R.E.C. Richardson was, prior to his appointment as
Chief Marketing Officer effective October 1, 2004,
Vice President, Global Marketing Enterprise Networks
from April 2004 to September 2004. Mr. Richardson
was a consultant from April 2003 to March 2004 and
prior thereto was Chief Sales and Marketing Officer,
and member of the board of directors, at T-Mobile UK,
the UK wireless unit of Deutsche Telekom AG, from
April 2001 to March 2003. Prior to that, Mr.
Richardson was Vice President Worldwide Developer
Relations and Worldwide Solutions Marketing, Apple
Computer, a company engaged in the desktop and
notebook computer industry as well as the production
of operating systems and professional applications,
from December 1997 to March 2001;
    
    C.R. Saffell, Jr. was, prior to his appointment as
President, Federal Network Solutions in October,
2004, Senior Vice President for National Security
Solutions, Titan Corporation, a technology developer
and systems integrator that provides a range of
systems solutions primarily for the Department of
Defense, the Department of Homeland Security,
intelligence and other U.S. government agencies, from
December 1988 to March 2004; 145




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
    
    K.E. Sledge joined Nortel 19 years ago as a
financial analyst. After holding various finance
positions with Nortel, she became director finance,
Europe Region before returning to the U.S. as finance
director West Coast Control and then later became
U.S. controller in August 2002. In July 2003, Ms.
Sledge was appointed assistant controller of the
registrant and Nortel Networks Corporation; and,
    
    S.E. Shepard, succeeded Mr. W.F. McCauley in the position of Chief Ethics and Compliance
Officer effective February 21, 2005. Over the course of her career, Ms. Shepard has served in
a number of positions specifically related to ethics and compliance. Ms. Shepard has been a
Commissioner for the New York State Ethics Commission since May 2003. In addition, prior to
becoming engaged in private practice in 1997, Ms. Shepard was Commissioner of Investigation
for New York City (1990 to 1994), Chief Counsel to the New York State Commission of
Investigation (1986 to 1990) and an Assistant United States Attorney for the Eastern District
of New York (1976 to 1986). 
 Section 16(a) beneficial ownership reporting compliance Section 16(a) of the United States Securities Exchange Act of 1934 requires persons who
beneficially own more than 10 percent of the Companys equity securities and certain other persons
to file reports concerning their ownership of Company equity securities with the United States
Securities and Exchange Commission, the New York Stock Exchange, and the Company. Nortel Networks
Corporation, the sole owner of the Companys common shares, filed its required reports on a timely
basis during 2004 and 2003. Audit committee financial expert The boards of directors of the Company and Nortel Networks Corporation have determined
that Mr. J.E. Cleghorn meets the criteria required by the United States Securities and Exchange
Commission for an audit committee financial expert (United States GAAP). Mr. Cleghorn is
independent under the requirements for the independence of audit committee members under the
New York Stock Exchange (or NYSE) corporate governance listing standards. Audit committee The Company and Nortel Networks Corporation have audit committees in accordance with
Section 3(a)(58)(A) of the United States Securities Exchange Act of 1934, as amended. The audit
committees have identical memberships. The members of both audit committees are J.E. Cleghorn
(Chairman), M. Bischoff, R.E. Brown, R.A. Ingram, G. Saucier, and S.H. Smith, Jr. Code of ethics and other corporate governance matters The Company and Nortel Networks Corporation have adopted a code of business conduct and
ethics, known as Living the Values: A Guide to Ethical Business Practices at Nortel Networks,
which applies to the chief executive officer, chief financial officer and controller, and other
persons performing similar functions, as well as to directors, officers and all other employees.
Certain waivers under the Guide if granted by the boards of directors or any committee thereof to
directors of the Company or Nortel Networks Corporation or officers will be posted on our website
at www.nortel.com, in accordance with applicable law and the requirements of the stock exchanges on
which the Company or Nortel Networks Corporation securities are listed and of securities regulatory
authorities as adopted or amended and in force from time to time. All employees, officers, and members of the board of directors are subject to insider trading
laws generally. In accordance with the Guide and applicable corporate policy, there are certain
individuals who, by virtue of their role, are deemed insiders. Because they may have knowledge
of, or access to, material information, the trading activities of these individuals are restricted
by Nortel: they may not engage in any trading activity for specified periods of time throughout
the year, known as black out periods. These deemed insiders can only trade during prescribed
window periods, and even then, only if they do not have knowledge of any Nortel material
information at that time. Generally, deemed insiders are company officers, directors, senior
executives and other leaders, and employees who frequently have access to material information. The audit committees of the Company and Nortel Networks Corporation have each adopted a
charter, known as the Audit Committee Mandate. The committee on directors of Nortel Networks
Corporation acts as the nominating committee and makes corporate governance recommendations to the
board of directors of Nortel Networks Corporation. The committee on directors has adopted a charter, known as the Committee on Directors Mandate. The joint
leadership resources
committee acts as the compensation committee of Nortel. The joint leadership
resources committee has adopted a charter, known as the Joint Leadership Resources Committee
Mandate. The Company and Nortel Networks Corporation have adopted corporate governance
guidelines, known as the Statement of Governance Guidelines. 146




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The Guide to Ethical Business Practices, the Audit Committee Mandates, the Committee on
Directors Mandate, the Joint Leadership Resources Mandate, and the Statement of Governance
Guidelines, as well as any future amendments to these documents, are available free of charge on
our website at www.nortel.com or by writing to the Corporate Secretary at Nortel Networks Limited,
8200 Dixie Road, Suite 100, Brampton, Ontario L6T 5P6. 
  ITEM 11.
    
    Executive Compensation The following tables are presented in accordance with the rules of the United States
Securities and Exchange Commission. 
 Summary compensation tables The following tables set forth the compensation awarded to, earned by, or paid to each of
the Companys named executive officers for services rendered by them to the Company, its
subsidiaries and affiliates in (1) 2004, 2003, and 2002, and (2) 2003, 2002 and 2001, respectively. 147




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2004 Long TermCompensationAwards
    
    
    PayoutsAnnual Compensation
    
    
    SecuritiesName
    
    
    
    
    
    
    
    
    
    
    
    Other Annual
    
    
    Underlying
    
    
    LTIP
    
    
    All OtherAnd Principal
    
    
    
    
    
    Salary
    
    
    Bonus
    
    
    Compensation
    
    
    Options
    
    
    Payouts
    
    
    CompensationPosition
    
    
    Year
    
    
    ($)
    
    
    ($)(1)
    
    
    ($)
    
    
    (#)
    
    
    (#)
    
    
    ($)W.A. Owens*
President and Chief
Executive Officer
    
    
    2004
2003
2002
    
    
    681,818


    
    
    


    
    
    


    
    
    


    
    
    


    
    
    70,298(2)

P. Debon**
President, Carrier
Networks
    
    
    2004
20032002
    
    
    590,000
590,000537,143
    
    
    
743,400(6)
1,475,000(8)(9)

    
    
    10,445(3)

    
    
    
250,000
    
    
    
90,000(7)
745,000(10)

    
    
    85,577(4)(5)
92,346(4)(5)125,875(4)(5)(11)B.W. McFadden**
Chief Technology Officer
    
    
    2004
20032002
    
    
    530,000
501,667458,545
    
    
    
528,675(6)
1,291,000(8)(9)

    
    
    

    
    
    
250,000
    
    
    
90,000(7)
745,000(10)

    
    
    38,601(12)(13)
65,430(12)(13)16,503(12)(13)S.L. Spradley**
President, Global
Operations
    
    
    2004
2003
2002
    
    
    530,000
496,667
354,275
    
    
    
609,325(6)
1,285,000(8)(9)

    
    
    


    
    
    

291,999(15)
    
    
    
575,000(10)

    
    
    6,500(14)
6,000(14)
5,500(14)N.J. DeRoma
Chief Legal Officer
    
    
    2004
2003
2002
    
    
    526,000
526,000
526,000
    
    
    
524,685(6)
1,315,000(8)(9)

    
    
    

24,038(13)(16)
    
    
    

250,000
    
    
    
135,000(7)
535,000(10)

    
    
    31,960(12)(13)
54,494(12)(13)
17,885(12)(13)F.A. Dunn*
Former President and
Chief Executive Officer
    
    
    2004
2003
2002
    
    
    417,043(17)
868,750
825,000
    
    
    
 (18)
3,540,000(8)(19)

    
    
    


    
    
    

750,000(20)
    
    
    
225,000(7)
745,000(10)(19)

    
    
    9,138(12)(13)
26,145(12)(13)
24,747(12)(13)
  *
    
    On April 27, 2004, Mr. Dunns employment as President and Chief Executive Officer of the
Company and Nortel Networks Corporation was terminated for cause and Mr. Owens was appointed
President and Chief Executive Officer of the Company and Nortel Networks Corporation.
Effective March 14, 2005, Mr. Owens became Vice-Chairman and Chief Executive Officer of the
Company and Nortel Networks Corporation. The compensation for Mr. Owens is described below
under Certain Employment Arrangements.**
    
    Prior to the change in positions effective October 1, 2004 in accordance with the corporate
reorganization announced by Nortel Networks Corporation on August 19, 2004, Messrs. Debon and
McFadden and Ms. Spradley held, respectively, the positions of: President, Wireless Networks;
President, Optical Networks; and President, Wireline Networks. Effective October 1, 2004, Mr.
McFadden was appointed Chief Technology Officer, a position he held until his appointment,
effective April 4, 2005, to the position of Chief Research Officer of the Company and Nortel
Networks Corporation.(1)
    
    Incentive cash awards for each fiscal year under the Nortel Networks Limited SUCCESS
Incentive Plan (or SUCCESS Plan), including payments made in connection with the Return to
Profitability bonus program component of that plan, in respect of each of the fiscal years,
whether or not deferred by the named executive officer. On April 27, 2004, the Company and
Nortel Networks Corporation terminated for cause the employment of each of its then president
and chief executive officer, chief financial officer and controller. On August 19, 2004,
Nortel Networks Corporation announced that seven individuals with, or who had, significant
responsibilities for financial reporting at the line of business and regional levels were
terminated for cause. Nortel has demanded from these individuals repayment of all payments
made under bonus plans in respect of 2003, including any awards under the SUCCESS Plan. In
the case of the former president and chief executive officer, chief financial officer and
controller who each had their employment terminated for cause, the Company and Nortel Networks
Corporation have commenced legal proceedings for the recovery of such bonus payments. See
footnotes (8) and (19) below. 148




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##### Table of Contents



(2)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan ($1,038),
expatriate expenses related to Mr. Owens responsibilities as President and Chief Executive
Officer of the Company and Nortel Networks Corporation ($43,588) and fees earned as a
non-employee director prior to being appointed as President and Chief Executive Officer of the
Company and Nortel Networks Corporation ($25,672). See Compensation of Directors.(3)
    
    A tax reimbursement payment in connection with certain permanent transfer expenses.(4)
    
    Certain payments paid in euros have been converted to United States dollars and included in
this amount. Payments have been converted using the average of the exchange rates in effect
during each year equal to US$1.00 = .8027 euros for 2004, US$1.00 = .8830 euros for 2003 and
US$1.00 = 1.0615 euros for 2002.(5)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan or Nortel
Networks (UK) Pension Plan, as applicable ($3,268 in 2004, $7,200 in 2003 and $8,467 in 2002),
and expatriate, permanent transfer and other similar expenses related to Mr. Debons global
responsibilities as President, Wireless Networks ($82,309 in 2004, $85,146 in 2003 and
$117,408 in 2002).(6)
    
    Represents a SUCCESS Plan annual incentive award. Nortel has demanded that the individuals
described in footnote (1) whose employment was terminated for cause repay all payments made
under bonus plans in respect of 2003, including SUCCESS Plan annual incentive awards, and has
commenced legal proceedings against certain of those individuals for the recovery of such
bonus payments.(7)
    
    Represents the number of restricted stock units issued and settled in respect of restricted
stock units allocated under the 2001 restricted stock unit program, or 2001 RSU program, of
the Nortel Networks Limited Restricted Stock Unit Plan (or RSU Plan). Restricted stock units
allocated in 2001 had a two year performance period that was divided into five shorter
performance segments. The performance criteria included resizing activity targets for the
first segment, and corporate performance objectives under the incentive plan for the remaining
four segments. Although the joint leadership resources committee determined that certain of
the distinct performance objectives were not achieved, it exercised its discretion in May 2003
to authorize the issuance and settlement in the form of common shares of Nortel Networks
Corporation (net of withholding taxes) of 90 percent of the restricted stock units allocated
under the 2001 RSU program based on its consideration of the improved financial performance of
Nortel Networks Corporation during the two-year performance period and Nortel Networks
Corporations overall performance over that period as compared to comparator companies.
The total before tax value of the restricted stock units that were issued and settled, using
the purchase price of our common shares of Nortel Networks Corporation on the date of
purchase, was: Cdn$945,293 ($672,902) for Mr. Dunn; $274,050 for Mr. Debon; Cdn$378,117
($269,161) for Mr. McFadden, and Cdn$567,176 ($403,741) for Mr. DeRoma. Amounts have been
converted using the exchange rates listed in footnote (13) below.(8)
    
    Represents a Return to Profitability program award under the SUCCESS Plan. Nortel has
demanded that the individuals described in footnote (1) whose employment was terminated for
cause repay all payments made under bonus plans in respect of 2003, including any Return to
Profitability program awards. In the case of the former president and chief executive
officer, chief financial officer and controller who each had their employment terminated for
cause, the Company and Nortel Networks Corporation have commenced legal proceedings for the
recovery of such bonus payments. See footnotes (1), (9) and (19).(9)
    
    Mr. Debon, Mr. McFadden, Ms. Spradley and Mr. DeRoma have voluntarily undertaken to pay to
Nortel Networks Corporation over a three year period an amount equal to their Return to
Profitability program bonus awarded in 2003 (net of any taxes deducted at source). The
following additional current members of senior management have similarly voluntarily
undertaken to pay an amount equal to their respective Return to Profitability program bonus
awards (net of any taxes deducted at source): Messrs. Bolouri, Collins, Donovan, Giamatteo,
Joannou, Mao, Mumford and Pusey. See Voluntary Undertaking: Return to Profitability Bonus
Program and 2003 Restricted Stock Unit Program.(10)
    
    Represents the number of restricted stock units issued and settled in respect of restricted
stock units allocated under the 2003 restricted stock unit program, or 2003 RSU program, of
the RSU Plan. Each unit entitled the holder to receive one common share of Nortel Networks
Corporation or, subject to certain conditions, a cash payment equal to the common share value.
In respect of payments made under the 2003 program of the RSU Plan, each named executive
officer, other than Mr. Dunn, received in July 2003 restricted stock units in connection with
the achievement of the first performance threshold as at the end of the second fiscal quarter
of 2003 (100% in the form of common shares) and in February 2004 restricted stock units in
connection with the achievement of the second
performance threshold as at the end of the third fiscal quarter of 2003 (50% in the form of
common shares and 50% in the form of cash). These individuals continue to hold the common
 shares received as a result of the settlement of their restricted stock units. Mr. Dunn
received in July 2003 restricted stock units in connection with the achievement of the first
performance threshold (100% in the form of common shares) but did not receive restricted
stock units in connection with the achievement of the second performance threshold. The
before tax total value of restricted stock units issued and settled was: Cdn$2,983,204
($2,123,579) for Mr. Dunn; $3,783,743 for Mr. Debon; $2,920,339 for Ms. Spradley;
Cdn$5,085,873 ($3,620,354) for Mr. McFadden; and Cdn$3,652,271 ($2,599,851) for Mr. DeRoma.
Restricted stock units are valued using the purchase price of common shares of Nortel
Networks Corporation on the date of purchase (for share settlement) and on the average price
for the specified 20 day trading period for cash settlement (where applicable). Amounts
have been converted using the exchange rates listed in footnote (13) below. See Long Term
Incentive Plans  Awards in Last Two Fiscal Years for a description of the applicable
performance criteria. See footnote (19) below. 149




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##### Table of Contents



(11)
    
    Certain payments paid in United Kingdom pounds have been converted to United States dollars
and included in this amount. Payments have been converted using the average of the exchange
rates in effect equal to US$1.00 = UK£0.6661 for 2002.(12)
    
    Represents contributions made under the Nortel Networks Limited Investment Plan for Employees
  Canada.(13)
    
    Represents the United States dollar equivalent of payments actually earned or paid in
Canadian dollars. Amounts have been converted using the average of the exchange rates in
effect during each year equal to US$1.00 = Cdn$1.2978 for 2004, US$1.00 = Cdn$1.4048 for 2003
and US$1.00 = Cdn$1.5708 for 2002.(14)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan.(15)
    
    In June 2001, Nortel Networks Corporation commenced a voluntary stock option exchange program
whereby eligible employees could exchange certain then outstanding stock options for new
options based on a prescribed formula. In January 2002, new stock options were granted to
eligible employees who participated in the stock option exchange program, with exercise prices
at the fair market value of Nortel Networks Corporations common shares on the date of grant.
Prior to Ms. Spradleys appointment as an officer of the Company, she was an employee eligible
to participate in the voluntary stock option exchange program. As a result, 41,999 of the
stock options granted to Ms. Spradley in 2002 were granted pursuant to the voluntary stock
option exchange program.(16)
    
    Amounts paid to reimburse Mr. DeRoma for income taxes payable by him in accordance with his
employment agreement. Mr. DeRomas employment agreement is described below under Certain
Employment Arrangements.(17)
    
    Includes Cdn$151,898 base salary for accrued vacation paid as required in accordance with
corporate policy and applicable law as a result of the termination of employment for cause.(18)
    
    Mr. Dunn did not receive any annual incentive bonus under the SUCCESS Plan with respect to
2003. See footnotes (1), (8) and (19).(19)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, the
Company and Nortel Networks Corporation demanded repayment of the Return to Profitability
program bonus award under the SUCCESS Plan of $3,540,000 and the 745,000 restricted stock
units issued and settled in respect of restricted stock units allocated under the 2003 program
of the RSU Plan. Since the initial demand, the Company and Nortel Networks Corporation have
commenced legal proceedings for the recovery of all bonus payments and an amount equal to the
value of the restricted stock units issued and settled under the 2003 RSU program. See
footnotes (8) and (10).(20)
    
    These options, along with all other options held by Mr. Dunn, terminated and expired
automatically upon the termination of Mr. Dunns employment for cause on April 27, 2004. 150




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2003 Long Term
        CompensationAnnual Compensation
    Awards
    PayoutsNameAnd PrincipalPosition
    Year
    Salary($)
    Bonus($)(1)
    Other AnnualCompensation($)
    SecuritiesUnderlyingOptions(#)
    LTIPPayouts(#)
    All OtherCompensation($)F.A. Dunn*
    
    2003
    
    
    868,750
    
    
     (2)
    
    
    
    
    
    
    
    
    225,000(3)
    
    
    26,145(4)(5)President and Chief
    
    
    
    
    
    
    
    3,540,000(6)(7)
    
    
    
    
    
    
    
    
    745,000(7)(8)Executive Officer
    
    2002
    
    
    825,000
    
    
    
    
    
    
    
    
    750,000(9)
    
    
    
    
    
    24,747(4)(5)2001
    
    
    564,833
    
    
    
    
    
    
    
    
    1,500,000(9)(10)
    
    
    
    
    
    16,806(4)(5)P. Debon**
    
    2003
    
    
    590,000
    
    
    743,400(11)
    
    
    
    
    
    
    
    
    90,000(3)
    
    
    92,346(12)(13)President, Wireless
    
    
    
    
    
    
    
    1,475,000(6)(14)
    
    
    
    
    
    
    
    
    745,000(8)Networks
    
    2002
    
    
    537,143
    
    
    
    
    
    
    
    
    250,000
    
    
    
    
    
    125,875(12)(13)(15)2001
    
    
    440,417
    
    
    
    
    
    68,713(15)(16)
    
    
    650,000
    
    
    
    
    
    332,020(13)(15)S.L. Spradley**
    
    2003
    
    
    496,667
    
    
    609,325(11)
    
    
    
    
    
    
    
    
    575,000(8)
    
    
    6,000(17)President, Wireline
    
    
    
    
    
    
    
    1,285,000(6)(14)Networks
    
    2002
    
    
    354,275
    
    
    
    
    
    
    
    
    291,999(18)
    
    
    
    
    
    5,500(17)2001
    
    
    269,026
    
    
    
    
    
    
    
    
     (19)
    
    
    
    
    
    5,100(17)C. Bolouri**
    
    2003
    
    
    510,000
    
    
    589,050(11)
    
    
    
    
    
    
    
    
    135,000(3)
    
    
    63,404(4)(5)President, Global
    
    
    
    
    
    
    
    1,275,000(6)(14)
    
    
    
    
    
    
    
    
    535,000(8)Operations
    
    2002
    
    
    510,000
    
    
    
    
    
    
    
    
    250,000
    
    
    
    
    
    18,358(4)(5)2001
    
    
    459,000
    
    
    
    
    
    
    
    
    700,000
    
    
    
    
    
    27,440(4)(5)N.J. DeRoma
    
    2003
    
    
    526,000
    
    
    524,685(11)
    
    
    
    
    
    
    
    
    135,000(3)
    
    
    54,494(4)(5)Chief Legal Officer
    
    
    
    
    
    
    
    1,315,000(6)(14)
    
    
    
    
    
    
    
    
    535,000(8)2002
    
    
    526,000
    
    
    
    
    
    24,038(5)(20)
    
    
    250,000
    
    
    
    
    
    17,885(4)(5)2001
    
    
    493,750
    
    
    
    
    
    62,921(5)(20)
    
    
    650,000
    
    
    
    
    
    27,642(4)(5)
  *
    
    On April 27, 2004, Mr. Dunns employment as President and Chief Executive Officer of the
Company and Nortel Networks Corporation was terminated for cause and Mr. W.A. Owens was
appointed President and Chief Executive Officer of the Company and Nortel Networks
Corporation. Effective March 14, 2005, Mr. Owens became Vice-Chairman and Chief Executive
Officer of the Company and Nortel Networks Corporation. The compensation for Mr. Owens is
described below under Certain Employment Arrangements.**
    
    In accordance with the corporate reorganization announced by Nortel Networks Corporation on
August 19, 2004, effective October 1, 2004, Messrs. Debon and Bolouri and Ms. Spradley were,
respectively, appointed to the positions of: President, Carrier Networks; President, Global
Services; and President, Global Operations.(1)
    
    Incentive cash awards for each fiscal year under the Nortel Networks Limited SUCCESS
Incentive Plan (or SUCCESS Plan), including payments made in connection with the Return to
Profitability bonus program component of that plan, in respect of each of the fiscal years,
whether or not deferred by the named executive officer. On April 27, 2004, the Company and
Nortel Networks Corporation terminated for cause the employment of each of their then
president and chief executive officer, chief financial officer and controller. On August 19,
2004, Nortel Networks Corporation announced that seven individuals with, or who had,
significant responsibilities for financial reporting at the line of business and regional
levels were terminated for cause. Nortel has demanded from these individuals repayment of all
payments made under bonus plans in respect of 2003, including any awards under the SUCCESS
Plan. In the case of the former president and chief executive officer, chief financial
officer and controller who each had their employment terminated for cause, the Company and
Nortel Networks Corporation have commenced legal proceedings for the recovery of such bonus
payments. See footnotes (6) and (7) below.(2)
    
    Mr. Dunn did not receive any annual incentive bonus under the SUCCESS Plan with respect to
2003. See footnotes (1), (6) and (7).(3)
    
    Represents the number of restricted stock units issued and settled in respect of restricted
stock units allocated under the 2001 restricted stock unit program, or 2001 RSU program, of
the Nortel Networks Limited Restricted Stock Unit Plan (or RSU Plan). Restricted stock units
allocated in 2001 had a two year performance period that was divided into five shorter
performance segments. The performance criteria included resizing activity targets for the
first
segment, and corporate performance objectives under the incentive plan for the remaining
four segments. Although the joint leadership resources committee determined that certain of
the distinct performance objectives were not achieved, it exercised its discretion in May
2003 to authorize the issuance and settlement in the form of common shares of Nortel
Networks Corporation (net of withholding taxes) of 90 percent of the restricted stock units
allocated under the 2001 RSU program based on its consideration of the improved financial
performance of Nortel Networks Corporation during the two-year performance period and Nortel
Networks Corporations overall performance over that period as compared to comparator
companies. The total before tax value of the restricted stock units that were issued and
settled, using the purchase price of common shares of Nortel Networks Corporation on the
date of purchase, was: Cdn$945,293 ($672,902) for Mr. Dunn; $274,050 for Mr. Debon;
Cdn$567,176 ($403,741) for Mr. Bolouri; and Cdn$567,176 ($403,741) for Mr. DeRoma. Amounts
have been converted using the exchange rates listed in footnote (5) below. 151




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(4)
    
    Represents contributions made under the Nortel Networks Limited Investment Plan for Employees
  Canada.(5)
    
    Represents the United States dollar equivalent of payments actually earned or paid in
Canadian dollars. Amounts have been converted using the average of the exchange rates in
effect during each year equal to US$1.00 = Cdn$1.4048 for 2003, US$1.00 = Cdn$1.5708 for 2002
and US$1.00 = Cdn$1.5489 for 2001.(6)
    
    Represents a Return to Profitability program award under the SUCCESS Plan. Nortel has
demanded that the individuals described in footnote (1) whose employment was terminated for
cause repay all payments made under bonus plans in respect of 2003, including any Return to
Profitability program awards. In the case of the former president and chief executive
officer, chief financial officer and controller who each had their employment terminated for
cause, the Company and Nortel Networks Corporation have commenced legal proceedings for the
recovery of such bonus payments. See footnotes (1), (7) and (14).(7)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, the
Company and Nortel Networks Corporation demanded repayment of the Return to Profitability
program bonus award under the SUCCESS Plan of $3,540,000 and the 745,000 restricted stock
units issued and settled in respect of restricted stock units allocated under the 2003 program
of the RSU Plan. Since the initial demand, the Company and Nortel Networks Corporation have
commenced legal proceedings for the recovery of all bonus payments and an amount equal to the
value of the issued and settled RSU Plan 2003 program restricted stock units. See footnotes
(6) and (8).(8)
    
    Represents the number of restricted stock units issued and settled in respect of restricted
stock units allocated under the 2003 restricted stock unit program, or 2003 RSU program, of
the RSU Plan. Each unit entitled the holder to receive one common share of Nortel Networks
Corporation or, subject to certain conditions, a cash payment equal to the common share value.
In respect of payments made under the 2003 RSU program of the RSU Plan, each named executive
officer, other than Mr. Dunn, received in July 2003 restricted stock units in connection with
the achievement of the first performance threshold as at the end of the second fiscal quarter
of 2003 (100% in the form of common shares) and in February 2004 restricted stock units in
connection with the achievement of the second performance threshold as at the end of the third
fiscal quarter of 2003 (50% in the form of common shares and 50% in the form of cash). These
individuals continue to hold the common shares received as a result of the settlement of their
restricted stock units. Mr. Dunn received in July 2003 restricted stock units in connection
with the achievement of the first performance threshold (100% in the form of common shares)
but did not receive restricted stock units in connection with the achievement of the second
performance threshold. The before tax total value of restricted stock units issued and
settled was: Cdn$2,983,204 ($2,123,579) for Mr. Dunn; $3,783,743 for Mr. Debon; $2,920,339
for Ms. Spradley; Cdn$3,652,271 ($2,599,851) for Mr. Bolouri; and Cdn$3,652,271 ($2,599,851)
for Mr. DeRoma. Restricted stock units are valued using the purchase price of common shares
of Nortel Networks Corporation on the date of purchase (for share settlement) and on the
average price for the specified 20 day trading period for cash settlement (where applicable).
Amounts have been converted using the exchange rates listed in footnote (5) above. See Long
Term Incentive Plans  Awards in Last Two Fiscal Years for a description of the
applicable performance criteria. See footnote (7) above.(9)
    
    These options terminated and expired automatically upon the termination of Mr. Dunns
employment for cause on April 27, 2004.(10)
    
    This amount has been reduced from the previously reported amount to reflect Mr. Dunns
voluntary return for immediate cancellation in June 2003 of 250,000 stock options that were
originally granted in 2001.(11)
    
    Represents a SUCCESS Plan annual incentive award. Nortel has demanded that the individuals
described in footnote (1) whose employment was terminated for cause repay all payments made
under bonus plans in respect of
2003, including any SUCCESS Plan annual incentive awards, and has commenced legal
proceedings against certain of those individuals for the recovery of such bonus payments. 152




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(12)
    
    Certain payments paid in euros have been converted and included in this amount. Payments
have been converted using the average of the exchange rates in effect during each year equal
to US$1.00 = .8830 euros for 2003 and US$1.00 = 1.0615 euros for 2002.(13)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan or Nortel
Networks (UK) Pension Plan, as applicable ($7,200 in 2003, $8,467 in 2002 and $6,068 in 2001),
and expatriate, permanent transfer and other similar expenses related to Mr. Debons global
responsibilities as President, Wireless Networks ($85,146 in 2003, $117,408 in 2002 and
$325,952 in 2001).(14)
    
    Mr. Debon, Mr. Bolouri, Ms. Spradley and Mr. DeRoma have voluntarily undertaken to pay to
Nortel Networks Corporation over a three year period an amount equal to their Return to
Profitability program bonus awarded in 2003 (net of taxes deducted at the source). The
following additional current members of senior management have similarly voluntarily
undertaken to pay an amount equal to their respective Return to Profitability program bonus
awards (net of any taxes deducted at source): Messrs. Collins, Donovan, Giamatteo, Joannou,
Mao, McFadden, Mumford and Pusey. See Voluntary Undertaking: Return to Profitability Bonus
Program and 2003 Restricted Stock Unit Program.(15)
    
    Certain payments paid in United Kingdom pounds have been converted and included in this
amount. Payments have been converted using the average of the exchange rates in effect during
each year equal to US$1.00 = UK£0.6661 for 2002 and US$1.00 = UK£0.6909 for 2001.(16)
    
    Mr. Debons responsibilities during 2001 as President, Wireless Networks were global in
nature and his offices and personal residences spanned several geographies. As a result,
transportation services and benefits (automobile benefits, commercial air travel, train and
car services) for Mr. Debon totaled $48,010 in 2001.(17)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan.(18)
    
    In June 2001, Nortel Networks Corporation commenced a voluntary stock option exchange program
whereby eligible employees could exchange certain then outstanding stock options for new
options based on a prescribed formula. In January 2002, new stock options were granted to
eligible employees who participated in the stock option exchange program, with exercise prices
at the fair market value of Nortel Networks Corporations common shares on the date of grant.
Prior to Ms. Spradleys appointment as an officer of the Company, she was an employee eligible
to participate in the voluntary stock option exchange program. As a result, 41,999 of the
stock options granted to Ms. Spradley in 2002 were granted pursuant to the voluntary stock
option exchange program.(19)
    
    All of Ms. Spradleys options that were granted in 2001 were cancelled in connection with her
participation in the voluntary stock option exchange program. See footnote (18) above.(20)
    
    Amounts paid to reimburse Mr. DeRoma for income taxes payable by him in accordance with his
employment agreement. Mr. DeRomas employment agreement is described below under Certain
Employment Arrangements. 
 Annual cash incentive awards Annual cash bonus awards under the SUCCESS Plan are based on achieving corporate and
individual performance objectives for a calendar year. The joint leadership resources committee
retains full discretion in determining whether, and the extent to which, corporate performance
objectives have been met and whether, and to what extent, an annual award under the SUCCESS Plan
will be made. An annual award is determined as a percentage of annual base salary by reference to
individual job scope, complexity, and responsibilities, and by individual performance and
contribution, as well as corporate performance. The joint leadership resources committee recommended the corporate performance objectives for
2004, which were approved by the boards of directors of the Company and Nortel Networks Corporation
in February 2004. The corporate performance objectives for 2004 were based on revenue, earnings,
cash flow and leadership criteria (including customer engagement, technology leadership and market
perception). The joint leadership resources committee also have discretion to consider other
business factors in making a final determination of corporate performance for 2004. In June 2004,
management recommended, and the joint leadership resources committee and the boards of directors of
the Company and
Nortel Networks Corporation subsequently approved, the addition of financial accountability as a key
quantitative factor in the individual leadership performance objectives for determination of
incentive cash awards under the SUCCESS Plan. Financial accountability as a performance objective
under the SUCCESS Plan includes, among other things: (i) compliance with financial reporting
obligations under United States and Canadian securities laws and the requirements of the
Sarbanes-Oxley Act of 2002; (ii) an assessment of training with respect to financial reporting
responsibilities and understanding of generally accepted accounting principles across Nortel; and
(iii) progress on the implementation of process and system improvements related to accounting and
management information systems across Nortel. Based on performance as compared to the corporate
performance objectives for 2004 and, after considering other relevant business factors, the
committee determined that no short term cash incentive awards would be paid in respect of 2004. 153




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Voluntary undertaking: Return to Profitability bonus program and 2003 restricted stock unit
program In a letter dated January 10, 2005 to Lynton (Red) Wilson, the Chairman of the board of
directors of the Company and Nortel Networks Corporation, the members of the core executive
leadership team of Nortel affirmed their voluntary, unilateral and unconditional undertaking to (i)
pay to Nortel Networks Corporation over a three year period an amount equal to the entire Return to
Profitability (RTP) bonus paid to each such member in 2003 (net of any taxes deducted at source)
regardless of whether the profitability metrics associated with the RTP were met on a restated
basis and (ii) not accept, and accordingly disclaim, any potential award of either the third or
fourth tranches of 2003 restricted stock units (regardless whether applicable financial targets for
these bonuses were achieved). The members indicated in their letter that, while they had not
engaged in the improper accounting activities that had been identified by the audit committee of
Nortel Networks Corporations board of directors, they shared the board of directors deep
disappointment in these actions and events and are determined to make clear to Nortel employees,
investors and others that such activities are unacceptable to them. The following table sets forth the amount of the RTP bonus to be paid by each member: Member
    
    RTP Amount (Net)Chahram Bolouri
    
    Cdn. $891,697Malcolm Kevin Collins
    
    GBP £395,409Pascal Debon
    
    U.S. $1,078,963Nicholas John DeRoma
    
    Cdn. $953,747William John Donovan
    
    U.S. $640,271John Joseph Giamatteo
    
    U.S. $259,875Dion Constandino Joannou
    
    U.S. $328,412Robert Yu Lang Mao
    
    U.S. $627,500Brian William McFadden
    
    Cdn. $899,630Donald Gregory Mumford
    
    Cdn. $921,500Stephen Charles Pusey
    
    GBP £473,173Susan Louise Spradley
    
    U.S. $967,694
 
 Option grants in 2004 and 2003 No options were granted to any of the named executive officers for 2004 during the fiscal
year ended December 31, 2004 and no options were granted to any of the named executive officers for
2003 during the fiscal year ended December 31, 2003. 154




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Aggregate option exercises in 2004 and 2003 and year-end option values No options to purchase common shares of Nortel Networks Corporation were exercised by any
named executive officer for 2004 during the fiscal year ended December 31, 2004 and no options to
purchase common shares of Nortel Networks Corporation were exercised by any named executive
officers for 2003 during the fiscal year ended December 31, 2003. The following tables set forth:
(i) the value of unexercised options to purchase common shares of Nortel Networks Corporation held
by named executive officers for 2004 as at December 31, 2004; and (ii) the value of unexercised
options to purchase common shares of Nortel Networks Corporation held by named executive officers
for 2003 as at December 31, 2003, respectively. 2004 CommonShares
AcquiredOn Exercise(#)
    
    
    
    
    
    Number of Securities
       Underlying
       Unexercised Options at Fiscal
       Year-End (#)(1)(2)(3)(4)
    
    
    Value of Unexercised
       In-the-Money
       Options at Fiscal Year-End ($)(4)ValueRealized ($)Name
    
    
    
    
    Exercisable
    
    
    
    Unexercisable
    
    
    
    Exercisable
    
    
    
    UnexercisableW.A. Owens
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    P. Debon
    
    
    
    
    
    
    
    
    
    
    1,358,666(5)
    
    
    
    243,334
    
    
    
    
    
    
    
    B.W. McFadden
    
    
    
    
    
    
    
    
    
    
    1,133,666(Cdn)(5)
    
    
    
    163,334(Cdn)
    
    
    
    
    
    
    
    S.L. Spradley
    
    
    
    
    
    
    
    
    
    
    238,665(6)
    
    
    
    83,334
    
    
    
    
    
    
    
    N.J. DeRoma
    
    
    
    
    
    
    
    
    
    
    1,290,000(Cdn)(5)80,000
    
    
    243,334(Cdn)
    
    
    
    
    
    
    
    F.A. Dunn*
    
    
    
    
    
    
    
    
    
    
     (7)
    
    
    
     (Cdn)(7) (7)
    
    
    
    
    
    
    
    
  *
    
    On April 27, 2004, Mr. Dunns employment as President and Chief Executive Officer of the
Company and Nortel Networks Corporation was terminated for cause.(1)
    
    As adjusted to reflect the two-for-one stock split of the Companys common shares effective
at the close of business on January 7, 1998, the stock dividend of one common share on each
issued and outstanding common share of the Company effective at the close of business on
August 17, 1999, and the two-for-one stock split of Nortel Networks Corporations common
 shares effective at the close of business on May 5, 2000, where applicable.(2)
    
    Includes the following number of replacement options: 160,000 for Mr. Debon; 80,000 for
Mr. McFadden (which will expire in January 2009 and which are unavailable for exercise
pursuant to the terms of the replacement option program); and 160,000 for Mr. DeRoma. Mr.
Dunn had also received 120,000 replacement options, which he subsequently voluntarily returned
for immediate cancellation in June 2003. See also footnote (7) below. Replacement options
are granted pursuant to the key contributor stock option program. Under that program, a
participant is granted concurrently an equal number of initial options and replacement
options. The initial options and the replacement options expire ten years from the date of
grant. The initial options have an exercise price equal to the market value of common shares
of Nortel Networks Corporation on the date of grant and the replacement options have an
exercise price equal to the market value of common shares of Nortel Networks Corporation on
the date all of the initial options are fully exercised, provided that in no event will the
exercise price be less than the exercise price of the initial options. Replacement options
are generally exercisable commencing 36 months after the date all of the initial options are
fully exercised, provided that the participant beneficially owns a number of common shares of
Nortel Networks Corporation at least equal to the number of common shares subject to the
initial options less any common shares sold to pay for option costs, applicable taxes, and
brokerage costs associated with the exercise of the initial options.(3)
    
    As Nortel Networks Corporation grants both United States dollar and Canadian dollar stock
options, the options are listed separately for each currency, where applicable. Unless
otherwise stated, all options are United States dollar options.(4)
    
    As at December 31, 2004, none of the outstanding exercisable or unexercisable United States
dollar or Canadian dollar stock options held by the named executive officers had an exercise
price that exceeded the closing price of Nortel Networks Corporations common shares on the
last trading day of the year on, respectively, the New York Stock Exchange for United States
stock options and on the Toronto Stock Exchange for Canadian stock
options. On December 31, 2004, the closing  price of 155




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Nortel Networks Corporations common shares on the
New York Stock Exchange and the Toronto Stock Exchange was $3.47 and Cdn$4.16, respectively.
The weighted average exercise price of the outstanding exercisable and unexercisable United
States dollar and Canadian dollar stock options as at December 31, 2004 was: $14.51 for
options held by Mr. Debon; $6.30 for options held by Ms. Spradley; Cdn$24.32 for options
held by Mr. McFadden; and Cdn$25.18 for Mr. DeRomas Canadian dollar stock options and
$11.29 for his United States dollar stock options. Where applicable, the weighted average
exercise price has been calculated assuming that replacement options that currently do not
have set exercise prices will have exercise prices equal to the exercise prices of the
corresponding initial options. See footnote (2) above.(5)
    
    The remaining two thirds of the performance accelerated stock options previously granted to
Messrs. Debon, McFadden and DeRoma vested and became exercisable in January 2004, the other
one third having vested and became exercisable in December 2003.(6)
    
    Prior to Ms. Spradleys appointment as an officer of the Company and Nortel Networks
Corporation, she was an employee eligible to participate in the voluntary stock option
exchange program. As a result, 41,999 of the stock options granted to Ms. Spradley in 2002
were granted pursuant to the voluntary stock option exchange program. All of those options
were exercisable as of December 31, 2004.(7)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, all
United States dollar and Canadian dollar options held by Mr. Dunn terminated and expired
automatically on April 27, 2004, including all performance accelerated stock options. 2003 Number of Securities
        Underlying
        Unexercised Options at Fiscal
        Year-End (#)(1)(2)(3)(4)Common
        Shares Acquired
        On Exercise
        (#)
    
    
    
    
    
    
    
    Value of Unexercised
        In-the-Money
        Options at Fiscal Year-End ($)(4)Value
        Realized ($)Name
    
    
    
    Exercisable
    
    Unexercisable
    
    Exercisable
    
    UnexercisableF.A. Dunn
    
    
    
    
    
    
    
    
    
    
    750,000(Cdn)
    (5)(6)
    
    
    1,500,000(Cdn)(5) (7)
    
    
    
    
    
    
    
    P. Debon
    
    
    
    
    
    
    
    
    
    
    891,999
    (6)
    
    
    710,001
    
    
    
    
    
    
    
    S.L. Spradley
    
    
    
    
    
    
    
    
    
    
    148,665
    (8)
    
    
    173,334(8)
    
    
    
    
    
    
    
    C. Bolouri
    
    
    
    
    
    
    
    
    
    
    931,332(Cdn)
    (6)
    
    
    686,668(Cdn)
    
    
    
    
    
    
    
    N.J. DeRoma
    
    
    
    
    
    
    
    
    
    
    663,333(Cdn)80,000
    (6)
    
    
    870,001(Cdn)
    
    
    
    
    
    
    
    
  (1)
    
    As adjusted to reflect the two-for-one stock split of the Companys common shares
effective at the close of business on January 7, 1998, the stock dividend of one common share
on each issued and outstanding common share of the Company effective at the close of business
on August 17, 1999, and the two-for-one stock split of Nortel Networks Corporations common
 shares effective at the close of business on May 5, 2000, where applicable.(2)
    
    Includes the following number of previously granted replacement options: 160,000 for Mr.
Debon; 120,000 for Mr. Bolouri; and 160,000 for Mr. DeRoma. Mr. Dunn had also been granted
120,000 replacement options, which he subsequently voluntarily returned for immediate
cancellation in June 2003. See also footnotes (5) and (7) below. Replacement options are
granted pursuant to Nortel Networks Corporations key contributor stock option program. Under
that program, a participant is granted concurrently an equal number of initial options and
replacement options. The initial options and the replacement options expire ten years from
the date of grant. The initial options have an exercise price equal to the market value of
common shares of Nortel Networks Corporation on the date of grant and the replacement options
have an exercise price equal to the market value of common shares of Nortel Networks
Corporation on the date all of the initial options are fully exercised, provided that in no
event will the exercise price be less than the exercise price of the initial options.
Replacement options are generally exercisable commencing 36 months after the date all of the
initial options are fully exercised, provided that the participant beneficially owns a number
of common shares of Nortel Networks Corporation at least equal to the number of common shares
subject to the initial options less any common shares sold to pay for options costs,
applicable taxes, and brokerage costs associated with the exercise of the initial options. 156




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(3)
    
    As Nortel Networks Corporation grants both United States dollar and Canadian dollar stock
options, the options are listed separately for each currency, where applicable. Unless
otherwise stated, all options are United States dollar options.(4)
    
    As at December 31, 2003, all of the outstanding exercisable or unexercisable United States
dollar or Canadian dollar stock options held by the named executive officers had an exercise
price that exceeded the closing price of Nortel Networks Corporations common shares on the
last trading day of the year on, respectively, the New York Stock Exchange for United States
stock options and on the Toronto Stock Exchange for Canadian stock options. On December 31,
2003, the closing price of Nortel Networks Corporations common shares on the New York Stock
Exchange and the Toronto Stock Exchange was $4.23 and Cdn$5.49, respectively. The weighted
average exercise price of the outstanding exercisable and unexercisable United States dollar
and Canadian dollar stock options as at December 31, 2003 was: Cdn$8.95 for options held by
Mr. Dunn; $14.51 for options held by Mr. Debon; $6.30 for options held by Ms. Spradley;
Cdn$37.06 for options held by Mr. Bolouri; and Cdn$25.18 for Mr. DeRomas Canadian dollar
stock options and $11.29 for his United States dollar stock options. Where applicable, the
weighted average exercise price has been calculated assuming that replacement options that
currently do not have set exercise prices will have exercise prices equal to the exercise
prices of the corresponding initial options. See footnote (2) above.(5)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, all
options held by Mr. Dunn terminated and expired automatically on April 27, 2004, including all
performance accelerated stock options. Previously, in June 2003, Mr. Dunn voluntarily
returned for immediate cancellation 934,668 previously granted Canadian dollar stock options,
comprised of 851,334 exercisable plus 83,334 unexercisable options as well as 120,000
exercisable replacement options referenced in footnote (2) above. See also footnote (7)
below.(6)
    
    One third of the performance accelerated stock options previously granted to Messrs. Dunn,
Debon, Bolouri and DeRoma in 2001 vested and became exercisable in December 2003. Other than
Mr. Dunn, who did not have any additional performance accelerated stock options accelerated,
the remaining two thirds of the performance accelerated stock options held by Messrs. Debon,
Bolouri and DeRoma vested and became exercisable in January 2004. See footnote (5).(7)
    
    In June 2003, Mr. Dunn voluntarily turned in for immediate cancellation 200,000 unexercisable
United States dollar stock options originally granted in July 1999.(8)
    
    Prior to Ms. Spradleys appointment as an officer of the Company and Nortel Networks
Corporation, she was an employee eligible to participate in the voluntary stock option
exchange program. As a result, 41,999 of the stock options granted to Ms. Spradley in 2002
were granted pursuant to the voluntary stock option exchange program. Of those options,
35,332 were exercisable as of December 31, 2003. 
 Long-term incentive plans  awards in last two fiscal years No long-term incentives were granted under any long-term incentive plan to any of the
named executive officers for 2004 during the fiscal year ended December 31, 2004. 157




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The following table sets forth certain information concerning the allocation of restricted
stock units to the named executive officers for 2003 under the Nortel Networks Limited Restricted
Stock Unit Plan (or RSU Plan) during the fiscal year ended December 31, 2003. Performance or Other
        Period Until
        Maturation or Payout
        (2)
    
    Estimated Future Payouts Under Non-Share
        Price Based PlansNumber of Shares,
        Units or Other Rights
        (#)(1)(2)Name
    
    
    
    Threshold (#)
    
    Target (#)
    
    Maximum (#)(2)F.A. Dunn
    
    
    2,980,000(3)
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    2,980,000(3)P. Debon
    
    
    1,490,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,490,000S.L. Spradley
    
    
    1,150,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,150,000C. Bolouri
    
    
    1,070,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,070,000N.J. DeRoma
    
    
    1,070,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,070,000
  (1)
    
    When issued and settled, a restricted stock unit entitles the holder to receive one
common share of Nortel Networks Corporation or, in the discretion of the joint leadership
resources committee, cash in lieu of shares in certain circumstances.(2)
    
    The 2003 RSU program provided for a three-year performance period ending December 31, 2005.
The three-year performance period included four performance thresholds that could be achieved
at any time during the performance period. The performance criteria for each of the four
thresholds were distinct Return on Sales before Tax (or ROSBT) percentage targets,
calculated on a rolling four-quarter basis. The joint leadership resources committee assessed
Nortel Networks Corporations performance on a quarterly basis against each of these
thresholds and further considered Nortel Networks Corporations performance as compared to its
competitors and certain business, financial, competitive, political and other relevant
criteria in determining, in the committees discretion, whether any or a portion of the
allocated restricted stock units would be issued and settled to participants. In respect of
2003, the committee exercised its discretion to authorize the issuance of restricted stock
units to the named executive officers based, among other things, on the achievement of two
performance thresholds. On January 10, 2005, the joint leadership resources committee
exercised the discretion reserved to it with respect to the 2003 RSU program and determined,
and the boards of directors of the Company and Nortel Networks Corporation confirmed and
approved, that no additional restricted stock units would be issued with respect to the 2003
RSU program (including in connection with the achievement of the third and fourth ROSBT
performance targets or otherwise) and that all unissued restricted stock units under the 2003
RSU program were immediately terminated and cancelled in their entirety. Information
regarding restricted stock units issued and settled under the 2003 program of the RSU Plan is
disclosed in the Summary Compensation Table  2003 above under LTIP Payouts. On April 27,
2004, the Company and Nortel Networks Corporation terminated for cause the employment of each
of their then chief financial officer and controller. The Company and Nortel Networks
Corporation have demanded repayment from the chief financial officer and controller of the
restricted stock units issued and settled in July 2003 with respect to the achievement of the
first performance threshold and, with respect to the controller, the restricted stock units
issued and settled in January 2004 with respect to the achievement of the second performance
threshold. All restricted stock units allocated to the chief financial officer and the
controller that were not issued have been forfeited. See footnote (3) regarding restricted
stock units allocated to the president and chief executive officer.(3)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, Mr.
Dunns allocated but unissued restricted stock units were automatically forfeited. With
respect to the restricted stock units issued to him and settled in July 2003 with respect to
the achievement of the first performance threshold, the Company and Nortel Networks
Corporation have demanded repayment and commenced legal proceedings for the recovery of the
value of such restricted stock units as noted in the Summary Compensation Table above. No
restricted stock units were issued to Mr. Dunn with respect to the second performance
threshold. 
 Retirement plans Nortel Networks Corporation has several pension plans. The following descriptions relate
to pension plans to which the named executive officers for 2004 and the named executive officers
for 2003 are eligible to participate. The non-contributory defined benefit pension plans (or base plans) in Canada and in the United
States are generally available to employees and executives who were participants prior to May 1,
2000. There is also the Nortel Networks Supplementary Executive Retirement Plan which is available
to eligible executives. The benefit calculated under the Supplementary Executive Retirement Plan
is reduced by the pension benefits payable under the registered/qualified defined benefit pension
plans and the non-qualified/excess plans. Effective January 1, 2000, the Supplementary Executive
Retirement Plan was closed to new participants. 158




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Defined Benefit Pension Plan  Canada A defined benefit pension plan, the Nortel Networks Limited Managerial and Non-Negotiated
Pension Plan, is maintained for eligible employees and executives in Canada. This plan has two
different formulas, called Part I and Part II. The Part I formula provides a monthly benefit at retirement based on years of service and a
pension accrual of 1.3 percent of the average annual earnings of the best three consecutive years. An early
retirement reduction applies for retirement prior to age 60. Eligible earnings include base salary
and, where applicable, overtime, off-shift differentials and an individual sales commission factor.
Effective January 1, 1999, the Part I defined benefit formula was closed to new participants. The Part II formula was introduced January 1, 1999. Employees who were participants in Part I
could continue to participate in Part I, or move to the new Part II formula, at their election.
Part II provides a benefit based on pension credits and the average annual earnings for the highest
three consecutive years in the last ten years prior to retirement or other termination of
employment. Pension credits are earned during each year of participation based on the
participants age attained in the year and on years of service. Eligible earnings include base
salary and, where applicable, incentive awards or bonuses, if any, paid under the Nortel Networks
Limited SUCCESS Incentive Plan (or SUCCESS Plan), overtime, off-shift differentials and sales
commissions. Effective May 1, 2000, the Part II defined benefit formula was closed to new
participants. The Part II benefit can be paid in a lump sum or as an actuarially equivalent annuity. Under
the annual income option, there are reductions for retirement prior to normal retirement age of 65.
Certain grandfathering rules exist for employees and executives who were participating in the
pension plan as at December 31, 1998. The Income Tax Act (Canada) (or ITA) limits the amount of pension that may be paid under a
registered pension plan. Pension benefits within the ITA limit are funded by a pension trust that
is separate from the general assets of the Company. Pension benefits that exceed the ITA limits
are paid from an excess plan, and are funded from the Companys general assets and the general
assets of Nortel Networks Technology Corporation (or NNTC), an affiliate of the Company. Defined Benefit Pension Plan  United States A defined benefit pension plan, the Nortel Networks Retirement Income Plan, is maintained for
eligible employees and executives in the United States. Benefits are paid to plan participants
under one of two formulas, depending on elections made by the plan participant: the Pension
Service Plan (or PSP) formula or the Cash Balance Plan formula. The PSP formula is available for participants who are employees of Nortel Networks Inc. (or
NNI) or other Nortel subsidiaries located in the United States who enrolled in the plan prior to
May 1, 2000, and who elected prior to May 1, 2000 to be covered by the PSP formula. As of May 1,
2000, the PSP formula under the Nortel Networks Retirement Income Plan was closed to new
participants. The PSP formula provides a benefit based on pension credits and average earnings for
the highest 1,095 consecutive calendar days of compensation out of the last 3,650 days prior to
retirement or other termination of employment. Pension credits are earned during each year of
participation based on the participants age attained in the year and on years of service.
Eligible earnings include base salary and, where applicable, incentive awards or bonuses, if any,
paid under the SUCCESS Plan, overtime, off-shift differentials and sales commissions. A new defined benefit pension formula, the Cash Balance Plan, was established, effective May
1, 2000, based on pay credits and interest credits. Employees who were participants in the PSP
could continue to participate in the PSP, or move to the new Cash Balance Plan, or elect to opt out
of the pension plan. The Cash Balance Plan formula provides a monthly credit equal to 4% of
eligible earnings, with interest being credited monthly based on the months starting balance.
Eligible earnings include base salary and, where applicable, incentive awards or bonuses, if any,
paid under the SUCCESS Plan, overtime, off-shift differentials and sales commissions earned prior
to retirement or other termination of employment. The PSP and Cash Balance Plan benefits can be paid in a lump sum or as an actuarially
equivalent annuity. Certain grandfathering rules exist for employees and executives who were participating in the
pension plan as at December 31, 1998. Federal laws place limitations on compensation amounts that may be included under a qualified
pension plan ($205,000 in 2004) as well as limitations on the total benefit that may be paid from
such plans. Pension benefits within the limit are funded by a pension trust that is separate from
the general assets of NNI. Pension benefits applicable to compensation that exceeds federal limitations and pension benefits in excess of the
limitations on total benefits are paid from a restoration (excess) plan, and are funded from NNIs
general assets. 159




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Supplementary Executive Retirement Plan Eligible executives in Canada and the United States also participate in the Supplementary
Executive Retirement Plan (or SERP). Effective January 1, 2000, the SERP was closed to new
participants and there are only 19 executives who remain eligible to participate in the SERP. For Canadian executives participating in the SERP as at December 31, 1998 who elected,
effective January 1, 1999, to remain in Part I of the pension plan, the SERP formula provides a
benefit based on years of service and a pension accrual of 1.3 percent of the final average
earnings of the best three consecutive years. An early retirement reduction of seven percent a
year prior to age 60 applies in the case of retirement prior to this age. The maximum total annual
retirement benefit cannot exceed 60 percent of an executives final average earnings at retirement.
Eligible earnings include base salary plus the incentive award or bonus, if any, paid under the
SUCCESS Plan, and commissions, however a bonus or commissions will not be included in a given year
to the extent that it exceeds 60 percent of a participants base salary for that calendar year. New SERP plan provisions, which became effective January 1, 1999 and are applicable to Part II
members participating in the Canadian plan and to US PSP formula members, provide a benefit based
on pension credits and final average earnings for the highest three consecutive years in the last
ten years prior to retirement, to a maximum benefit of 550 percent of final average earnings.
Pension credits are earned during each year of participation based on the participants age
attained in the year and on years of service. Eligible earnings include base salary plus the
incentive award or bonus, if any, paid under the SUCCESS Plan, and commissions, however a bonus or
commissions will not be included in a given year to the extent that it exceeds 60 percent of a
participants base salary for that calendar year. All participating executives at December 31, 1998 have their benefits protected under the
pre-1999 grandfathered SERP formula. Pension benefits from the SERP are funded from the general assets of, respectively, Nortel
Networks Limited and NNTC in Canada and Nortel Networks Inc. in the United States. The following tables show the aggregate approximate annual retirement benefits for an eligible
executive officer for certain compensation and years of service categories assuming retirement at
age 65, and assuming grandfathering provisions do not apply. Table I estimates the total retirement benefit (including the SERP) for all participating
United States executives (PSP formula members), and for participating Canadian executives who
elected and continue to participate in Part II of the Nortel Networks Limited Managerial and
Non-Negotiated Pension Plan. It estimates the benefit payable as a life annuity with a 60 percent
survivor pension. The approximate benefits for the service of Messrs. Debon, McFadden and DeRoma (named
executive officers in 2004) and Mr. Bolouri (a named executive officer in 2003, along with Messrs.
Debon and DeRoma) are shown in Table I. The approximate total eligible earnings and years of
credited pensionable service at December 31, 2004 was: $808,525 and 4.92 years of United States
service for Mr. Debon; $708,816 and 27.50 years of Canadian service for Mr. McFadden; and $823,931
and 5.58 years of Canadian pensionable service for Mr. DeRoma. Mr. DeRoma is also eligible to
receive additional credited pensionable service, up to a maximum of 8.125 years, under the terms of
his employment agreement. See Certain Employment Arrangements. The approximate total eligible
earnings and years of credited pensionable service for Mr. Bolouri at December 31, 2003 was
$696,984 and 22 years of Canadian service. 160




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##### Table of Contents



Table I Years of ServiceTotal Earnings
    15
    20
    25
    30
    35$600,000
    
    $138,578
    
    
    $169,034
    
    
    $207,612
    
    
    $235,023
    
    
    $273,602700,000
    
    161,674
    
    
    197,206
    
    
    242,215
    
    
    274,194
    
    
    319,202800,000
    
    184,770
    
    
    225,379
    
    
    276,817
    
    
    313,365
    
    
    364,802900,000
    
    207,866
    
    
    253,551
    
    
    311,419
    
    
    352,535
    
    
    410,4031,000,000
    
    230,963
    
    
    281,724
    
    
    346,021
    
    
    391,706
    
    
    456,0031,100,000
    
    254,059
    
    
    309,896
    
    
    380,623
    
    
    430,876
    
    
    501,6031,200,000
    
    277,155
    
    
    338,068
    
    
    415,225
    
    
    470,047
    
    
    547,2031,300,000
    
    300,251
    
    
    366,241
    
    
    449,827
    
    
    509,217
    
    
    592,8041,400,000
    
    323,348
    
    
    394,413
    
    
    484,429
    
    
    548,388
    
    
    638,4041,500,000
    
    346,444
    
    
    422,585
    
    
    519,031
    
    
    587,558
    
    
    684,0041,600,000
    
    369,540
    
    
    450,758
    
    
    553,633
    
    
    626,729
    
    
    729,6051,700,000
    
    392,636
    
    
    478,930
    
    
    588,235
    
    
    665,900
    
    
    775,2051,800,000
    
    415,733
    
    
    507,102
    
    
    622,837
    
    
    705,070
    
    
    820,8051,900,000
    
    438,829
    
    
    535,275
    
    
    657,439
    
    
    744,241
    
    
    866,4062,000,000
    
    461,925
    
    
    563,447
    
    
    692,042
    
    
    783,411
    
    
    912,006
 Table II estimates the benefits calculated under the United States Cash Balance Plan
formula under the Nortel Networks Retirement Income Plan for participating employees and
executives, payable as a straight life annuity. The approximate benefits for Mr. Owens and Ms. Spradleys service are shown in Table II. The
approximate total eligible earnings and years of credited service at December 31, 2004 for Mr.
Owens was $680,328 and .75 years of United States service and $1,139,325 and 16.67 years of United
States service for Ms. Spradley. As Mr. Owens and Ms. Spradley are in the Cash Balance Plan,
eligible earnings for 2004 reflect 2004 base salary and, for Ms. Spradley, also includes an award
paid during 2004 under the SUCCESS Plan. Mr. Owens is also eligible for Special Pension
Arrangements. See Certain Employment Arrangements. Table II Years of ServiceTotal Earnings
    5
    10
    15
    20
    25
    30
    35$600,000
    
    $10,330
    
    
    $20,659
    
    
    $30,989
    
    
    $41,318
    
    
    $51,648
    
    
    $61,978
    
    
    $72,308700,000
    
    12,051
    
    
    24,102
    
    
    36,153
    
    
    48,204
    
    
    60,256
    
    
    72,307
    
    
    84,359800,000
    
    13,773
    
    
    27,546
    
    
    41,318
    
    
    55,091
    
    
    68,864
    
    
    82,637
    
    
    96,411900,000
    
    15,494
    
    
    30,989
    
    
    46,483
    
    
    61,977
    
    
    77,472
    
    
    92,967
    
    
    108,4621,000,000
    
    17,216
    
    
    34,432
    
    
    51,648
    
    
    68,863
    
    
    86,080
    
    
    103,296
    
    
    120,5131,100,000
    
    18,938
    
    
    37,875
    
    
    56,813
    
    
    75,750
    
    
    94,688
    
    
    113,626
    
    
    132,5651,200,000
    
    20,659
    
    
    41,318
    
    
    61,977
    
    
    82,636
    
    
    103,296
    
    
    123,956
    
    
    144,6161,300,000
    
    22,381
    
    
    44,762
    
    
    67,142
    
    
    89,522
    
    
    111,904
    
    
    134,285
    
    
    156,6671,400,000
    
    24,103
    
    
    48,205
    
    
    72,307
    
    
    96,409
    
    
    120,512
    
    
    144,615
    
    
    168,7191,500,000
    
    25,824
    
    
    51,648
    
    
    77,472
    
    
    103,295
    
    
    129,120
    
    
    154,945
    
    
    180,7701,600,000
    
    27,546
    
    
    55,091
    
    
    82,636
    
    
    110,181
    
    
    137,728
    
    
    165,274
    
    
    192,8211,700,000
    
    29,267
    
    
    58,534
    
    
    87,801
    
    
    117,068
    
    
    146,336
    
    
    175,604
    
    
    204,8731,800,000
    
    30,989
    
    
    61,978
    
    
    92,966
    
    
    123,954
    
    
    154,944
    
    
    185,933
    
    
    216,9241,900,000
    
    32,711
    
    
    65,421
    
    
    98,131
    
    
    130,840
    
    
    163,552
    
    
    196,263
    
    
    228,9752,000,000
    
    34,432
    
    
    68,864
    
    
    103,296
    
    
    137,727
    
    
    172,160
    
    
    206,593
    
    
    241,027
 On April 27, 2004, the Company and Nortel Networks Corporation terminated for cause the
employment of each of their then president and chief executive officer, chief financial
officer and controller. On August 19, 2004, Nortel Networks Corporation announced that seven
individuals with, or who had, significant responsibilities for
financial reporting at the line of business and regional levels were terminated for 161




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cause and that Nortel would demand
repayment of payments made under bonus plans in respect of 2003. Further to that announcement, a
demand for repayment was made and, in the case of the former president and chief executive officer,
chief financial officer and controller who each had their employment terminated for cause, the
Company and Nortel Networks Corporation have commenced legal proceedings for the recovery of such
bonus payments. As a result, where applicable and permitted under applicable law, the pension
benefits for the terminated executives were recalculated to include base salary only in 2003. As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, he was no
longer eligible for any SERP benefit that would have otherwise applied as a result of his past
election to remain in Part I of the pension plan. Upon the termination of his employment for
cause, Mr. Dunn received Cdn$2,416,517.18 representing the commuted value of his pension benefits
accrued pursuant to the Nortel Networks Limited Managerial and Non-Negotiated Pension Plan. The
payment was calculated based on Mr. Dunns 27.92 years of service in accordance with the Part I
formula described under Defined Benefit Pension Plan  Canada. 
 Certain employment arrangements On August 31, 2004, the Company and Nortel Networks Corporation entered into an
employment agreement with
Mr. Owens confirming his appointment as President and Chief Executive Officer of the Company
and Nortel Networks Corporation as of April 27, 2004. The agreement provides that Mr. Owens will
receive a base salary of $1,000,000 and will be eligible for a targeted annual bonus of 170% of
base salary under the Nortel Networks Limited SUCCESS Incentive Plan (or SUCCESS Plan). Under the
agreement, Mr. Owens will receive a special pension benefit that will accrue ratably over the first
five years of his employment as President and Chief Executive Officer. Assuming retirement at the
end of such five years, Mr. Owens will receive an estimated monthly pension benefit of $33,540,
payable over the five year period following his retirement. Mr. Owens is based at the Companys
offices in Ontario, Canada. In connection with his relocation to Ontario, Mr. Owens was eligible
for certain benefits under the Nortel Networks-International Assignment Relocation program, in
accordance with the generally applicable terms of such program and consistent with his senior
executive position. Mr. Owens agreement also confirms his eligibility to participate in certain
employee and executive plans and programs, including the Nortel Networks Corporation Executive
Retention and Termination Plan (or ERTP) described below. Effective March 14, 2005, Mr. Owens
became Vice-Chairman and Chief Executive Officer of the Company and Nortel Networks Corporation.
On March 22, 2005, the joint leadership resources committee of the boards of directors of the
Company and Nortel Networks Corporation and the independent members of the boards of directors of
the Company and Nortel Networks Corporation approved an additional special pension benefit of $4.5
million to compensate Mr. Owens for equity compensation that he forfeited upon his resignation from
the boards of directors of various other companies in connection with his appointment as President
and Chief Executive Officer. The additional special pension benefit vested immediately upon
approval and will be paid in accordance with the terms of the original arrangement. Upon
retirement, Mr. Owens will receive an additional monthly pension benefit of $86,247 as a result of
the revised arrangement. The revised total monthly pension benefit will be $119,787, payable over
the five years following his retirement. Mr. Owens compensation arrangements are also discussed
under Report on 2004 and 2003 Executive Compensation. Effective March 4, 2005, Nortel Networks Corporation entered into an employment agreement with
Gary J. Daichendt, 53, in connection with his appointment as President and Chief Operating Officer
of the Company and Nortel Networks Corporation, effective March 14, 2005. The agreement provides
that Mr. Daichendt will receive a base salary of $800,000. Mr. Daichendt will be eligible for a
target annual bonus of 125% of base salary under the SUCCESS Plan, based on the generally
applicable performance criteria under such plan. For 2005, Mr. Daichendt will receive a guaranteed
annual bonus under the SUCCESS Plan of at least 125% of base salary. The agreement also specifies
that, once the suspension on the grant of options caused by the delay of certain regulatory filings
by the Company and Nortel Networks Corporation ends, the Company intends to recommend for approval
a new hire grant of 500,000 stock options of Nortel Networks Corporation for Mr. Daichendt, subject
to the terms and conditions of the applicable stock option plan of Nortel Networks Corporation.
The agreement also provides that Nortel Networks Corporation intends to award to Mr. Daichendt a
2005 long term incentive package valued at the time of award equivalent to $3.75 million and
conditional upon shareholder and all other required approvals having been obtained prior to the
award. Mr. Daichendt will also be eligible to participate in the employee benefit plans of Nortel
Networks Inc. and Nortel Networks Corporation, including the ERTP, in accordance with the generally
applicable terms of such plans. Mr. Daichendt will also, in certain circumstances, be entitled to
certain involuntary separation awards in the event certain aspects of his position change after the
effective date of his employment or Nortel Networks Corporation initiates the separation of his
employment as President and Chief Operating Officer, although such involuntary separation awards
would preclude any awards under the ERTP. Such involuntary separation awards include the
equivalent of two years base salary and one year of SUCCESS Plan payment at target, and continued
vesting of outstanding stock options during the two-year salary continuance period. 162




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Nortel Networks Corporation entered into an employment agreement with Peter W. Currie, 54, in
connection with his appointment as Chief Financial Officer, as of February 14, 2005. The agreement
provides that Mr. Currie will receive a base salary of $600,000 and a bonus of $300,000 to be paid
within 60 days of commencing employment. Mr. Currie will be eligible for a target annual bonus of
100% of base salary under the SUCCESS Plan, based on the generally applicable performance criteria
under such plan. For 2005, Mr. Currie will receive a guaranteed annual bonus under the SUCCESS
Plan of at least 100% of base salary, pro-rated for the number of months of active employment. The
agreement also specifies that Mr. Currie will be eligible to participate in certain employee
benefit plans and the ERTP in accordance with the generally applicable terms of such plans. Mr.
Currie subsequently became Executive Vice-President and Chief Financial Officer of the Company and
Nortel Networks Corporation effective March 14, 2005. Mr. DeRoma entered into an employment agreement in April 1997, prior to commencing employment
as Vice-President and Deputy General Counsel. Pursuant to the agreement, Nortel Networks Limited
agreed to make a gross-up payment to Mr. DeRoma for calendar years 1997 through 2000. The gross-up
payment was intended to place Mr. DeRoma in the same after-tax position with respect to his base
salary and any annual incentive award as if he were a resident of the State of Connecticut and a
taxpayer in the United States. After June 2000, this gross-up was subject to annual review by the
joint leadership resources committee of the boards of directors of the Company and Nortel Networks
Corporation, and was not renewed subsequent to March 2002. Under the terms of the agreement, Mr.
DeRoma is also eligible for the Nortel Networks Limited Special Pension Credit Program which
covered new executive hires older than age 35. Mr. DeRoma will be credited, for pension purposes,
with additional years and months equal to one half of the years between the age of 35 and Mr.
DeRomas age at the time of hire, if he retires after the age of 60, to a maximum of 8.125 years. Other than Mr. Dunn, each of the named executive officers and certain other executive officers
and senior employees, including the current Vice-Chairman and Chief Executive Officer, currently
participate in the ERTP. The ERTP provides that if a participants employment is terminated
without cause within a period commencing 30 days prior to the date of a change in control of Nortel
Networks Corporation and ending 24 months after the date of a change in control of Nortel Networks
Corporation, or the participant resigns for good reason (including, among other things, a reduction
in overall compensation, geographic relocation or reduction in responsibility, in each case without
the consent of the participant) within 24 months following the date of a change in control of
Nortel Networks Corporation, the participant will be entitled to certain payments and benefits,
including (i) the payment of an amount equal to three times (in the case of the chief executive
officer) and two times (in the case of the other named executive officers) of the participants
annual base salary; (ii) the payment of an amount equal to 300 percent (in the case of the chief
executive officer) and 200 percent (in the case of the other named executive officers) of the
participants target annual incentive bonus; (iii) accelerated vesting of all or substantially all
stock options; and (iv) the pay-out at target of any restricted stock units under the Nortel
Networks Limited Restricted Stock Unit Plan. For purposes of the ERTP, a change in control is deemed to occur if:  (i)
    
    any party or group acquires beneficial ownership of securities of Nortel
Networks Corporation representing more than 20 percent of the outstanding securities
entitled to vote in the election of directors of Nortel Networks Corporation;(ii)
    
    Nortel Networks Corporation participates in a business combination, including,
among other things, a merger, amalgamation, reorganization, sale of all or
substantially all of its assets, or plan of arrangement, unless the business
combination only involves Nortel Networks Corporation and/or its affiliates or,
following the completion of the business combination, Nortel Networks Corporations
common shareholders beneficially own, directly or indirectly, more than 50 percent of
the then-outstanding voting shares of the entity resulting from the business
combination (or of an entity which ultimately controls such entity) and a majority of
the members of the board of directors of the entity resulting from the business
combination (or the entity ultimately controlling such entity) were members of the
board of directors of Nortel Networks Corporation when the business combination was
approved or the initial agreement in connection with the business combination was
executed;(iii)
    
    the persons who were directors of Nortel Networks Corporation on the effective
date of the ERTP cease (for reasons other than death or disability) to constitute at
least a majority of Nortel Networks Corporations board of directors; provided, that
any person who was not a director on the effective date of the ERTP shall be deemed to
be an incumbent director if such person was elected or appointed to Nortel Networks
Corporations board of directors by, or on the recommendation of or with the approval
of, at least two-thirds of the directors who then qualify as incumbent directors unless
such election, appointment, recommendation or approval was the result of any actual or
publicly threatened proxy contest for the election of directors; or 163




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(iv)
    
    any other event occurs which Nortel Networks Corporations board of directors
determines in good faith could reasonably be expected to give rise to a change in
control. Until June 30, 2003, each of the named executive officers (other than Mr. Dunn) and certain
other executive officers of Nortel Networks Corporation were eligible to participate in the Nortel
Networks Corporation Special Retention Plan (or SRP). The SRP provided that if a participants
employment was terminated by the participant for good reason or by Nortel Networks Corporation
without cause (as defined in the SRP) during the period from November 1, 2001 to June 30, 2003,
that participant would have been entitled to certain payments and benefits. Other than payments
made in accordance with the SRP in March 2003 in connection with a former executive officers
previously announced termination of employment, no amounts were paid or became payable in 2003 to
any executive officer prior to June 30, 2003. 
 Compensation of directors Effective January 1, 2002, each non-employee director of the Company and Nortel Networks
Corporation elected to receive all compensation for services rendered as a member of the board of
directors of the Company and Nortel Networks Corporation, any committees thereof, and as board or
committee chairperson, in the form of share units, instead of cash, under the Directors Deferred
Share Compensation Plans maintained by the Company and Nortel Networks Corporation. The share
units are settled a specified number of trading days following the release of Nortel Networks
Corporations financial results after the director ceases to be a member of the applicable board,
and each share unit entitles the holder to receive one common share of Nortel Networks Corporation.
Effective January 1, 2004, each non-employee director of the Company and Nortel Networks
Corporation was entitled to elect to receive fees in cash, in share units under the Directors
Deferred Share Compensation Plans or in a combination of cash and share units. The compensation of directors is considered on a combined basis in light of the overall
governance structure of the Company and Nortel Networks Corporation. Director compensation is set
solely on an annual fee basis (paid quarterly in arrears) and fees are not paid for board or
committee meeting attendance. From January 1, 2002 to December 31, 2003, directors of the Company
and Nortel Networks Corporation, who were not salaried employees of Nortel Networks Corporation or
any of its subsidiaries, received an annual Nortel Networks Corporation board retainer of $50,000,
an annual committee membership retainer of $12,500 (or $6,250 each for membership on the same
committee of the boards of the Company and Nortel Networks Corporation) and, except as noted below,
an annual committee chairperson fee of $7,500 (or $3,750 each for chairing the same committee of
the boards of the Company and Nortel Networks Corporation). Effective July 25, 2002, the fee for
the audit committee chairperson was increased to $17,500 (or $8,750 for each audit committee of the
Company and Nortel Networks Corporation) in recognition of the significant responsibilities assumed
by the audit committee chairperson. Annual directors fees were initially increased effective January 1, 2004, after having been
essentially unchanged for the previous two year period, as described above. However, in light of
the challenges subsequently faced by the Company and Nortel Networks Corporation, the boards of
directors in July 2004 decreased the annual directors fees back to the fees in effect prior to
January 1, 2004. The boards of directors also determined that the directors fees to be paid
during the remainder of 2004 would be reduced so that the total amount of the directors fees paid
for 2004 would equal the amount of fees that would have been paid under the 2003 directors fee
schedule. Accordingly, the net effect of these determinations was that the directors fees paid to
non-employee directors remain essentially unchanged since January 1, 2002. Between January 1, 2004 to June 30, 2004, directors of the Company and Nortel Networks
Corporation, who were not salaried employees of Nortel Networks Corporation or any of its
subsidiaries, received an annual Company board retainer of $60,000 and an annual committee
membership retainer and, except as described below, an annual committee chairperson retainer of
$12,500 (or $6,250 each for membership on or chairing the same committee of the boards of the
Company and Nortel Networks Corporation). The fee for the audit committee chairperson was $27,500
(or $13,750 each for chairing the audit committee of the Company and Nortel Networks Corporation),
in recognition of the significant responsibilities assumed by the audit committee chairperson. The Company maintains, at its cost, life insurance for directors, who are not salaried
employees of the Company and Nortel Networks Corporation. Such insurance is in an amount of
Cdn$100,000 while a director and in an amount of Cdn$75,000 following retirement at or after age 65
or, at any lesser age after ten years of board membership (including Company board membership). Directors entitled to the above remuneration are also reimbursed for reasonable travel and
living expenses properly incurred by them in attending any meetings of the boards of directors of
the Company and Nortel Networks Corporation or their committees or for performing services as
directors. 164




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Effective January 1, 2004, amended share ownership guidelines adopted by the boards of
directors of the Company and Nortel Networks Corporation require each non-chairman director to own,
directly or indirectly, common shares of Nortel Networks Corporation having a fair market value of
at least $300,000 within five years from the earlier of the date he or she was first elected or
appointed to the boards of directors of the Company or Nortel Networks Corporation. Share
ownership guideline compliance must thereafter be maintained during an individuals tenure as a
director. The chairman of the board must own, directly or indirectly, common shares of Nortel
Networks Corporation having a fair market value of at least $1,600,000 within five years from the
earlier of the date he or she was first appointed as chairman of the boards of directors of the
Company or Nortel Networks Corporation. Directors are expected to continue to comply with these
share ownership guidelines during the balance of their tenures as directors. Share units credited
under the Directors Deferred Share Compensation Plans are included in the calculation of the
number of common shares of Nortel Networks Corporation owned by a director for this purpose.
Messrs. Bischoff, Manley, McCormick and Pearce have been prevented under applicable securities laws
from participating in the Directors Deferred Share Compensation Plans due to the restatement of
certain financial statements and the delay in the filing of certain other financial statements and
related periodic reports of the Company and Nortel Networks Corporation. Retirement benefits are not paid to non-employee directors of Nortel Networks Corporation or
to non-employee directors of the Company elected after January 1, 1996. Non-employee directors of
the Company elected prior to January 1, 1996 are entitled to receive retirement benefits equal to
75 percent of the greater of $27,500 and the annual retainer paid to each director at retirement,
indexed to reflect approximately half of the increase in directors retainers after retirement.
The benefits are payable for a maximum of ten years. From his appointment in April 2001 to December 31, 2003, Mr. Wilson served as non-executive
chairman of the board of directors of the Company and Nortel Networks Corporation, except for the
November 2001 to February 2002 period in which he served as executive chairman. During the April
2001 to December 31, 2003 period, Mr. Wilsons additional compensation for serving as chairman of
the board of directors of the Company and Nortel Networks Corporation from each of the Company and
Nortel Networks Corporation was $45,000 per fiscal quarter. As with the directors annual fees,
Mr. Wilsons additional compensation for serving as non-executive chairman of the board of the
Company and of Nortel Networks Corporation was initially increased to $50,000 per fiscal quarter
from each of the Company and Nortel Networks Corporation for the period from January 1, 2004 to
June 30, 2004. Effective July 1, 2004, his additional compensation for serving as non-executive
chairman of the board of directors of the Company and of Nortel Networks Corporation was reduced
back to the $45,000 per fiscal quarter that was being paid prior to January 1, 2004 by each of the
Company and Nortel Networks Corporation. The boards of directors also determined that the amount
of additional compensation for serving as non-executive chairman paid to Mr. Wilson from July 1,
2004 to December 31, 2004 would be reduced so that the total amount of additional compensation to
be paid to Mr. Wilson in 2004 for serving as non-executive Chairman would equal his pre-2004
compensation. The net effect of these determinations was that the additional fees paid to Mr.
Wilson for serving as non-executive Chairman remain unchanged since his original appointment. 
 Compensation committee interlocks and insider participation The joint leadership resources committee of the board of directors of the Company and the
board of directors of Nortel Networks Corporation is comprised of members from the boards of
directors of the Company and Nortel Networks Corporation. The members of the joint committee are
Messrs. R.E. Brown (Chairman), R.D. McCormick, H.J. Pearce, S.H. Smith, Jr., and L.R. Wilson. Mr.
Owens served as a member of the joint leadership resources committee until April 27, 2004, but
resigned from the committee in connection with his appointment as President and Chief Executive
Officer of the Company and Nortel Networks Corporation. Messrs. McCormick and Pearce were
appointed to the joint leadership resources committee effective January 18, 2005. No other changes
to the membership of the joint leadership resources committee have occurred during 2004 or 2003.
No member of the joint leadership resources committee was an officer (within the meaning of
applicable United States securities rules) or employee of Nortel Networks Corporation or any of its
subsidiaries at any time during 2004 or 2003. No executive officer of the Company serves on the board of directors or compensation committee
of any other entity that has or has had one or more of its executive officers serving as a member
of the Companys board of directors. 165




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ITEM 12.
    
    Security Ownership of Certain Beneficial Owners and Management 
 Security ownership of certain beneficial owners The following table shows the number of common shares of the Company beneficially owned
by persons who are known to the Company to be beneficial owners of more than five percent of the
Companys common shares as of December 31, 2004. Name and Address ofBeneficial Owner
    
    
    
    Title of Classof Security
    
    
    
    Amount and Nature ofBeneficial Ownership
    
    
    
    Percent ofClassNortel Networks Corporation8200 Dixie Road, Suite 100Brampton, Ontario, Canada L6T 5P6
    
    
    
    Common shares of the Company
    
    
    
    1,460,978,638
    
    
    
    100
 
 Security ownership of directors and management The following table shows the number of common shares of Nortel Networks Corporation and
Bookham Technology plc beneficially owned, as of April 25, 2005 (unless otherwise noted), by each
of the Companys directors, nominees for directors and the individuals named in the 2004 and 2003
summary compensation tables set forth above under Executive Compensation, as well as by the
directors and executive officers as a group. None of the directors, nominees for election as
director, or executive officers of the Company beneficially own any common or preferred shares of
the Company. A person is deemed to be a beneficial owner of a common share if that person has, or shares,
the power to direct the vote or investment of the common share. Under applicable United States
securities laws, a person is also deemed to be a beneficial owner of a common share if such person
has the right to acquire the share within 60 days (whether or not, in the case of a stock option,
the current market price of the underlying common share is below the stock option exercise price).
More than one person may be deemed a beneficial owner of a common share and a person need not have
an economic interest in a share to be deemed a beneficial owner. 166




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Amount and Nature ofName of Beneficial Owner
    
    
    Title of Class of Security
    
    
    Beneficial Ownership(1)J.H. Bennett**
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    
M. Bischoff*
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    J.J. Blanchard
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    19,392
120,003
    (2)
(3)R.E. Brown
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    417,281
123,254
    (4)
(3)J.E. Cleghorn
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    29,000
136,960
    (5)
(3)L.Y. Fortier
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    22,585
138,498
    (6)
(3)J.B. Hunt, Jr.**
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    
R.A. Ingram
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    10,756 
140,646
    (7)
(3)J.A. MacNaughton**
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    100,000
J.P. Manley*
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    R.D. McCormick*
    
    
    Common shares of Nortel Networks Corporation
    
    
    

100,000R.W. Osborne**
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    
W.A. Owens
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    
103,917
    (3)H.J. Pearce*
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    10,000G. Saucier
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    28,673 
136,127
    (8)
(3)S.H. Smith, Jr.
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    131,192
165,697
    (9)
(3)L.R. Wilson
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    1,201,871
571,200
    (10)
(3)F.A. Dunn***
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    793,541
    (11)P. Debon
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,958,190
    (12)B.W. McFadden
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,718,486
    (13)S.L. Spradley
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    615,297
    (14)C. Bolouri****
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,909,446
    (15)N.J. DeRoma
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,919,280
    (16)Directors and executive
officers as a group
(consisting of 39 persons,
comprised of the current
directors and current
executive officers)
    
    
    Common shares of Nortel Networks Corporation
Share units
Common shares of Bookham Technology plc
    
    
    

18,560,974
1,636,302

    (17)(3)




|*  |  | Messrs. Bischoff and Manley were each appointed a director of the Company and of Nortel
Networks Corporation on April 29, 2004 and May 26, 2004, respectively, and the appointment of
Messrs. McCormick and Pearce as directors of Nortel Networks Corporation became effective
January 11, 2005 upon the filing of the NNC 2003 Form 10-K and their appointment as directors
of the Company became effective January 18, 2005 upon the filing of the NNL 2003 Form 10-K.
Messrs. Bischoff, Manley, McCormick and Pearce have been prevented under applicable securities
laws from participating in the Directors Deferred Share Compensation Plans due to the
restatement and resulting delay in the filing of certain financial statements and related
periodic reports of the Company and Nortel Networks Corporation and, since May 31, 2004, have
been subject to an Ontario Securities Commission management cease trade order prohibiting
trading by directors, officers and certain current and former employees in securities of the
Company and Nortel Networks Corporation until after the filing of all required financial
statements and related periodic reports of the Company and Nortel Networks Corporation.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|** |  | Nominee for election as a director of the Company and Nortel Networks Corporation for the
first time, except Mr. Osborne who was a director of the Company (formerly known as Northern
Telecom Limited) from April 1996 to September 1997.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

167



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***
    
    Mr. Dunn ceased to be president and chief executive officer of the Company and Nortel
Networks Corporation on April 27, 2004 and ceased to be a director of the Company and Nortel
Networks Corporation on May 21, 2004.****
    
    A named executive officer in 2003 only.(1)
    
    Except as set forth below, each person has sole investment and voting power with respect to
the common shares beneficially owned by such person. Includes common shares subject to stock
options exercisable on April 25, 2005 or that become exercisable within 60 days after such
date (whether or not the market price of the underlying common shares is below the stock
option exercise price). As of April 25, 2005 each director and named executive officer
individually, and the directors and executive officers as a group, beneficially owned less
than 1.0 percent of the outstanding common shares of Nortel Networks Corporation.(2)
    
    Includes 8,000 common shares subject to stock options.(3)
    
    Share units issued under the Nortel Networks Corporation Directors Deferred Share
Compensation Plan and the Nortel Networks Limited Directors Deferred Share Compensation Plan.
Each share unit represents the right to receive one common share of Nortel Networks
Corporation. Those plans are described under Compensation of Directors.(4)
    
    Includes 8,000 common shares subject to stock options. Excludes 94 common shares
beneficially owned by Mr. Browns son residing with Mr. Brown and 671 common shares
beneficially owned by Mr. Browns spouse. Mr. Brown disclaims beneficial ownership of those
excluded shares.(5)
    
    Includes 4,000 common shares subject to stock options.(6)
    
    Includes 8,000 common shares subject to stock options. Excludes 5,000 common shares
beneficially owned by Mr. Fortiers spouse. Mr. Fortier disclaims beneficial ownership of
those excluded shares.(7)
    
    Includes 8,000 common shares subject to stock options and 1,800 common shares as to which Mr.
Ingram shares investment and voting power with his spouse.(8)
    
    Includes 8,000 common shares subject to stock options and 20,673 common shares beneficially
owned by a corporation that is wholly-owned by Mrs. Saucier.(9)
    
    Includes 8,000 common shares subject to stock options. Excludes 1,600 common shares
beneficially owned by Mr. Smiths spouse. Mr. Smith disclaims beneficial ownership of those
excluded shares.(10)
    
    Includes 38,000 common shares subject to stock options and 1,157,855 common shares
beneficially owned by a corporation that is wholly-owned by Mr. Wilson. Excludes 2,204 common
 shares beneficially owned by Mr. Wilsons spouse. Mr. Wilson disclaims beneficial ownership
of those excluded shares.(11)
    
    Includes 5,000 common shares beneficially owned by Mr. Dunns son as to which Mr. Dunn shares
investment power. Excludes 10,000 common shares beneficially owned by Mr. Dunns spouse and
daughter residing with Mr. Dunn. Mr. Dunn disclaims beneficial ownership of those 15,000
included and excluded shares. As Mr. Dunn was no longer an insider of the Company effective
May 21, 2004, the number of common shares reported as part of his holdings is based on
information in our corporate records and Mr. Dunns filings on the Canadian insider reporting
system, the System for Electronic Disclosure by Insiders, as at May 12, 2004 and reports filed
pursuant to Section 16(a) of the U.S. Securities Exchange Act of 1934.(12)
    
    Includes 1,442,000 common shares subject to stock options.(13)
    
    Includes 1,217,000 common shares subject to stock options.(14)
    
    Includes 321,999 common shares subject to stock options.(15)
    
    Includes 1,498,000 common shares subject to stock options.(16)
    
    Includes 1,453,334 common shares subject to stock options and 397,127 common shares as to
which Mr. DeRoma shares investment and voting power with his spouse.(17)
    
    Includes 11,971,889 common shares subject to stock options. Also includes 414,920 common
 shares as to which investment and voting power is shared with one or more other persons.
Excludes 40,144 common shares as to which beneficial ownership is disclaimed. 168




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ITEM 13.
    
    Certain Relationships and Related Transactions Nortel Networks Corporation and its subsidiaries paid the law firm of Ogilvy Renault LLP,
of which Mr. Fortier is a senior partner and Chairman, fees for legal services with respect to
several matters in 2003 and 2004 and are expected to continue to pay fees for legal services in
2005. Nortel Networks Corporation and its subsidiaries paid the law firm of Piper Rudnick LLP, of
which Mr. Blanchard is a partner, fees for legal services with respect to several matters in 2003
and 2004 and are expected to continue to pay fees for legal services in 2005. Nortel Networks Corporation and its subsidiaries paid the law firm of McCarthy Tétrault LLP
fees for legal services in 2003 and 2004. In May 2004, Mr. Manley became a senior counsel of the
law firm of McCarthy Tétrault LLP, serving as an independent consultant but not a partner.
McCarthy Tétrault LLP represents a former executive of Nortel in connection with matters related to
his former association with Nortel, including certain civil proceedings commenced in 2001, the fees
for which are being paid by Nortel Networks Corporation pursuant to indemnification provisions of
applicable law. 
 Indebtedness of management Nortel Networks Corporation and the Company provide relocation assistance under the
Nortel Networks  International Assignment Relocation program to employees who are requested to
relocate that is designed to minimize the financial exposure to employees as a result of the move.
In the past, the assistance has included housing loans, advances on real estate equity, and
payments on behalf of employees of direct costs associated with the move. The assistance offered
is specific to each employee and is structured to be competitive in the area to which the employee
is relocated, subject to the overall relocation policy. Effective July 30, 2002, Nortel Networks
Corporation and the Company no longer offer executive officers housing loans as part of their
relocation assistance. No loans have been extended by Nortel Networks Corporation and the Company or its subsidiaries
to any director or executive officer of Nortel Networks Corporation or the Company since January 1,
2003. Neither Nortel Networks Corporation, the Company nor its subsidiaries have given any
guarantee, support agreement, letter of credit, or similar arrangement or understanding, to any
other entity in connection with indebtedness of current and former directors or executive officers
since January 1, 2003. As at April 15, 2005, approximately $3.87 million of indebtedness was owed by current and
former employees to Nortel Networks Nortel Networks Corporation, the Company and its subsidiaries.
Except for the indebtedness previously owed by a recently appointed executive officer as set out in
the table below, no current or former director or executive officer had any loans outstanding since
January 1, 2003. Table of Indebtedness of Directors and Executive Officers Name and Principal
        Position
    
    Involvement of
        Company or Subsidiary
    
    
    Largest Amount Outstanding
        January 1, 2003 
        December 31, 2004 ($)
    
    
    Amount Outstanding
        as at December 31, 2004 ($)
    
    
    Amount Forgiven
        January 1, 2003 to
December 31, 2004 ($)Martha H. Bejar(1)
        President, CALA
    
    Lender
    
    
    200,000
    
    
    0
    
    
    0
  (1)
    
    A subsidiary of Nortel Networks Corporation extended a housing loan to Ms. Bejar in 2001
in connection with a relocation. The loan was for a period of 10 years, interest-free and
secured against Ms. Bejars residence. The full amount of this indebtedness was repaid by Ms.
Bejar prior to her appointment as an executive officer effective October 1, 2004. 169




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Related party transactions The Company and its subsidiaries engage in transactions with Nortel Networks Corporation
and its subsidiaries (other than the Company). These transactions include sales, purchases,
research and development services and other financial arrangements and funding activities between
such entities. 2004 As
at December 31, 2004, the balance in trade and other payables owing from Nortel Networks
Corporation was $134, and the balance in trade and other payables owing from Nortel Networks
subsidiaries (other than the Company) was $114. During
the year ended December 31, 2004, Nortel Networks Corporation
and its subsidiaries (other than the Company) provided research and
development services to the Company for $20. 2003 As at December 31, 2003, the balance in trade and other payables owing from Nortel Networks
Corporation was $67 million, and the balance in trade and other payables owing from Nortel Networks
subsidiaries (other than the Company) was $87 million. During the year ended December 31, 2003,
Nortel Networks Corporation and its subsidiaries (other than the Company) provided research and
development services to the Company for $30 million. 
  ITEM 14.
    
    Principal Accountant Fees and Services Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective
affiliates (or, collectively, the Deloitte Entities) are the principal independent accountants of
the Company and Nortel Networks Corporation. In accordance with applicable laws and the requirements of stock exchanges and securities
regulatory authorities, the audit committees of the Company and Nortel Networks Corporation
pre-approve all audit and non-audit services to be provided by the Deloitte Entities. In addition,
in April 2002, the audit committees of the Company and Nortel Networks Corporation recommended for
approval, and the boards of directors of the Company and Nortel Networks Corporation approved, a
policy that thereafter the Companys and Nortel Networks Corporations auditors would be retained
solely to provide audit and audit-related services and advice with respect to tax matters, and that
the auditors would not be retained to provide consulting services, such as information technology
services. The boards policy applies to new engagements and did not affect limited term
engagements in effect at the time the policy was approved. Certain services in each fee category below were not subject to the audit committee
pre-approval requirements as the fees related to engagements for services prior to the audit
committee pre-approval requirements coming into effect. Five percent of the fees billed for 2003
are for engagements that were undertaken prior to the pre-approval requirements coming into effect
and were primarily for tax compliance services. Services for which the fees were less than one
percent of the total fees billed by the Deloitte Entities for 2003 were inadvertently not
pre-approved by the audit committees but were promptly brought to the attention of the audit
committees and, in accordance with applicable laws and the requirements of securities regulatory
authorities, were approved prior to the completion of the services associated with those fees. 
 Audit Fees The Company and Nortel Networks Corporation prepare financial statements in accordance with
United States generally accepted accounting principles (or US GAAP), with a reconciliation to
Canadian generally accepted accounting principles (or Canadian GAAP). Deloitte Entities billed to
date Nortel Networks Corporation and its subsidiaries $46 million for 2004 for the following audit
services: (i) interim audit work related to the audit of the annual consolidated financial
statements of the Company and Nortel Networks Corporation for the year ended December 31, 2004;
(ii) reviews of the financial statements of the Company and Nortel Networks Corporation included as
comparative financial statements in Forms 10-Q for the periods ended March 31, 2004, June 30, 2004
and September 30, 2004; and (iii) audit of internal controls over financial reporting as required
under the United States Sarbanes-Oxley Act of 2002. Deloitte Entities billed to date Nortel
Networks Corporation and its subsidiaries $55.0 million and $8.1 million for 2003 and 2002,
respectively, for the following audit services: (i) audits of the annual consolidated financial
statements of the Company and Nortel Networks Corporation included in annual reports on Form 10-K
and annual reports to shareholders for the fiscal years ended December 31, 2003 and 2002; (ii)
reviews of the interim financial statements of the Company and Nortel Networks Corporation included
in quarterly reports on Form 10-Q and quarterly reports to shareholders for the periods ended March
31, June 30 and September 30, 2003 and 2002 (and in the Companys amended Form 10-Q/A for the
period ended September 30, 2003); (iii) audits and reviews of the restated financial statements of
the Company and Nortel Networks Corporation included in their respective amended annual reports on Form 10-K/A for the fiscal
year ended December 31, 2002 and amended quarterly reports on Form 10-Q/A for the periods ended
March 31 and June 30, 2003; (iv) audits and reviews of the restated financial statements of the
Company and Nortel Networks Corporation included as comparative financial statements in their
respective Form 10-K for the fiscal year ended December 31, 2003; (v) audits of individual
subsidiary statutory financial statements; and (vi) comfort letters, attest services, statutory and
regulatory audits, consents and other services related to United States Securities and Exchange
Commission matters. 170




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Audit-Related Fees Deloitte Entities billed to date Nortel Networks Corporation and its subsidiaries $3.8
million, $3.1 million and $1.1 million for 2004, 2003 and 2002, respectively, for the following
audit-related services: (i) audit of pension plan financial statements; (ii) financial accounting
and reporting consultations; (iii) information system reviews; (iv) advisory services related to
the United States Sarbanes-Oxley Act of 2002; (v) accounting consultations and audits in connection
with dispositions; (vi) internal control reviews; and (vii) accounting consultations regarding
financial accounting standards for various local business-related transactions. Tax Fees Deloitte Entities billed Nortel Networks Corporation and its subsidiaries $7.1 million, $14.6
million and $13.7 million for 2004, 2003 and 2002, respectively for tax compliance services. Tax
compliance services are services rendered based upon facts already in existence or transactions
that have already occurred to document, compute and obtain government approval for amounts to be
included in tax filings and consisted of: (i) assistance in filing tax returns in various
jurisdictions; (ii) sales and use, property and other tax return assistance; (iii) research and
development tax credit documentation and analysis for purposes of filing amended returns; (iv)
transfer pricing documentation; (v) requests for technical advice from taxing authorities; (vi)
assistance with tax audits and appeals; and (vii) preparation of expatriate tax returns. All Other Fees Deloitte Entities billed Nortel Networks Corporation and its subsidiaries $0, $0 and $1.7
million for 2004, 2003 and 2002, respectively, for the following services: (i) non-financial
information systems design and implementation; (ii) financial information systems design and
implementation; (iii) immigration services; and (iv) review of import/export and social security
requirements/reports. Approximately $1.0 million of the above services billed by Deloitte Entities
in 2002 were for services provided by Deloitte Consulting. 171




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PART IV  ITEM 15.
    
    Exhibits, Financial Statement Schedules  1.
    
    Financial StatementsThe index to the Consolidated Financial Statements appears on
page 126.2.
    
    Financial Statement Schedules PageQuarterly Financial Data (Unaudited)
    
    
    F-89Report of Independent Registered Chartered Accountants
    
    
    F-90II  Valuation and Qualifying Accounts and Reserves, Provision for Uncollectibles
    
    
    F-91
 All other schedules are omitted because they are inapplicable or not required.  3.
    
    Other Documents Filed as a Part of This Report Managements Report on Internal Control over Financial Reporting
    
    
    127Report of Independent Registered Chartered Accountants
    
    
    F-2
 Individual financial statements of entities accounted for by the equity method have been omitted
because no such entity constitutes a significant subsidiary requiring such disclosure at December
31, 2004.  4.
    
    Exhibit Index Pursuant to the rules and regulations of the Securities and Exchange Commission, Nortel has
filed certain agreements as exhibits to this Annual Report on Form 10-K. These agreements may
contain representations and warranties by the parties. These representations and warranties have
been made solely for the benefit of the other party or parties to such agreements and (i) may have
been qualified by disclosures made to such other party or parties, (ii) were made only as of the
date of such agreements or such other date(s) as may be specified in such agreements and are
subject to more recent developments, which may not be fully reflected in Nortels public
disclosure, (iii) may reflect the allocation of risk among the parties to such agreements and (iv)
may apply materiality standards different from what may be viewed as material to investors.
Accordingly, these representations and warranties may not describe Nortels actual state of affairs
at the date hereof and should not be relied upon. 172




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The items listed as Exhibits 10.2 to 10.7, 10.27 to 10.37, 10.41 10.43, 10.49 and item 10.50 relate
to management contracts or compensatory plans or arrangements. ExhibitNumber
    
    Description*2.
    
    
    Amended and Restated Arrangement Agreement involving BCE Inc., Nortel Networks Corporation,
formerly known as New Nortel Inc., and Nortel Networks Limited, formerly known as Nortel
Networks Corporation, made as of January 26, 2000, as amended and restated March 13, 2000
(including Plan of Arrangement under Section 192 of the Canada Business Corporations Act)
(filed as Exhibit 2.1 to Nortel Networks Limiteds Current Report on Form 8-K dated May 1,
2000).*3.1
    
    
    Restated Certificate and Articles of Incorporation of Nortel Networks Limited (filed as
Exhibit 3 to Nortel Networks Limiteds Current Report on Form 8-K dated October 18, 2000).*3.2
    
    
    By-Law No. 1 of Nortel Networks Limited (filed as Exhibit 3.2 to Nortel Networks Limiteds
Annual Report on Form 10-K for the year ended December 31, 2000).*4.1
    
    
    Indenture dated as of November 30, 1988, between Nortel Networks Limited and The
Toronto-Dominion Bank Trust Company, as trustee, related to debt securities authenticated
and delivered thereunder, which comprised the 6% Notes due September 1, 2003, and the 6
7/8% Notes due September 1, 2023 issued by Nortel Networks Limited (filed as Exhibit 4.1 to
Nortel Networks Corporations Annual Report on Form 10-K for the year ended December 31,
1999).*4.2
    
    
    Indenture dated as of February 15, 1996, among Nortel Networks Limited, as issuer and
guarantor, Nortel Networks Capital Corporation, formerly Northern Telecom Capital
Corporation, as issuer, and The Bank of New York, as trustee, related to debt securities
and guarantees authenticated and delivered thereunder, which comprised the 7.40% Notes due
2006 and the 7.875% Notes due 2026 (filed as Exhibit 4.1 to Registration Statement on Form
S-3 (No. 333-1720) of Nortel Networks Limited and Nortel Networks Capital Corporation).*4.3
    
    
    Indenture dated as of December 15, 2000 among Nortel Networks Limited, as issuer and
guarantor, Nortel Networks Capital Corporation, as issuer, and Citibank, N.A., as trustee,
related to debt securities authenticated and delivered thereunder (filed as Exhibit 4.1 to
Registration Statement on Form S-3 (No. 333-51888) of Nortel Networks Limited and Nortel
Networks Capital Corporation).*4.4
    
    
    First Supplemental Indenture dated as of February 1, 2001 to Indenture dated as of December
15, 2000 among Nortel Networks Limited, as issuer and guarantor, Nortel Networks Capital
Corporation, as issuer, and Citibank, N.A., as trustee, related to 6.125% Notes due 2006
(filed as Exhibit 4.1 to Nortel Networks Limiteds Current Report on Form 8-K dated
February 2, 2001).*4.5
    
    
    Instrument of Resignation, Appointment and Acceptance entered into as of December 19, 2002,
effective as of January 2, 2003, among Nortel Networks Limited, as issuer and guarantor,
Nortel Networks Capital Corporation, as issuer, Citibank, N.A. and Deutsche Bank Trust
Company Americas, with respect to the Indenture dated as of December 5, 2000, as
supplemented by a First Supplemental Indenture dated as of February 1, 2001 related to debt
securities (filed as Exhibit 4.5 to Nortel Networks Limiteds Annual Report on Form 10-K
for the year ended December 31, 2002).
 173




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ExhibitNumber
    
    Description*4.6
    
    
    Indenture dated as of August 15, 2001 between Nortel Networks Corporation, Nortel Networks
Limited, as guarantor, and Bankers Trust Company, as trustee, related to convertible debt
securities and guarantees authenticated and delivered thereunder, which comprised the 4.25%
Convertible Senior Notes due 2008 (filed as Exhibit 4 to Nortel Networks Corporations
Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).*10.1
    
    
    Third Amended and Restated Reciprocal Credit Agreement dated as of December 19, 2002
between Nortel Networks Corporation, Nortel Networks Limited and the other parties who have
executed the agreement (filed as Exhibit 10.1 to Nortel Networks Limiteds Annual Report on
Form 10-K for the year ended December 31, 2002).*10.2
    
    
    Nortel Networks Supplementary Executive Retirement Plan, as amended effective October 18,
2001 and October 23, 2002 (filed as Exhibit 10.2 to Nortel Networks Limiteds Annual Report
on Form 10-K for the year ended December 31, 2002).*10.3
    
    
    Agreement dated April 29, 1997 related to the remuneration of the Chief Legal Officer
(filed as Exhibit 10.3 to Nortel Networks Limiteds Annual Report on Form 10-K for the year
ended December 31, 2001).*10.4
    
    
    Acknowledgement effective as of June 1, 2000 related to the remuneration of the Chief Legal
Officer (filed as Exhibit 10.4 to Nortel Networks Limiteds Annual Report on Form 10-K for
the year ended December 31, 2001).*10.5
    
    
    Statement describing the retirement arrangements of the former President and Chief
Executive Officer (filed as Exhibit 10.5 to Nortel Networks Limiteds Annual Report on Form
10-K for the year ended December 31, 2001).*10.6
    
    
    Nortel Networks Corporation Executive Retention and Termination Plan, as amended and
restated, effective from June 26, 2002 (filed as Exhibit 10.1 to Nortel Networks
Corporations Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).*10.7
    
    
    Nortel Networks Corporation Special Retention Plan effective August 1, 2001 and expired on
June 30, 2003 (filed as Exhibit 10.3 to Nortel Networks Corporations Quarterly Report on
Form 10-Q for the quarter ended September 30, 2001).*10.8
    
    
    Assumption Agreement between Nortel Networks Corporation and Nortel Networks Limited dated
March 5, 2001, regarding the assumption and agreement by Nortel Networks Corporation to
perform certain covenants and obligations of Nortel Networks Limited under the Nortel
Networks Limited Executive Retention and Termination Plan (filed as Exhibit 10.25 to Nortel
Networks Corporations Annual Report on Form 10-K for the year ended December 31, 2000).*10.9
    
    
    Five Year Credit Agreement dated as of April 12, 2000, among Nortel Networks Limited, as
borrower, various banks, as lenders, Royal Bank of Canada and Toronto Dominion Bank, as
co-syndication agents, and J.P. Morgan Canada, as administrative agent (filed as Exhibit
10.4 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter ended June
30, 2001).*10.10
    
    
    Five Year Credit Agreement dated as of April 12, 2000, among Nortel Networks Limited, as
guarantor, Nortel Networks Inc., as borrower, various banks, as lenders, ABN AMRO Bank
N.V., Bank of America N.A. and Citibank N.A., as co-syndication agents, and Morgan Guaranty
Trust Company of New York, as administrative agent (which terminated on April 28, 2004)
(filed as Exhibit 10.5 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the
quarter ended June 30, 2001).
 174




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ExhibitNumber
    
    Description*10.11
    
    
    U.S. Guarantee and Security Agreement dated as of the first day of the Collateral Period
(as defined therein) among Nortel Networks Limited, Nortel Networks Inc. and certain of
their subsidiaries and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 99.1 to
Nortel Networks Limiteds Current Report on Form 8-K dated January 18, 2002).*10.12
    
    
    Amendment No. 1 dated as of December 12, 2002 to the U.S. Guarantee and Security Agreement
dated as of April 4, 2002 among Nortel Networks Limited, Nortel Networks Inc., the
Subsidiary Lien Grantors party thereto and JPMorgan Chase Bank, as Collateral Agent (filed
as Exhibit 99.2 to Nortel Networks Limiteds Current Report on Form 8-K dated December 13,
2002).*10.13
    
    
    Canadian Guarantee and Security Agreement dated as of the first day of the Collateral
Period (as defined therein) among Nortel Networks Limited and certain of its subsidiaries
and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 99.1 to Nortel Networks
Limiteds Current Report on Form 8-K dated February 4, 2002).*10.14
    
    
    Amendment No. 1 dated as of December 12, 2002 to the Canadian Guarantee and Security
Agreement dated as of April 4, 2002 among Nortel Networks Limited, Nortel Networks Inc.,
the Subsidiary Guarantors party thereto and JPMorgan Chase Bank, as Collateral Agent (filed
as Exhibit 99.3 to Nortel Networks Limiteds Current Report on Form 8-K dated December 13,
2002).*10.15
    
    
    Form of Nortel Networks Limited Foreign Subsidiary Guarantee dated as of April 4, 2002 and
schedule thereto listing the specific foreign subsidiary guarantees which are not attached
as exhibits (filed as Exhibit 10.5 to Nortel Networks Limiteds Quarterly Report on Form
10-Q for the quarter ended March 31, 2002).*10.16
    
    
    Amendment No. 1 dated as of December 12, 2002 to certain Foreign Subsidiary Guarantees
dated as of April 4, 2002 among Nortel Networks (Ireland) Limited, Nortel Networks UK
Limited, Nortel Networks (Asia) Limited and JPMorgan Chase Bank, as Collateral Agent (filed
as Exhibit 99.4 to Nortel Networks Limiteds Current Report on Form 8-K dated December 13,
2002).*10.17
    
    
    Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, the
Subsidiary Guarantors party thereto and JPMorgan Chase Bank, as Collateral Agent (filed as
Exhibit 10.6 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002).*10.18
    
    
    Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, Nortel
Networks International Corporation and JPMorgan Chase Bank, as Collateral Agent (filed as
Exhibit 10.7 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002).*10.19
    
    
    Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Inc. and JPMorgan
Chase Bank, as Collateral Agent (filed as Exhibit 10.8 to Nortel Networks Limiteds
Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).*10.20
    
    
    Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, Nortel Networks
International Finance & Holding B.V., Nortel Networks S.A., and JPMorgan Chase Bank, as
Collateral Agent (filed as Exhibit 10.9 to Nortel Networks Limiteds Quarterly Report on
Form 10-Q for the quarter ended March 31, 2002).
 175




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ExhibitNumber
    
    Description*10.21
    
    
    Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks International
Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB
and JPMorgan Chase Bank, as Collateral Agent, together with (a) the Supplementing Pledge
Agreement dated as of April 4, 2002 among Nortel Networks International Finance & Holding,
B.V. and JPMorgan Chase Bank, as Collateral Agent, (b) the Pledge Agreement Supplement
dated as of April 4, 2002 between Nortel Networks Limited and JPMorgan Chase Bank, as
Collateral Agent, and (c) the Pledge Agreement Supplement dated as of April 4, 2002 between
Nortel Networks U.K. Limited and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit
10.10 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter ended
March 31, 2002).*10.22
    
    
    Foreign Pledge Agreement dated as of April 4, 2002 between Nortel Networks International
Finance & Holding B.V. and JPMorgan Chase Bank, as Collateral Agent, together with (a) the
Pledge Agreement Supplement, dated as of April 4, 2002 between Nortel Networks Optical
Components Limited and JPMorgan Chase Bank, as Collateral Agent, and (b) the Pledge
Agreement Supplement dated as of April 4, 2002 between Nortel Networks International
Finance & Holding B.V., Nortel Networks Optical Components Limited and JPMorgan Chase Bank,
as Collateral Agent (filed as Exhibit 10.11 to Nortel Networks Limiteds Quarterly Report
on Form 10-Q for the quarter ended March 31, 2002).*10.23
    
    
    Pledge Agreement Supplement dated as of May 20, 2002 between Nortel Networks Mauritius Ltd
and JPMorgan Chase Bank, as Collateral Agent supplementing the Foreign Pledge Agreement
dated as of April 4, 2002 among Nortel Networks International Finance & Holding B.V.,
Nortel Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase Bank,
as Collateral Agent (filed as Exhibit 10.2 to Nortel Networks Limiteds Quarterly Report on
Form 10-Q for the quarter ended June 30, 2002).*10.24
    
    
    Pledge Agreement Supplement dated as of May 15, 2002 between Nortel Networks International
Finance & Holding B.V. and JPMorgan Chase Bank, as Collateral Agent, supplementing the
Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks International
Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB
and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 10.3 to Nortel Networks
Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).*10.25
    
    
    Pledge Agreement Supplement dated as of June 4, 2002 between Nortel Networks Singapore Pte
Ltd, and JPMorgan Chase Bank, as Collateral Agent, supplementing the Foreign Pledge
Agreement dated as of April 4, 2002 among Nortel Networks International Finance & Holding
B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase
Bank, as Collateral Agent (filed as Exhibit 10.4 to Nortel Networks Limiteds Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002).*10.26
    
    
    Pledge Agreement Supplement dated as of May 15, 2002 between Nortel Networks Limited and
JPMorgan Chase Bank, as Collateral Agent, supplementing the Foreign Pledge Agreement dated
as of April 4, 2002 among Nortel Networks Limited, the Subsidiary Guarantors party thereto
and JP Morgan Chase Bank, as Collateral Agent (filed as Exhibit 10.5 to Nortel Networks
Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).*10.27
    
    
    Nortel Networks Limited SUCCESS Plan approved on July 25, 2002, as amended and restated on
July 28, 2003 with effect from January 1, 2003, as amended on July 28, 2003 with effect
from January 1, 2003, as amended on February 26, 2004 with effect from January 1, 2004
(filed as Exhibit 10.3 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the
quarter ended March 31, 2004).*10.28
    
    
    Supplementary Pension Credits Arrangement (filed as Exhibit 10.14 to Nortel Networks
Corporations Registration Statement on Form S-1 (No. 2-71087)).*10.29
    
    
    Statements describing the right of certain executives in Canada to defer all or part of
their short-term and long-term incentive awards (filed as Exhibit 10.4 to Nortel Networks
Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30, 2000).
 176




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ExhibitNumber
    
    Description*10.30
    
    
    Statement describing eligibility for the Group Life Insurance Plan for directors who are
not salaried employees of Nortel Networks Corporation (filed as Exhibit 10.30 to Nortel
Networks Limiteds Annual Report on Form 10-K for the year ended December 31, 2002).*10.31
    
    
    Resolutions of the Board of Directors of Nortel Networks Limited dated December 18, 2003,
related to the remuneration of the chairman of the board, directors and chairman of the
audit committee, effective January 1, 2004 (filed as Exhibit 10.31 to Nortel Networks
Limiteds Annual Report on Form 10-K for the year ended December 31, 2003).*10.32
    
    
    Resolutions of the Board of Directors of Nortel Networks Limited dated December 17, 1993,
as amended by resolutions of the Board of Directors of Nortel Networks Limited dated
February 29, 1996, providing for retirement compensation of directors who are not salaried
employees of Nortel Networks Limited or its subsidiaries (filed as Exhibit 10.32 to Nortel
Networks Limiteds Annual Report on Form 10-K for the year ended December 31, 2002).*10.33
    
    
    Agreement between a director of Nortel Networks Corporation and Nortel Networks Limited and
the respective companies dated June 22, 2001, setting forth the arrangements with respect
to serving as non-executive chairman of each of the board of directors of Nortel Networks
Corporation and Nortel Networks Limited (filed as Exhibit 10.1 to Nortel Networks Limiteds
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001).*10.34
    
    
    Amended general description of cash bonus for employees and executives of Nortel Networks
Corporation and Nortel Networks Limited as originally filed as Exhibit 10.3 to Nortel
Networks Corporations Quarterly Report on Form 10-Q for the quarter ended September 30,
2002 (filed as Exhibit 10.1 to the Nortel Networks Limiteds Quarterly Report on Form 10-Q
for the quarter ended June 30, 2003).*10.35
    
    
    Nortel Networks Limited Restricted Stock Unit Plan dated as of January 30, 1997, as amended
effective April 29, 1999, September 1, 1999, February 15, 2000, May 1, 2000,November 15,
2000 and January 23, 2003 (filed as Exhibit 10.1 to Nortel Networks Limiteds Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003).*10.36
    
    
    Nortel Networks Limited Directors Deferred Share Compensation Plan effective June 30, 1998
and amended and restated as of May 1, 2000, as amended and restated effective January 1,
2002, as amended and restated May 29, 2003, as amended and restated December 18, 2003
effective January 1, 2004. (filed as Exhibit 10.36 to Nortel Networks Limiteds Annual
Report on Form 10-K for the year ended December 31, 2003).*10.37
    
    
    Nortel Networks U.S. Deferred Compensation Plan (filed as Exhibit 4.3 to Post-Effective
Amendment No. 1 to Nortel Networks Corporations Registration Statement on Form S-8 (No.
333-11558)).*10.38
    
    
    Master Facility Agreement dated as of February 14, 2003, and amended July 10, 2003, between
Nortel Networks Limited and Export Development Canada, and as further amended by a letter
agreement dated March 29, 2004, May 28, 2004, August 20, 2004 and September 29, 2004
(filed as Exhibit 99.2 to Nortel Networks Limiteds Current Report on Form 8-K dated
September 30, 2004).*10.39
    
    
    Master Indemnity Agreement dated as of February 14, 2003 between Nortel Networks Limited
and Export Development Canada (filed as Exhibit 99.3 to Nortel Networks Limiteds Current
Report on Form 8-K dated February 14, 2003).*10.40
    
    
    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
(filed as Exhibit 99.2 to Nortel Networks Limiteds Current Report on Form 8-K dated July
10, 2002).
 177




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##### Table of Contents



ExhibitNumber
    
    Description*10.41
    
    
    Letter dated June 23, 2003 from the former President and Chief Executive Officer of Nortel
Networks, to the Joint Leadership Resources Committee of the Board of Directors of Nortel
Networks Corporation and Nortel Networks Limited regarding the voluntary return for
cancellation of certain stock options to purchase common shares of Nortel Networks
Corporation (filed as Exhibit 10.3 to the Nortel Networks Limiteds Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003).*10.42
    
    
    Notice of Blackout to the Registrants Board of Directors and Executive Officers Regarding
Suspension of Trading dated March 10, 2004 (filed as Exhibit 99.1 to Nortel Networks
Limiteds Current Report on Form 8-K dated March 10, 2004).*10.43
    
    
    Summary statement of terms of initial compensation arrangements related to the president
and chief executive officer approved by the Board of Directors of Nortel Networks
Corporation and Nortel Networks Limited as of April 29, 2004 (filed as Exhibit 10.1 to
Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30,
2004).*10.44
    
    
    Asset Purchase Agreement dated June 29, 2004 among Nortel Networks Limited, Flextronics
International Ltd. and Flextronics Telecom Systems, Ltd. (filed as Exhibit 10.3 to Nortel
Networks Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).**10.45
    
    
    Amended and Restated Master Contract Manufacturing Services Agreement dated June 29, 2004
between Nortel Networks Limited and Flextronics Telecom Systems, Ltd. (filed as Exhibit
10.4 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter ended June
30, 2004).**10.46
    
    
    Master Repair Services Agreement dated June 29, 2004 between Nortel Networks Limited and
Flextronics Telecom Systems Limited (filed as Exhibit 10.5 to Nortel Networks Limiteds
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).**10.47
    
    
    Master Contract Logistics Services Agreement dated June 29, 2004 between Nortel Networks
Limited and Flextronics Telecom Systems, Ltd. (filed as Exhibit 10.6 to Nortel Networks
Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).**10.48
    
    
    Letter Agreement dated June 29, 2004 among Nortel Networks Limited, Flextronics
International Ltd. and Flextronics Telecom Systems, Ltd. (filed as Exhibit 10.7 to Nortel
Networks Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).*10.49
    
    
    William A. Owens, President and Chief Executive Officer Employment Letter dated as at
August 31, 2004 (filed as Exhibit 10.2 to Nortel Networks Limiteds Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004).*10.50
    
    
    Resolutions of the Board of Directors of Nortel Networks Limited dated July 30, 2004,
related to the remuneration of the chairman of the board, directors, members of a board
committee, chairman of a board committee (other than the audit committee) and chairman of
the audit committee, effective July 1, 2004 (filed as Exhibit 10.3 to Nortel Networks
Corporations Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).10.51
    
    
    First Amending Agreement to Amended and Restated Master Contract Manufacturing Services
Agreement dated as of November 1, 2004 between Nortel Networks Limited and Flextronics
Telecom Systems, Ltd.10.52
    
    
    First Amending Agreement to Asset Purchase Agreement dated as of November 1, 2004 among
Nortel Networks Limited, Flextronics International Ltd. and Flextronics Telecom Systems,
Ltd.21.
    
    
    Subsidiaries of the Registrant.
 178




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##### Table of Contents



ExhibitNumber
    
    Description23.
    
    
    Consent of Deloitte & Touche LLP.24.
    
    
    Power of Attorney of certain directors and officers.31.1
    
    
    Rule 13a  14(a)/15d  14(a) Certification of the Vice-Chairman and Chief Executive Officer.31.2
    
    
    Rule 13a  14(a)/15d  14(a) Certification of the Chief Financial Officer.32.
    
    
    Certification of the Vice-Chairman 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.
  *
    
    Incorporated by Reference**
    
    Certain portions of this Exhibit have been omitted based upon a request for confidential
treatment. These portions have been filed separately with the United States Securities and
Exchange Commission. 179




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Brampton, Ontario, Canada on the 29th day of April, 2005. NORTEL NETWORKS LIMITEDBy:
    /s/ William A. Owens(William A. Owens, President andChief Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the
capacities indicated on the 29th day of April, 2005. Signature
    
    TitlePrincipal Executive Officer/s/ William A. Owens
    
    Vice-Chairman and Chief Executive Officer,
and a Director(WILLIAM A. OWENS)Principal Financial Officer/s/ Peter W. Currie
    
    Executive Vice-President
and Chief Financial Officer(PETER W. CURRIE)Principal Accounting Officer/s/ Karen E. Sledge
    
    Controller(KAREN E. SLEDGE)
 180




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##### Table of Contents



Directors: M. Bischoff*
    
    J. Manley*(M. BISCHOFF)
    
    (J. MANLEY)J.J. Blanchard*
    
    R.D. McCormick*(J.J.BLANCHARD)
    
    (R.D. MCCORMICK)R.E. Brown*
    
    W.A. Owens*(R.E. BROWN)
    
    (W.A. OWENS)J.E. Cleghorn*
    
    H.J. Pearce*(J.E. CLEGHORN)
    
    (H.J. PEARCE)L.Y. Fortier*
    
    G. Saucier*(L.Y. FORTIER)
    
    (G. SAUCIER)R.A. Ingram*
    
    S.H. Smith, JR.*(R.A. INGRAM)
    
    (S.H. SMITH, JR.)L.R. Wilson*(L.R. WILSON)By:*
    /s/ Gordon A. Davies(GORDON A. DAVIES, as attorney-in fact)
April 29, 2005
 181