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

FORM 10-K/A

Amendment No. 1

|  |  |                                                                                                                                                                | 
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|x |  | Annual report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2002                               | 
|  |  |                                                                                                                                                                | 
|o |  | Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from _________________ to _________________ | 

Commission file number 000-30758

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

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

|                                                                                               |  |                   
|---------------------------------------------------------------------------------------------- |  | ------------------
|8200 Dixie Road, Suite 100, Brampton, Ontario, Canada
(Address of principal executive offices) |  | L6T 5P6
(Zip Code)

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

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

|                                            |  |                                          
|------------------------------------------- |  | -----------------------------------------
|Title of each class                         |  | Name of each exchange on which registered
|Guarantees of Nortel Networks Corporations |  | New York Stock Exchange                  
|4.25% 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/A or any amendment to
this Form 10-K/A. ü

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

At February 28, 2003, 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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|         |                                                                                                 |                                                                 |  |  |  |  |  | 
|-------- | ----------------------------------------------------------------------------------------------- | --------------------------------------------------------------- |  |  |  |  |  | 
|PART I  
|         | ITEM 1. Business                                                                               
|         |                                                                                                 | Overview                                                       
|         |                                                                                                 | Developments in 2002                                           
|         |                                                                                                 | Networking solutions                                           
|         |                                                                                                 | Wireless Networks                                              
|         |                                                                                                 | Enterprise Networks                                            
|         |                                                                                                 | Wireline Networks                                              
|         |                                                                                                 | Optical Networks                                               
|         |                                                                                                 | Sales and distribution                                         
|         |                                                                                                 | Product standards, certification and regulation                
|         |                                                                                                 | Sources and availability of materials                          
|         |                                                                                                 | Seasonality                                                    
|         |                                                                                                 | Strategic alliances, acquisitions and minority investments     
|         |                                                                                                 | Research and development                                       
|         |                                                                                                 | Intellectual property                                          
|         |                                                                                                 | Employee relations                                             
|         |                                                                                                 | Environmental matters                                          
|         |                                                                                                 | Financial information by operating segment and product category
|         |                                                                                                 | Financial information by geographic area                       
|         |                                                                                                 | Working capital                                                
|         |                                                                                                 | Risk factors                                                   
|PART II 
|         | ITEM 6. Selected Financial Data (unaudited)                                                    
|         | ITEM 7.   Managements Discussion and Analysis of Financial Condition and Results of Operations
|         | ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk                            
|         | ITEM 8. Consolidated Financial Statements and Supplementary Data                               
|PART III
|         | ITEM 14. Controls and Procedures                                                               
|PART IV 
|         | ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                       
|         | SIGNATURES                                                                                     
|Ex-12   
|Ex-23.1 
|Ex-23.2 
|Ex-31.1 
|Ex-31.2 
|Ex-32   



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EXPLANATORY NOTE

This Amendment No. 1 to our Annual Report on Form 10-K for the year ended
December 31, 2002 initially filed with the Securities and Exchange Commission
(SEC) on March 10, 2003 (the Originally Filed 10-K) is being filed to
reflect restatements of the following (audited) financial statements:
consolidated statements of operations, shareholders equity and cash flows for
the years ended December 31, 2002, 2001 and 2000, and consolidated balance
sheets as at December 31, 2002 and 2001. On October 23, 2003, we announced
that we would restate our consolidated financial statements for the years ended
December 31, 2002, 2001 and 2000 and for the quarters ended March 31, 2003 and
June 30, 2003 in connection with our previously announced comprehensive review
and analysis of our assets and liabilities and certain related reviews.
For a description of the
restatements, see Restatements in note 3 to the
accompanying (audited)
consolidated financial statements and Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations  Developments in
2003  Restatements in this Amendment No. 1.

This Amendment No. 1 amends and restates Item 1 of Part I, Items 6, 7, 7A, and
8 of Part II, Item 14 of Part III and Item 15 of Part IV of the Originally
Filed 10-K, and except for such items and Exhibits 12, 23.1, 23.2, 31.1, 31.2
and 32, no other information in the Originally Filed 10-K is amended hereby.
The explanatory caption at the beginning of each item of this Amendment No. 1
sets forth the nature of the revisions to that item.

We did not amend our Annual Reports on Form 10-K or Quarterly Reports on Form
10-Q for periods affected by the restatements that ended prior to December 31,
2002, and the financial statements, auditors reports and related financial
information for the affected periods contained in such reports should no longer
be relied upon.

For a discussion of events and developments subsequent to December 31, 2002,
see:



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



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



| |  | our other filings subsequent to December 31, 2002.
| | - | --------------------------------------------------





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TABLE OF CONTENTS

PART I

PAGEITEM 1.
    
    Business
    
    
    1Overview
    
    
    1Developments in 2002
    
    
    2Networking solutions
    
    
    3Wireless Networks
    
    
    4Enterprise Networks
    
    
    8Wireline Networks
    
    
    12Optical Networks
    
    
    15Sales and distribution
    
    
    19Product standards, certification and regulation
    
    
    19Sources and availability of materials
    
    
    20Seasonality
    
    
    20Strategic alliances, acquisitions and minority investments
    
    
    20Research and development
    
    
    21Intellectual property
    
    
    22Employee relations
    
    
    22Environmental matters
    
    
    23Financial information by operating segment and product category
    
    
    23Financial information by geographic area
    
    
    23Working capital
    
    
    24Risk factors
    
    
    24PART IIITEM 6.
    
    Selected Financial Data (Unaudited)
    
    
    25ITEM 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    26ITEM 7A.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    76ITEM 8.
    
    Consolidated Financial Statements and Supplementary Data
    
    
    77PART IIIITEM 14.
    
    Controls and Procedures
    
    
    78PART IVITEM 15.
    
    Exhibits, Financial Statement Schedules and Reports on Form 8-K
    
    
    80SIGNATURES
    
    
    
    
    122CERTIFICATIONS
    
    
    
    
    126




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

NORTEL NETWORKS, NORTEL NETWORKS LOGO, NT, the GLOBEMARK, BAYSTACK, CALLPILOT,
CONTIVITY, DMS, EPICON, MERIDIAN, NORSTAR, OPTERA, PASSPORT, PERIPHONICS,
PRESIDE, SHASTA, SUCCESSION, SYMPOSIUM and UNIVERSAL EDGE are trademarks of
Nortel Networks.

ALTEON is a trademark of Alteon WebSystems.

CDMA2000 is a trademark of the Telecommunications Industry Association.

CDMAONE  designmark is a trademark of the CDMA Development Group, Inc.

CLARIFY is a trademark of Amdocs Software Systems Limited.





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JUNGLEMUX is a trademark of GE Industrial Systems Technology Management Inc.

MICROSOFT and WINDOWS XP are trademarks of Microsoft Corporation.

MOODYS is a trademark of Moodys Investors Services, Inc.

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





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PART I




ITEM 1. Business

This Item 1 has been revised to reflect the restatements and certain
developments occurring subsequent to the filing of the Originally
Filed10-K
with respect to our business, including an update of information with
respect to research and development expenses and product development. In
addition, this Item 1 has been revised to incorporate certain conforming
changes.




Overview

Nortel Networks Limited is an industry leader and innovator focused on
transforming how the world communicates and exchanges information. We are
removing barriers to business opportunity through the supply of communications
technology and infrastructure to enable value-added internet protocol, or IP,
data, voice and multimedia services that support the Internet and other public
and private networks using wireline and wireless technologies. We refer to the
technology and infrastructure that we supply as networking solutions. Our
networking solutions generally bring together diverse networking products from
our various product families, and related services, to create either a
customized or off the shelf solution for our customers. Our business
consists of the design, development, manufacture, assembly, marketing, sale,
licensing, installation, servicing and support of these networking solutions.
A substantial portion of Nortel Networks has a technology focus and is
dedicated to research and development. This focus forms a core strength and a
factor differentiating us from many of our competitors. We envision an
information society where people will be able to connect and interact with
information and with each other instantly, simply and reliably, seamlessly
accessing data, voice and multimedia communications services and sharing
experiences anywhere, anytime.

Our networking solutions include network equipment, software and other
technologies that enable local and long-distance communications companies,
wireless service providers, cable multiple system operators and other
communications service providers to provide their customers with services to
communicate locally, regionally or globally through the use of data, voice and
multimedia communications.

Also, our networking solutions provide enterprises such as large and small
businesses, governments, educational institutions and other organizations, with
the ability to communicate locally or globally within their organization and
with other organizations and individuals through the use of data, voice and
multimedia communications. We are focused on providing high-performance
networking solutions that transform the way people and companies communicate
and conduct business.

During the third quarter of 2002, we changed the way we managed our
business to streamline and focus more directly on our customers in our four
core business areas. We now conduct business in the following four reportable
segments: Wireless Networks; Enterprise Networks; Wireline Networks; and
Optical Networks (formerly named Optical Long-Haul Networks). During the
second quarter of 2002, we shifted the accountability for the metro optical
portion of Metro and Enterprise Networks (now split into Enterprise Networks
and Wireline Networks) into Optical Networks. We refer you to the descriptions
of Wireless Networks, Enterprise Networks, Wireline Networks and Optical
Networks below. All financial information has been restated to reflect these
re-organizations. For financial information by reporting segment and product
category, see Segmented information in note 6 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.

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 originally incorporated under the laws of Canada as the
Northern Electric Company, Limited (a successor to the business of Northern
Electric and Manufacturing Company, Limited, a subsidiary of Bell Canada
incorporated in 1895) on January 5, 1914. The Company participated in a
corporate amalgamation with two of its wholly owned subsidiaries on January 4,
1982. The Company changed its name to 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

1



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Networks Corporation, previously known as New Nortel Inc., and BCE Inc.,
the largest shareholder of the Company prior to the plan of arrangement. In
connection with the plan of arrangement on May 1, 2000:

| |  | the company changed its name to Nortel Networks Limited;
| | - | --------------------------------------------------------

| |  | the holders of the outstanding publicly traded common shares of the
Company became common shareholders of Nortel Networks Corporation;
| | - | --------------------------------------------------------------------------------------------------------------------------------------

| |  | common shares of Nortel Networks Corporation were distributed to the common shareholders of BCE; and
| | - | ----------------------------------------------------------------------------------------------------

| |  | the Company became the principal operating subsidiary of Nortel Networks Corporation.
| | - | -------------------------------------------------------------------------------------

References to the Company mean Nortel Networks Limited without its
subsidiaries. References to we, our, us, or Nortel Networks mean the
Company and its subsidiaries.

We make our 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.nortelnetworks.com
as soon as reasonably practicable after we electronically file this material
with, or furnish this material to, the United States Securities and Exchange
Commission. Information contained on our website is not incorporated by
reference into our annual report on Form 10-K.




Developments in 2002

In 2002, the telecommunications industry continued to experience
significant adjustment which began in 2001. Industry demand for networking
equipment continued to decline in response to the ongoing industry adjustment,
economic downturn and to the related tightening in the global capital markets.
As a result of the continued industry adjustment, the business marketplace has
changed. In 2002, excess network capacity still existed as a result of the
pace of new network construction and strong economic growth in 1999 and 2000
and due to the financial difficulties of a number of communications service
providers around the world. In 2002, the industry also experienced continuing
consolidation.

Our customers continued to focus in 2002 on conserving capital, decreasing
their debt levels, reducing costs and/or increasing the capacity utilization
rates and efficiency of existing networks. Customers are no longer building
new networks in anticipation of market demand but are waiting until actual end
user demand warrants such increased network capacity. Enterprises and service
providers are focused on conservative capital spending that can reduce their
costs, provide new revenue growth and maximize their return on invested
capital. As a result, capital spending by enterprises and service providers
around the world continued to decline in 2002.

In response to the ongoing industry adjustment, we engaged in a number of
activities in 2002 to further streamline our operations and activities around
our four core businesses and to strengthen our financial position. Some of our
activities in 2002 included:



| |  | realignment of Optical Networks, including the sale of certain optical components assets;
| | - | -----------------------------------------------------------------------------------------

| |  | restructuring, including additional workforce reductions and asset writedowns;
| | - | ------------------------------------------------------------------------------

| |  | equity offerings by Nortel Networks Corporation during the second quarter; and
| | - | ------------------------------------------------------------------------------

| |  | expiration and termination of certain of our credit facilities and amendments to our security agreements.
| | - | ---------------------------------------------------------------------------------------------------------

As a result of these initiatives, we have made substantial progress in
reducing our costs and creating a business model that we believe is better
aligned to the current state of our industry. For information on these and
other developments in 2002, see Special charges in note 7, Divestitures,
closures and acquisitions in note 10, Long-term debt and credit facilities
in note 11 and Capital stock in note 15 of the accompanying consolidated
financial statements and Developments in 2002 in Managements Discussion and
Analysis of Financial Condition and Results of Operations.

2



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Networking solutions

Our networking solutions include network equipment, software and other
technologies that enable communications through the use of data, voice and
multimedia networking. In our industry, networking refers to:



| |  | the connecting of two or more communications devices, such as
telephones for voice communications and personal computers for data
communications, 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.
| | - | ----------------------------------------------

A telecommunications network generally consists of network access
equipment, network transport equipment and core networking equipment.

Network access

Network access refers to the portion of a network that runs from an end
user to the network access equipment that resides in locations between the end
users site and the interior or core areas of a network. For our network
access solutions, we refer you to each of our segment descriptions below.

Network transport

Network transport refers to the portion of a network that runs from
network access equipment to core networking equipment, or from core networking
equipment in one location to core networking equipment in another location.
Network transport may be over wireline cabling (fiber optic, copper wire or
coaxial), or over wireless radio signals transmitted through the air between
locations using antennas. The most common method for long-distance network
transport is optical networking, which uses light waves to transmit
communications signals through fiber optic cables. Network transport by
wireless radio signals is also known as digital radio transport, which we do
not offer as part of our products and services. For our optical transport
products, we refer you to our Optical Networks description below.

Core networking

Core networking refers to the apparatus and workings of the interior areas
of a network. Core networking equipment directs, routes or switches the
data, voice and multimedia communications signals from one part of the network
to another. Core networking uses either packet-based networking or circuit
networking. Packet-based networking involves the partitioning 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, which requires a separate network circuit to be maintained for each
communications signal for the duration of the transmission. For our core
networking solutions, we refer you to each of our segment descriptions below.

3



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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 and personal digital assistants. 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.



| |  | First generation (1G) wireless technology refers to analog wireless
communications networks based on circuit switching technology that are
limited to voice communications.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Second generation (2G) wireless technology refers to digital wireless
communications networks based on circuit switching technology with
modest data transmission capabilities.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Third generation (3G) wireless technology refers to digital wireless
communications networks based on packet networking technology with
voice, high-speed data and multimedia transmission capabilities.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 based on 2G
wireless technologies. However, 3G networks have been launched in several
regions. There are several main international standards for wireless
communications networks.



| |  | Time Division Multiple Access (TDMA) is a 2G wireless standard
supported mainly in the United States, Canada and the Caribbean and
Latin America region, or CALA, that uses timeslots within a radio
frequency channel to separate users conversations.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Code Division Multiple Access (CDMA) is a 2G wireless standard, also
known as cdmaOne, supported in each geographic region. CDMA uses codes,
much like encryption, to distinguish one call from another, with all
calls in a given cell transmitted over the entire range of radio
frequencies assigned to the network operator within the cell. CDMA
networks are evolving to 3G according to the CDMA 3G 1xRTT (single
channel (1x) Radio Transmission Technology) standard, also known as cdma
2000, for voice and high-speed data mobility. CDMA 3G 1xEV-DO
(EVolution Data Only) and CDMA 3G 1xEV-DV (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 (GSM) is a 2G wireless
standard supported all over the world that, like TDMA, uses time slots
within a specified radio frequency channel to distinguish one call from
another. GSM networks are evolving to carry data, as well as voice,
with the introduction of General Packet Radio Standard (GPRS). GPRS is
viewed as a 2.5G technology that provides faster and therefore
increased data transmission capabilities. Enhanced Data Rates for
Global Evolution (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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Universal Mobile Telecommunications System (UMTS) is an emerging
standard for 3G networks based on Wideband CDMA (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 offer a broad portfolio of solutions for wireless communications
networks. Our wireless networking products support the TDMA, CDMA/CDMA 3G,
GSM/GPRS/EDGE and UMTS standards. We also offer a range of related
professional services to our customers, including: network design and
engineering services; installation services; network optimization services;
network operation services; and technical operations and maintenance services.

4



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Network access

Radio network access equipment uses radio waves to provide wireless access
to the subscribers hand held 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 and base station controllers. As a mobile subscriber moves away
from the area covered by a base station transceiver, also known as a cell site,
the subscriber will lose the call unless an adjacent cell site provides the
coverage. This requires that an active wireless call be transferred from one
cell to another cell without breaking or disconnecting the call in progress,
also known as a hand-off. Base station transceivers and base station
controllers work together with core networking equipment to perform a call
hand-off. We offer our customers a wide range of base station transceivers and
base station controllers for TDMA, CDMA/CDMA 3G, GSM/GPRS/EDGE and UMTS
standards. The base stations are available in the common frequency spectrum
bands that are assigned to mobile communications and support a wide variety of
network requirements, including metropolitan and dense urban networks. These
are generally available in micro, macro and mini base station transceiver
packages and are available in both outdoor and indoor versions of base station
transceivers. We do not manufacture or sell cellular phones.



| |  | Our CDMA base station transceivers support CDMA 2G (IS-95) and CDMA
3G transmission standards. Many of our customers have already deployed
CDMA 3G base station transceivers that support 1xRTT and are upgradeable
to support emerging CDMA 3G 1xEV-DO and CDMA 3G 1xEV-DV standards in the
future.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our GSM base station products support wireless service providers with
licensed radio spectrum and can be upgraded to support GPRS.
| | - | ----------------------------------------------------------------------------------------------------------------------------------



| |  | Our UMTS Access Network radio network access equipment is now
available for commercial deployment.
| | - | --------------------------------------------------------------------------------------------------

Core networking

Core networking equipment directs, routes or switches communications
signals within a service providers wireless communications network. The
primary functions of core networking equipment in wireless communications
networks are: identifying and authenticating the called party; locating the
called party; directing the call through the system; and generating call detail
records for billing purposes. The key network elements in the core part of a
wireless communications network are mobile switching centers and home location
registers.



| |  | Mobile switching centers direct or switch data, voice and
multimedia communications signals from one network circuit to another.
Mobile switching centers also support advanced voice services like 3-way
calling, calling party number/name delivery, call holding and call
redirection. Mobile switching centers work in conjunction with adjunct
systems like voice mail systems, short message service centers and
multimedia messaging systems to provide voice, text and multimedia
messaging services.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A home location register is a database that contains permanent
subscriber data, such as provisioning and service information and
dynamic information, such as the wireless handsets current location.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We offer mobile switching centers and home location registers that support
TDMA, CDMA/CDMA 3G, GSM/GPRS/EDGE and UMTS core networks. Our GPRS core
network portfolio includes Serving GPRS Support Node and Gateway GPRS Support
Node. Our Serving GPRS Support Node, which connects the GPRS backbone
network to the base station transceiver and the home location register,
registers and tracks mobile users and delivers data communications to cellular
phones and other mobile devices in a given service area. Our GPRS Gateway
Support Node routes data communications and connects the GPRS backbone network
to external data networks. Our UMTS 3G core networking equipment, including
our UMTS Serving Support Node and our UMTS Gateway Support Node, are
commercially available. Our 3G product portfolio reuses the same platforms
used in 2G and 2.5G products, providing significant investment protection for
our customers.

5



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Product development

Our wireless networking products in development include the next evolution
of our CDMA 3G products, our GSM/GPRS/EDGE products and our 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 undergoing commercial trials in the
United States and Brazil. 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 successfully completed customer trials of Adaptive
MultiRate (AMR) base station transceivers in the second half of 2002.
AMR provides higher spectral efficiency to support more customers on the
same network.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The enhanced version of our GSM base station controller, the GSM BSC
e3 is currently in development. We have been shipping EDGE hardware
ready base station transceivers since the second quarter of 2002, and we
are currently developing EDGE software.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our UMTS radio network access and core networking products are
currently being tested for commercial launch by several operators in the
Europe, Middle East and African region, or EMEA. In 2003, we continued
development on our UMTS solutions for use in the Asia Pacific (including
Greater China) region as well as in the United States.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The further development of 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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Markets

The original wireless communications networks were built using 1G analog
technology. In the early 1990s, advanced 2G digital technology based systems,
including TDMA, CDMA and GSM, were introduced. Over the next couple of years,
we expect most of the remaining analog wireless networks to migrate to digital
technologies.



| |  | Wireless service providers operating TDMA networks, a mature
technology, are expected to migrate to either GSM/GPRS/EDGE or CDMA/CDMA
3G systems based on their business strategies.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Many CDMA operators have already upgraded their network to support
CDMA 3G technology that provides higher data speeds and increased voice
capacity. These networks are expected to evolve to CDMA 3G 1xEV-DO and
CDMA 3G 1xEV-DV standards to further increase data speeds and voice
capacity.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Since the beginning of 2000, many wireless service providers have
been upgrading their GSM networks to GPRS. The upgrade to EDGE is
expected to occur over the next several years, and is viewed by many
operators as 3G. GSM will continue to be an important standard for the
United States, Canada and developing countries.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Certain operators in EMEA and the Asia Pacific region have either
launched or announced their intention to launch 3G networks based on
UMTS technology.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

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. However, the timing of this migration is difficult to
predict as a result of the complexities and potential for delays in
implementation of 3G network deployments.

We anticipate that demand for wireless networking equipment will be driven
primarily by the growth of 2.5G and 3G wireless networking systems. Several
commercial CDMA 3G networks have been launched in the United States, Canada,
CALA and the Asia Pacific region. GPRS networks have already been launched in
EMEA, the Asia Pacific region, the

6



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United States and Canada. In addition, several existing operators are
planning to upgrade their networks to EDGE to support higher data rates. While
the first launches have taken place in EMEA and the Asia Pacific region, the
timing of UMTS network deployments remains uncertain, generally due to delays
in UMTS hand set availability as a result of technology issues, the high
license fees and continued financial difficulty of certain UMTS wireless
service providers.

In the United States and Canada, 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 be driven by CDMA 3G 1xRTT deployment for CDMA-based
networks, and by GPRS and UMTS deployment for GSM and TDMA-based networks.
However, the timing of this migration is uncertain.

Within EMEA, wireless subscriber growth has slowed dramatically over the
last two years in many Western European countries, largely due to very 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. However, many wireless service providers in Europe
have delayed new 3G investments as a result of financing constraints as well as
the significant debt incurred to obtain government licenses for 3G wireless
networks.

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, and a CDMA 3G network build-out by
China Unicom. 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. In CALA, our customers wireless subscriber base has continued to grow
in 2002, largely due to the popularity and increased affordability of wireless
communications services. In Brazil, capital spending by service providers has
begun to shift from wireline communications networks to wireless communications
networks.

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 percent of Nortel
Networks consolidated revenues in 2002.

Competition

Our major competitors in the global wireless infrastructure business have
traditionally included Telefonaktiebolaget LM Ericsson, Lucent Technologies
Inc., Motorola, Inc., Siemens Aktiengesellschaft and Nokia Corporation. Nokia
and Siemens compete in the sale of GSM and UMTS equipment, whereas Lucent
competes in the sale of CDMA, TDMA and UMTS equipment. Motorola is a
competitor in the sale of GSM, UMTS and CDMA radio network access 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. has emerged as a competitor for GSM, CDMA and UMTS systems in China
and many other developing countries. 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;
| | - | ------------------------------

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

| |  | regulatory certification; and
| | - | -----------------------------

| |  | provision of customer financing.
| | - | --------------------------------

We intend to continue to compete with our traditional competitors as the
global market for wireless networking equipment migrates to 3G technologies.
We also expect newer competitors, such as NEC Corporation and Matsushita
Electric Industrial Co., Ltd. (also known as Panasonic), to emerge.




Enterprise Networks

Products

Our Enterprise Networks portfolio of products provide voice, data and
multimedia communications for our customers. We also provide our customers
with related professional services including: strategic planning and network
design services; operations planning and consulting services; technology and
process outsourcing services; network applications and network content
services; and installation and ongoing technical support.

Circuit and packet voice solutions

Our voice portfolio includes a broad range of circuit and packet voice
communications solutions. These include circuit to packet convergence systems,
combined voice and data integration solutions, as well as next generation and
legacy voice systems.



| |  | Our enterprise Succession solutions are combined voice and data
communications systems for service providers and large enterprises.
These solutions are designed to give our customer the ability to support
data and large enterprises networking without replacing their existing
voice networks, or the ability to add voice services to existing data
networks. Our enterprise Succession solutions can be used by customers
building new networks, and customers who want to transform their
existing voice communications network into a more cost effective
packet-based network supporting data, voice and multimedia
communications.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our Business Communications Manager is a combined voice and data
communications system for branch offices and small to medium-sized
businesses that uses both digital and IP technologies. This solution
allows migration from an enterprises separate voice and data
communications infrastructures to a combined next generation
Internet-based system. Available applications include voice messaging,
cordless phones, contact center software and data communications
routing.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our Meridian telephone switching systems (Meridian) are designed for
small, medium and large commercial enterprises and government agencies.
These circuit and packet network telephone systems provide voice
communications features, such as voice messaging, call waiting and call
forwarding, as well as advanced voice services, multimedia applications
and other networking capabilities. Our customers can also configure
their Meridian to send voice communications over the Internet with our
Internet Telephony Gateway products using our i2002/i2004/i2050 and
standards-based Internet telephones, Meridian digital telephone or any
standard analog telephones.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our remote office portfolio contains a combination of products that
allow remote users, whether individuals at home or groups of employees
in small offices, to access the full complement of Meridian features.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our Norstar telephone switching systems are designed for small to
medium-sized businesses and branch offices of large organizations.
These telephone systems can be configured with a suite of applications,
such as voice messaging, cordless phones, contact center software and
interactive voice response systems.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Our customer contact and voice portal solutions provide the means for
enterprises to do business with their customers efficiently and
consistently regardless of where they are located, the time zone or
whether they interact over the telephone or Internet. Our solutions
include our:
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Periphonics interactive voice response systems that
automate functions often conducted by a companys telephone
agents. Our interactive voice response systems answer the
telephone, greet callers, offer menu options and provide
information to the caller in a consistent, accurate manner. These
systems use advanced speech recognition systems to allow a caller
to interact with the system by orally responding to questions or
prompts presented to the caller by the system.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Symposium contact center portfolio of products that
provide contact center solutions for small, medium and large
organizations. Our Symposium contact center solutions can provide
either a standard circuit-switched voice system or an
Internet-based contact center solution.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | CallPilot, which is a unified messaging tool that
utilizes speech recognition and Transmission Control Protocol/IP
digital networking to give complete access and user control of
facsimile, e-mail and voice messages. Using simple voice commands
like play or print, a user can remotely manage their
multimedia communications over the telephone. The user can print
and forward facsimiles, store, forward or delete voice messages
and more by simply speaking.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our multimedia communications server provides session initiation
protocol (SIP) services for user and gateway devices that run over a
public or private IP network. Such advanced multimedia services that
can be enabled include instant messaging, personal computer camera video
calling, user availability monitoring and control, user-controlled
profile management, and enhanced collaboration and user mobility using
public wireline and wireless networks.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Data networking and security solutions

We offer a broad range of data networking (packet switching and routing)
and security solutions for our customers. Our packet switching and routing
systems include data switching systems, aggregation products, virtual private
network gateways and routers.



| |  | Our Alteon Web products provide data switching designed to allow
service providers and enterprises to provide Internet data security, to
manage and prioritize the Internet content that is provided to end
users, and to balance the amount of communications traffic on multiple
Internet servers.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Our Baystack and Business Policy Switch 2000 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. These switching systems
are designed to allow the prioritization of communications traffic to
ensure network integrity and provide power to Ethernet devices based on
the Ethernet standard used for certain applications, such as systems for
voice communications over the Internet.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our Passport family of multi-service switching products offers
high-speed, high-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. These products
are also key components of our Succession solution, voice over packet
applications and IP virtual private network services. Our Passport
Ethernet Routing Switch delivers IP routing and switching.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our Bay router portfolio is a family of routers that work with a
variety of data networking protocols to offer expandable, contractible
and cost-effective connections for use in our enterprise customers
local area networks, campus networks and wide area networks. These
solutions use the IP standard to route data communications traffic from
one corporate site to another within an enterprises network.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Contivity Secure IP Services Gateways (Contivity) are a family of
products delivering security and IP services in a single integrated
platform. IP services including IP routing, virtual private networks,
firewall applications, policy management and Quality of Service
services, which normally would require several different devices, are
provided by a single Contivity device. Designed for enterprise
networks, Contivity leverages the cost advantages of the Internet while
providing secure communications across the public IP infrastructure.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we introduced a portfolio of wireless local area network
service switching products that are designed to provide secure and
efficient transmission of wireless local area network data traffic for
mobile users.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Product development

We are currently focused on developing products that support the
continuing evolution of voice and data communications systems toward converged
or combined voice and data networks including:



| |  | The continued development of our multimedia communication server for
enterprise, a product that provides the capability to deliver multimedia
applications and enhanced networking capabilities.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Additions to our applications in our Succession products to allow
integration of voice over IP with voice extensible markup language and
new Microsoft operating systems and servers and the development of new
integrated voice recognition speech products offering expanded
scalability and functionality.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | New developments in data networking with our BayStack Layer 2
switches that will deliver resiliency and Quality of Service
capabilities and Power over Ethernet to provide network connectivity and
power to devices over the same line, along with the development of the
next generation Alteon Web platform which will feature higher
performance, scalability (ie. the ability to grow a service or
capability with incremental cost) and integrated applications.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we introduced enhancements to our security portfolio
including the new Alteon SSL and Web Switching products and a new
high-end Contivity product.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we introduced enhanced capabilities to our Passport 8600
version 3.3 software, delivering 10 Gigabit Ethernet on either local
area network or wide area network platforms that feature improved
scaling, multicast and resilience for better overall performance.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we updated our Meridian telephone systems to support our
Succession software. This update enables our Meridian telephone systems
to function entirely as a packet-based system or as a hybrid packet and
circuit switching system. This development allows existing Meridian
customers to upgrade their telephone systems to deploy packet switching
and provides new customers with the ability to customize their desired
mix of packet and circuit switching equipment.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Markets

We offer Enterprise Networks products to enterprises around the world.
With the growth of voice and data 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, 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. However, the timing of this
progression is unclear.

Globally, enterprise customers continue to invest in equipment for their
communications networks, primarily for network security and resiliency, for
voice over IP, wireless local area network and for virtual private networks.
In the United States and Canada, enterprise customers are investing in voice
over IP as they transition from legacy voice products to our enterprise
Succession products. Our enterprise Succession products enable this 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 technology 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.

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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 institutions and utility organizations. Key industry sectors for
our business customers include the telecommunications, high-technology
manufacturing and financial services sectors. We also serve customers in the
healthcare, retail, hospitality, services, transportation, governments 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 also act as a distribution channel for our
Enterprise Networks sales and include incumbent local telephone companies,
competitive local telephone companies and system integrators. None of our
Enterprise Networks customers represent more than 10 percent of Nortel Networks
consolidated revenues in 2002.

Competition

Our principal competitors in the sale of our Enterprise Networks solutions
to enterprises are Cisco Systems, Inc., Avaya Inc., Alcatel S.A., Siemens,
Huawei Technologies Company Limited 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 Foundry Networks, Inc.,
Extreme Networks, Inc., Enterasys Networks, Inc. in data networking, Mitel
Networks Corporation, 3Com Corporation in Internet-based voice communications
solutions and Genesys Telecommunications Laboratories, Inc. in contact centers.
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 products 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; and
| | - | ------------------------------

| |  | alternative solutions offered to enterprises by service providers.
| | - | ------------------------------------------------------------------

The principal competitive factors for the sale of our products to
enterprises also include the leveraging of existing customer-supplier
relationships and the availability of distribution channels.

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Wireline Networks

Products

Our wireline portfolio addresses the demand by our service provider
customers for cost efficient data, voice and multimedia communication
solutions. Our converged wireline solutions, including related professional
services, simplify network architectures bringing voice, video, data and
emerging broadband applications for revenue generating services together on one
easy-to-manage 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 and cable multiple operators
sustainable operating and capital cost reduction, new revenue opportunities, as
well as high levels of reliability and network resiliency.



| |  | Our wireline Succession solutions are voice over packet network
solutions for service providers. Succession provides the complete range
of voice over packet solutions, including local, toll, long-distance,
operator services and international gateway capabilities and enables
voice applications to run on the new multi-services packet network.
Succession solutions leverage more efficient packet-based, as opposed to
circuit-based technologies, which 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 Communication Server (MCS) 5200 (formerly called
Interactive Multimedia Server) is a SIP- based application server. SIP
is a standard protocol for initiating an interactive user session that
involves multimedia elements such as video, voice, chat, gaming and
virtual reality. MCS 5200 works as a stand-alone solution or in
conjunction with our Digital Multiplex System (DMS) or our Succession
solutions to provide advanced packet voice and multimedia capabilities
to service providers. Using MCS 5200, our customers can deploy new,
enhanced multimedia services, including video, collaboration and
personal agent services. Personal agent services allow a user 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our DMS brand is a family of digital, circuit-based telephone
switches that provide local, toll, long-distance and international
gateway capabilities for service providers and includes Directory and
Operator Services for our customers in the United States and Canada.
Our DMS systems enable service providers to connect people making local
and long-distance telephone calls. Our DMS systems also provide for a
broad range of service capabilities, including revenue-generating
features such as caller identification and call waiting that are offered
to the service providers residential and business customers. Our DMS
family of products can evolve to Succession solutions.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we also introduced the Nortel Networks Developers Partner
Program to drive the interoperability of our Succession, MCS 5200 and
DMS portfolios with third party vendors including infrastructure and
application companies.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These products 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. The Passport family of
multi-service wide area network switches and the Shasta Broadband Service Node
enable our service provider customers to offer connectivity solutions and high
value services to both enterprises and residential customers. These
connectivity solutions include packet services such as: frame relay;
Asynchronous Transfer Mode (ATM); Ethernet; and IP access for digital
subscriber line and cable users. In addition, high-value services such as IP
virtual private networks connect enterprise sites and remote users. As well,
they provide enhanced network capabilities, such as network

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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.



| |  | Our Passport family of products, which have the ability to combine
multiple services on a single platform, provide for reliable packet
switching, as well as enabling emerging applications such as wireless
packet core networking, radio access network aggregation, IP network
aggregation, circuit networking traffic grooming and packet voice
gateway applications.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our Shasta Broadband Service Node is designed to give service
providers the ability to logically group tens of thousands of
residential and business subscribers in order to re-direct them to
various IP virtual private networks, and to centrally apply IP data
network services, such as security, firewall applications and class of
service, on a per subscriber and/or per application basis. These
value-add services also play a key role in enabling next generation
communications services, such as those enabled by our Succession voice
over packet product portfolio. The Shasta Broadband Service Node
supports a wide range of data network access technologies, including
standard dial-up over copper telephone wire, digital subscriber line,
ATM, wireless, frame relay and coaxial cable technologies.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 and cable multiple system operators. As well,
we continue to develop products that support the evolution of voice and data
communications systems toward converged or combined voice and data networks
including:



| |  | Enhancements to our Succession packet voice 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Enhancements to the MCS 5200 that will allow a service provider to
offer intelligent multimedia services across any manufacturers circuit
switches. Additionally, development will focus on increasing the
breadth and usability of the MCS 5200 applications.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Additions to the DMS 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 to those
business that use next generation telephones designed for use in IP
networks.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Enhancements to our Shasta 5000 Broadband Service Node solution 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Enhancements to our Passport portfolio to improve the
interoperability with other vendors products. In addition, development
will focus on enhancing the migration to converged networks which
simultaneously support voice, video and data.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The development of a new, lower-capacity, next generation data
product as well as enhancements to our existing line of Passport and
Shasta data products that are intended to efficiently aggregate
different types of data traffic at the network edge.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A focus on cable standards compliance to drive revenue from the cable
multiple system operator market.
| | - | ------------------------------------------------------------------------------------------------------

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Markets

With the growth of voice and data 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 most types of
communications traffic and applications. As data, voice and multimedia
communications technologies continue to converge, we anticipate that in the
future all communications networks will be able to carry data, voice and
multimedia communications effectively, and we anticipate that these networks
will use packet-based technologies. 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 DMS and Passport solutions to packet-based solutions.

To meet the growing demand for increased capacity which these new
multimedia applications will drive at lower per-minute rates, we anticipate
that service providers will transition their digital circuit-based voice
communications to more cost effective packet-based technologies. As a result,
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. However, the timing of this
convergence is unclear given the continuing industry adjustment and reduction
in capital spending by our service provider customers spending.

Cable multiple system operators are increasing the size of voice and data
markets, as well as increasing the competitive pressure on established service
providers.

The market for our Wireline Networks products is global. In the United
States and Canada, many service providers have focused on reducing their
capital spending in response to continuing industry adjustment and economic
slowdown. However, 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. As well, service providers are focused on capital spending that
reduces their ongoing operational costs, albeit with emphasis on shorter
payback periods. In EMEA, we continue to see market demand for certain
networking products including equipment for voice over IP and equipment for
virtual private networking. While service providers in EMEA are also focused
on reducing their capital spending, we anticipate opportunities with leading
national public telephone companies, alternate operators and wireless operators
(a customer segment which devotes significant capital expenditures to wireline
infrastructure).

In the Asia Pacific region, we continue to see market demand for certain
networking products including equipment for voice over IP and equipment for
virtual private networking. Deregulation in China has created opportunities
for new entrants who we anticipate will build-out their networks with
packet-based technologies. In CALA, service providers are also focused on
reducing their capital spending tempered by the need to increase their revenue
generating service offerings.

Customers

We offer our Wireline Networks products and services to a wide range of
wireline and wireless service providers around the world. We are focused on
increasing our market presence with key global service providers who we
currently expect to account for a substantial proportion of service provider
capital spending in 2003 and beyond. Our service provider customers include:



| |  | incumbent local telephone companies (also known as incumbent local
exchange carriers and post telegraph and telecommunications companies);
| | - | ------------------------------------------------------------------------------------------------------------------------------------------

| |  | competitive local telephone companies (also known globally as competitive local exchange carriers);
| | - | ---------------------------------------------------------------------------------------------------

| |  | long-distance telephone companies (also known as interexchange carriers in the United States);
| | - | ----------------------------------------------------------------------------------------------

| |  | wireless service providers;
| | - | ---------------------------

| |  | internet service providers; and
| | - | -------------------------------

| |  | cable multiple system operators.
| | - | --------------------------------

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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 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 percent of Nortel Networks consolidated revenues in 2002.

Competition

Our principal competitors are large communications companies, such as
Cisco, Lucent, Alcatel and Siemens. In addition, we compete with smaller
companies that address specific niches within this market, such as Sonus
Systems Limited, BroadSoft, Inc. and Taqua Inc. in packet and Internet-based
voice communications solutions, Redback Networks Inc. in aggregation products,
as well as Equipe Communications Corporation, Laurel Networks, Inc. and Ciena
Corporation (which acquired Wavesmith Networks, Inc. in 2003) in
ATM/multi-protocol label switching, multiservice core and edge switching.
Certain competitors also are 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 this
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 multi-system 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.
| | - | ------------------------------

The competition remains intense as a result of the continued decline in
market demand, the substantially reduced availability of capital, the continued
consolidation in the service provider industry, and the renewed focus by
suppliers on selling to the remaining large service providers with financial
resources.




Optical Networks

Products

Our Optical Networks solutions portfolio addresses the varying
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 Dense
Wavelength Division Multiplexing (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 engineering expertise, installation and support services worldwide.



| |  | Photonic networking DWDM technology allows 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 DWDM
line systems include optical transmission terminals and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | optical transmission repeaters. Optical transmission terminals are
connected at the ends of the fiber optic cable and send communication
signals through this medium using light waves. Optical transmission
repeaters are used at locations along fiber optic cables that span long
distances to strengthen and reform light wave signals. Our OPTera
long-haul DWDM line systems span distances up to 1200 kilometres without
the need for optical transmission repeaters and allow the adding and
dropping of communication signals at intermediate locations along the
route. Our OPTera Metro 5000 metro DWDM series provides market leading
protocol and bit rate tolerant scalable multi-service networking solutions
within a city or region for up to 350 kilometres.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our synchronous optical transmission systems use traditional optical
standards, including the Synchronous Optical Network (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 (SDH) standard, which is the most common standard in EMEA and
many other countries. Our synchronous optical transmission equipment
includes our next-generation SONET/SDH solutions: the OPTera Metro 4000
family (next-generation SDH); the OPTera Metro 3000 family (next
generation SONET); and the OPTera Metro Connect. These solutions
deliver a multi-service optical platform that integrates diverse
protocols and technology-based 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 optical switching products provide grooming,
aggregation (the efficient re-packing of lower speed signals into higher
speed signals to maximize the use of network capacity) and protection of
the end users communications traffic. These systems focus on
delivering cost-efficient solutions to switch large amounts of
information between optical transmission systems. Our optical switching
products include the OPTera Connect HDX and OPTera Connect DX platforms.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 network management software includes
our Preside for Optical end-to-end network management software portfolio
which support the functions required for controlling, planning and
monitoring the equipment and performance of an optical network, such as
predetermined traffic routing, equipment configuration management, fault
reporting, connection management, performance management and network
security.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 connectivity services. Such network transformation
will increase deployment of managed broadband services, such as:



| |  | Optical Ethernet solutions that combine the ubiquity, flexibility and
simplicity of the Ethernet network computing protocol with the
reliability and speed of optics. 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. Our Optical Ethernet solutions:
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | enable service providers to extend Ethernets benefits
outside of local area networks and sell enterprises Ethernet
connectivity services in conjunction with Internet access and
other applications made possible due to greater bandwidth; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | deliver economical site-to-site connectivity for
enterprises through these solutions, which are designed to
alleviate the congested and complex metropolitan networking
bottleneck created by the wide range of technologies and services
utilized by users that exist within 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.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

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Product development

We are committed to providing next generation optical networking systems,
including the evolution of our next generation SONET/SDH systems, our metro
DWDM systems and our optical long-haul line and terminal solutions.



| |  | In 2003, we introduced our Optical Multiservice Edge 6500, an
advanced metro optical network product that enables the convergence of
multiple platforms onto a single platform.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we enhanced the capabilities of products from our OPTera
Metro 3000 family and our OPTera Metro 5000 DWDM series (the OPTera
Metro 3500 and OPTera Metro 5000), to enable new storage area solutions
that address emerging enterprise business continuity requirements.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we introduced a new product that utilizes photonic
networking DWDM technology, our Long Haul Dense Terminal, which assists
customers in lowering their network costs by providing improved
densities and optical performance.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We continue to enhance 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our OPTera Connect HDX switching system had its first network
deployment in 2002 with its first product release and the second release
is currently under development to provide additional customer
applications.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We continue to invest in improving the density, capacity and
flexibility of our optical long-haul transmission systems.
| | - | -----------------------------------------------------------------------------------------------------------------------

We 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. Starting in 2001 and continuing
through 2003, capital spending in optical networking equipment and services by
service providers around the world decreased substantially. Although there are
indications that the global optical market may be beginning to stabilize, the
robust market observed a few years ago is not expected to return in the near
future. Accordingly, service providers remain focused on maximizing return on
invested capital by increasing their capacity utilization rates and the
efficiency of their existing networks. With the ongoing industry adjustment,
many service providers with excess capacity in their optical networks continued
to focus on optimizing existing networks and 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. It is also expected 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 is further impacted by service
providers preferring to lease excess network capacity from others with excess
capacity or to purchase assets from distressed operators rather than making
capital investments in their networks. We expect that any additional capital
spending by our customers will continue to be directed to 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 their network capacity. In addition, regulatory developments in the
United States and other countries, such as the success of regional bell
operating companies in 2002 in obtaining permission to offer long-distance
voice services, may result in new capital spending by service providers.
However, the timing and impact of these developments remain difficult to
predict.

The market for our Optical Networks solutions is global. In the United
States and Canada, new networks are no longer built by service providers in
anticipation of market demand, but are more closely aligned with actual end
user demand. 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. Some service
providers in

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Europe are still experiencing capital constraints after having invested in
government licenses for 3G wireless networks, and have postponed significant
optical network expansions. 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 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, with foreign vendors such
as Nortel Networks frequently limited to secondary vendor positions with these
service providers.

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. Prospects for increased capital expenditures continue to be
dampened by the weak economic climate and the political uncertainty in the
region.

Customers

Our Optical Networks business is primarily focused on offering our optical
networking products and services to service providers around the world. The
service provider customers for our optical networking products include, local
and long-distance telephone companies, cable multiple system operators,
Internet service providers and other communications service providers. We are
currently focused on increasing our market presence with key service provider
customers worldwide, who we expect to account for a substantial proportion of
service provider optical capital spending in the remainder of 2003 and beyond.

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 networks for enterprises. We leverage
numerous 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 percent of Nortel Networks consolidated
revenues in 2002.

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. In 2002, we sold certain of our optical
components assets and we therefore continue to focus on competing primarily
with optical systems vendors. Market position in the global market for optical
networking equipment fluctuates significantly on a quarter-by-quarter basis.
However, we continue to be a leading global provider of optical networking
equipment. 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;
| | - | ------------------------------

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

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We and many of our competitors have been negatively impacted by the severe
decline in service provider optical network spending. As a result, our focus
is on increasing market share relative to our competitors. In particular, the
financial difficulties of certain of our competitors have created the potential
for new relationships with international-incumbent service providers in EMEA
and elsewhere. In addition, the competition from optical networking start-up
companies has decreased due to general concerns by many service providers about
these start-up companies long term viability.




Sales and distribution

All of our four reportable segments use the Nortel Networks direct sales
force to market and sell to customers around the world. The Nortel Networks
global sales force is divided into regional groups. The head office for the
United States and Canadian sales forces is located in Richardson, Texas and the
EMEA sales force head office is based in Maidenhead, U.K. The sales force for
Greater China report to a senior executive whose office is located in Beijing.
The sales force for the remainder of the Asia Pacific region report to a senior
executive whose office is located in Tokyo, Japan. The CALA sales force head
office is based in Sunrise, Florida. Within these regional sales groups, we
have dedicated sales account teams for certain major service provider
customers. These dedicated teams are located close to the customers main
purchasing locations. In addition, within the regional sales groups are teams
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 the Peoples Republic of
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.




Product standards, certification and regulation

Our products are subject to equipment standards, registration and
certification in Canada, the United States 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
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 Federal Communications
Commission in the United States, and the European Telecommunications Standards
Institute in Western Europe, as well as with the various regulations of other
countries.

The operations of our service provider customers are subject to extensive
country-specific telecommunications regulations. In the United States, on
February 20, 2003, the Federal Communications Commission (FCC), announced a
decision in its triennial review proceeding of the rules regarding unbundled
network elements (UNEs). The text of the FCCs order and reasons for the
decision were released on August 21, 2003. The decision is now subject to
petitions for reconsideration filed by various parties with the FCC and has
also been appealed to the U.S. federal courts. The uncertainty surrounding the
FCC decision is affecting, and may continue to affect, the decisions of our
United States-based service provider customers regarding investment in the
telecommunications infrastructure, and the extent of the impact of the FCC
decision continues to be assessed. These UNE 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 market for networking solutions.

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Sources and availability of materials

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

Market conditions in 2002 were similar to conditions in 2001. In 2002, we
continued to face supply surpluses and excess inventories in some areas
including optical components, memory devices and semi-conductors. However, we
were able to effectively manage our inventories in 2002 with minimal impact to
our supply chain. In 2003, however, we are seeing fewer instances of supply
surpluses as the industry has been adjusting to eliminate excess capacity.

During 2002, we continued to refine our relationships with our electronics
manufacturing services suppliers by focusing on service, quality, cost
reduction and inventory management. In 2003, we also are continuing our focus on
inventory management and component cost reduction, and expect to continue 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 Guarantees and
commitments in note 13 of the accompanying consolidated financial statements
and Liquidity and capital resources  Commitments and guarantees  Supply and
network outsourcing contracts and Off-balance sheet arrangements, contractual
obligations and contingent liabilities and commitments  Contingent liabilities
and commitments  Purchase commitments in Managements Discussion and Analysis
of Financial Condition and Results of Operations.




Seasonality

Prior to 2001, our business results in all of our reportable segments were
generally strongest in our fourth quarter, second strongest in our second
quarter, third strongest in our third quarter and the weakest in our first
quarter, primarily due to the networking industry purchasing cycles exhibited
by our customers. With the continued industry adjustment and economic downturn
in the United States and elsewhere in 2001 and 2002, our customers have faced
restricted capital markets, which affected their traditional purchasing
patterns, the demand for our products and services and the traditional
seasonality of our business. In 2003, our customers continue to spend
cautiously. It is difficult to predict the duration of the current industry
adjustment, as sustained growth in industry spending is not expected to occur
until economic and financial concerns have subsided. Market visibility remains
limited and we do not expect that our results of operations for any quarter
will necessarily be consistent with our historical quarterly profile or
indicative of our expected results in future quarters. See Forward-looking
statements in Managements Discussion and Analysis of Financial Condition and
Results of Operations.




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 we do not consider to be part of our core businesses but support our core
businesses. Strategic alliances also augment our access to potential new
customers. We intend to continue to pursue strategic alliances with businesses
that offer the technology and/or resources that would enhance our ability to
compete in existing markets or exploit new market opportunities.

We did not acquire any companies in 2002. However, 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. For information regarding the risks
associated with strategic alliances and

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| |  | acquisitions, see Forward-looking statements in Managements Discussion
and Analysis of Financial Condition and Results of Operations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  | 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. In
addition, our investment activity decreased in 2002 and we do not expect to
increase our minority investments in start-up businesses in the near future.
However, we may make selective minority investments in start-up ventures where
we believe the relationship could lay the foundation for future alliances that
would support our customer solutions.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------






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



| |  | We intend to continue to make strategic investments in our research and
development activities, to remain among the technology leaders in anticipated
growth areas. 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
transformations and next generation core products and solutions including
wireless voice and data, voice over packet, multimedia services and
applications and broadband networking. 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 a factor
differentiating us from many of our competitors. As at December 31, 2002, we
employed approximately 13,570 regular full-time research and development
employees (excluding employees on notice of termination) including
approximately:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 5,770 regular full-time research and development employees in Canada;
| | - | ---------------------------------------------------------------------

| |  | 5,260 regular full-time research and development employees in the United States;
| | - | --------------------------------------------------------------------------------

| |  | 2,200 regular full-time research and development employees in EMEA; and
| | - | -----------------------------------------------------------------------

| |  | 340 regular full-time research and development employees in other countries.
| | - | ----------------------------------------------------------------------------



| |  | 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 last three fiscal years ended December 31:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------



(millions of dollars)
    
    2002
    
    
    2001
    
    
    2000R&D expense
    
    $
    2,205
    
    
    $
    3,208
    
    
    $
    3,629R&D
costs incurred on behalf of others(a)
    
    
    49
    
    
    
    68
    
    
    
    64Total
    
    $
    2,254
    
    
    $
    3,276
    
    
    $
    3,693
 (a)
    
    These costs include research and development charged to our customers
pursuant to contracts that provide for full recovery of the estimated cost
of development, material, engineering, installation and all other
attracted costs, which are accounted for as contract costs.


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Intellectual property

Our intellectual property is fundamental to the Company and business of
each of our four reportable segments. 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.

As of December 31, 2002, we and our parent, Nortel Networks Corporation
have, on a consolidated basis, approximately:



| |  | 2,800 United States patents;
| | - | ----------------------------

| |  | 2,650 patents in other countries; and
| | - | -------------------------------------

| |  | 6,000 pending patent applications worldwide.
| | - | --------------------------------------------

In 2002, we were granted 441 United States patents, continuing our plan of
improving our patent holdings. At December 31, 2002, the patents were
primarily allocated as follows:



| |  | 23 percent to Wireless Networks;
| | - | --------------------------------

| |  | 22 percent to Enterprise Networks;
| | - | ----------------------------------

| |  | 24 percent to Wireline Networks;
| | - | --------------------------------

| |  | 12 percent to Optical Networks; and
| | - | -----------------------------------

| |  | 19 percent span multiple reportable segments or relate to other areas.
| | - | ----------------------------------------------------------------------

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 trademark and trade name, Nortel Networks, is one of our most valuable
assets. We sell our products primarily under the Nortel Networks brand name.
We have registered the Nortel Networks trademark, and many of our other
trademarks, in countries around the world. As of December 31, 2002, we and our
parent, Nortel Networks Corporation, own, on a consolidated basis approximately
130 registered trademarks in the United States, and approximately 2,100
registered trademarks in other countries. In addition, we have approximately
200 pending trademark registrations worldwide.




Employee relations

At December 31, 2002, we employed approximately 36,760 regular full-time
employees (excluding employees on notice of termination), including
approximately:



| |  | 13,580 regular full-time employees in the United States;
| | - | --------------------------------------------------------

| |  | 10,140 regular full-time employees in Canada;
| | - | ---------------------------------------------

| |  | 8,350 regular full-time employees in EMEA; and
| | - | ----------------------------------------------

| |  | 4,690 regular full-time employees in other countries.
| | - | -----------------------------------------------------

We also employ individuals on a part-time basis, and we engage the
services of independent contractors. 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 12,100 regular full
time employees during 2002. As well, the divestiture of non-core businesses
completed or entered into in 2002 resulted in additional employee reductions.
For additional information, see Special charges in note 7 of the accompanying
consolidated financial statements and Results of

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operations  continuing operations  Operating expenses  Special charges
in Managements Discussion and Analysis of Financial Condition and Results of
Operations.

At December 31, 2002, labor contracts covered approximately five percent
of our employees worldwide. At the same date, five labor contracts covered
approximately 12 percent of our employees in Canada including:

| |  | one labor contract covering approximately nine percent of Canadian
unionized employees which was renewed, ratified and became effective
February 26, 2003;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | one labor contract covering less than one percent of Canadian
unionized employees which was due to expire in the third quarter of 2003
(which contract was renewed, ratified and became effective August 16,
2003);
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | two labor contracts covering approximately 74 percent of Canadian
unionized employees which were due to expire in 2004 (of which one
contract covering approximately ten percent of Canadian unionized
employees was renewed, ratified and became effective June 19, 2003); and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | one labor contract covering approximately 17 percent of Canadian
unionized employees which expires in 2008.
| | - | -----------------------------------------------------------------------------------------------------------

At December 31, 2002, labor contracts covered approximately four percent
of our employees in EMEA and all of our employees in Brazil. The labor
contracts generally have a one-year term in EMEA and Brazil, and primarily
relate to remuneration. We have no labor contracts in the United States.

We believe our employee relations are generally positive. We are
currently focused on rebuilding employee morale following the substantial
workforce reductions and other restructuring activities in 2001 and 2002.
Although the recruitment and retention of technically skilled employees in
recent years was highly competitive in the global networking industry, current
economic conditions have lessened the competition for skilled employees in our
industry. We do, however, believe that our ability to recruit and retain
skilled employees will continue to be critical to our future success. See
Forward-looking statements in Managements Discussion and Analysis of
Financial Condition and Results of Operations.




Environmental matters

Our manufacturing and research operations are subject to a wide range of
environmental protection laws in various jurisdictions around the world. We
seek to operate our business in compliance with such laws, and have a corporate
environmental management system standard and an environmental protection
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
Segmented information in note 6 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.




Financial information by geographic area

For financial information by geographic area, see Segmented information
in note 6 of the accompanying consolidated financial statements and Results of
operations  continuing operations  Geographic revenues in Managements
Discussion and Analysis of Financial Condition and Results of Operations.

23



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##### Table of Contents






Working capital

For a discussion of our working capital, see Long-term debt and credit
facilities in note 11 of the accompanying consolidated financial statements
and Liquidity and capital resources in Managements Discussion and Analysis
of Financial Condition and Results of Operations.




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 FORWARD LOOKING
STATEMENTS IN MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

24



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##### Table of Contents






PART II




ITEM 6.   Selected Financial Data (unaudited)

The selected financial data for the years ended December 31, 2002, 2001 and
2000 and as at December 31, 2002 and 2001 set forth in this
Item 6 has been
revised to reflect the restatements. The selected financial data for the years
ended December 31, 1999 and 1998 and as at December 31, 1999 and 1998 set forth
in this Item 6 has not been restated.

(millions of U.S. dollars, except per share amounts)
    
    2002
    
    
    2001
    
    
    2000
    
    

1999 (1)
    
    

1998 (1)As restated *
    
    
    As restated *
    
    
    As restated *Results of OperationsRevenues
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836
    
    
    $
    19,628
    
    
    $
    16,084Research and development expense
    
    
    2,205
    
    
    
    3,208
    
    
    
    3,629
    
    
    
    2,724
    
    
    
    2,318Other income (expense)  net
    
    
    (34
    )
    
    
    (367
    )
    
    
    897
    
    
    
    236
    
    
    
    201Income tax benefit (provision)
    
    
    422
    
    
    
    2,973
    
    
    
    (1,216
    )
    
    
    (576
    )
    
    
    (488
    )Net loss from continuing operations(1)
    
    
    (2,745
    )
    
    
    (11,430
    )
    
    
    (843
    )
    
    
    (230
    )
    
    
    (561
    )Net
earnings (loss) from discontinued operations  net of tax
    
    
    21
    
    
    
    (2,524
    )
    
    
    (414
    )
    
    
    (94
    )
    
    
    (689
    )Dividends on preferred shares
    
    
    22
    
    
    
    27
    
    
    
    31
    
    
    
    27
    
    
    
    32Net loss applicable to common shares
    
    
    (2,746
    )
    
    
    (13,966
    )
    
    
    (1,288
    )
    
    
    (351
    )
    
    
    (1,282
    )Financial Position at December 31Total assets
    
    $
    15,896
    
    
    $
    20,061
    
    
    $
    31,323
    
    
    $
    24,007
    
    
    $
    21,828Long-term debt
    
    
    2,182
    
    
    
    2,677
    
    
    
    1,622
    
    
    
    1,426
    
    
    
    1,529Minority interest in subsidiary companies
    
    
    129
    
    
    
    118
    
    
    
    161
    
    
    
    45
    
    
    
    91Preferred shares
    
    
    536
    
    
    
    536
    
    
    
    609
    
    
    
    609
    
    
    
    609Common shareholders equity
    
    
    4,290
    
    
    
    5,691
    
    
    
    18,021
    
    
    
    13,072
    
    
    
    12,190


|(1) |  | The selected financial data for 1999 and 1998 has not been restated for the effect of the restatement
adjustments as described in note 3 to the accompanying consolidated financial statements, as the impact was
not significant to the financial statements for those years. The cumulative effect on Retained earnings
(deficit) at December 31, 1999 was $4 and has been reflected as an adjustment to Retained earnings
(deficit) as at January 1, 2000.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|*   |  | See note 3 to the accompanying consolidated financial statements                                                                                                                                                                                                                                                                                                                                                                                             

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ITEM 7. Managements Discussion and Analysis of Financial Condition and Results of Operations

This Managements Discussion and Analysis of Financial Condition and
Results of Operations, or MD&A, set forth in this Item 7 has been revised to
reflect the restatements and to update certain forward looking statements to
reflect current expectations, as well as to incorporate certain conforming
changes.

You should read this section in combination with the accompanying audited
consolidated financial statements prepared in accordance with United States
generally accepted accounting principles. This section contains forward-looking
statements and should be read in conjunction with the risk factors described
below under Forward looking statements which risk factors have been updated
to reflect the restatements as well as for events and developments subsequent
to December 31, 2002. All dollar amounts in this Managements Discussion and
Analysis of Financial Condition and Results of Operations are in millions of
United States dollars unless otherwise stated.

Apart from the revisions described above, this MD&A does not reflect
events and developments subsequent to December 31, 2002.

Where we say we, us, our, or Nortel Networks, we mean Nortel
Networks Limited and its subsidiaries. Where we refer to the industry, we
mean the telecommunications industry.

Business overview

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

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

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

Developments in 2002

Business segments re-organizations

During the third quarter of 2002, we changed the way we managed our
business to streamline and focus more directly on our customers in our four
core business areas: Wireless Networks; Enterprise Networks (formerly part of
Metro and Enterprise Networks); Wireline Networks (formerly part of Metro and
Enterprise Networks); and Optical Networks (formerly named Optical Long-Haul
Networks). During the second quarter of 2002, we shifted the accountability
for the metro optical portion of Metro and Enterprise Networks into Optical
Networks. All financial information has been restated to reflect these
re-organizations.

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##### Table of Contents



Optical Networks

On May 29, 2002, Nortel Networks Corporation announced plans to further
realign our Optical Networks segment, including optical components, given that
it does not expect a meaningful recovery in the long-haul optical market before
early 2004. As part of this realignment, we sold certain optical components
assets to Bookham Technology plc, or Bookham, in November 2002 for shares,
warrants, debt and cash consideration resulting in a gain of $18. The
transaction included a minimum purchase commitment of $120. The terms of the
commitment require us to purchase approximately $120 of product from Bookham
prior to March 31, 2004 and to make a cash payment to Bookham for a portion of
any shortfall in the purchase commitment. For additional information, see
Divestitures, closures and acquisitions in note 10 of the accompanying
consolidated financial statements.

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

Filing of shelf registration statement and base shelf prospectus

In the second quarter of 2002, Nortel Networks Corporation and Nortel
Networks Limited filed a shelf registration statement with the United States
Securities and Exchange Commission and a base shelf prospectus with the
applicable securities regulatory authorities in Canada, for the purpose of
qualifying the potential sale, from time to time, in the United States and/or
Canada of up to an aggregate of $2,500 of various types of securities by Nortel
Networks Corporation and of guaranteed debt securities of Nortel Networks
Limited. On June 12, 2002, Nortel Networks Corporation utilized approximately
$1,700 of the $2,500 in connection with two concurrent equity offerings.
Approximately $800 remains available under the shelf registration and base
shelf prospectus. During the second and third quarters of 2002, Nortel
Networks Corporation contributed approximately $1,472 of the proceeds from its
June 12, 2002 equity offerings to Nortel Networks Limited in return for 2
common shares. See Liquidity and capital resources for additional
information.

Credit facilities

On December 13, 2002, Nortel Networks Corporation announced amendments to
our existing security agreements to facilitate our future financial
flexibility. These security agreements pledged substantially all of our assets
in favor of certain lenders and the holders of Nortel Networks Corporations
and our public debt. As part of the amendments, we terminated the $1,175 April
2002 364-day revolving facilities that would have expired in April 2003. Also,
on December 13, 2002, our $1,510 December 2001 364-day credit facilities
expired and were not extended. As of December 31, 2002, our $750 April 2000
five year credit facilities remained available and undrawn. See Available
credit and support facilities for additional details.

Debt rating downgrades

On April 4, 2002, Moodys Investors Services, Inc. lowered our senior
long-term debt rating below investment grade to Ba3 and on November 1, 2002,
lowered the rating from Ba3 to B3 with a negative outlook.

On April 9, 2002, Standard & Poors Ratings Service lowered our credit
rating to below investment grade to BB and on September 18, 2002, lowered the
rating from BB to B with a negative outlook.

As a result of the April 2002 debt rating downgrades, various liens,
pledges and guarantees became effective under certain credit and security
agreements entered into by us. Our obligations under our public debt and our
support facility entered into with Export Development Canada, or EDC, on
February 14, 2003 are secured by these liens, pledges and guarantees. Further,
any amounts drawn under our $750 April 2000 five year credit facilities would
also be secured by these liens, pledges and guarantees. These liens, pledges
and guarantees also apply equally and ratably to the obligations under our
guarantee of Nortel Networks Corporations 4.25% convertible senior notes due
on September 1, 2008.

27



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##### Table of Contents



See Liquidity and capital resources for additional details on our credit
ratings and the granting of security under our credit and support facilities.
For additional financial information related to those subsidiaries providing
guarantees, see Supplemental consolidating financial information in note 22
of the accompanying consolidated financial statements.

Deferred income taxes

As part of our quarterly review procedures, we performed an evaluation of
the recoverability of our deferred income tax assets. In the third quarter of
2002, in addition to recording a write down of our existing deferred tax asset,
we began recording full valuation allowances against the benefit of our
quarterly losses. In 2002, we recorded a net income tax benefit of $422 on a
pre-tax loss of $3,167. Our gross income tax valuation allowances in 2002 were
$964, including certain additional income tax valuation allowances of $430. If
market conditions deteriorate further or future results of operations are less
than expected, additional tax valuation allowances may be required for all or a
portion of our deferred tax assets. See Income tax benefit for additional
information.

Employee benefit plans

In the fourth quarter of 2002, we recorded a non-cash charge of $692 ($559
after-tax) to shareholders equity related to the increase in the minimum
required recognizable deficit associated with our registered defined benefit
pension plans. This charge was the result of the negative impact that changes
in global capital markets and interest rates have had on our pension plan
assets and obligations.

During 2002, we made $75 in required cash contributions to our registered
defined benefit pension plans as well as additional voluntary contributions of
$75. In 2003, we expect required cash contributions under applicable
legislation to be similar to those made in 2002. For additional information on
our registered defined benefit pension plans, see Application of critical
accounting policies.

Restructuring and asset write downs

We recorded special charges of $1,699 in 2002 and $5,328 in 2001. These
charges related to restructuring activities and write downs of goodwill and
other assets. The special charges relating to restructuring were associated
with our work plan to streamline operations and activities around core markets
and leadership strategies. We began implementing our work plan in 2001 and it
has continued throughout 2002. The goodwill write down in 2002 related to a
fair value impairment in our Optical Networks segment. We expect that
additional charges will be required in 2003 related to our remaining announced
workforce reductions and related charges. See Special charges for additional
information.

Developments in 2003

Restatements

In 2001, we entered into an unprecedented period of business realignment
in response to a significant adjustment in the telecommunications industry.
Industry demand for networking equipment dramatically declined in response to
the industry adjustment, severe economic downturns in various regions around
the world and a tightening in global capital markets. We implemented a
company-wide restructuring plan to streamline our operations and activities
around core markets and operations, which included significant workforce
reductions, global real estate closures and dispositions, substantial
write-downs of its capital assets, goodwill and other intangible assets and
extensive contract settlements with customers and suppliers around the world.
As a result of these actions, our workforce declined significantly from January
1, 2001 to December 31, 2002 and over the same time period we significantly
reduced our facilities.

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

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Based on the completion of the comprehensive review and certain related
reviews (collectively, the comprehensive review), we determined that
approximately $924 and $507 of certain liabilities (primarily accruals and
provisions) carried on our previously reported consolidated balance sheets as
at December 31, 2002 and 2001, respectively, needed to be released to income.
These provisions were either initially recorded incorrectly in prior periods or
not properly released or adjusted for changes in estimates in the appropriate
periods. In certain cases, costs were incorrectly charged to operations rather
than to the appropriate provisions. Following our determination to restate our
consolidated financial statements for the periods noted above, we also
determined that we would correct certain known errors that were previously not
recorded because the amount of the errors was not material to the consolidated
financial statements. Specifically, among other items, we made certain revenue
adjustments to reflect revenue which should have been deferred instead of
recognized in a particular period. Also, as part of the restatements, we made
adjustments to correct errors related to our deferred income tax assets and
foreign currency translation accounts. In addition, we made reclassification
adjustments within the consolidated balance sheets to better reflect the
underlying nature of certain items; these reclassifications did not impact the
net assets as at the end of any period. The net effect of all of these
adjustments was a reduction in accumulated deficit of $486, $171 and $32 as at
December 31, 2002, 2001 and 2000, respectively.

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

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


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

We have also undertaken a series of physical counts and reconciliations of
plant and equipment. While we believe that the portion of the work completed
to date supports the carrying value of the plant and equipment recorded in our
consolidated balance sheet as at December 31, 2002, the conclusion of this work
could result in adjustments to the carrying value of certain assets.

The following presents details by category, aggregating to the net
decrease in net losses resulting from the restatement adjustments for the years
ended December 31:

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Net decrease in net loss

2002
    
    
    2001
    
    
    2000Contract and customer-related accruals
    
    $
    136
    
    
    $
    209
    
    
    $
    14Special charges related to restructuring actions
    
    
    138
    
    
    
    117
    
    
    
    2Other accruals and provisions
    
    
    115
    
    
    
    64
    
    
    
    47Total accruals and provisions adjustments
    
    
    389
    
    
    
    390
    
    
    
    63Income tax adjustments
    
    
    (25
    )
    
    
    (100
    )
    
    
    (16
    )Revenue adjustments
    
    
    8
    
    
    
    (103
    )
    
    
    (17
    )Foreign currency translation adjustments related to Brazilian operations
    
    
    (57
    )
    
    
    (48
    )
    
    
    (2
    )Net decrease in net loss
    
    $
    315
    
    
    $
    139
    
    
    $
    28


Impacts of the restatements on the accompanying consolidated financial statements

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

Consolidated statement of operations for the year ended December 31, 2002 as restated

Net loss applicable to common shares for the year ended December 31, 2002
was reduced by $315 from $3,061 to $2,746. The major components of the
reduction included:



| |  | a $163 improvement in gross profit primarily from adjustments to
contracts and customer-related accruals partially offset by foreign
exchange adjustments related to our Brazilian operations;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $41 decrease in selling, general and administrative expense and a
$23 decrease in research and development expense, both due to net
decrease in other accruals and provisions;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $117 decrease in special charges which resulted from the release of
accruals associated with severance and fringe benefits for terminated
employees;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $32 increase in other expense (which resulted from $28 in losses
from foreign exchange translation adjustments related to our Brazilian
operations and a $22 increase for minority interest as a result of the
restatement adjustments partially offset by $18 of other items); and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $21 adjustment to discontinued operations for items previously
recorded incorrectly as an expense in discontinued operations.
| | - | -------------------------------------------------------------------------------------------------------------------------------

Consolidated statement of operations for the year ended December 31, 2001 as restated

Net loss applicable to common shares for the year ended December 31, 2001
was reduced by $139 from $14,105 to $13,966. The major components of the
reduction included:



| |  | a $49 improvement in gross profit which included a $103 reduction in
revenues which resulted from revenue deferrals and a $152 improvement to
cost of revenues (which resulted from adjustments to contract and
customer-related accruals in the amount of $207 partially offset by $48
of foreign exchange adjustments related to our Brazilian operations and
a $40 reversal of previously recorded releases of accruals for
inter-company out of balance amounts);
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $103 decrease in selling, general and administrative expense which
resulted primarily from the release of $71 of accruals for inter-company
out of balance amounts;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $22 decrease in research and development expense which resulted
primarily from the release of $15 of accruals for inter-company out of
balance amounts;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $115 decrease which resulted from the release of special charges
primarily related to costs associated with severance and fringe benefits
for terminated employees; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $42 increase in other expense which resulted primarily from the
reversal of a previously recorded release of $31 of accruals for
inter-company out of balance amounts.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents



Consolidated statement of operations for the year ended December 31, 2000 as restated

Net loss applicable to common shares for the year ended December 31, 2000
was reduced by $28 from $1,316 to $1,288. The major components of the
reduction included:

| |  | a $34 increase in selling, general and administrative expense which
resulted primarily from the reversal of previously recorded release of
accruals for inter-company out of balance amounts; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $62 increase in other income which resulted primarily from the
release of accruals for inter-company out of balance amounts.
| | - | ------------------------------------------------------------------------------------------------------------------------------

Consolidated balance sheets as at December 31, 2002 and 2001 as restated

Restatements

The consolidated balance sheets included in Restatements in note 3 of
the accompanying consolidated financial statements present the cumulative
impact of the restatement adjustments classified by balance sheet line item as
at December 31, 2002 and 2001.

Reclassification adjustments

In addition to the restatement adjustments, reclassification adjustments
were made between line items which also impacted the consolidated balance
sheets as at December 31, 2002 and 2001. The principal reclassifications are
set forth below.

As at
December 31, 2002

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

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

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

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

As at December 31, 2001

| |  | a $55 reduction to cash and cash equivalents and notes payable to
reflect, upon consolidation, that a bank note payable by one subsidiary
was fully collateralized by, and could be offset against, a deposit in
the same bank by another subsidiary;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $152 increase in accounts receivable-net which included a $339
increase primarily to recognize advance billings in excess of revenues as a
liability partially offset by a $63 reclassification from other accrued
liabilities to properly offset amounts billed by us as collection agent
under receivable sales agreements against the corresponding receivables
and a $124 increase in allowance for doubtful accounts for financed
receivables which resulted from a reclassification from other long-term
assets;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $259 increase in net inventory with related reductions of $144 in
other current assets and of $115 in other long-term assets; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------

| |  | a $295 increase in other accrued liabilities including a $339
increase partially offset by a $63 decrease, both related to accounts
receivable-net (as noted above).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

For further information on the restatements see Significant accounting
policies and Restatements in notes 2 and 3, respectively, of the
accompanying consolidated financial statements.

Support facility with EDC

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

Stock options

We adopted fair value accounting for new grants of stock options beginning
January 1, 2003. As a result, all stock option grants in 2003 and beyond will
be expensed over the stock option vesting period based on the fair value at the
date the options are granted. For additional information, see Significant
accounting policies in note 2(t) of the accompanying consolidated financial
statements.

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##### Table of Contents



Results of operations  continuing operations

Segment revenues

For the years ended December 31,
    
    
    2002 vs 2001
    
    
    2001 vs 20002002
    
    
    2001
    
    
    2000
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    4,216
    
    
    $
    5,610
    
    
    $
    5,423
    
    
    $
    (1,394
    )
    
    
    (25
    )
    
    $
    187
    
    
    
    3Enterprise Networks
    
    
    2,569
    
    
    
    3,237
    
    
    
    3,889
    
    
    
    (668
    )
    
    
    (21
    )
    
    
    (652
    )
    
    
    (17
    )Wireline Networks
    
    
    2,264
    
    
    
    4,450
    
    
    
    7,774
    
    
    
    (2,186
    )
    
    
    (49
    )
    
    
    (3,324
    )
    
    
    (43
    )Optical Networks
    
    
    1,464
    
    
    
    3,307
    
    
    
    9,732
    
    
    
    (1,843
    )
    
    
    (56
    )
    
    
    (6,425
    )
    
    
    (66
    )Other (a)
    
    
    41
    
    
    
    668
    
    
    
    1,018
    
    
    
    (627
    )
    
    
    (94
    )
    
    
    (350
    )
    
    
    (34
    )Consolidated
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836
    
    
    $
    (6,718
    )
    
    
    (39
    )
    
    $
    (10,564
    )
    
    
    (38
    )


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

Geographic revenues

For the years ended December 31,
    
    
    2002 vs 2001
    
    
    2001 vs 20002002
    
    
    2001
    
    
    2000
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeUnited States
    
    $
    5,376
    
    
    $
    8,503
    
    
    $
    16,782
    
    
    $
    (3,127
    )
    
    
    (37
    )
    
    $
    (8,279
    )
    
    
    (49
    )EMEA (a)
    
    
    2,561
    
    
    
    4,322
    
    
    
    5,834
    
    
    
    (1,761
    )
    
    
    (41
    )
    
    
    (1,512
    )
    
    
    (26
    )Canada
    
    
    656
    
    
    
    934
    
    
    
    1,505
    
    
    
    (278
    )
    
    
    (30
    )
    
    
    (571
    )
    
    
    (38
    )Other regions
    
    
    1,961
    
    
    
    3,513
    
    
    
    3,715
    
    
    
    (1,552
    )
    
    
    (44
    )
    
    
    (202
    )
    
    
    (5
    )Consolidated (b)
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836
    
    
    $
    (6,718
    )
    
    
    (39
    )
    
    $
    (10,564
    )
    
    
    (38
    )


|(a) |  | The Europe, Middle East and Africa region (EMEA)                      
|--- |  | ------------------------------------------------------------------------
|(b) |  | Revenues by geographic regions are based on the location of the customer

Consolidated revenues

2002
compared to 2001

In 2002, the industry continued to experience a significant adjustment
which began in 2001. Following a period of rapid infrastructure build-out and
strong economic growth in 1999 and 2000, we saw a continued tightening in the
global capital markets and slowdown in the industry throughout 2001. Our
revenues declined sequentially in 2001 due to lower capital spending by
industry participants and substantially less demand for our products and
services as customers focused on maximizing their return on invested capital.
During 2002, we continued to see these constraints on capital expenditures by
our customers. Also, excess network capacity continued to exist in the
industry. In addition, we saw continuing consolidation of service providers
within the industry. This environment created a change in our customers focus
from building new networks to conserving capital, decreasing their debt levels,
reducing costs and/or increasing the capacity utilization rates and efficiency
of existing networks. As a result, our 2002 consolidated revenues declined 39%
compared to 2001. From a geographic perspective, we experienced considerable
declines across all regions in 2002 compared to 2001.

2001 compared to 2000

The significant adjustment in the industry in 2001, which was initially
felt and was most severe in the United States, also impacted the Europe, Middle
East and Africa region, or EMEA, the Caribbean and Latin America region, or
CALA, and the Asia Pacific region during 2001. Revenues in 2001 declined 38%
compared to 2000. Revenues also declined
substantially across all regions, with the exception of the Asia Pacific
region. Revenues in the Asia Pacific region grew 24% in 2001 compared to 2000
due to considerable growth in the first half of 2001. This growth was the
result of expansion in the Peoples Republic of China as contracts entered into
during 2000 were completed. However, we experienced a substantial

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sequential
decline in the second half of 2001 in the Asia Pacific region. EMEA
experienced a substantial sequential decline in the second quarter of 2001 and
significant sequential declines in the third and fourth quarters of 2001. The
decline in CALA reflected substantial sequential declines in the second and
third quarters of 2001. The United States experienced sequential revenue
declines throughout 2001 although not to the same degree in the second half of
2001 as was experienced in the first half of 2001.

2003

Entering 2003, we expect overall spending in the telecommunications
equipment market to be down modestly in 2003 compared to 2002. However, we
cannot predict the economic impact of acts of war or terrorism on the market.
We expect to see continued constraints on capital spending by customers due to:



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

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

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

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

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

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

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

Also, we expect to experience increased pricing pressures on sales of our
products as a result of increased competition. Anticipating cautious spending
by our customers in the near term and the seasonal softness traditionally
typical of the first quarter, we expect that revenues in the first quarter of
2003 will be lower than revenues in the fourth quarter of 2002. It is
difficult to predict the duration of the current industry adjustment, as growth
in industry spending is not expected to occur until global economic and
financial concerns have subsided. Market visibility remains limited and we do
not expect that our results of operations for any quarter will necessarily be
consistent with our quarterly historical profile or indicative of our expected
results in future quarters.

See Forward-looking statements for factors that may affect our revenues.

Wireless Networks

2002
compared to 2001

The 25% decline in Wireless Networks revenues in 2002 compared to 2001 was
primarily due to a continued deterioration in wireless service providers
financial condition and subscriber growth and increased competition for
customers by service providers which has resulted in the decision of many
wireless service providers to delay capital expenditures.

Time Division Multiple Access, or TDMA, revenues declined substantially in
2002 compared to 2001 primarily due to a substantial decline in the United
States as customers migrated from TDMA to Code Division Multiple Access, or
CDMA, and Global System for Mobile communications, or GSM, technologies as a
result of TDMA technology and networks being in its maturity stage. TDMA
revenues continued to be a smaller portion of Wireless Networks in 2002
compared to 2001. Also CDMA revenues declined in 2002 compared to 2001.
Continued capital spending constraints and financial difficulties experienced
by our customers globally contributed to both the CDMA and TDMA revenue
declines. In 2002, we continued to experience significant pricing pressures on
our CDMA and TDMA technologies in the United States and CALA resulting from the
increased competition for customers.

Overall GSM revenues, which includes General Packet Radio Standard, or
GPRS, and Enhanced Data Rates for Global Evolution, or EDGE, 2.5G technologies,
declined substantially in 2002 compared to 2001 due to substantial declines in
EMEA and the Asia Pacific region. These substantial declines were primarily
due to a continued deterioration in wireless

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service providers financial
condition and subscriber growth, and delays in capital expenditures. Also in
the Asia Pacific region, customers began to deploy CDMA technology solutions as
they migrated away from the maturing GSM technologies. This shift in
technology focus contributed to the substantial decline in GSM revenues in the
Asia Pacific region.

In 2002, Universal Mobile Telecommunications Systems, or UMTS, revenues
continued to be an insignificant portion of overall Wireless Networks revenues.
While the first commercial launches in the industry did take place in EMEA and
the Asia Pacific region, technology issues associated with third generation, or
3G, handsets contributed to delays in larger deployments of 3G networks in
2002. Also, some of our 3G customers in EMEA incurred significant costs in 2002
associated with licensing fees, which, along with their continued financial
difficulties, limited their spending on network deployments. As a result, 3G
network deployments suffered delays in EMEA in 2002.

From a geographic perspective, the 25% decrease in Wireless Networks
revenues in 2002 compared to 2001 was primarily due to a:



| |  | 53% decline in revenues in the Asia Pacific region;
| | - | ---------------------------------------------------

| |  | 17% decline in revenues in the United States;
| | - | ---------------------------------------------

| |  | 13% decline in revenues in EMEA; and
| | - | ------------------------------------

| |  | 26% decline in revenues in CALA.
| | - | --------------------------------

2001 compared to 2000

The 3% increase in Wireless Networks revenues in 2001 compared to 2000 was
primarily due to a substantial increase in revenues in the first half of 2001,
driven by growth in the United States and the Asia Pacific region as our major
customers continued their network expansion programs. Subsequently, Wireless
Networks revenues declined in the second half of 2001 compared to 2000 as a
result of deterioration in our customers financial condition, our providing
limited, incremental customer financing as a result of the market conditions
and the decision of many wireless service providers to delay certain capital
expenditures.

CDMA revenues increased substantially in 2001 compared to 2000 primarily
due to significant growth in CDMA technology in the Asia Pacific region, driven
by new network deployments. This significant growth was offset by the global
decline in TDMA technology caused by pricing pressures and this technology
reaching its maturity stage.

GSM revenues decreased substantially in 2001 compared to 2000 primarily
due to a substantial decline in EMEA and a significant decline in the Asia
Pacific region. The substantial decline in EMEA was due to deterioration in
our wireless service providers financial condition and subscriber growth, and
reductions in capital spending as many customers completed their initial
network deployments in 2000. In the Asia Pacific region, the significant
decline was due to a reduction in capital expenditures by some of our wireless
customers. Revenues in the United States and CALA increased in 2001 compared
to 2000 as new customers began network deployments. In 2001, the United States
and CALA represented a larger proportion of GSM and GPRS revenues compared to
2000.

UMTS revenues were not a significant portion of Wireless Networks in 2001.
UMTS revenues increased substantially in 2001 compared to 2000 primarily due
to a substantial increase in EMEA as some of our customers began their 3G
network deployments.

From a geographic perspective, the 3% increase in Wireless Networks
revenues in 2001 compared to 2000 was primarily due to a:



| |  | 14% increase in revenues in the United States; and
| | - | --------------------------------------------------

| |  | 37% increase in revenues in the Asia Pacific region; partially offset by
| | - | ------------------------------------------------------------------------

| |  | 46% decline in revenues in CALA; and
| | - | ------------------------------------

| |  | 24% decline in revenues in EMEA.
| | - | --------------------------------

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2003

In 2002, Wireless Networks revenues continued to be primarily generated by
sales of CDMA and GSM technologies. In 2003, TDMA revenues are expected to
decline. Overall GSM sales are also expected to decline as technology
transitions from GSM to GPRS and EDGE. In 2003, our CDMA 3G and UMTS
technology sales are expected to grow and represent a larger proportion of
Wireless Networks revenues as 3G technologies are expected to gain a greater
foothold in the market due to increased wireless data traffic and requirements
for greater wireless spectrum efficiency. Also, we expect to experience
increased pricing pressures on sales of Wireless Networks products as a result
of increased competition.

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

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

Enterprise Networks

2002 compared to 2001

The 21% reduction in Enterprise Networks revenues in 2002 compared to 2001
was primarily a result of enterprise customers continuing to reduce their
spending due to the ongoing industry adjustment, the overall economic
conditions and uncertainties surrounding the technology evolution of next
generation products.

Revenues from the circuit and packet voice portion of this segment
declined significantly in 2002 compared to 2001. The significant decline was
primarily due to reductions in customer spending in the United States and EMEA.
Revenues for traditional circuit switching products did begin to show signs of
improvement in the United States in the second half of 2002 after experiencing
sequential quarterly reductions during 2001 and the first half of 2002. In
2002, traditional circuit switching also continued its evolution towards
internet protocol, or IP, telephony, as reliability and quality of service
concerns, traditionally associated with voice over packet solutions, were
reduced. Regardless, customers remained cautious in 2002 with respect to their
investment decisions due to uncertainties surrounding the migration to packet
voice solutions.

The data networking and security portion of this segment experienced
substantial declines in 2002 compared to 2001. The substantial decrease in
revenues was primarily due to customer spending constraints and a decline in
demand for mature products across all regions. Pricing pressures continued in
2002 in the data networking and security portion of this segment as we
experienced continued significant competition for enterprise customers.

From a geographic perspective, the 21% decline in Enterprise Networks
revenues in 2002 compared to 2001 was primarily due to a:



| |  | 19% decline in revenues in the United States;
| | - | ---------------------------------------------

| |  | 25% decline in revenues in EMEA; and
| | - | ------------------------------------

| |  | 13% decline in revenues in the Asia Pacific region.
| | - | ---------------------------------------------------

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2001 compared to 2000

The 17% decline in revenues in 2001 compared to 2000 was primarily due to
the significant industry adjustment and the impact this adjustment had on
spending by our enterprise customers.

The substantial decrease in sales of the circuit and packet voice portion
of this segment was primarily the result of reduced demand in the enterprise
market due to the significant industry adjustment, industry consolidation,
tightened capital markets and our circuit switching products reaching their
maturity stage.

The significant decline in sales of the data networking and security
portion of this segment was primarily due to a decline in demand for mature
products, compounded by the continued industry adjustment as customers delayed
their purchase of next generation products.

From a geographic perspective, the 17% decline in Enterprise Networks
revenues in 2001 compared to 2000 was primarily due to a:



| |  | 20% decline in revenues in the United States;
| | - | ---------------------------------------------

| |  | 41% decline in revenues in Canada;
| | - | ----------------------------------

| |  | 31% decline in revenues in CALA; and
| | - | ------------------------------------

| |  | 16% decline in revenues in the Asia Pacific region; partially offset by
| | - | -----------------------------------------------------------------------

| |  | 1% increase in revenues in EMEA.
| | - | --------------------------------

2003

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

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

Wireline Networks

2002 compared to 2001

The 49% decline in Wireline Networks revenues in 2002 compared to 2001 was
primarily due to a substantial reduction in capital spending by our service
provider customers.

The considerable decline in the circuit and packet voice portion of this
segment was the result of continued reduced demand in the local exchange and
interexchange carrier markets due to the significant industry adjustment,
including industry consolidation and tightened capital markets, and the
substantial decline in demand for traditional circuit switching products.
During 2002, many of our service provider customers continued to delay their
investment decisions on our packet voice solutions due to the technology
evolution uncertainty in the industry. In 2002, we continued to experience
significant pricing pressures on our traditional circuit switching products due
to the increased competition for service provider customers. In addition, the
lack of packet-based technology choices from competitive suppliers hindered our
ability to respond to these pricing pressures.

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

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From a geographic perspective, the 49% decline in Wireline Networks
revenues in 2002 compared to 2001 was primarily due to a:



| |  | 57% decline in revenues in the United States;
| | - | ---------------------------------------------

| |  | 30% decline in revenues in EMEA;
| | - | --------------------------------

| |  | 47% decline in revenues in the Asia Pacific region; and
| | - | -------------------------------------------------------

| |  | 52% decline in revenues in Canada.
| | - | ----------------------------------

2001 compared to 2000

The 43% decline in revenues in 2001 compared to 2000 was due to a
substantial decline in sales of the circuit and packet voice portion of this
segment and a significant decline in the data networking and security portion
of this segment.

The substantial decrease in sales in the circuit and packet voice portion
of this segment was primarily the result of reduced demand in the interexchange
carrier market due to the significant industry adjustment, industry
consolidation, tightened capital markets and the maturing of circuit switching
products.

The significant decline in sales in the data networking and security
portion of this segment was primarily due to a decline in demand for mature
products, compounded by the continued industry adjustment as customers delayed
the purchase of next generation products.

From a geographic perspective, the 43% decline in Wireline Networks revenues was primarily due to a:



| |  | 48% decline in revenues in the United States;
| | - | ---------------------------------------------

| |  | 39% decline in EMEA; and
| | - | ------------------------

| |  | 45% decline in Canada.
| | - | ----------------------

2003

In the future, we anticipate that service providers will increase the use
of packet-based technologies in their communications networks as they look for
ways to optimize their existing networks and offer new revenue generating
services while controlling capital expenditures and operating costs. However,
the timing of this transition is unclear. We expect that the continuing
industry adjustment, continuing industry consolidation and reduction in capital
spending by our customers will have a negative impact on the level of spending
by our service provider customers and could adversely affect Wireline Networks
revenues in the future.

Optical Networks

2002 compared to 2001

The 56% decline in Optical Networks revenues in 2002 compared to 2001 was
primarily the result of substantial reductions in capital spending by our major
United States and EMEA customers.

Our major customers in the long-haul portion of this segment focused on
maximizing return on invested capital by increasing the capacity utilization
rates and efficiency of existing networks. Revenues in the optical long-haul
portion of the segment declined substantially in 2002 compared to 2001. The
considerable decline was primarily due to the continued industry adjustment,
including industry consolidation, continued capital spending constraints and,
to a lesser extent, the large redeployment of assets that occurred in 2001 and
continued throughout 2002. The spending constraints and redeployment of assets
were caused primarily by significant excess inventories which resulted in
significant pricing pressures.

Revenues in the metro optical portion of the segment are primarily driven
by demand for enterprise connectivity and storage solutions. The substantial
decline in revenue in the metro optical portion of the segment in 2002 compared
to 2001

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was primarily due to a decline in demand for mature products. This
decline was compounded by the ongoing industry adjustment as customers
continued to focus on optimizing existing networks and delayed the deployment
of next generation products. Industry consolidation also contributed to the
reduction in service provider capital spending during 2002 and 2001. The
current generation of metro products, namely, the OPTera Metro family of
products were the key products contributing to revenue in 2002 and accounted
for a substantial portion of the overall Optical Networks revenues. Revenue in
the metro optical portion of the segment increased as a percentage of total
Optical Networks revenue in 2002 compared to 2001.

From a geographic perspective, the 56% decline in Optical Networks
revenues in 2002 compared to 2001 was primarily due to a:



| |  | 62% decline in revenues in EMEA;
| | - | --------------------------------

| |  | 58% decline in revenues in the United States;
| | - | ---------------------------------------------

| |  | 42% decline in revenues in the Asia Pacific region; and
| | - | -------------------------------------------------------

| |  | 75% decline in revenues in CALA.
| | - | --------------------------------

2001 compared to 2000

The 66% decline in revenues in 2001 compared to 2000 was primarily the
result of substantial reductions in capital spending, primarily by our major
United States customers. Our major customers in the long-haul portion of this
segment focused on maximizing return on invested capital by increasing the
capacity utilization rates and efficiency of existing networks. Our revenues in
the first quarter of 2001 reflected the then in-process network build-outs that
had begun in 2000. However, when the industry began experiencing a significant
adjustment and the capital markets tightened, our customers reduced their
purchases significantly and focused on reducing inventory levels to complete
existing network build-outs and on improving the efficiency of existing
networks. The continuing industry consolidation in 2001 also contributed to
the reduction in service provider capital spending during 2001. Overall, a
large redeployment of assets occurred in this segment of the industry in 2001
primarily due to significant excess inventories. This redeployment, in
conjunction with the continuing industry consolidation, resulted in significant
pricing pressures in 2001. Due to the severe reduction, in number and size, of
new network build-outs during 2001, we experienced a substantial decline in the
long-haul portion of this segment compared to 2000.

The substantial decline in sales of the metro optical portion of this
segment in 2001 compared to 2000 was primarily due to a decrease in sales
volumes of mature optical products that have a metropolitan or regional
application.

From a geographic perspective, the 66% decline in Optical Networks
revenues in 2001 compared to 2000 was primarily due to a:



| |  | 84% decline in revenues in the United States; and
| | - | -------------------------------------------------

| |  | 25% decline in revenues in EMEA.
| | - | --------------------------------

2003

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

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

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

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

Gross profit and gross margin

For the years ended December 31,
    
    
    2002 vs 2001
    
    
    2001 vs 20002002
    
    
    2001
    
    
    2000
    
    
    Change
    
    
    % Change
    
    
    Change
    
    
    % ChangeGross profit
    
    $
    3,564
    
    
    $
    3,183
    
    
    $
    12,790
    
    
    $
    381
    
    
    
    12
    
    
    $
    (9,607
    )
    
    
    (75
    )Gross margin
    
    
    33.8
    %
    
    
    18.4
    %
    
    
    45.9
    %
    
    
    15.4
    
    
    
    84
    
    
    
    (27.5
    )
    
    
    (60
    )


The substantial increase in gross profit in 2002 compared to 2001 was
primarily due to approximately $209 of incremental charges recorded in 2002
versus approximately $1,478 of incremental charges in 2001. These charges
primarily related to incremental inventory provisions and contract and customer
settlement costs. After adjusting for these incremental costs, the substantial
increase in gross profit in 2002 was primarily due to improvements in our cost
structure as we have reduced inventory levels to more closely reflect our sales
volume and received more favorable supplier pricing in 2002. Gross profit
increased even though we experienced substantial pricing pressures in 2002.

Gross profit decreased substantially in 2001 compared to 2000 due to
substantial declines in revenues and gross margin. The overall decrease in
gross margin was primarily due to:



| |  | approximately $1,478 of incremental charges, related to the entire
supply chain and contract and customer settlement costs, resulting from
the significant industry adjustment;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our fixed cost structure that was not reflective of the lower sales
volumes in 2001;
| | - | ------------------------------------------------------------------------------------

| |  | pricing pressures across certain products and services, primarily in
Optical Networks, resulting from increased competition; and
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | shifts in the geographic mix of sales from the United States to EMEA
and the Asia Pacific region, where we generally earn lower gross
margins. Sales in the United States accounted for approximately 49% of
overall sales in 2001, compared to approximately 60% in 2000.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

While we cannot predict the extent to which changes in product mix and
pricing pressures will impact our gross margin, we have begun to see the
effects of our work plan which we began implementing in 2001 to create a cost
structure that is more reflective of the current industry and economic
environment. As a result, we expect that gross margin will continue to trend
towards the low 40% range in 2003.

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

See Forward-looking statements for factors that may affect our gross
margins.

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| |  | Operating expenses
| |  | ------------------



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

For the years ended December 31,
    
    
    2002 vs 2001
    
    
    2001 vs 20002002
    
    
    2001
    
    
    2000
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeSG&A expense
    
    $
    2,621
    
    
    $
    5,712
    
    
    $
    5,405
    
    
    $
    (3,091
    )
    
    
    (54
    )
    
    $
    307
    
    
    
    6As a percentage of revenues
    
    
    24.8
    %
    
    
    33.1
    %
    
    
    19.4
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A


| |  | Selling, general and administrative, or SG&A, expense declined
substantially in 2002 compared to 2001, primarily reflecting the impact of our
work plan. Incremental charges of $220 were recorded in 2002 compared to
incremental charges of $1,067 in 2001. The incremental charges in both 2002
and 2001 related to increased provisioning for trade and customer financed
receivables. The remaining substantial decrease in SG&A expense in 2002
compared to 2001 was primarily due to the impact of workforce reductions, which
in turn has also resulted in a reduction in other related costs such as
information services and real estate.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | SG&A expense increased in 2001 compared to 2000. During the first half of
2001, we incurred incremental costs that resulted from increasing our
investment in North America and international markets across all of our
reporting segments. We increased our investment to support our revenue growth
in the second half of 2000 and the then anticipated revenue growth for 2001.
The increase in SG&A expense in 2001 also resulted from increased provisions of
approximately $1,067 related to various trade and customer-financed receivables
due to the worsening financial position of certain customers. Excluding the
impact of these increased provisions, SG&A expense in 2001 declined
significantly compared to 2000.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2003, we expect that our annual SG&A expense will continue to decline
although not to the same extent as was experienced in 2002 compared to 2001.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



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

For the years ended December 31,
    
    
    2002 vs 2001
    
    
    2001 vs 20002002
    
    
    2001
    
    
    2000
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeR&D expense
    
    $
    2,205
    
    
    $
    3,208
    
    
    $
    3,629
    
    
    $
    (1,003
    )
    
    
    (31
    )
    
    $
    (421
    )
    
    
    (12
    )As a percentage of revenues
    
    
    20.9
    %
    
    
    18.6
    %
    
    
    13.0
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A


| |  | Research and development, or R&D, expense represents our planned
investment in our next generation core products across all businesses. R&D
expense decreased substantially in 2002 compared to 2001, reflecting focused
investments to drive market leadership across our product portfolios.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | R&D expense decreased significantly in 2001 compared to 2000, reflecting
the impact of our initiatives to focus our spending on key potential growth
areas.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our continuing strategic investments in R&D are aligned with technology
leadership in anticipated growth areas, while targeting a level of R&D expense
that is representative of our overall cost structure. In 2003, we expect that
our annual R&D expense will continue to decline although not to the same extent
as was experienced in 2002 compared to 2001.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

41



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| |  | Amortization of intangibles
| |  | ---------------------------



For the years ended December 31,
    
    
    2002 vs 2001
    
    
    2001 vs 20002002
    
    
    2001
    
    
    2000
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeAmortization of
intangiblesAcquired technology
    
    $
    19
    
    
    $
    574
    
    
    $
    789
    
    
    $
    (555
    )
    
    
    (97
    )
    
    $
    (215
    )
    
    
    (27
    )Goodwill
    
    
    
    
    
    
    2,080
    
    
    
    2,491
    
    
    
    (2,080
    )
    
    
    (100
    )
    
    
    (411
    )
    
    
    (16
    )




| |  | Amortization of acquired technology
| |  | -----------------------------------



| |  | The amortization of acquired technology in 2002 primarily reflected the
charge related to the acquisition of Bay Networks, Inc. The amortization of
acquired technology in 2001 primarily reflected the charges related to the
acquisitions of Bay Networks, and Clarify Inc. The amortization of acquired
technology in 2000 primarily reflected the charge related to the acquisition of
Bay Networks.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Amortization of goodwill
| |  | ------------------------



| |  | On January 1, 2002, we adopted the provisions of Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS
142. As a result, amortization of goodwill, including goodwill recorded in
past business combinations, and amortization of intangibles with an indefinite
life ceased upon adoption of SFAS 142. We completed the first SFAS 142
transitional impairment test during the second quarter of 2002 and concluded at
that time that there was no impairment of recorded goodwill, as the fair values
of our reporting units exceeded their carrying amount as of January 1, 2002.
Therefore, the second step of the transitional impairment test under SFAS 142
was not required to be performed.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As part of our review of financial results during the third quarter of
2002, we evaluated the goodwill associated with the businesses within Optical
Networks for potential impairment. The conclusion of those evaluations was
that we wrote down the remaining value of goodwill in the amount of $264. For
additional information on the write down of goodwill, see Special charges in
note 7 of the accompanying consolidated financial statements.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The amortization of goodwill for 2001 primarily reflected the charges
related to the acquisitions of Bay Networks, Qtera Corporation and Clarify.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The amortization of goodwill for 2000 primarily reflected the charges
related to the acquisitions of Bay Networks, Qtera and Clarify.
| |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  | The remaining net carrying value of goodwill was $2,021 on December 31,
2002 and $2,283 on December 31, 2001.
| |  | -------------------------------------------------------------------------------------------------------------



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



| |  | In 2002, we recorded special charges of $1,699, related to restructuring
activities and write downs of goodwill and other assets. The special charges
relating to restructuring were associated with our work plan to streamline
operations and activities around core markets and leadership strategies. Our
special charges in 2002 related to workforce reduction costs of $823, contract
settlement and lease costs of $192, plant and equipment write downs of $332,
other charges of $88 and a goodwill write down of $264.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2001, we recorded special charges of $5,328 related to restructuring
activities and write downs of goodwill and other assets. The special charges
related to workforce reduction costs of $1,236, contract settlement and lease
costs of $876, plant and equipment write downs of $940, other charges of $37
and a goodwill write down of $2,239.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2000, we recorded special charges of $265 related to restructuring
activities and a one-time intangible asset write down.
| |  | ----------------------------------------------------------------------------------------------------------------------------

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On December 31, 2002, our workforce numbered approximately 37,000 and our
previously announced employee reductions were nearing completion. As a result
of changes in certain outsourcing plans, we expect to have approximately 36,000
employees by the end of the first quarter of 2003, compared to our previous
estimate of approximately 35,000. Going forward, our focus will be on managing
each of our businesses based on financial performance, the market and customer
priorities. Additional charges will be required in 2003 related to our
remaining announced workforce reductions and related charges.

For additional information related to these restructuring activities, see
Special charges in note 7 of the accompanying consolidated financial
statements.

Gain on sale of businesses

In 2002, the gain on sale of businesses of $39 was primarily related to a
gain of $18 on the sale of certain assets relating to our optical components
business to Bookham Technology plc. Also, we recorded a gain of $16
related to a previously deferred gain associated with the sale of substantially
all of the assets of our Cogent Defence Systems business to EADS Telecom S.A.S.
(formerly EADS Defence and Security Networks S.A.S.) as well as the
cancellation and replacement of a call option to acquire an additional
approximate 7% ownership interest in Nortel Networks France S.A.S. which was
originally included as part of the consideration received on the sale
of these assets. For additional
information relating to these sales of assets, see Divestitures, closures and
acquisitions in note 10 and Guarantees and commitments in note 13 of the
accompanying consolidated financial statements.

Gain on sale of businesses for 2001 of $126 was primarily related to net
gains associated with both the outsourcing of certain activities as part of our
continued supply chain transformation strategy that began in 1999 and the
divestiture of certain non-core businesses in connection with our work plan to
streamline our business around core markets.

In 2000, the gain on sale of businesses of $173 was primarily related to
the divestiture of certain manufacturing operations and tangible and intangible
assets in connection with our operations strategy.

Other income (expense)  net

For 2002, other expense  net of $34 was primarily related to interest
income of $87 and income of $1 relating to minority interests. This was offset
by a $29 loss on sale or write down of certain minority investments and other
expenses of $93.

For 2001, other expense  net of $367 was primarily related to a loss on
sale or write down of certain minority investments. This write down occurred
during the third quarter from our review of our investment portfolio, and was
due to a change in our strategic focus relative to certain minority
investments, as well as an other than temporary decline in carrying values
caused by the continued significant downturn in both the industry and economic
environment. Public company investments were generally written down against
earnings to their current market value. Private company investments were
written down to the estimated current market value by applying a
telecommunications market average adjustment factor calculated using the
declines of a representative group of public companies. Previous
mark-to-market adjustments on both our public and private company investments
were recorded in accumulated other comprehensive income.

For 2000, other income  net of $897 was primarily related to a $513
pre-tax ($344 after-tax) gain from the sale of a portion of our share ownership
in Entrust, Inc. (formerly Entrust Technologies, Inc.) in the first quarter of
2000, and a $169 pre-tax ($116 after-tax) gain due to a reduction in our
investment in Entrust from 33.5% to 27.0% primarily as a result of Entrusts
issuance of common shares in connection with its acquisition of enCommerce,
Inc. in the third quarter of 2000.

43



---



##### Table of Contents



Interest expense

Interest expense decreased $119 in 2002 compared to 2001. The decrease
was primarily related to a lower level of short-term notes payable in 2002,
partially offset by additional interest expense due to long-term debt offerings
during 2001. The increase in interest expense of $124 in 2001, compared to
2000, was primarily related to our new debt offerings during the year, and an
increase in the amount and cost of borrowings under the commercial paper
program during the first and second quarters of 2001.

Income tax benefit (provision)

In 2002, we recorded a net income tax benefit of $422 on a pre-tax loss of
$3,167. Our gross income tax valuation allowances in 2002 were $964, including
certain additional income tax valuation allowances of $430. We assessed
positive evidence including forecasts of future taxable income to support
realization of the net deferred tax assets, and other negative evidence
including our eight consecutive quarters of tax losses, and concluded that it
was more likely than not, that certain additional tax valuation allowances of
$430 were required. If market conditions improve and future results of
operations exceed our current expectations, our existing tax valuation
allowances may be adjusted, resulting in future tax benefits. Alternatively,
if market conditions deteriorate further or future results of operations are
less than expected, additional tax valuation allowances may be required for all
or a portion of our deferred tax assets.

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

Our effective tax benefit/provision rate fluctuates from period to period
primarily as a result of the impact of non-tax deductible goodwill amortization
and write downs, non-tax deductible restructuring charges, certain additional
valuation allowances, stock option compensation expense and in-process research
and development expense. As a result, our effective tax rates were neither
comparable nor meaningful in 2002, 2001 and 2000.

For additional information, see Income taxes in note 8 of the
accompanying consolidated financial statements and Application of critical
accounting policies.

Net loss from continuing operations

As a result of the items discussed under our results of operations, our
reported net loss from continuing operations improved by $8,685 in 2002
compared to 2001 and increased by $ 10,587 in 2001 compared to 2000.

44



---



##### Table of Contents





| |  | Results of operations  discontinued operations
| |  | -----------------------------------------------



For the years ended December 31,
    
    
    2002 vs 2001
    
    
    2001 vs 20002002
    
    
    2001
    
    
    2000
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeRevenues
    
    $
    141
    
    
    $
    994
    
    
    $
    2,342
    
    
    $
    (853
    )
    
    
    (86
    )
    
    $
    (1,348
    )
    
    
    (58
    )Net (earnings) loss from discontinued
operations
- net of tax
    
    
    21
    
    
    
    (340
    )
    
    
    (414
    )
    
    
    361
    
    
    
    N/A
    
    
    
    74
    
    
    
    18Net (earnings) loss on
disposal of operations
- net of tax
    
    
    
    
    
    
    (2,184
    )
    
    
    
    
    
    
    2,184
    
    
    
    100
    
    
    
    (2,184
    )
    
    
    N/ANet (earnings) loss from
discontinued operations
    
    $
    21
    
    
    $
    (2,524
    )
    
    $
    (414
    )
    
    $
    2,545
    
    
    
    N/A
    
    
    $
    (2,110
    )
    
    $
    N/ANet cash from (used in)
- discontinued operations
    
    $
    375
    
    
    $
    (649
    )
    
    $
    (1,057
    )
    
    $
    1,024
    
    
    
    N/A
    
    
    
    408
    
    
    
    39




| |  | During 2002, we continued to wind down our access solutions operations and
there has been no change to the initial disposal strategy or intent to exit the
business since June 14, 2001. However, the continued deterioration in industry
and market conditions has delayed certain disposal activities beyond the
original planned timeframe of one year. In particular, actions involving
negotiations with customers, who have also been affected by industry
conditions, are taking longer than expected. Therefore, although disposal
activities continue beyond the one-year period, we continue to present the
access solutions operations as discontinued operations in the accompanying
consolidated financial statements. We now expect to complete this plan by mid
2003, subject to the closing of specific transactions, the timing of which may
continue to be impacted by customer and business issues and any applicable
regulatory requirements.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For additional information, see Discontinued operations in note 18 of
the accompanying consolidated financial statements.
| |  | ---------------------------------------------------------------------------------------------------------------------------



| |  | Application of critical accounting policies
| |  | -------------------------------------------



| |  | Our consolidated financial statements are based on the selection and
application of accounting policies, generally accepted in the United States,
which require us to make significant estimates and assumptions. We believe
that the following accounting policies may involve a higher degree of judgment
and complexity in their application and represent our critical accounting
policies. The application of these policies requires us to make subjective and
objective judgments.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In general, any changes in estimates or assumptions relating to revenue
recognition, provisions for receivables, 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
with the Audit Committee of our Board of Directors.
| |  | ---------------------------------------------------------------------------------------------------------------------------

45



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Revenue recognition

Our material revenue streams are the result of a wide range of activities,
from custom design and installation over a long period of time to pack and
ship, with many variations in between. 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 in which
geographic region they are sold.

The collectibility of trade and notes receivables is also critical in
determining whether revenue should be recognized, especially considering the
current economic environment within our industry. 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. When we determine that a loss
exists on a particular contract, we will recognize the loss immediately.

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 receivables

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 their 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 that are greater than 365 days are fully
provisioned for and amounts greater than 180 days are 50% provisioned for. A
misinterpretation or misunderstanding of any of the above mentioned conditions
could result in bad debts in excess of the provisions determined to be
appropriate as of the balance sheet date.

46



---



##### Table of Contents



We recorded receivable provisions, relating to continuing operations, of
$283 in 2002, $1,356 in 2001 and $330 in 2000. The following table summarizes
our accounts receivable and long-term receivable balances and related reserves
of our continuing operations:

As at December 31,2002
    
    
    2001Gross accounts receivable
    
    $
    2,763
    
    
    $
    3,832Related reserves
    
    
    (516
    )
    
    
    (776
    )Net accounts receivable
    
    $
    2,247
    
    
    $
    3,056Accounts receivable reserves as a percentage of gross accounts receivables
    
    
    19
    %
    
    
    20
    %Gross long-term receivables
    
    $
    1,001
    
    
    $
    1,204Related reserves
    
    
    (736
    )
    
    
    (764
    )Net long-term receivables
    
    $
    265
    
    
    $
    440Long-term receivable reserves as a percentage of long-term receivables
    
    
    74
    %
    
    
    63
    %


Our level of reserves for both accounts receivable and long-term
receivables fluctuate depending on all of the factors mentioned above. In 2002
and 2001, significant provisions have been recorded; however, due to the
current market conditions and the creditworthiness of some of our customers, it
is difficult to determine the extent to which this trend will continue in the
future.

Provisions for inventory

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 reserves 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.

We recorded inventory provisions and other provisions related to our
contract manufacturers and suppliers, relating to continuing operations, of
$568 in 2002, $1,639 in 2001 and $448 in 2000. The following table summarizes
our inventory balances and related reserves of our continuing operations:

As at December 31,2002
    
    
    2001Gross inventory
    
    $
    2,056
    
    
    $
    2,653Related reserves
    
    
    (1,070
    )
    
    
    (819
    )Net inventory
    
    $
    986
    
    
    $
    1,834Inventory reserves as a percentage of gross inventory
    
    
    52
    %
    
    
    31
    %Other reserves for claims related to our contract manufacturers and suppliers (a)
    
    
    (167
    )
    
    
    (563
    )


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

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##### Table of Contents



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

Tax asset valuation

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



| |  | future earnings potential determined through the use of internal forecasts;
| | - | ---------------------------------------------------------------------------

| |  | cumulative losses in recent years;
| | - | ----------------------------------

| |  | history of loss carryforwards and other tax assets expiring;
| | - | ------------------------------------------------------------

| |  | the carryforward period associated with the deferred tax assets; and
| | - | --------------------------------------------------------------------

| |  | the nature of the income that
can be used to realize the deferred tax asset.
| | - | ----------------------------------------------------------------------------

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. Gross income tax valuation allowances were $964 in 2002, including
certain additional income tax valuation allowances of $430. We assessed
positive evidence including forecasts of future taxable income to support
realization of the net deferred tax assets, and negative evidence including our
eight consecutive quarters of tax losses, and concluded that it was more likely
than not, that certain additional tax valuation allowances of $430 were
required.

If market conditions improve and future results of operations exceed our
current expectations, our existing tax valuation allowances may be adjusted,
resulting in future tax benefits. Alternatively, if market conditions
deteriorate further or future results of operations are less than expected,
future assessments may result in a determination that some or all of the net
deferred tax assets are not realizable. As a result, we may need to establish
additional tax valuation allowances for all or a portion of the net deferred
tax assets, which may have a material adverse effect on our business, results
of operations and financial condition.

Goodwill valuation

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



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

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

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

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

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

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

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

48



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

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. 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 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%.

In 2001, we incurred a goodwill write down of $2,239. In 2001, we
performed an assessment of the carrying values of goodwill associated with our
acquisitions. The assessment during that period was performed in light of the
significant negative industry and economic trends impacting our operations and
expected future growth rates, and the adjustment of technology valuations. The
conclusion of our assessment was that the decline in market conditions within
the industry was significant and other than temporary. The write downs were
primarily related to the goodwill within Enterprise Networks, Optical Networks
and Other. Fair value was determined based on discounted future cash flows for
the businesses within these reportable segments that had separately
distinguishable goodwill balances and whose operations had not yet been fully
integrated. The cash flow periods used were five years, the discount rate used
was 20%, and the terminal values were estimated based upon terminal growth
rates ranging from 5% to 11%. The discount rate was based on our weighted
average cost of capital, adjusted for the risks associated with the operations.

In 2000, we incurred a goodwill write down of $133 related to certain
operations in EMEA and as a result of a change in business mandate for those
operations from a product focus to a focus on distribution channels.

For additional information on our goodwill write-downs, see Special
charges in note 7 of the accompanying consolidated financial statements.

The carrying value of goodwill was $2,021 at December 31, 2002 and $2,283
at December 31, 2001. For more information on the goodwill amounts attributed
to each reportable segment, you should refer to Consolidated financial
statement details in note 5 of the accompanying consolidated financial
statements.

Pension and post retirement benefits

We maintain various pension and post-retirement benefit plans for our
employees in North America and the United Kingdom. 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 2002, the expected long-term
rate of return on plan assets used to estimate pension expenses was 7.8% on a
weighted average basis, which was the rate determined at September 30, 2001.
The expenses for 2001 were based on a weighted average long-term rate of return
of 8.1%. The discount rate used to estimate the net pension obligations and
expenses for 2002 were 6.3% and 6.7% respectively on a weighted average basis,
compared to 6.7% and 7.0% respectively in 2001. The lower rates reflected the
decline in global capital markets and interest rates.

The key assumptions used to estimate the post-retirement costs for 2002
were an expected long-term rate of return on plan assets of 8.0% and a
discount rate of 6.8% and 7.0% for the obligations and costs, respectively,
both on a weighted average basis. The expected long-term rate of return on
plan assets remained unchanged from 2001. The discount rates for the
obligations and costs decreased from 7.0% and 7.5% respectively in 2001 due to
the decline in global interest rates.

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 the 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.

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In developing these assumptions, we evaluated, among other things, input
from our actuaries, expected long-term market returns and current high-quality
bond rates.

Plan assets are comprised primarily of common stocks, bonds, debentures,
secured mortgages and property. Included in plan assets are common shares of
Nortel Networks Corporation with an aggregate market value of $3 in 2002 ($23
in 2001).

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 2002, we had unrecognized net actuarial
losses of $1,400 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 estimated accumulated benefit obligations for the defined benefit
plans exceeded the fair value of the plan assets at September 30, 2002 as a
result of the negative impact that declines in global capital markets and
interest rates had on our pension plan assets and obligations. Accordingly, we
recorded a non-cash charge of $692 ($559 after-tax) to shareholders equity 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 is measured.

During 2002, we made $75 in required cash contributions to our registered
defined benefit pension plans as well as additional voluntary contributions of
$75. In 2003, we expect required cash contributions under applicable
legislation to be similar to those made in 2002, although global capital market
and interest rate fluctuations could impact future funding requirements.

For 2003, our expected rate of return on plan assets remains unchanged
from 2002 for pension expenses and post-retirement costs. However, for 2003,
we lowered our discount rate approximately 0.4% to 6.3% on a weighted average
basis for pension expenses and 0.25% to 6.8% on a weighted average basis for
post-retirement costs given the 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.

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 and other claims (some of
which may involve substantial dollar amounts), including proceedings under laws
and government regulations related to securities, environmental, labor, product
and other matters. We are required to assess the likelihood of any adverse
judgments or outcomes in 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. For more information related to our
outstanding legal proceedings, see Contingencies in note 20 of the
accompanying consolidated financial statements.

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Liquidity and capital resources

Cash flows

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

Year ended December 31,2002
    
    
    2001Net cash from (used in) operating activities of continuing operations
    
    $
    (966
    )
    
    $
    405Net cash used in investing activities of continuing operations
    
    
    (97
    )
    
    
    (805
    )Net cash from financing activities of continuing operations
    
    
    953
    
    
    
    2,896Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    74
    
    
    
    (10
    )Net cash from (used in) continuing operations
    
    
    (36
    )
    
    
    2,486Net cash from (used in) discontinued operations
    
    
    375
    
    
    
    (649
    )Net increase in cash and cash equivalents
    
    
    339
    
    
    
    1,837Cash and cash equivalents at beginning of year  net
    
    
    3,404
    
    
    
    1,567Cash and cash equivalents at end of year  net
    
    $
    3,743
    
    
    $
    3,404


During 2002 and 2001, we took actions to strengthen our cash and liquidity
positions. As of December 31, 2002, our primary source of liquidity is our
current cash and cash equivalents, or cash. At December 31, 2002, we had cash
of $3,743, excluding $249 of restricted cash. We believe this cash will be
sufficient to fund our current business model, manage our investments and meet
our customer commitments for at least the next 12 months. However, if capital
spending by service providers and other customers declines more significantly
than we currently expect, we may be required to adjust our current business
model. As a result, our revenues and cash flows may be materially lower than
we expect and we may be required to further reduce our capital expenditures and
investments or take other measures in order to meet our cash requirements. We
may seek additional funds from liquidity-generating transactions and other
conventional sources of external financing (which may include a variety of
debt, convertible debt and/or equity financings). We cannot provide any
assurance that our net cash requirements will be as we currently expect, that
we will continue to have access to our credit facilities when and as needed, or
that liquidity-generating transactions or financings will be available to us on
acceptable terms or at all.

Cash flows used in operating activities were $966 due to a net loss of
$2,745, less an adjustment of $1,399 for non-cash and other items, plus a net
cash inflow of $380 from operating assets and liabilities. The reduction in
income tax was primarily due to the collection of $1,385 in income tax refunds
during the period. Any future income tax payments are expected to be minimal
versus historical levels until we utilize our available income tax loss
carryforwards and tax credits. The reduction in the remaining operating assets
and liabilities was primarily due to the continued decline in sales volumes and
the associated size of the business, as well as the utilization of certain
contract manufacturer and supplier provisions and restructuring provisions.

Cash flows used in investing activities were $97 and were primarily due
to: an increase of $231 in restricted cash held as cash collateral for certain
customer bid and performance bonds and contracts; and expenditures for plant
and equipment of $335. These amounts were partially offset by: proceeds on
disposal of certain plant and equipment of $406, mainly related to the sale of
certain real estate in the United Kingdom; a net decrease of $31 in our
long-term receivables; and net proceeds on the sale/acquisition of investments
and businesses of $32, primarily related to the sale of certain assets of our
Service Commerce operation support system business. In 2003, we expect that
our expenditures for plant and equipment will be similar in amount to 2002.

As at December 23, 2003, we expect that our plant and equipment purchases
for 2003 will decline substantially from the $335 in purchases we made in 2002.

Cash flows generated from financing activities were $953 and were
primarily due to $1,472 received from Nortel Networks Corporation in return for
2 common shares, relating to the proceeds from its June 12, 2002 equity
offerings, and

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$815 received from Nortel Networks Corporation in return for an
additional 2 common shares. These amounts were partially offset by a stock
option fair value increment of $525, which was a payment made by one of our
subsidiaries to Nortel Networks Corporation representing the difference between
the market value of Nortel Networks Corporation common shares issued upon
option exercises and the exercise price of Nortel Networks Corporation stock
options exercised by employees of the subsidiary; net cash of $445 used to
reduce our long-term debt; a net reduction of $333 in notes payable; and $22 in
preferred share dividends.

Uses of liquidity

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



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

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

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

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

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

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

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

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

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

Obligations under special charges

The remaining cash payments of $230 relating to workforce reduction
initiatives are expected to be substantially completed by the end of 2003. The
remaining cash payments of $632 related to contract settlement and lease costs
are expected to be substantially completed by the end of 2006. Additional
charges will be required in 2003 related to our remaining announced workforce
reductions and related charges. We expect restructuring related cash outflows
of approximately $900 in 2003.

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

As at December 23, 2003, we expect to incur approximately $100 to $125 in
restructuring work plan related cash outflows during the fourth quarter of
2003. For the entire year 2003, we currently expect to incur approximately
$550 to $600 in restructuring work plan related cash flows.

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Contractual cash obligations

Payments
due
    TotalContractual cash obligations (a)
    
    2003
    
    
    2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    Thereafter
    
    
    ObligationsLong-term debt
    
    $
    233
    
    
    $
    21
    
    
    $
    1
    
    
    $
    1,467
    
    
    $
    1
    
    
    $
    459
    
    
    $
    2,182Outsourcing contracts
    
    
    291
    
    
    
    273
    
    
    
    270
    
    
    
    268
    
    
    
    265
    
    
    
    263
    
    
    
    1,630Operating leases
    
    
    305
    
    
    
    220
    
    
    
    195
    
    
    
    144
    
    
    
    117
    
    
    
    690
    
    
    
    1,671Unconditional purchase obligations
    
    
    80
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110Total contractual obligations
    
    $
    909
    
    
    $
    544
    
    
    $
    466
    
    
    $
    1,879
    
    
    $
    383
    
    
    $
    1,412
    
    
    $
    5,593


|(a) |  | Contractual cash obligations do not include provisioned lease costs as they were included in our special charges
|--- |  | ----------------------------------------------------------------------------------------------------------------

On October 1, 2002, we repaid the $300 6.875% Notes due October 1, 2002,
including accrued interest, as part of our normal course debt repayments. Also
during 2002, we purchased $36 of our 6.00% Notes due September 1, 2003 and $186
of our 6.125% Notes due February 15, 2006. In 2002, we have made all required
cash contributions to our registered pension plans as well as additional
voluntary contributions, totaling approximately $150. In 2003, we plan to
repay the remaining $164 of our 6.00% Notes due September 1, 2003.

Commitments and guarantees



| |  | Bid and performance related bonds
| |  | ---------------------------------

We enter into bid and performance related bonds in connection with various
contracts. These contracts generally have terms ranging from two to five
years. Performance related bonds generally have a term of about twelve months
and are typically renewed, as required, over the term of the applicable
contract. Bid bonds generally have a much shorter term than performance
related bonds, depending on the length of the bid period for the applicable
contract. Any potential payments that we would be required to make are related
to our performance under the applicable contract. The following table provides
information related to these types of bonds:

Year ended December 31,Bid and performance related bonds (a)
    
    2002
    
    
    2001Performance guarantees (b)
    
    $
    362
    
    
    $
    1,170


|(a) |  | Represents available and undrawn commitments as at December 31, 2002 and December 31, 2001                            
|--- |  | ----------------------------------------------------------------------------------------------------------------------
|(b) |  | $249 in cash and cash equivalents was restricted as cash collateral and is excluded from the December 31, 2002 balance

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

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

Our support facility with EDC provides support for certain of our
obligations under bid and performance related bonds and may reduce the
requirement for us to provide cash collateral to support these obligations.
Although this facility provides for up to $750 in support, only $300 is
committed support for these bonds (within certain parameters). In addition,
any bid or performance related bonds with terms that extend beyond June 30,
2004, which is the expiry date of this facility, are currently not eligible for
the support provided by this facility. Unless EDC agrees to an extension of
the facility or agrees to provide support in respect of any such bid or
performance related bonds on a case-by-case basis outside the scope of the

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facility, we may be required to provide cash collateral to support these
obligations. In addition to the support facility with EDC, our existing
security agreements permit us to secure additional obligations under bid and
performance related bonds with the assets pledged under the security agreements
and to provide cash collateral as security for these types of bonds. See
Available credit and support facilities for additional information on this
support facility and the security agreements.



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

In the normal course of business, we have guaranteed the debt of certain
customers. These third party debt agreements require us to make debt payments
throughout the term of the related debt instrument if the customer fails to
make a scheduled payment.

The following table provides information related to our third party debt
agreements:

Year ended December 31,Third party debt
agreements (a)
    
    2002
    
    
    2001Financial guarantees
    
    $
    13
    
    
    $
    12


|(a) |  | Represents available and undrawn commitments as at December 31, 2002 and December 31, 2001
|--- |  | ------------------------------------------------------------------------------------------

Historically, we have not had to make material payments and currently, we
do not anticipate that we will be required to make material payments under
these debt instruments. See Guarantees and commitments in note 13 of the
accompanying consolidated financial statements for additional information.



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

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



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

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

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

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

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

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Customer financing

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

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

Year ended December 31,2002
    
    
    2001Drawn and outstanding  gross (a)
    
    $
    1,091
    
    
    $
    1,349Related provisions
    
    
    (799
    )
    
    
    (902
    )Drawn and outstanding  net
    
    
    292
    
    
    
    447Undrawn commitments
    
    
    801
    
    
    
    1,611Total customer financing
    
    $
    1,093
    
    
    $
    2,058


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

We currently have customer financing commitments and/or balances
outstanding in connection with the construction of new networks, including 3G
wireless networks. Although we may commit to provide customer financing to
customers in areas that are strategic to our core businesses, we remain focused
on reducing our overall customer financing exposures consistent with our
financing agreements. During 2002, we reduced undrawn commitments by $810
reflecting commitment expiration, cancellations and changing customer business
plans. In addition to being highly selective in providing customer financing,
we have programs in place to monitor and mitigate customer credit risk,
including performance milestones and other conditions of funding. Management
is focused on the strategic use of our customer financing capacity and on
reducing the amount of our existing and future customer financing exposure.

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

In 2001 and 2002, our ability to place customer financing with third-party
lenders was significantly reduced primarily due to:



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

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

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

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

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

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

Joint ventures/minority interests

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

For additional information, see Guarantees and commitments in note 13 of
the accompanying consolidated financial statements.

Discontinued operations

As of December 31, 2002, the remaining accruals of the discontinued access
solutions operations totaled $44 and were related to future contractual
obligations and estimated liabilities, and estimated operating losses during
the planned period of disposition. The remaining accruals are expected to be
substantially drawn down by cash payments over the period of disposition, the
impact of which is expected to be partially offset by proceeds from the sale of
certain remaining assets. During 2002, we generated cash of approximately $375
on the disposition of various assets from the access solutions operations and
associated wind-down activities.

For additional information related to our discontinued operations, see
Discontinued operations in note 18 of the accompanying consolidated financial
statements.

Sources of liquidity

Available credit and support facilities

We currently have $750 in available and undrawn credit facilities which
expire in April 2005. These credit facilities were entered into on April 12,
2000 by us and Nortel Networks Inc. and permit borrowings for general corporate
purposes. As of December 31, 2002, there were no outstanding balances under
our available credit facilities.

The following table summarizes our credit facilities:

Year ended December 31,2002
    
    
    2001December 2001 364-day credit facilities
    
    $
    
    
    
    $
    1,575April 2000 five year credit facilities
    
    
    750
    
    
    
    750April 2002 364-day revolving credit facilities
    
    
    
    
    
    
    1,750Total available credit facilities
    
    $
    750
    
    
    $
    4,075


The $750 April 2000 five year credit facilities contain a financial
covenant requiring that our consolidated tangible net worth at any time be not
less than $1,888. As of December 31, 2002, we were in compliance with this
covenant. We continue to monitor our financial position in light of this
covenant and if we continue to incur net losses or record additional charges
relating to our restructuring work plan, the accounting of our registered
pension plans, the valuation of deferred income tax assets or for other events,
our consolidated tangible net worth may be reduced below the $1,888 threshold.
If we are unable to comply with the consolidated tangible net worth covenant,
we will be unable to access the $750 April 2000 five year credit facilities.

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On December 13, 2002, Nortel Networks Corporation announced amendments to
our security agreements to facilitate our future financial flexibility. These
security agreements pledge substantially all of our assets in favor of certain
lenders and the holders of our outstanding public debt. The amendments, among
other things, permit us to secure additional obligations with the assets
pledged under the security agreements. These additional obligations include
those under the support facility with EDC and other indemnity, guarantee and
reimbursement obligations with respect to letters of credit, letters of
guarantee, performance bonds, surety bonds, indemnification arrangements and
other instruments. As part of the amendments to the security agreements, we
terminated the $1,175 April 2002 364-day revolving credit facilities that would
have expired in April 2003. These credit facilities had previously been
amended and extended, and reduced in size from $1,750 to $1,175 on April 8,
2002. Also on December 13, 2002, our $1,510 December 2001 364-day credit
facilities expired and were not extended. During 2002, we sold certain real
estate in the United Kingdom, which resulted in reductions in the available
commitments under the December 2001 364-day credit facilities from $1,575 to
$1,510.

On February 14, 2003, we entered into an agreement with EDC regarding
arrangements to provide support, on a secured basis, of certain of our
contingent obligations arising out of normal course business activities,
including letters of credit, letters of guarantee, indemnity arrangements,
performance bonds, surety bonds, receivables sales, securitizations, and
similar instruments issued or entered into for our benefit. This facility,
which expires on June 30, 2004, provides for up to $750 in performance-related
support and is comprised of:



| |  | up to $300 of committed support for performance bonds (within certain parameters);
| | - | ----------------------------------------------------------------------------------

| |  | up to $150 of uncommitted support for receivables sales/securitizations; and
| | - | ----------------------------------------------------------------------------

| |  | up to $300 of additional uncommitted support for performance bonds and receivable sales/securitizations.
| | - | --------------------------------------------------------------------------------------------------------

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

Any amounts that are drawn under the $750 April 2000 five year credit
facilities and all of the obligations under the support facility with EDC, our
current outstanding public debt and our guarantee of Nortel Networks
Corporations 4.25% convertible senior notes, or the Senior Notes, are secured
equally and ratably with each other. The security provided under the security
agreements is comprised of:



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

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

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

The security agreements were entered into in connection with the $1,510
December 2001 364-day credit facilities, which have expired. The security
became effective in the second quarter of 2002, following Moodys downgrade of
our senior long-term debt rating to below investment grade. At that time, the
security became effective in respect of the $1,510 December 2001 364-day credit
facilities, as well as any other credit facilities and outstanding public debt
which, by their terms, required that the security also apply to them. This
included the $1,175 April 2002 364-day revolving credit facilities, which we
have terminated, the $750 April 2000 five year credit facilities, our
outstanding public debt and our guarantee of the Senior Notes.

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

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For additional information relating to our outstanding public debt and the
$750 April 2000 five year credit facilities, see Long-term debt and credit
facilities in note 11 of the accompanying consolidated financial statements.
For additional information relating to our guarantee of the Senior Notes, see
Related party transactions in note 19 of the accompanying consolidated
financial statements. For additional information relating to the support
facility with EDC, see Subsequent events in note 21 of the accompanying
consolidated financial statements. For additional financial information
related to those subsidiaries providing guarantees, see Supplemental
consolidating financial information in note 22 of the accompanying
consolidated financial statements. For information relating to our debt
ratings, see Credit ratings below. See Forward-looking statements for
factors that may affect our ability to comply with covenants and conditions in
our credit and support facilities in the future.

Shelf registration statement and base shelf prospectus

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

At the same time as the filing of the shelf registration statement and
base shelf prospectus, Nortel Networks Limited and its financing subsidiary
withdrew a shelf registration statement filed with the United States Securities
and Exchange Commission under which they were previously eligible to issue up
to $1,000 in debt securities and warrants to purchase debt securities.

Credit ratings

Rating on long-termdebt issued orguaranteed byNortel Networks
    
    
    Rating on preferredLimited/Nortel
    
    
    shares issued byNetworks
    
    
    Nortel NetworksRating agency
    
    Corporation
    
    
    Limited
    
    
    Last updateStandard & Poors Ratings Service
    
    
    B
    
    
    CCC
    
    September 18, 2002Moodys Investors Services, Inc.
    
    
    B3
    
    
    Caa3
    
    November 1, 2002


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

Preferred Shares

Nortel Networks Corporation, 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 $3,187 in 2002 and
$16,800 in 2001. Among other things, these reductions enhance our ability to
continue to declare and pay dividends on our outstanding preferred shares under
applicable Canadian corporate laws.

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. 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

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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 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.

Debt to capitalization ratio

The total debt to total capitalization ratio of Nortel Networks was 31% at
December 31, 2002, compared to 32% at December 31, 2001. The ratio reflects
the increase in our deficit, partially offset by the $1,472 in common share
equity received from Nortel Networks Corporation, in connection with the equity
offerings on June 12, 2002.

See our Forward-looking statements for factors that may impact our
liquidity and capital resources.

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

Off-balance sheet arrangements

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

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

Certain lease financing transactions are structured through single
transaction special purpose entities that currently do not have sufficient
equity at risk as defined in FIN 46. In addition, we retain certain risks
associated with guaranteeing recovery of between 75 percent and 88 percent of
the unamortized principal balance of debt which is expected to represent the
majority of the risks associated with the special purpose entities activities.
This percentage will be adjusted over time as the underlying debt matures.
Therefore, we expect that unless the existing arrangements are modified prior
to July 1, 2003, we will be required to consolidate the assets, liabilities and
any non-controlling interests of these special purpose entities effective July
1, 2003. The total assets and total liabilities held by these entities at
December 31, 2002 were approximately $176 and $176 respectively.

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Contractual obligations

The following table summarizes our contractual obligations over the
periods noted below:

Payments due
    
    TotalContractual cash
obligations (a)
    
    2003
    
    
    2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    Thereafter
    
    
    ObligationsLong-term debt
    
    $
    233
    
    
    $
    21
    
    
    $
    1
    
    
    $
    1,467
    
    
    $
    1
    
    
    $
    459
    
    
    $
    2,182Outsourcing contracts
    
    
    291
    
    
    
    273
    
    
    
    270
    
    
    
    268
    
    
    
    265
    
    
    
    263
    
    
    
    1,630Operating leases
    
    
    305
    
    
    
    220
    
    
    
    195
    
    
    
    144
    
    
    
    117
    
    
    
    690
    
    
    
    1,671Unconditional purchase obligations
    
    
    80
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110Total contractual obligations
    
    $
    909
    
    
    $
    544
    
    
    $
    466
    
    
    $
    1,879
    
    
    $
    383
    
    
    $
    1,412
    
    
    $
    5,593


|(a) |  | Contractual cash obligations do not include provisioned lease costs as they
were included in our special charges.
|--- |  | -----------------------------------------------------------------------------------------------------------------

Contingent liabilities and commitments

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

In certain instances, we are committed to provide future financing to
certain customers in connection with their purchases of our products and
services. The undrawn commitments were $801 at December 31, 2002 and $1,611 at
December 31, 2001. Commitments to extend future financing generally have
conditions for funding, fixed expiration or termination dates and specific
interest rates and purposes. Based on the terms of the existing agreements, we
expect that a substantial amount of these undrawn commitments will not be
funded in 2003. However, we cannot predict with certainty the extent to which
our customers will satisfy the applicable conditions for funding, and
subsequently request funding, prior to the termination date of the commitments.

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

We have entered into purchase commitments with certain suppliers under
which we commit to buy a minimum amount or percentage of designated products in
exchange for price guarantees or similar concessions. In certain of these
agreements, we may be required to acquire and pay for such products up to the
prescribed minimum or forecasted purchases.

We entered into an arrangement with a minimum purchase commitment of $120
with Bookham Technology plc. The terms of the commitment require us to purchase
$120 of product from Bookham between November 8, 2002 and March 31, 2004.
Should there be a shortfall, we would make a cash payment for a portion of the
balance.

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

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

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Other contingent liabilities and commitments

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



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

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

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

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

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

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

Historically, we have not made any significant payments under any of these
indemnifications or guarantees. In certain cases, due to the nature of the
agreement, we have not been able to estimate our maximum potential loss or the
maximum potential loss has not been specified. However, for those agreements
where we have been able to make an estimate, the maximum amount that we would
be obliged to pay under these indemnifications and guarantees would be $212.

For more information on these contingent liabilities and commitments, you
should refer to Guarantees and commitments in note 13 of the accompanying
consolidated financial statements.

Market risk

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

For a discussion of our accounting policies for derivative financial
instruments, see Significant accounting policies in note 2(s) of the
accompanying consolidated financial statements. Additional disclosure of our
financial instruments is included in Financial instruments and hedging
activities in note 12 of the accompanying consolidated financial statements.

We manage foreign exchange exposures using forward and option contracts to
hedge firm sale and purchase commitments. Our most significant foreign
exchange exposures are in the Canadian dollar, the United Kingdom pound and the
Euro. We enter into United States to Canadian dollar forward and option
contracts intended to hedge the United States to Canadian dollar exposure on
future revenue and expenditure streams. We recognize the gains and losses on
these contracts in income when the hedged transaction occurs.

We expect to continue to expand our business globally and, as such, expect
that an increasing proportion of our business will be denominated in currencies
other than United States dollars. As a result, fluctuations in foreign
currencies may have a material impact on our business, results of operations
and financial condition. We try to minimize the impact of such currency
fluctuations through our ongoing commercial practices and by attempting to
hedge our exposures to major currencies. In attempting to manage this foreign
exchange risk, we identify operations and transactions that may have exposure
based upon the excess or deficiency of foreign currency receipts over foreign
currency expenditures. Our significant currency flows for the year ended
December 31, 2002 were in United States dollars, Canadian dollars, United
Kingdom pounds and the Euro. The net impact of foreign exchange fluctuations
resulted in a loss of $27 in 2002, a loss of $73 in 2001 and a gain of $8 in
2000. Given our exposure to international markets, we regularly monitor all of
our foreign currency exposures. We cannot predict whether we will incur
foreign exchange losses in the future; however, if significant foreign exchange
losses are experienced, they could have a material adverse effect on our
business, results of operations and financial condition.

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

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, 2002 and 2001, 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 the exchange rates would result in a potential decrease in after-tax
cash flows of $132 as of December 31, 2002 and $91 as of December 31, 2001.
This potential decrease would result primarily from our exposure to the
Canadian dollar, the United Kingdom pound and the Euro.

We also use sensitivity analysis to measure our interest rate risk. As of
December 31, 2002, a 100 basis point adverse change in interest rates would not
have a material effect on our business, results of operations and financial
condition.

Legal proceedings

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

For additional information related our legal proceedings, see
Contingencies in note 20 of the accompanying consolidated financial
statements.

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 five Superfund sites in
the United States. 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 $30.

For a discussion of Environmental matters, see Contingencies in note 20
of the accompanying consolidated financial statements.

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Forward-looking statements

Certain statements in this Annual Report onForm 10-K, contain words such
as could, expects, may, anticipates, believes, intends,
estimates, plans, envisions, and other similar language and are
considered forward-looking statements. These statements are based on our
expectations, estimates, forecasts and projections about the operating
environment, economies and markets in which we operate. In addition, other
written or oral statements which are considered forward-looking may be made by
us or others on our behalf. These statements are subject to important risks,
uncertainties and assumptions, which are difficult to predict and the actual
outcome may be materially different. Some of the factors which could cause
results or events to differ from current expectations include, but are not
limited to, the risk factors described below. Unless required by applicable
securities laws, we do not have any intention or obligation to publicly update
or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. The risk factors have been updated to
reflect the restatements as well as for events and developments subsequent to
December 31, 2002

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

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

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

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



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

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

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

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

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

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have a material adverse effect on our business, results of operations and
financial condition.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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



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

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

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

The material weaknesses noted above, if not addressed, could result in
accounting errors such as those underlying the restatements of our consolidated
financial statements more fully discussed in note 3 of the accompanying
consolidated

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financial statements and Developments in 2003  Restatements in the
MD&A. Our failure to fully address these material weaknesses could have a
material adverse effect on our business, results of operations and financial
condition. Please see Item 14. Controls and Procedures below.

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Our working capital requirements and cash flows historically have been,
and are expected to continue to be, subject to quarterly and yearly
fluctuations, depending on such factors as timing and size of capital
expenditures, levels of sales, timing of deliveries and collection of
receivables, inventory levels, customer payment terms, customer financing
obligations and supplier terms and conditions. In addition, due to the current
general economic and industry environment, and our current credit condition, an
increased portion of our cash and cash equivalents may be restricted as cash
collateral for customer performance bonds and contracts, notwithstanding our
support facility with EDC. Our $750 April 2000 five year credit facilities are
our only remaining credit facilities. We continue to have ongoing discussions
with our banks and other financial institutions to explore additional financing
opportunities and credit and support arrangements. As we continue to

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assess our overall liquidity and business needs as well as our expected
financial performance, we may elect or it may be necessary to reduce or
terminate our $750 April 2000 five year credit facilities prior to their
expiries. We believe our cash on hand will be sufficient to fund our current
business model, manage our investments and meet our customer commitments for at
least the next 12 months. However, a greater than expected slow down in
capital spending by service providers and other customers may require us to
adjust our current business model. As a result, our revenues and cash flows
may be materially lower than we expect and we may be required to further reduce
our capital expenditures and investments or take other measures in order to
meet our cash requirements. We may seek additional funds from
liquidity-generating transactions and other conventional sources of external
financing (which may include a variety of debt, convertible debt and/or equity
financings). We cannot provide any assurance that our net cash requirements
will be as we currently expect, that we will continue to have access to our
$750 April 2000 five year credit facilities or the support facility with EDC
when and as needed, or that liquidity-generating transactions or financings
will be available to us on acceptable terms or at all. Our inability to manage
cash flow fluctuations resulting from the above factors and the potential
reduction or termination of our $750 April 2000 five year credit facilities or
the support facility with EDC could have a material adverse effect on our
ability to fund our working capital requirements from operating cash flows and
other sources of liquidity or to achieve our business objectives in a timely
manner.

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

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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We have risks related to our defined benefit plans.

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

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

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

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

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

We cannot be sure what the rate of such convergence of voice and data
networks will be, due to the dynamic and rapidly evolving nature of the
communications business, the technology involved and the availability of
capital. Consequently, market discontinuities and the resulting demand for
IP-optimized networking solutions or 3G wireless

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networks may not materialize. Alternatively, the pace of that development
may be slower than currently anticipated. It may also be the case that the
market may develop in an unforeseen direction. Certain events, including the
commercial availability and actual implementation of new technologies,
including 3G networks, or the evolution of other technologies, may occur which
would affect the extent or timing of anticipated market demand, or increase
demand for products based on other technologies, or reduce the demand for
IP-optimized networking solutions or 3G wireless networks, which in turn may
reduce purchases of our networking solutions by our customers, require
increased expenditures to develop and market different technologies, or provide
market opportunities for our competitors. Our performance may also be
materially and adversely affected by a lack of growth in the rate of data
traffic, a reduction in the use of the Internet or a reduction in the demand
for IP-optimized networking solutions or 3G wireless networks in the future.

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

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



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

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

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

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

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

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

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

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

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

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

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

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

The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. We expect our success to depend, in substantial
part, on the timely and successful introduction of high quality, new products
and upgrades, as well as cost reductions on current products to address the
operational speed, bandwidth, efficiency and cost requirements of our
customers. Our success will also depend on our ability to comply with emerging
industry standards, to operate with products of other suppliers, to address
emerging market trends, to provide our customers with new revenue-generating
opportunities and to compete with technological and product developments
carried out by others. The development of new, technologically advanced
products, including IP-optimized networking solutions, software products and 3G
wireless networks, is a complex and uncertain process requiring high levels of
innovation, as well as the accurate anticipation of technological and market
trends. Investments in such development may result in expenses growing at a
faster rate than revenues, particularly since the initial investment to bring a

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product to market may be high. We may not be successful in targeting new
market opportunities, in developing and commercializing new products in a
timely manner or in achieving market acceptance for our new products.

The success of new or enhanced products, including IP-optimized networking
solutions and 3G wireless networks, depends on a number of other factors,
including the timely introduction of such products, market acceptance of new
technologies and industry standards, the quality and robustness of new or
enhanced products, competing product offerings, the pricing and marketing of
such products and the availability of funding for such networks. Products and
technologies developed by our competitors may render our products obsolete.
Hackers may attempt to disrupt or exploit our customers use of our
technologies. If we fail to respond in a timely and effective manner to
unanticipated changes in one or more of the technologies affecting
telecommunications and data networking or our new products or product
enhancements fail to achieve market acceptance, our ability to compete
effectively in our industry, and our sales, market share and customer
relationships could be materially and adversely affected.

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

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

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

Our major competitors in Wireless Networks have traditionally included
Telefonaktiebolagat LM Ericsson, Lucent Technologies Inc., Motorola, Inc.,
Siemens Aktiengesellschaft and Nokia Corporation. More recently, Samsung
Electronics Co., Ltd. and Huawei Technologies Co., Ltd. have emerged as
competitors. Our principal competitors in the sale of our Enterprise Networks
solutions to enterprises are Cisco Systems, Inc., Avaya Inc., Alcatel S.A., and
Siemens. We also compete with smaller companies that address specific niches,
such as Foundry Networks, Inc., Extreme Networks, Inc., Enterasys Networks,
Inc., 3Com Corporation and Genesys Telecommunications Laboratories, Inc. Our
principal competitors in the sale of our Wireline Networks products to service
providers are large communications companies such as Cisco, Lucent, Alcatel and
Siemens. In addition, we compete with smaller companies that address specific
niches within this market, such as Sonus Systems Limited, BroadSoft, Inc.,
Taqua Inc., Redback Networks Inc., Equipe Communications Corporation, Laurel
Networks, Inc. and WaveSmith Networks, Inc. Certain competitors are also
strong on a regional basis, such as ZTE Corporation and Huawei. Our major
competitors in Optical Networks include Alcatel, Lucent, Siemens, Marconi plc,
Cisco, Huawei, NEC Corporation, Ciena Corporation and ADVA International Inc.
Since some of the markets in which we compete are characterized by the
potential for rapid growth and, in certain cases, low barriers to entry and
rapid technological changes, smaller, specialized companies and start-up
ventures are now or may become principal competitors in the future. We may
also face competition from the resale of used telecommunications equipment,
including our own on occasion, by failed, downsized or consolidated high
technology enterprises and telecommunications service providers. In addition,
one way to maximize market growth, enhance existing products and introduce new
products is through acquisitions of companies, where advisable. Certain of our
competitors may enter into additional business combinations, to accelerate
product development, or to engage in aggressive price reductions or other
competitive practices, creating even more powerful or aggressive competitors.

We expect that we will face additional competition from existing
competitors and from a number of companies that have entered or may enter our
existing and future markets. Some of our current and potential competitors
have greater marketing, technical and financial resources, including access to
capital markets and/or the ability to provide customer financing in connection
with the sale of products. Many of our current and potential competitors have
also established, or may in the future establish, relationships with our
current and potential customers. Other competitive factors include the ability
to provide new technologies and products, end-to-end networking solutions, and
new product features, such as security, as well as conformance to industry
standards. Increased competition could result in price reductions, negatively

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affecting our operating results, reducing profit margins and potentially
leading to a loss of market share.

We face certain barriers in our efforts to expand internationally.

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



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

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

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

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

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

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

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

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

| |  | taxation;
| | - | ---------

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Recent pronouncements

For a discussion of recent pronouncements, see Significant accounting
policies in note 2 of the accompanying financial statements.

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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.

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ITEM 8. Consolidated Financial Statements and Supplementary Data

The restated consolidated financial statements and supplementary data,
including the notes to the restated consolidated financial statements, set
forth in this Item 8 have been revised to reflect the restatements and, except
for these revisions, do not reflect events and developments subsequent to
December 31, 2002.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGEIndependent Auditors Report
    
    
    F-1Consolidated Statements of Operations
    
    
    F-2Consolidated Balance Sheets
    
    
    F-3Consolidated Statements of Shareholders Equity
    
    
    F-4Consolidated Statements of Cash Flows
    
    
    F-5Notes to Consolidated Financial Statements
    
    
    F-6Quarterly Financial Data (Unaudited)
    
    
    F-73


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INDEPENDENT AUDITORS REPORT

To the Shareholders of Nortel Networks Limited

We have audited the accompanying consolidated balance sheets of Nortel Networks
Limited and its subsidiaries (Nortel Networks) as of December 31, 2002 and
2001 and the related consolidated statements of operations, shareholders
equity and cash flows for each of the years in the three-year period ended
December 31, 2002. These financial statements are the responsibility of Nortel
Networks management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Nortel Networks as of December 31,
2002 and 2001 and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America.

As described in note 4 to the consolidated financial statements, effective
January 1, 2002, Nortel Networks changed its method of accounting for goodwill
in accordance with Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets.

As described in note 3 to the consolidated
financial statements, the accompanying
consolidated financial statements of Nortel Networks as of
December 31, 2002 and 2001, and for each of the years in the
three-year period ended December 31, 2002, have been restated.

On February 10, 2003, (February 14, 2003 as to
note 20, December 23, 2003 as to the effects of the
restatements described in note 3) we
reported separately to the Shareholders of Nortel Networks on consolidated
financial statements for the same periods, audited in accordance with Canadian
generally accepted auditing standards and prepared in accordance with Canadian
generally accepted accounting principles.

/s/ Deloitte & Touche LLP

Chartered Accountants

Toronto, Canada
February 10, 2003 (February 14, 2003 as to
note 21, December 23, 2003 as to the effects of the
restatements described in note 3)

F-1



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##### Table of Contents



NORTEL NETWORKS LIMITED

Consolidated Statements of Operations for the years ended December 31


(millions of U.S. dollars)
    
    2002
    
    
    2001
    
    
    2000As restated *
    
    
    As restated *
    
    
    As restated *Revenues
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836Cost of revenues
    
    
    6,990
    
    
    
    14,089
    
    
    
    15,046Gross profit
    
    
    3,564
    
    
    
    3,183
    
    
    
    12,790Selling, general and administrative expense (excluding stock option
compensation)
    
    
    2,621
    
    
    
    5,712
    
    
    
    5,405Research and development expense
    
    
    2,205
    
    
    
    3,208
    
    
    
    3,629In-process research and development expense
    
    
    
    
    
    
    
    
    
    
    622Amortization of intangiblesAcquired technology
    
    
    19
    
    
    
    574
    
    
    
    789Goodwill
    
    
    
    
    
    
    2,080
    
    
    
    2,491Stock option compensation
    
    
    
    
    
    
    
    
    
    
    99Special chargesGoodwill impairment
    
    
    264
    
    
    
    2,239
    
    
    
    133Other special charges
    
    
    1,435
    
    
    
    3,089
    
    
    
    132Gain on sale of businesses
    
    
    (39
    )
    
    
    (126
    )
    
    
    (173
    )Operating loss
    
    
    (2,941
    )
    
    
    (13,593
    )
    
    
    (337
    )Equity in net loss of associated companies
    
    
    (18
    )
    
    
    (150
    )
    
    
    (18
    )Other income (expense)  net
    
    
    (34
    )
    
    
    (367
    )
    
    
    897Interest expenseLong-term debt
    
    
    (130
    )
    
    
    (173
    )
    
    
    (86
    )Other
    
    
    (44
    )
    
    
    (120
    )
    
    
    (83
    )(Loss) earnings from continuing operations before income taxes
    
    
    (3,167
    )
    
    
    (14,403
    )
    
    
    373Income tax benefit (provision)
    
    
    422
    
    
    
    2,973
    
    
    
    (1,216
    )Net loss from continuing operations
    
    
    (2,745
    )
    
    
    (11,430
    )
    
    
    (843
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    21
    
    
    
    (2,524
    )
    
    
    (414
    )Net loss before cumulative effect of accounting change
    
    
    (2,724
    )
    
    
    (13,954
    )
    
    
    (1,257
    )Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    15
    
    
    
    Net loss
    
    
    (2,724
    )
    
    
    (13,939
    )
    
    
    (1,257
    )Dividends on preferred shares
    
    
    22
    
    
    
    27
    
    
    
    31Net loss applicable to common shares
    
    $
    (2,746
    )
    
    $
    (13,966
    )
    
    $
    (1,288
    )


* See note 3

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

F-2



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##### Table of Contents



NORTEL NETWORKS LIMITEDConsolidated Balance Sheets as at December 31

(millions of U.S. dollars)
    
    2002
    
    
    2001As restated *
    
    As restated *Current assetsCash and cash equivalents
    
    $
    3,743
    
    
    $
    3,404Restricted cash and cash equivalents
    
    
    249
    
    
    
    Accounts receivable (less provisions of $516 for 2002, $776 for 2001)
    
    
    2,247
    
    
    
    3,056Inventories  net
    
    
    986
    
    
    
    1,834Income taxes recoverable
    
    
    58
    
    
    
    790Deferred income taxes  net
    
    
    793
    
    
    
    1,401Other current assets
    
    
    457
    
    
    
    716Current assets of discontinued operations
    
    
    211
    
    
    
    699Total current assets
    
    
    8,744
    
    
    
    11,900Investments at cost and associated companies at equity
    
    
    248
    
    
    
    261Plant and equipment  net
    
    
    1,464
    
    
    
    2,450Goodwill
    
    
    2,021
    
    
    
    2,283Intangible assets  net
    
    
    
    
    
    
    20Deferred income taxes  net
    
    
    2,653
    
    
    
    1,985Other assets
    
    
    766
    
    
    
    1,162Total assets
    
    $
    15,896
    
    
    $
    20,061LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    30
    
    
    $
    371Trade and other accounts payable
    
    
    899
    
    
    
    1,603Payroll and benefit-related liabilities
    
    
    499
    
    
    
    614Contractual liabilities
    
    
    1,213
    
    
    
    1,600Restructuring
    
    
    537
    
    
    
    755Other accrued liabilities
    
    
    2,894
    
    
    
    4,019Long-term debt due within one year
    
    
    233
    
    
    
    384Total current liabilities
    
    
    6,305
    
    
    
    9,346Long-term debt
    
    
    1,949
    
    
    
    2,293Deferred income taxes  net
    
    
    366
    
    
    
    477Other liabilities
    
    
    2,321
    
    
    
    1,600Minority interest in subsidiary companies
    
    
    129
    
    
    
    11811,070
    
    
    
    13,834Guarantees, commitments and contingencies (notes 13 and 20)SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited;Issued and outstanding shares: 30,000,000 for 2002 and 30,000,000 for 2001
    
    
    536
    
    
    
    536Common shares, without par value  Authorized shares: unlimited;Issued and outstanding shares: 1,460,978,638 for 2002 and 1,460,978,634 for 2001
    
    
    1,211
    
    
    
    2,111Additional paid-in capital
    
    
    22,004
    
    
    
    18,805Deficit
    
    
    (17,607
    )
    
    
    (14,336
    )Accumulated other comprehensive loss
    
    
    (1,318
    )
    
    
    (889
    )Total shareholders equity
    
    
    4,826
    
    
    
    6,227Total liabilities and shareholders equity
    
    $
    15,896
    
    
    $
    20,061


* See note 3

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

F-3



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##### Table of Contents



NORTEL NETWORKS LIMITEDConsolidated Statements of Shareholders Equity

(millions of U.S. dollars)
    
    2002
    
    
    2001
    
    
    2000As restated *
    
    As restated *
    
    As restated *Preferred sharesBalance at the beginning of the year
    
    $
    536
    
    
    $
    609
    
    
    $
    609Conversion of series 4 preferred shares
    
    
    
    
    
    
    (73
    )
    
    
    Balance at the end of the year
    
    $
    536
    
    
    $
    536
    
    
    $
    609Common sharesBalance at the beginning of the year
    
    $
    2,111
    
    
    $
    17,024
    
    
    $
    11,745Common shares issued  net
    
    
    2,287
    
    
    
    1,800
    
    
    
    206Common shares issued for acquisitions  net
    
    
    
    
    
    
    26
    
    
    
    4,922Fair value and costs associated with assumed options and stock purchase plan
    
    
    
    
    
    
    
    
    
    
    151Conversion of series 4 preferred shares
    
    
    
    
    
    
    61
    
    
    
    Reduction of legal stated capital
    
    
    (3,187
    )
    
    
    (16,800
    )
    
    
    Balance at the end of the year
    
    $
    1,211
    
    
    $
    2,111
    
    
    $
    17,024Additional paid-in capitalBalance at the beginning of the year
    
    $
    18,805
    
    
    $
    1,878
    
    
    $
    794Additions resulting from acquisitions
    
    
    5
    
    
    
    8
    
    
    
    805Fair value and costs associated with assumed options and stock purchase plan
    
    
    
    
    
    
    
    
    
    
    (168
    )Conversion of series 4 preferred shares
    
    
    
    
    
    
    12
    
    
    
    Reduction of legal stated capital
    
    
    3,187
    
    
    
    16,800
    
    
    
    Tax benefit associated with stock options
    
    
    13
    
    
    
    105
    
    
    
    447Other
    
    
    (6
    )
    
    
    2
    
    
    
    Balance at the end of the year
    
    $
    22,004
    
    
    $
    18,805
    
    
    $
    1,878Retained earnings (deficit)Balance at the beginning of the year
    
    $
    (14,336
    )
    
    $
    (370
    )
    
    $
    967Adjustment as of January 1, 2000 due to restatement
    
    
    
    
    
    
    
    
    
    
    4Net loss
    
    
    (2,724
    )
    
    
    (13,939
    )
    
    
    (1,257
    )Dividends on preferred shares
    
    
    (22
    )
    
    
    (27
    )
    
    
    (31
    )Dividends on common shares
    
    
    
    
    
    
    
    
    
    
    (53
    )Stock option fair value increment
    
    
    (525
    )
    
    
    
    
    
    
    Balance at the end of the year
    
    $
    (17,607
    )
    
    $
    (14,336
    )
    
    $
    (370
    )Accumulated other comprehensive lossBalance at the beginning of the year
    
    $
    (889
    )
    
    $
    (511
    )
    
    $
    (434
    )Adjustment as of January 1, 2000 due to restatement
    
    
    
    
    
    
    
    
    
    
    29Foreign currency translation adjustment
    
    
    99
    
    
    
    (243
    )
    
    
    (128
    )Unrealized gain (loss) on investments  net
    
    
    19
    
    
    
    (40
    )
    
    
    22Unrealized derivative (gain) losses on cash flow hedges  net
    
    
    12
    
    
    
    (7
    )
    
    
    Minimum pension liability adjustment  net
    
    
    (559
    )
    
    
    (81
    )
    
    
    Cumulative effect of accounting change
    
    
    
    
    
    
    (7
    )
    
    
    Other comprehensive loss
    
    
    (429
    )
    
    
    (378
    )
    
    
    (106
    )Balance at the end of the year
    
    $
    (1,318
    )
    
    $
    (889
    )
    
    $
    (511
    )Total shareholders equity
    
    $
    4,826
    
    
    $
    6,227
    
    
    $
    18,630Total comprehensive loss for the yearNet loss
    
    $
    (2,724
    )
    
    $
    (13,939
    )
    
    $
    (1,257
    )Other comprehensive loss
    
    
    (429
    )
    
    
    (378
    )
    
    
    (106
    )Total comprehensive loss for the year
    
    $
    (3,153
    )
    
    $
    (14,317
    )
    
    $
    (1,363
    )


* See note 3

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

F-4



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##### Table of Contents



NORTEL NETWORKS LIMITEDConsolidated Statements of Cash Flows for the years ended December 31

(millions of U.S. dollars)
    
    2002
    
    
    2001
    
    
    2000As restated *
    
    As restated *
    
    As restated *Cash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (2,745
    )
    
    $
    (11,430
    )
    
    $
    (843
    )Adjustments to reconcile net loss from continuing operations to net cash from (used
in) operating activities, net of effects from acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    561
    
    
    
    3,379
    
    
    
    4,047In-process research and development expense
    
    
    
    
    
    
    
    
    
    
    622Non-cash portion of special charges and related asset write downs
    
    
    784
    
    
    
    3,165
    
    
    
    137Equity in net loss of associated companies
    
    
    18
    
    
    
    150
    
    
    
    18Stock option compensation
    
    
    
    
    
    
    
    
    
    
    99Deferred income taxes
    
    
    (432
    )
    
    
    (2,568
    )
    
    
    522Other liabilities
    
    
    (9
    )
    
    
    78
    
    
    
    105Gain on repurchases of outstanding debt securities
    
    
    (60
    )
    
    
    
    
    
    
    (Gain) loss on sale or write down of investments and businesses
    
    
    7
    
    
    
    229
    
    
    
    (1,058
    )Other  net
    
    
    530
    
    
    
    (158
    )
    
    
    200Change in operating assets and liabilitiesAccounts receivable
    
    
    892
    
    
    
    5,826
    
    
    
    (991
    )Inventories
    
    
    655
    
    
    
    2,013
    
    
    
    (1,580
    )Income taxes
    
    
    1,256
    
    
    
    (953
    )
    
    
    (180
    )Accounts payable and accrued liabilities
    
    
    (2,215
    )
    
    
    115
    
    
    
    930Other operating assets and liabilities
    
    
    (208
    )
    
    
    559
    
    
    
    (836
    )Net cash from (used in) operating activities of continuing operations
    
    
    (966
    )
    
    
    405
    
    
    
    1,192Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (335
    )
    
    
    (1,267
    )
    
    
    (1,838
    )Proceeds on disposals of plant and equipment
    
    
    406
    
    
    
    208
    
    
    
    33Increase in restricted cash and cash equivalents
    
    
    (231
    )
    
    
    
    
    
    
    Increase in long-term receivables
    
    
    (271
    )
    
    
    (733
    )
    
    
    (1,780
    )Decrease in long-term receivables
    
    
    302
    
    
    
    472
    
    
    
    1,300Acquisitions of investments and businesses  net of cash acquired
    
    
    (29
    )
    
    
    (89
    )
    
    
    (316
    )Proceeds on sale of investments and businesses
    
    
    61
    
    
    
    604
    
    
    
    1,633Net cash used in investing activities of continuing operations
    
    
    (97
    )
    
    
    (805
    )
    
    
    (968
    )Cash flows from (used in) financing activitiesDividends on common and preferred shares
    
    
    (22
    )
    
    
    (27
    )
    
    
    (84
    )Increase (decrease) in notes payable  net
    
    
    (333
    )
    
    
    85
    
    
    
    114Proceeds from long-term debt
    
    
    33
    
    
    
    1,530
    
    
    
    107Repayments of long-term debt
    
    
    (478
    )
    
    
    (469
    )
    
    
    (69
    )Decrease in capital leases payable
    
    
    (9
    )
    
    
    (23
    )
    
    
    (2
    )Issuance of common shares
    
    
    2,287
    
    
    
    1,800
    
    
    
    206Stock option fair value increment
    
    
    (525
    )
    
    
    
    
    
    
    Net cash from financing activities of continuing operations
    
    
    953
    
    
    
    2,896
    
    
    
    272Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    74
    
    
    
    (10
    )
    
    
    (25
    )Net cash from (used in) continuing operations
    
    
    (36
    )
    
    
    2,486
    
    
    
    471Net cash from (used in) discontinued operations
    
    
    375
    
    
    
    (649
    )
    
    
    (1,057
    )Net increase (decrease) in cash and cash equivalents
    
    
    339
    
    
    
    1,837
    
    
    
    (586
    )Cash and cash equivalents at beginning of year  net
    
    
    3,404
    
    
    
    1,567
    
    
    
    2,153Cash and cash equivalents at end of year  net
    
    $
    3,743
    
    
    $
    3,404
    
    
    $
    1,567


* See note 3

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

F-5



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##### Table of Contents



NORTEL NETWORKS LIMITEDNotes to Consolidated Financial Statements
(millions of U.S. dollars, unless otherwise stated)



|1. |  | Nortel Networks Limited
|-- |  | -----------------------



| |  | Effective May 1, 2000, Nortel Networks Limited (Old Nortel) and a newly
formed Canadian corporation (New Nortel) participated in a Canadian
court-approved plan of arrangement (the Arrangement) with BCE Inc. (BCE).
As a result of the Arrangement: Old Nortel and its subsidiaries became
direct and indirect subsidiaries, respectively, of New Nortel; New Nortel
assumed the name Nortel Networks Corporation; New Nortels common shares
began to trade publicly on the New York and Toronto stock exchanges under the
symbol NT; Old Nortel was renamed Nortel Networks Limited; and 100
percent of Old Nortels common shares were acquired by New Nortel and ceased
to be publicly traded. The preferred shares and debt securities of Old
Nortel outstanding immediately prior to the Arrangement remained outstanding
and continued to be obligations of Old Nortel immediately after the
Arrangement.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | All of the business and operations conducted by Old Nortel and its
subsidiaries immediately prior to the effective date of the Arrangement
continued to be conducted by Old Nortel and its subsidiaries as subsidiaries
of New Nortel immediately after the Arrangement.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As part of the Arrangement, the outstanding common shares of Old Nortel were
exchanged for common shares of New Nortel. The aggregate number of New
Nortel common shares issued in the Arrangement was the same as the aggregate
number of Old Nortel common shares outstanding immediately prior to the
Arrangement (excluding the effect of the reservation of certain shares for
issuance pursuant to stock option plans).
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | All acquisitions completed prior to May 1, 2000 were consummated by Old
Nortel or its subsidiaries. Since May 1, 2000, acquisitions involving any
share consideration have been consummated by New Nortel, while acquisitions
not involving share consideration have continued to be consummated by Old
Nortel or its subsidiaries.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|2. |  | Significant accounting policies
|-- |  | -------------------------------



| |  | Basis of Presentation
| |  | ---------------------



| |  | The accompanying consolidated financial statements of Nortel Networks Limited
(Nortel Networks) include all majority owned subsidiaries over which Nortel
Networks exercises control and have been prepared in accordance with
accounting principles generally accepted in the United States of America
(GAAP). Although Nortel Networks is headquartered in Canada, the
accompanying consolidated financial statements are expressed in United States
dollars as the greater part of the financial results and net assets of Nortel
Networks are denominated in United States dollars.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As described in note 3, the consolidated statements of operations,
shareholders equity and cash flows for the years ended December 31, 2002,
2001 and 2000, and the consolidated balance sheets as at
December 31, 2002 and 2001, including the applicable notes,
have been restated.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) | Principles of consolidation
| | --- | ---------------------------



| |  | The financial statements of entities which are controlled by Nortel
Networks, 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 Networks has the ability to
exercise significant influence, referred to as associated companies, are
accounted for using the equity method. Intercompany accounts and
transactions are eliminated upon consolidation and unrealized intercompany
gains and losses are eliminated when accounting under the equity method.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents





| | (b) | Use of estimates
| | --- | ----------------



| |  | Nortel Networks makes estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as at the date of the 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 long-term contracts, allowance
for uncollectible accounts
receivable and customer financings, receivables sales, inventory
obsolescence, product warranty, amortization, asset valuations, impairment
assessments, employee benefits, taxes, restructuring and other provisions,
in-process research and development (IPR&D) and contingencies.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Translation of foreign currencies
| | --- | ---------------------------------



| |  | The functional currency of Nortel Networks is the United States dollar.
The financial statements of Nortel Networks operations whose functional
currency is not the United States dollar (except for highly inflationary
economies as described below), are translated to United States dollars at
the exchange rates in effect at the balance sheet date for assets and
liabilities, and at average rates for the period for revenues and
expenses. The unrealized translation gains and losses on Nortel Networks
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 Networks operations in
countries considered to have highly inflationary economies and whose
functional currency is not the United States dollar are translated into
United States dollars at the exchange rates in effect at the balance sheet
date for monetary assets and liabilities, and at historical exchange rates
for non-monetary assets and liabilities. Revenues and expenses are
translated at average rates for the period, except for amortization and
depreciation which is translated on the same basis as the related assets.
Resulting gains or losses are reflected in net earnings (loss).
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | When appropriate, Nortel Networks 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
Networks 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 these hedging instruments are recorded in OCI or net earnings
(loss) as appropriate.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | Revenue recognition
| | --- | -------------------



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



| |  | Nortel Networks recognizes revenue under 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 Staff Accounting Bulletin (SAB) 101
Revenue Recognition in Financial Statements (SAB 101) depending upon
the terms of the contract.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Revenue for hardware that does not require significant customization is
recognized under SAB 101. Hardware revenue, net of trade discounts and
allowances, is recognized upon shipment and when all significant
contractual obligations have been satisfied and collection is reasonably
assured.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Software revenue is generally recognized under SOP 97-2. Software revenue
under SOP 97-2 is recognized when persuasive evidence of an arrangement
exists, when the software is delivered in accordance with all terms and
conditions of the customer contracts, when the fee is fixed or
determinable, and when collection is reasonably assured. Nortel Networks
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 Networks 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. For software
arrangements involving multiple elements, Nortel Networks allocates
revenue to each element based on vendor specific objective evidence of
relative fair values, which are derived by allocating a value to each
element that is based upon the prices charged when the element is sold
separately.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-7



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##### Table of Contents





| |  | For contracts involving multiple elements, Nortel Networks allocates
revenue to each element based on relative fair values. Provided none of
the undelivered elements are essential to the functionality of the
delivered elements, 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 101. Engineering, installation and other services
are recognized as the services are performed.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For long-term contracts, primarily those related to customized network
solutions and network build outs, revenues are recognized under SOP 81-1
using the percentage-of-completion method on the basis of percentage of
costs incurred to date on a contract, relative to the estimated total
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.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks 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. Accruals for estimated sales
returns and other allowances are recorded at the time of shipment and are
based on contract terms and prior claims experience.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | Research and development
| | --- | ------------------------



| |  | Research and development (R&D) costs are charged to net earnings (loss)
in the periods in which they are incurred, except for costs incurred
pursuant to specific contracts with third parties which are charged to net
earnings (loss) 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 Networks 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
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
Networks 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 net
deferred tax assets or a portion thereof will be realized.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (g) | Earnings (loss) per common share
| | --- | --------------------------------



| |  | Basic earnings (loss) per common share is calculated by dividing the net
earnings (loss) by the weighted average number of Nortel Networks
Limiteds common shares outstanding during the period. Diluted earnings
(loss) per common share is calculated by dividing the applicable net
earnings (loss) by the sum of the weighted average number of common shares
outstanding and all additional common shares that would have been
outstanding if potentially dilutive common shares had been issued during
the period. The treasury stock method is used to compute the dilutive
effect of options, warrants and similar instruments.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As all of Nortel Networks Limiteds common shares are held by Nortel
Networks Corporation and are not publicly traded, information concerning
Nortel Networks Limiteds earnings (loss) per common share and weighted
average number of common shares outstanding has not been presented in the
accompanying consolidated financial statements. For information regarding
Nortel Networks Corporations earnings (loss) per common share and
weighted average number of common shares outstanding, see Nortel Networks
Corporations consolidated financial statements and notes thereto for the
year ended December 31, 2002 contained in the Annual Report on Form 10-K
filed with the United States Securities and Exchange Commission (SEC) as
amended by Amendment No. 1 thereto.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-8



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##### Table of Contents





| | (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 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 and performance
related contracts that Nortel Networks is not able to unilaterally revoke.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (j) | Inventories
| | --- | -----------



| |  | Inventories are valued at the lower of cost (calculated generally on a
first-in, first-out basis) and market. The cost of finished goods and
work in process is comprised of material, labor and manufacturing
overhead.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (k) | Receivables sales
| | --- | -----------------



| |  | Generally, Nortel Networks retains servicing rights and, in some cases,
provides limited recourse when it sells receivables. A gain or loss is
recorded 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 value 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.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks, 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 Networks, 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 paid at the
discretion of the transferee. Nortel Networks initially values the
servicing bonus at a fair value of nil based on the determination that
future credit losses will offset the servicing bonus and due to the fact
that it is paid at the discretion of the transferee.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks reviews the fair value assigned to retained interests,
including the servicing bonus, at each reporting date subsequent to the
date of the transfer. 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 adjustments are recorded in other income (expense)  net.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (l) | Investments
| | --- | -----------



| |  | Investments in publicly traded equity securities of companies over which
Nortel Networks 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. Nortel Networks monitors these investments for factors
indicating other than temporary impairment and takes a charge to net
earnings (loss) when appropriate.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Investments in equity securities of private companies over which Nortel
Networks does not exert significant influence are accounted for using the
cost method. Nortel Networks monitors these investments for factors
indicating other than temporary impairment and takes a charge to net
earnings (loss) when appropriate.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks reviews its investments in associated companies, accounted
for using the equity method, for impairment. An impairment loss is
recorded when there has been a loss in value of the investment that is
other than temporary.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-9



---



##### Table of Contents





| | (m) | 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (n) | Impairment or disposal of long-lived assets (plant and equipment and
acquired technology)
| | --- | -----------------------------------------------------------------------------------------



| |  | Long-lived assets held and used
| |  | -------------------------------



| |  | Nortel Networks tests long-lived assets or asset groups 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; 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 current
expectation that the asset will more likely than not be sold or
disposed significantly before the end of its estimated useful life.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Recoverability is assessed based on the carrying amount of the asset
and its fair value which is generally determined based on the sum of
the undiscounted cash flows expected to result from the use and the
eventual disposal of the asset. An impairment loss is recognized when
the carrying amount is not recoverable and 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 commitment to a plan to sell the
assets; the availability of the assets for immediate sale in their
present condition; whether an active program to locate buyers and other
actions to sell the assets has been initiated; whether the sale of the
assets is probable and their transfer is expected to qualify for
recognition as a completed sale within one year; whether the assets are
being marketed at reasonable prices in relation to their fair value;
and how unlikely it is that significant changes will be made to the
plan to sell the assets.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks measures long-lived assets to be disposed of by sale at
the lower of carrying amount and fair value less cost to sell. Fair
value is determined using quoted market prices or the anticipated cash
flows discounted at a rate commensurate with the risk involved.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Long-lived assets to be disposed of other than by sale
| |  | ------------------------------------------------------



| |  | Nortel Networks classifies an asset or asset group that will be
disposed of other than by sale as held and used until the disposal
transaction occurs. The asset or asset group continues to be
depreciated based on revisions to its estimated useful life 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. An
impairment loss is recognized when the carrying amount is not
recoverable and exceeds the fair value of the asset.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (o) | Goodwill
| | --- | --------



| |  | Goodwill represents the excess of the purchase price of an acquired
enterprise over the fair values of the identifiable assets acquired and
liabilities assumed. Commencing January 1, 2002, Nortel Networks tests
for impairment of goodwill on an annual basis and at any other time if
events occur or circumstances change that would more likely than not
reduce the fair value of the reporting unit goodwill below its carrying
amount (see note 4(a)).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Circumstances that could trigger an impairment test include but are not
limited to: a significant adverse change in the business climate or legal
factors; an adverse action or assessment by a regulator; unanticipated
competition; loss of key personnel; the likelihood that a reporting unit
or significant portion of a reporting unit will be sold or otherwise
disposed; results of testing for recoverability of a significant asset
group within a reporting unit; and
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-10



---



##### Table of Contents





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



| |  | If the carrying amount of the reporting unit goodwill exceeds the implied
fair value of that goodwill, an impairment loss is recorded in net
earnings (loss). Measurement of the fair value of a reporting unit is
based on one or more of the following fair value measures including:
amounts at which the unit as a whole could be bought or sold in a
current transaction between willing parties; using present value
techniques of estimated future cash flows; or using valuation techniques
based on multiples of earnings or revenue, or a similar performance
measure.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (p) | Acquired technology and IPR&D
| | --- | -----------------------------



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



| |  | An impairment loss is recognized as the amount by which the carrying value
of the acquired technology exceeds the fair value. Fair value is
determined using the anticipated cash flows discounted at a rate
commensurate with the risk involved.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | IPR&D represents the value, on closing of a business combination, of
acquired research and development which was not technologically feasible
as of the acquisition date and, other than its intended use, had no
alternative future use. Independent valuations are performed to assess
and allocate a value to IPR&D. The value allocated to IPR&D represents
the estimated fair value based on risk-adjusted future cash flows
generated from the products that would result from each of the in-process
projects. Estimated future after tax cash flows of each project, on a
product by product basis, are based on Nortel Networks estimates of
revenues less operating expenses, cash flow adjustments, income taxes and
charges for the use of contributory assets. Future cash flows are also
adjusted for the value contributed by any core technology and development
efforts that would be completed post-acquisition. IPR&D is charged to net
earnings (loss) as at the date of acquisition.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (q) | Warranty costs
| | --- | --------------



| |  | Nortel Networks products are covered by product warranty plans that
generally range from one to five years. A liability for the expected cost
of warranty-related claims is established when products are sold and the
related revenue is recognized. The amount of the warranty liability
accrued reflects an estimate of the expected future costs of honoring
obligations under the warranty plan. In estimating the warranty
liability, historical material replacement costs and associated labor to
correct the product failure are considered. Should future product failure
rates and/or replacement costs differ from historical levels, revisions to
the estimated warranty liability may be required.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (r) | Pension, post-retirement and post employment benefits
| | --- | -----------------------------------------------------



| |  | Pension expense, based on managements assumptions, consists of: the
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, to active employees are accrued in the
consolidated financial statements during the years employees provide
service to Nortel Networks. Other post-employment benefits are recognized
when the event triggering the obligation occurs.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (s) | Derivative financial instruments
| | --- | --------------------------------



| |  | Nortel Networks 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 Networks enters
into foreign currency forward contracts, foreign currency swaps, foreign
currency option contracts, interest rate swaps, and equity forward
contracts. 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
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-11



---



##### Table of Contents





| |  | 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 net earnings (loss). If the derivative used in an economic
hedging relationship is not designated in an accounting hedging
relationship or if it becomes ineffective, changes in the fair value of
the derivative are recognized in net earnings (loss).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks may also invest in warrants to purchase securities of
other companies as a strategic investment. 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 Networks may
enter into certain commercial contracts containing embedded derivative
financial instruments. For these embedded derivatives, for which the
matching is not clearly and closely related to the terms of the contract,
the underlying exposure is recorded in net earnings (loss).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (t) | Stock-based compensation
| | --- | ------------------------



| |  | Under various stock option programs of Nortel Networks Corporation,
options may be granted to various eligible employees and directors of
Nortel Networks to purchase common shares of Nortel Networks Corporation.
Nortel Networks, as permitted under Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-based Compensation
(SFAS 123), applies Accounting Principles Board Opinion (APB) No. 25,
Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for its stock-based compensation plans.
SFAS 123 requires disclosure of pro forma amounts to reflect the impact if
Nortel Networks had elected to adopt the optional recognition provisions
of SFAS 123 for its stock option plans and employee stock purchase plans.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Had Nortel Networks applied the fair value based method in prior years,
regarding the participation of Nortel Networks eligible employees and
directors in the stock option programs of Nortel Networks Corporation,
Nortel Networks reported net loss applicable to common shares would have
been increased to the pro forma amounts as indicated below for each of the
three years ended December 31:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Net loss applicable to common shares  reported
    
    $
    (2,746
    )
    
    $
    (13,966
    )
    
    $
    (1,288
    )Stock option expense as reported (a)
    
    
    
    
    
    
    
    
    
    
    99Pro forma stock option expense (b)
    
    
    (946
    )
    
    
    (1,258
    )
    
    
    (1,173
    )Net loss applicable to common shares  pro forma
    
    $
    (3,692
    )
    
    $
    (15,224
    )
    
    $
    (2,362
    )
 (a)
    
    Stock option expense as reported represents the amortization
of deferred stock option compensation related primarily to unvested
stock options held by employees of companies acquired in a purchase
acquisition. The amount is tax effected and offset by a full
valuation allowance.(b)
    
    Pro forma stock option expense is net of tax of $276, $365 and
$316 for the years ended December 31, 2002, 2001 and 2000,
respectively.




| |  | The fair value of Nortel Networks stock options used to compute pro forma
net earnings (loss) is the estimated fair value at grant date applicable
to Nortel Networks, using the Black-Scholes option-pricing model with the
following weighted average assumptions related to Nortel Networks
Corporation, for each of the three years ended December 31:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Weighted -average assumptions
    
    2002
    
    
    2001
    
    
    2000Expected dividend
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.13
    %Expected volatility
    
    
    71.25
    %
    
    
    70.36
    %
    
    
    54.01
    %Risk-free interest rate
    
    
    4.43
    %
    
    
    4.49
    %
    
    
    4.94
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4




| |  | The weighted average fair values of Nortel Networks stock options,
calculated using the Black-Scholes option-pricing model, granted during
the three years ended December 31, 2002, 2001 and 2000 were $3.50, $8.38
and $27.25 per option, respectively.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option-pricing models require the input
of highly
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-12



---



##### Table of Contents





| |  | subjective assumptions including the expected price volatility.
Nortel Networks uses expected volatility rates which are based on
historical volatility rates. Changes in the subjective input assumptions
can materially affect the fair value estimate, and therefore the existing
models do not necessarily provide a reliable single measure of the fair
value of Nortel Networks stock options.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In December 2002, the Financial Accounting Standards Board (the FASB)
issued SFAS No. 148 Accounting for Stock-Based Compensation  Transition
and Disclosure  an amendment of FASB Statement No. 123 (SFAS 148)
which amended the transitional provisions of SFAS 123 for entities
choosing to recognize stock-based compensation under the fair value based
method of SFAS 123, rather than electing to continue to follow the
intrinsic value method of APB 25. Under SFAS 148, Nortel Networks may
adopt the recommendations of SFAS 123 either (1) prospectively to awards
granted or modified after the beginning of the year of adoption, (2)
retroactively with restatement for awards granted or modified since
January 1, 1995, or (3) prospectively to awards granted or modified since
January 1, 1995.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks will commence expensing employee stock-based compensation
using the fair value based method prospectively, in accordance with SFAS
123, for all awards granted or modified after January 1, 2003, as
permitted under SFAS 148. Stock-based compensation will be measured using
the Black-Scholes option pricing model. The impact of adopting the fair
value based method will depend on various factors including, but not
limited to, the extent to which Nortel Networks will use stock-based
compensation in the future and the fair value of the awards, which is
dependent on a number of variables including Nortel Networks Corporation
common share price and its historical volatility. Because of the
uncertainty associated with each of these factors, the expense to be
recognized by Nortel Networks will vary as a result of the adoption of the
fair value based method.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



| |  | Certain lease financing transactions are structured through single
transaction special purpose entities that currently do not have sufficient
equity at risk as defined in FIN 46. In addition, Nortel Networks retains
certain risks associated with guaranteeing recovery of between 75 percent
and 88 percent of the unamortized principal balance of the debt which is
expected to represent the majority of the risks associated with the
special purpose entities activities. This percentage will be adjusted
over time as the underlying debt matures. Therefore, it is expected that
unless the existing arrangements are modified prior to July 1, 2003,
Nortel Networks will be required to consolidate the assets, liabilities
and any non-controlling interests of these special purpose entities
effective July 1, 2003. The total assets and total liabilities held by
these entities at December 31, 2002 are approximately $176 and $176,
respectively.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | In December 2002, the FASB issued SFAS 148 which is effective for
years ending after December 15, 2002 (see note 2(t)).
| | --- | -----------------------------------------------------------------------------------------------------------------------



| | (c) | In November 2002, the FASB issued FIN 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45), which requires elaborating on the
disclosures that must be made by a guarantor in financial statements
about its obligations under certain guarantees. It also requires that a
guarantor recognize, at the inception of certain types of guarantees, a
liability for the fair value
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-13



---



##### Table of Contents





| |  | of the obligation undertaken in issuing the
guarantee. The disclosure requirements of FIN 45 are effective for
financial statements issued after December 15, 2002, and have been
applied in the presentation of the accompanying consolidated financial
statements. The recognition requirements of FIN 45 are applicable for
guarantees issued or modified after December 31, 2002. Nortel Networks
has not yet determined the effect, if any, the recognition
requirement for guarantees issued or modified after December 31, 2002 will
have on its business, results of operations and financial condition.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | In June 2002, the FASB issued SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), which is
effective for exit or disposal activities initiated after December 31,
2002. SFAS 146 supercedes Emerging Issues Task Force (EITF) Issue No.
94-3 Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in
Restructuring) (EITF 94-3). SFAS 146 requires that costs associated
with an exit or disposal activity be recognized when the liability is
incurred, whereas EITF 94-3 required recognition of a liability when an
entity committed to an exit plan. Therefore, the effect of SFAS 146
will be to change the timing of recognition of certain liabilities and
no material valuation differences are expected. Plans initiated before
December 31, 2002 continue to be accounted for under EITF 94-3. Nortel
Networks does not expect the adoption of SFAS 146 to have a material
impact on its business, results of operations and financial condition.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS 143), which is effective for financial
statements issued for fiscal years beginning after June 15, 2002. SFAS
143 addresses the recognition and measurement of obligations associated
with the retirement of tangible long-lived assets. Nortel Networks does
not expect the adoption of SFAS 143 to have a material impact on its
business, results of operations and financial condition.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Certain 2001 and 2000 figures in the accompanying consolidated financial
statements have been reclassified to conform to the 2002 presentation and
certain 2001 and 2000 figures have been restated as set out in note 3.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Restatements
|-- |  | ------------



| |  | In 2001, Nortel Networks entered into an unprecedented period of business
realignment in response to a significant adjustment in the telecommunications
industry. Industry demand for networking equipment dramatically declined in
response to the industry adjustment, severe economic downturns in various
regions around the world and a tightening in global capital markets. Nortel
Networks implemented a company-wide restructuring plan to streamline its
operations and activities around core markets and operations, which included
significant workforce reductions, global real estate closures and
dispositions, substantial write-downs of its capital assets, goodwill and
other intangible assets and extensive contract settlements with customers and
suppliers around the world. As a result of these actions, Nortel Networks
workforce declined significantly from January 1, 2001 to December 31, 2002
and over the same time period Nortel Networks significantly reduced its
facilities.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Based on the completion of the comprehensive review and certain related
reviews (collectively, the comprehensive review), Nortel Networks has
determined that approximately $924 and $507 of certain liabilities (primarily
accruals and provisions) carried on its previously reported consolidated
balance sheets as at December 31, 2002 and 2001, respectively, needed to be
released to income. These provisions were either initially recorded
incorrectly in prior periods or not properly released or adjusted for changes
in estimates in the appropriate periods. In certain cases, costs were
incorrectly charged to operations rather than to the appropriate provisions.
Following its determination to restate its consolidated financial statements
for the periods noted above, Nortel Networks also determined that it would
correct certain known errors that were previously not recorded because the
amount of the errors was not material to the consolidated financial
statements. Specifically, among other items, Nortel Networks has made certain
revenue adjustments to reflect revenue which should have been deferred
instead of recognized in a particular period. Also, as
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-14



---



##### Table of Contents





| |  | part of the
restatements, Nortel Networks made adjustments to correct errors related to
its deferred income tax assets and foreign currency translation accounts. In
addition, Nortel Networks made reclassification adjustments within the
consolidated balance sheets to better reflect the underlying nature of
certain items; these reclassifications did not impact
the net assets as at the end of any period. The net effect of all of these
adjustments was a reduction in accumulated deficit of $486, $171 and $32 as
at December 31, 2002, 2001 and 2000, respectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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




| |  | Nortel Networks has also undertaken a series of physical counts and
reconciliations of plant and equipment. While Nortel Networks believes that
the portion of the work completed to date supports the carrying value of the
plant and equipment recorded in its consolidated balance sheet as at December
31, 2002, the conclusion of this work could result in adjustments to the
carrying value of certain assets.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following presents details by category, aggregating to the net decrease
in net losses resulting from the restatement adjustments for the years ended
December 31:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Net decrease in net loss
| |  | ------------------------



2002
    
    
    2001
    
    
    2000Contract and customer-related accruals
    
    $
    136
    
    
    $
    209
    
    
    $
    14Special charges related to restructuring actions
    
    
    138
    
    
    
    117
    
    
    
    2Other accruals and provisions
    
    
    115
    
    
    
    64
    
    
    
    47Total accruals and provisions adjustments
    
    
    389
    
    
    
    390
    
    
    
    63Income tax adjustments
    
    
    (25
    )
    
    
    (100
    )
    
    
    (16
    )Revenue adjustments
    
    
    8
    
    
    
    (103
    )
    
    
    (17
    )Foreign currency translation adjustments related to Brazilian operations
    
    
    (57
    )
    
    
    (48
    )
    
    
    (2
    )Net decrease in net loss
    
    $
    315
    
    
    $
    139
    
    
    $
    28


F-15



---



##### Table of Contents





| |  | Descriptions of the categories of the restatement adjustments to Nortel
Networks net loss for the years ended December 31, 2002, 2001 and 2000 that
were determined as a result of its comprehensive review are set forth below.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Adjustments related to certain contract and customer-related accruals were
approximately $136, $209 and $14 for the years ended December 31, 2002, 2001
and 2000, respectively. These accruals were identified as having been
accrued in
error and were reversed in the appropriate periods. Nortel Networks
identified situations in which additional accruals related to certain
contracts were recognized when circumstances did not justify such accruals.
Certain of these accruals were not supported by adequate documentation. In
addition, Nortel Networks identified situations where accruals had been
released in inappropriate periods. Therefore, certain adjustments have been
made to recognize these releases in the appropriate periods.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | During the period January 1, 2000 to December 31, 2002, Nortel Networks
recorded, prior to the restatement adjustments, $4,890 of special charges
related to workforce reductions, contract settlement and lease costs, plant
and equipment write-downs and other ancillary special charges in connection
with the implementation of specific restructuring actions to streamline its
operations and activities around core markets and operations. As part of the
restatements, Nortel Networks has reduced special charges by $138, $117 and
$2 for the years ended December 31, 2002, 2001 and 2000, respectively. The
following table provides details of the total adjustments related to these
special charges for the years ended December 31:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Severance and fringe benefits calculations
    
    $
    77
    
    
    $
    99
    
    
    $
    2Plant and equipment and real estate related adjustments
    
    
    51
    
    
    
    9
    
    
    
    Contract settlements
    
    
    10
    
    
    
    9
    
    
    
    Total
adjustments related to special charges(a)
    
    $
    138
    
    
    $
    117
    
    
    $
    2


|(a) |  | The majority of the total adjustments related to special charges impacted
Special charges-Other special charges in the consolidated statements of
operations. However, $21, $2 and nil of the above noted amounts for the
years ended December 31, 2002, 2001 and 2000, respectively, impacted other
lines in the consolidated statements of operations.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



| |  | Nortel Networks determined that accruals and provisions of approximately
$115, $64 and $47 for the years ended December 31, 2002, 2001 and 2000,
respectively, should not have been recorded as the appropriate conditions and
documentation supporting the establishment of these accruals and provisions
did not exist at the time of such recognition. The restatement adjustments
included the reversal of these accruals and provisions in the periods in
which
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-16



---



##### Table of Contents





| |  | they were originally recorded. Nortel
Networks also identified situations where accruals had been released
in inappropriate periods. Therefore, certain adjustments have been
made to recognize these releases in the appropriate periods. The following table details the amounts
related to each of these adjustments for the years ended December 31:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Release (reverse previously released) provisions related to inter-company balances
    
    $
    (24
    )
    
    $
    15
    
    
    $
    45Reverse accruals related to finance system upgrades
    
    
    10
    
    
    
    10
    
    
    
    15Reverse accruals related to discretionary bonuses
    
    
    15
    
    
    
    10
    
    
    
    Other adjustments to modify accruals
    
    
    114
    
    
    
    29
    
    
    
    (13
    )Total adjustments related to other accruals and provisions
    
    $
    115
    
    
    $
    64
    
    
    $
    47




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



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



| |  | Nortel Networks has determined that certain tax liabilities, principally in
Canada and the United States, were netted against deferred tax assets as at
December 31, 2002. As a result, the valuation allowance recorded in those
affected tax jurisdictions at December 31, 2002 should have included an
additional amount. The correction to the valuation allowance resulted in a
decrease in the income tax benefit for the year ended December 31, 2002.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The income tax benefit decreased $25 for the year ended December 31, 2002
primarily from the adjustment to the valuation allowance, as noted above, of
$130 partially offset by the tax impacts of the restatement adjustments. The
income tax benefit decreased $100 for the year ended December 31, 2001 which
resulted primarily from the tax impact of the restatement adjustments. The
income tax provision increased $16 for the year ended December 31, 2000 as a
result of the tax impacts of the restatement adjustments.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks recognized revenue in circumstances in which such revenue
should have been deferred to later periods. Adjustments primarily related to
the accounting treatment of certain contract related obligations with a
limited number of customers. In these cases, such obligations should not have
been recorded; rather, recognition of revenue should have been deferred.
Also, in the Caribbean and Latin America region, Nortel Networks determined
that there were revenue calculation errors. In the restatements, Nortel
Networks deferred the recognition of such revenues to the appropriate periods
and released associated accrued costs in the appropriate periods. The net
impact for these adjustments was a $8 increase, a $103 decrease and a $17
decrease to revenues for the years ended December 31, 2002, 2001 and 2000,
respectively.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks had recorded net losses on the translation of foreign
currency denominated balances of its Brazilian entities in the currency
translation adjustment account included in accumulated other comprehensive
loss on its balance sheet. These net losses totaled $57, $48 and $2 for the
years ended December 31, 2002, 2001 and 2000, respectively. In connection
with the comprehensive review, Nortel Networks determined that the
appropriate accounting treatment would have been to record the foreign
exchange losses in its statement of operations in the appropriate periods.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

F-17



---



##### Table of Contents





| |  | Consolidated statement of operations for the year ended December 31, 2002 as
restated
| |  | -------------------------------------------------------------------------------------



| |  | Net loss applicable to common shares for the year ended December 31, 2002 was
reduced by $315 from $3,061 to $2,746. The major components of the reduction
included:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $163 improvement in gross profit primarily from adjustments to
contracts and customer-related accruals partially offset by foreign
exchange adjustments related to Nortel Networks Brazilian operations;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $41 decrease in selling, general and administrative expense and a
$23 decrease in research and development expense, both due to net
decrease in other accruals and provisions;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $117 decrease in special charges which resulted from the release of
accruals associated with severance and fringe benefits for terminated
employees;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $32 increase in other expense (which resulted from $28 in losses
from foreign exchange translation adjustments related to Nortel Networks
Brazilian operations and a $22 increase for minority interest as a
result of the restatement adjustments partially offset by $18 of other
items); and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $21 adjustment to discontinued operations for items previously
recorded incorrectly as an expense in discontinued operations.
| | - | -------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated statement of operations for the year ended December 31, 2001 as
restated
| |  | -------------------------------------------------------------------------------------



| |  | Net loss applicable to common shares for the year ended December 31, 2001 was
reduced by $139 from $14,105 to $13,966. The major components of the
reduction included:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $49 improvement in gross profit which included a $103 reduction in
revenues which resulted from revenue deferrals and a $152 improvement to
cost of revenues (which resulted from adjustments to contract and
customer-related accruals in the amount of $207 partially offset by $48
of foreign exchange adjustments related to Nortel Networks Brazilian
operations and a $40 reversal of previously recorded releases of
accruals for inter-company out of balance amounts);
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $103 decrease in selling, general and administrative expense which
resulted primarily from the release of $71 of accruals for inter-company
out of balance amounts;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $22 decrease in research and development expense which resulted
primarily from the release of $15 of accruals for inter-company out of
balance amounts;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $115 decrease which resulted from the release of special charges
primarily related to costs associated with severance and fringe benefits
for terminated employees; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $42 increase in other expense which resulted primarily from the
reversal of a previously recorded release of $31 of accruals for
inter-company out of balance amounts.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated statement of operations for the year ended December 31, 2000 as
restated
| |  | -------------------------------------------------------------------------------------



| |  | Net loss applicable to common shares for the year ended December 31, 2000 was
reduced by $28 from $1,316 to $1,288. The major components of the reduction
included:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $34 increase in selling, general and administrative expense which
resulted primarily from the reversal of previously recorded release of
accruals for inter-company out of balance amounts; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $62 increase in other income which resulted primarily from the
release of accruals for inter-company out of balance amounts.
| | - | ------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated balance sheets as at December 31, 2002 and 2001 as restated
| |  | ------------------------------------------------------------------------



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



| |  | The consolidated balance sheets below present the cumulative impact of the
restatement adjustments described above classified by balance sheet line item
as at December 31, 2002 and 2001.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-18



---



##### Table of Contents





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



| |  | In addition to the restatement adjustments, reclassification adjustments were
made between line items which also impacted the consolidated balance sheets
as at December 31, 2002 and 2001. The principal reclassifications are set
forth below.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

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

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

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



| |  | As at December 31, 2001
| |  | -----------------------



| |  | a $55 reduction to cash and cash equivalents and notes payable to
reflect, upon consolidation, that a bank note payable by one subsidiary
was fully collateralized by, and could be offset against, a deposit in
the same bank by another subsidiary;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $152 increase in accounts receivable-net which included a $339
increase primarily to recognize advance billings in excess of revenues as a
liability partially offset by a $63 reclassification from other accrued
liabilities to properly offset amounts billed by Nortel Networks as
collection agent under receivable sales agreements against the
corresponding receivables and a $124 increase in allowance for doubtful
accounts for financed receivables which resulted from a reclassification
from other long-term assets;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $259 increase in net inventory with related reductions of $144 in
other current assets and of $115 in other long-term assets; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------

| |  | a $295 increase in other accrued liabilities including a $339
increase partially offset by a $63 decrease, both related to accounts
receivable-net (as noted above).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-19



---



##### Table of Contents





| |  | Consolidated Statement of Operations for the year ended December 31
| |  | -------------------------------------------------------------------



2002Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    10,546
    
    
    $
    8
    
    
    $
    10,554Cost of revenues
    
    
    7,145
    
    
    
    (155
    )
    
    
    6,990Gross profit
    
    
    3,401
    
    
    
    163
    
    
    
    3,564Selling, general and administrative expense (excluding stock option compensation)
    
    
    2,662
    
    
    
    (41
    )
    
    
    2,621Research and development expense
    
    
    2,228
    
    
    
    (23
    )
    
    
    2,205Amortization of intangiblesAcquired technology
    
    
    20
    
    
    
    (1
    )
    
    
    19Special chargesGoodwill impairment
    
    
    264
    
    
    
    
    
    
    
    264Other special charges
    
    
    1,552
    
    
    
    (117
    )
    
    
    1,435Gain on sale of businesses
    
    
    (22
    )
    
    
    (17
    )
    
    
    (39
    )Operating loss
    
    
    (3,303
    )
    
    
    362
    
    
    
    (2,941
    )Equity in net loss of associated companies
    
    
    (9
    )
    
    
    (9
    )
    
    
    (18
    )Other income (expense)  net
    
    
    (2
    )
    
    
    (32
    )
    
    
    (34
    )Interest expenseLong-term debt
    
    
    (131
    )
    
    
    1
    
    
    
    (130
    )Other
    
    
    (41
    )
    
    
    (3
    )
    
    
    (44
    )(Loss) earnings from continuing operations before income taxes
    
    
    (3,486
    )
    
    
    319
    
    
    
    (3,167
    )Income tax benefit (provision)
    
    
    447
    
    
    
    (25
    )
    
    
    422Net loss from continuing operations
    
    
    (3,039
    )
    
    
    294
    
    
    
    (2,745
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    
    
    
    
    21
    
    
    
    21Net loss
    
    
    (3,039
    )
    
    
    315
    
    
    
    (2,724
    )Dividends on preferred shares
    
    
    22
    
    
    
    
    
    
    
    22Net loss applicable to common shares
    
    $
    (3,061
    )
    
    $
    315
    
    
    $
    (2,746
    )


F-20



---



##### Table of Contents





| |  | Consolidated Statement of Operation for the year ended December 31
| |  | ------------------------------------------------------------------



2001Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    17,375
    
    
    $
    (103
    )
    
    $
    17,272Cost of revenues
    
    
    14,241
    
    
    
    (152
    )
    
    
    14,089Gross profit
    
    
    3,134
    
    
    
    49
    
    
    
    3,183Selling, general and administrative expense (excluding stock option compensation)
    
    
    5,815
    
    
    
    (103
    )
    
    
    5,712Research and development expense
    
    
    3,230
    
    
    
    (22
    )
    
    
    3,208Amortization of intangiblesAcquired technology
    
    
    574
    
    
    
    
    
    
    
    574Goodwill
    
    
    2,082
    
    
    
    (2
    )
    
    
    2,080Special chargesGoodwill impairment
    
    
    2,239
    
    
    
    
    
    
    
    2,239Other special charges
    
    
    3,204
    
    
    
    (115
    )
    
    
    3,089Gain on sale of businesses
    
    
    (125
    )
    
    
    (1
    )
    
    
    (126
    )Operating loss
    
    
    (13,885
    )
    
    
    292
    
    
    
    (13,593
    )Equity in net loss of associated companies
    
    
    (134
    )
    
    
    (16
    )
    
    
    (150
    )Other income (expense)  net
    
    
    (325
    )
    
    
    (42
    )
    
    
    (367
    )Interest expenseLong-term debt
    
    
    (165
    )
    
    
    (8
    )
    
    
    (173
    )Other
    
    
    (119
    )
    
    
    (1
    )
    
    
    (120
    )(Loss) earnings from continuing operations before income taxes
    
    
    (14,628
    )
    
    
    225
    
    
    
    (14,403
    )Income tax benefit (provision)
    
    
    3,073
    
    
    
    (100
    )
    
    
    2,973Net loss from continuing operations
    
    
    (11,555
    )
    
    
    125
    
    
    
    (11,430
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (2,538
    )
    
    
    14
    
    
    
    (2,524
    )Net loss before cumulative effect of accounting change
    
    
    (14,093
    )
    
    
    139
    
    
    
    (13,954
    )Cumulative effect of accounting change  net of tax
    
    
    15
    
    
    
    
    
    
    
    15Net loss
    
    
    (14,078
    )
    
    
    139
    
    
    
    (13,939
    )Dividends on preferred shares
    
    
    27
    
    
    
    
    
    
    
    27Net loss applicable to common shares
    
    $
    (14,105
    )
    
    $
    139
    
    
    $
    (13,966
    )


F-21



---



##### Table of Contents





| |  | Consolidated Statement of Operations for the year ended December 31
| |  | -------------------------------------------------------------------



2000Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    27,853
    
    
    $
    (17
    )
    
    $
    27,836Cost of revenues
    
    
    15,069
    
    
    
    (23
    )
    
    
    15,046Gross profit
    
    
    12,784
    
    
    
    6
    
    
    
    12,790Selling, general and administrative expense (excluding stock option compensation)
    
    
    5,371
    
    
    
    34
    
    
    
    5,405Research and development expense
    
    
    3,626
    
    
    
    3
    
    
    
    3,629In-process research and development expense
    
    
    623
    
    
    
    (1
    )
    
    
    622Amortization of intangiblesAcquired technology
    
    
    789
    
    
    
    
    
    
    
    789Goodwill
    
    
    2,492
    
    
    
    (1
    )
    
    
    2,491Stock option compensation
    
    
    99
    
    
    
    
    
    
    
    99Special chargesGoodwill impairment
    
    
    133
    
    
    
    
    
    
    
    133Other special charges
    
    
    134
    
    
    
    (2
    )
    
    
    132Gain on sale of businesses
    
    
    (174
    )
    
    
    1
    
    
    
    (173
    )Operating loss
    
    
    (309
    )
    
    
    (28
    )
    
    
    (337
    )Equity in net loss of associated companies
    
    
    (29
    )
    
    
    11
    
    
    
    (18
    )Other income (expense)  net
    
    
    835
    
    
    
    62
    
    
    
    897Interest expenseLong-term debt
    
    
    (86
    )
    
    
    
    
    
    
    (86
    )Other
    
    
    (82
    )
    
    
    (1
    )
    
    
    (83
    )(Loss) earnings from continuing operations before income taxes
    
    
    329
    
    
    
    44
    
    
    
    373Income tax benefit (provision)
    
    
    (1,200
    )
    
    
    (16
    )
    
    
    (1,216
    )Net loss from continuing operations
    
    
    (871
    )
    
    
    28
    
    
    
    (843
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (414
    )
    
    
    
    
    
    
    (414
    )Net loss
    
    
    (1,285
    )
    
    
    28
    
    
    
    (1,257
    )Dividends on preferred shares
    
    
    31
    
    
    
    
    
    
    
    31Net loss applicable to common shares
    
    $
    (1,316
    )
    
    $
    28
    
    
    $
    (1,288
    )


F-22



---



##### Table of Contents





| |  | Consolidated Balance Sheet
| |  | --------------------------



December
31, 2002Aspreviously
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    Reclassification
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    3,813
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    3,743Restricted cash and cash equivalents
    
    
    249
    
    
    
    
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    1,993
    
    
    
    (11
    )
    
    
    265
    
    
    
    2,247Inventories  net
    
    
    889
    
    
    
    7
    
    
    
    90
    
    
    
    986Income taxes recoverable
    
    
    58
    
    
    
    
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    793
    
    
    
    
    
    
    
    
    
    
    
    793Other current assets
    
    
    494
    
    
    
    15
    
    
    
    (52
    )
    
    
    457Current assets of discontinued operations
    
    
    212
    
    
    
    (1
    )
    
    
    
    
    
    
    211Total current assets
    
    
    8,501
    
    
    
    10
    
    
    
    233
    
    
    
    8,744Investments at cost and associated companies at equity
    
    
    246
    
    
    
    2
    
    
    
    
    
    
    
    248Plant and equipment  net
    
    
    1,441
    
    
    
    23
    
    
    
    
    
    
    
    1,464Goodwill
    
    
    2,021
    
    
    
    
    
    
    
    
    
    
    
    2,021Deferred income taxes  net
    
    
    2,797
    
    
    
    (144
    )
    
    
    
    
    
    
    2,653Other assets
    
    
    747
    
    
    
    9
    
    
    
    10
    
    
    
    766Total assets
    
    $
    15,753
    
    
    $
    (100
    )
    
    $
    243
    
    
    $
    15,896LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    100
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    30Trade and other accounts payable
    
    
    931
    
    
    
    (32
    )
    
    
    
    
    
    
    899Payroll and benefit-related liabilities
    
    
    513
    
    
    
    (14
    )
    
    
    
    
    
    
    499Contractual liabilities
    
    
    1,546
    
    
    
    (333
    )
    
    
    
    
    
    
    1,213Restructuring
    
    
    761
    
    
    
    (224
    )
    
    
    
    
    
    
    537Other accrued liabilities
    
    
    2,803
    
    
    
    (215
    )
    
    
    306
    
    
    
    2,894Long-term debt due within one year
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    6,887
    
    
    
    (818
    )
    
    
    236
    
    
    
    6,305Long-term debt
    
    
    1,919
    
    
    
    (1
    )
    
    
    31
    
    
    
    1,949Deferred income taxes  net
    
    
    366
    
    
    
    
    
    
    
    
    
    
    
    366Other liabilities
    
    
    2,351
    
    
    
    (6
    )
    
    
    (24
    )
    
    
    2,321Minority interests in subsidiary companies
    
    
    78
    
    
    
    51
    
    
    
    
    
    
    
    12911,601
    
    
    
    (774
    )
    
    
    243
    
    
    
    11,070SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited;issued and outstanding shares: 30,000,000 at December 31, 2002
    
    
    536
    
    
    
    
    
    
    
    
    
    
    
    536Common shares, without par valueissued and outstanding shares: 1,460,978,638 at December 31, 2002
    
    
    1,211
    
    
    
    
    
    
    
    
    
    
    
    1,211Additional paid-in capital
    
    
    21,991
    
    
    
    13
    
    
    
    
    
    
    
    22,004Deficit
    
    
    (18,093
    )
    
    
    486
    
    
    
    
    
    
    
    (17,607
    )Accumulated other comprehensive loss
    
    
    (1,493
    )
    
    
    175
    
    
    
    
    
    
    
    (1,318
    )Total shareholders equity
    
    
    4,152
    
    
    
    674
    
    
    
    
    
    
    
    4,826Total liabilities and shareholders equity
    
    $
    15,753
    
    
    $
    (100
    )
    
    $
    243
    
    
    $
    15,896


F-23



---



##### Table of Contents





| |  | Consolidated Balance Sheet
| |  | --------------------------



December
31, 2001Aspreviously
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    Reclassification
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    3,457
    
    
    $
    2
    
    
    $
    (55
    )
    
    $
    3,404Restricted cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accounts receivable  net
    
    
    2,923
    
    
    
    (19
    )
    
    
    152
    
    
    
    3,056Inventories  net
    
    
    1,563
    
    
    
    12
    
    
    
    259
    
    
    
    1,834Income taxes recoverable
    
    
    790
    
    
    
    6
    
    
    
    (6
    )
    
    
    790Deferred income taxes  net
    
    
    1,401
    
    
    
    
    
    
    
    
    
    
    
    1,401Other current assets
    
    
    847
    
    
    
    13
    
    
    
    (144
    )
    
    
    716Current assets of discontinued operations
    
    
    698
    
    
    
    1
    
    
    
    
    
    
    
    699Total current assets
    
    
    11,679
    
    
    
    15
    
    
    
    206
    
    
    
    11,900Investments at cost and associated companies at equity
    
    
    263
    
    
    
    (2
    )
    
    
    
    
    
    
    261Plant and equipment  net
    
    
    2,459
    
    
    
    (9
    )
    
    
    
    
    
    
    2,450Goodwill
    
    
    2,283
    
    
    
    
    
    
    
    
    
    
    
    2,283Intangible assets  net
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    20Deferred income taxes  net
    
    
    2,106
    
    
    
    (121
    )
    
    
    
    
    
    
    1,985Other assets
    
    
    1,183
    
    
    
    (30
    )
    
    
    9
    
    
    
    1,162Total assets
    
    $
    19,993
    
    
    $
    (147
    )
    
    $
    215
    
    
    $
    20,061LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    426
    
    
    $
    
    
    
    $
    (55
    )
    
    $
    371Trade and other accounts payable
    
    
    1,638
    
    
    
    (10
    )
    
    
    (25
    )
    
    
    1,603Payroll and benefit-related liabilities
    
    
    613
    
    
    
    1
    
    
    
    
    
    
    
    614Contractual liabilities
    
    
    1,841
    
    
    
    (241
    )
    
    
    
    
    
    
    1,600Restructuring
    
    
    871
    
    
    
    (116
    )
    
    
    
    
    
    
    755Other accrued liabilities
    
    
    3,772
    
    
    
    (48
    )
    
    
    295
    
    
    
    4,019Long-term debt due within one year
    
    
    384
    
    
    
    
    
    
    
    
    
    
    
    384Total current liabilities
    
    
    9,545
    
    
    
    (414
    )
    
    
    215
    
    
    
    9,346Long-term debt
    
    
    2,293
    
    
    
    
    
    
    
    
    
    
    
    2,293Deferred income taxes  net
    
    
    477
    
    
    
    
    
    
    
    
    
    
    
    477Other liabilities
    
    
    1,605
    
    
    
    (5
    )
    
    
    
    
    
    
    1,600Minority interests in subsidiary companies
    
    
    100
    
    
    
    18
    
    
    
    
    
    
    
    11814,020
    
    
    
    (401
    )
    
    
    215
    
    
    
    13,834SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited;issued and outstanding shares: 30,000,000 at December 31, 2001
    
    
    536
    
    
    
    
    
    
    
    
    
    
    
    536Common shares, without par valueissued and outstanding shares: 1,460,978,634 at December 31, 2001
    
    2,111
    
    
    
    
    
    
    
    
    
    
    
    2,111Additional paid-in capital
    
    
    18,797
    
    
    
    8
    
    
    
    
    
    
    
    18,805Deficit
    
    
    (14,507
    )
    
    
    171
    
    
    
    
    
    
    
    (14,336
    )Accumulated other comprehensive loss
    
    
    (964
    )
    
    
    75
    
    
    
    
    
    
    
    (889
    )Total shareholders equity
    
    
    5,973
    
    
    
    254
    
    
    
    
    
    
    
    6,227Total liabilities and shareholders equity
    
    $
    19,993
    
    
    $
    (147
    )
    
    $
    215
    
    
    $
    20,061


F-24



---



##### Table of Contents





|4. |  | Accounting changes
|-- |  | ------------------



| | (a) | Accounting for goodwill and other intangible assets
| | --- | ---------------------------------------------------



| |  | In June 2001, the FASB issued SFAS 142 effective for fiscal years
beginning after December 15, 2001. SFAS 142 changed the accounting for
goodwill from an amortization method to an impairment-only approach.
Thus, amortization of goodwill, including goodwill recorded in past
business combinations and amortization of intangibles with an indefinite
life, ceased upon adoption of SFAS 142. For any acquisitions completed
after June 30, 2001, goodwill and intangible assets with an indefinite
life are not amortized. Nortel Networks adopted the provisions of SFAS
142 effective January 1, 2002.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks completed the SFAS 142 transitional impairment test during
the second quarter of 2002 and concluded that there was no impairment of
recorded goodwill, as the fair value of its reporting units exceeded their
carrying amount as of January 1, 2002. Therefore, the second step of the
transitional impairment test under SFAS 142 was not required to be
performed.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As a result of the continued decline in both Nortel Networks overall
market value generally and within the Optical Networks segment
specifically, Nortel Networks as part of its review of financial results
during the three months ended September 30, 2002, evaluated the goodwill
associated with the businesses within the Optical Networks segment for
potential impairment. The conclusion of those evaluations was that the
fair value associated with the businesses within the Optical Networks
segment could no longer support the carrying value of the goodwill
associated with them. As a result, Nortel Networks recorded a goodwill
impairment charge of $264. See note 7 for further information regarding
this goodwill impairment charge.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following table presents the impact on net loss from both continuing
and discontinued operations of the SFAS 142 requirement to cease the
amortization of goodwill as if the standard had been in effect beginning
January 1, 2000, for each of the years ended December 31:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Reported results:Net loss from continuing operations
    
    $
    (2,745
    )
    
    $
    (11,430
    )
    
    $
    (843
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    21
    
    
    
    (2,524
    )
    
    
    (414
    )Cumulative effect of accounting change  net of tax of $9
    
    
    
    
    
    
    15
    
    
    
    Net loss  reported
    
    $
    (2,724
    )
    
    $
    (13,939
    )
    
    $
    (1,257
    )Adjustments:Amortization of goodwill from continuing operations net of tax (a)
    
    $
    
    
    
    $
    2,089
    
    
    $
    2,506Amortization of goodwill from discontinued operations
    
    
    
    
    
    
    121
    
    
    
    195Total net adjustments
    
    $
    
    
    
    $
    2,210
    
    
    $
    2,701Adjusted results:Net earnings (loss) from continuing operations
    
    $
    (2,745
    )
    
    $
    (9,341
    )
    
    $
    1,663Net earnings (loss) from discontinued operations  net of tax
    
    
    21
    
    
    
    (2,403
    )
    
    
    (219
    )Cumulative effect of accounting change  net of tax of $9
    
    
    
    
    
    
    15
    
    
    
    Net earnings (loss)  adjusted
    
    $
    (2,724
    )
    
    $
    (11,729
    )
    
    $
    1,444
 (a)
    
    Includes goodwill amortization of equity accounted
investments of nil, $9 (net of tax of $5) and $15 (net of tax of $7)
for the years ended December 31, 2002, 2001 and 2000, respectively.




| | (b) | Impairment or disposal of long-lived assets (plant and equipment and
acquired technology)
| | --- | -----------------------------------------------------------------------------------------



| |  | In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144), which addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets. SFAS 144 applies to certain long-lived assets,
including those reported as discontinued operations, and develops one
accounting model for long-lived assets to be disposed of by sale. SFAS
144 supersedes SFAS No. 121, Accounting for the Impairment of Long-lived
Assets and for Long-lived Assets to be Disposed Of, and APB No. 30,
Reporting the Results of Operations  Reporting the Effects of Disposal
of a Segment of a Business, and
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-25



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| |  | Extraordinary, Unusual and Infrequently
Occurring Events and Transactions (APB 30), for the disposal of a
segment of a business. Nortel Networks adopted the provisions of SFAS 144
effective January 1, 2002.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | SFAS 144 requires that long-lived assets to be disposed of by sale be
measured at the lower of carrying amount or fair value less cost to sell,
whether reported in continuing operations or in discontinued operations.
Discontinued operations will no longer be measured at net realizable value
or include amounts for operating losses that have not yet been incurred.
SFAS 144 also broadens the reporting of discontinued operations to include
the disposal of a component of an entity provided that the operations and
cash flows of the component will be eliminated from the ongoing operations
of the entity and the entity will not have any significant continuing
involvement in the operations of the component. During the year ended
December 31, 2002, Nortel Networks recorded write downs for plant and
equipment of $170 related to long-lived assets held and used, $122 related
to long-lived assets held for sale. See note 7 for further information
regarding these write downs.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Derivative financial instruments
| | --- | --------------------------------



| |  | Effective January 1, 2001, Nortel Networks adopted SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities (SFAS
133), and the corresponding amendments under SFAS No. 138, Accounting
for Certain Derivative Instruments and Certain Hedging Activities  an
amendment of SFAS No. 133 (SFAS 138). SFAS 133 requires that all
derivative financial instruments be recognized in the financial statements
and measured at fair value regardless of the purpose or intent for holding
them. If the derivative is 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). If the derivative
is 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 net earnings (loss). If the derivative used in an economic
hedging relationship is not designated in an accounting hedging
relationship, changes in the fair value of the derivative are recognized
in net earnings (loss).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For the year ended December 31, 2001, the adoption of SFAS 133 resulted in
a cumulative decrease in net loss of $15 (pre-tax $24) and a charge to OCI
of $7 (pre-tax $11). The decrease in net loss is primarily attributable
to embedded derivatives. The charge to OCI is primarily attributable to
the effective portion of option and forward contracts related to the
Canadian dollar hedge program that are designated as cash flow hedges.
The adoption of SFAS 133 did not materially affect either the basic or
diluted loss per common share.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | Consolidated financial statement details
|-- |  | ----------------------------------------



| |  | The following consolidated financial statement details are presented as at
December 31, for the consolidated balance sheet details, and for each of the
years ended December 31, for the consolidated statements of operations and
consolidated statements of cash flows.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



2002
    
    
    2001
    
    
    2000R&D expense
    
    $
    2,205
    
    
    $
    3,208
    
    
    $
    3,629R&D costs incurred on behalf of others (a)
    
    
    49
    
    
    
    68
    
    
    
    64Total
    
    $
    2,254
    
    
    $
    3,276
    
    
    $
    3,693
 (a)
    
    These costs include R&D charged to customers of Nortel Networks
pursuant to contracts that provide for full recovery of the estimated
cost of development, material, engineering, installation and all other
attracted costs, which are accounted for as contract costs.


F-26



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##### Table of Contents





| |  | Other income (expense)  net:
| |  | -----------------------------

2002
    
    
    2001
    
    
    2000Interest income
    
    $
    87
    
    
    $
    119
    
    
    $
    130Minority interest
    
    
    1
    
    
    
    5
    
    
    
    (54
    )Gain (loss) on sale or write down of investments
    
    
    (29
    )
    
    
    (354
    )
    
    
    884Other  net
    
    
    (93
    )
    
    
    (137
    )
    
    
    (63
    )Other income (expense)  net
    
    $
    (34
    )
    
    $
    (367
    )
    
    $
    897
 Currency exchange gains: 2002
    
    
    2001
    
    
    2000Currency
exchange gains (losses)(a)
    
    $
    (27
    )
    
    $
    (73
    )
    
    $
    8
 (a)
    
    Currency exchange gains (losses) included in net loss. Consolidated balance sheets Inventories  net: 2002
    
    
    2001Raw materials
    
    $
    343
    
    
    $
    745Work in process
    
    
    308
    
    
    
    577Finished goods
    
    
    335
    
    
    
    512Inventories  net (a)
    
    $
    986
    
    
    $
    1,834
 (a)
    
    Net of inventory provisions of $1,070 and $819 as at December 31,
2002 and 2001, respectively. Included in other accrued liabilities are
accruals of $167 and $563 at December 31, 2002 and 2001, respectively
for cancellation charges, inventory in excess of future demand and the
settlement of certain other claims related to contract manufacturers or
suppliers. Plant and equipment  net: 2002
    
    
    2001Cost:Land
    
    $
    53
    
    
    $
    122Buildings
    
    
    1,161
    
    
    
    1,744Machinery and equipment
    
    
    3,389
    
    
    
    4,3794,603
    
    
    
    6,245Less accumulated depreciation:Buildings
    
    
    (481
    )
    
    
    (791
    )Machinery and equipment
    
    
    (2,658
    )
    
    
    (3,004
    )(3,139
    )
    
    
    (3,795
    )Plant and equipment  net
    
    $
    1,464
    
    
    $
    2,450


F-27



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##### Table of Contents





| |  | Goodwill:
| |  | ---------



Wireless
    
    
    Enterprise
    
    
    Wireline
    
    
    OpticalNetworks
    
    
    Networks
    
    
    Networks
    
    
    Networks
    
    
    Other
    
    
    TotalBalance  net as at January 1, 2002
    
    $
    21
    
    
    $
    1,523
    
    
    $
    481
    
    
    $
    258
    
    
    $
    
    
    
    $
    2,283Change:Disposal
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment (a)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (264
    )
    
    
    
    
    
    
    (264
    )Foreign exchange
    
    
    
    
    
    
    (3
    )
    
    
    (1
    )
    
    
    6
    
    
    
    
    
    
    
    2Balance  net as at December 31, 2002
    
    $
    21
    
    
    $
    1,520
    
    
    $
    480
    
    
    $
    
    
    
    $
    
    
    
    $
    2,021
 (a)
    
    See note 7 for further information regarding this goodwill
impairment charge. Intangible assets  net: 2002
    
    
    2001Acquired Technology
    
    $
    
    
    
    $
    66Less: accumulated amortization
    
    
    
    
    
    
    (46
    )
    
    
    
    20
 Other accrued liabilities: 2002
    
    
    2001Outsourcing and selling, general and administrative related
    
    $
    616
    
    
    $
    670Customer deposits
    
    
    58
    
    
    
    51Product related
    
    
    343
    
    
    
    756Warranty
    
    
    253
    
    
    
    269Deferred income
    
    
    586
    
    
    
    642Miscellaneous taxes
    
    
    126
    
    
    
    88Income taxes payable
    
    
    98
    
    
    
    143Current liabilities of discontinued operations
    
    
    44
    
    
    
    385Interest expense
    
    
    52
    
    
    
    57Advance billings in excess of revenues (a)
    
    
    365
    
    
    
    419Other
    
    
    353
    
    
    
    539Other accrued liabilities
    
    $
    2,894
    
    
    $
    4,019
 (a)
    
    Amounts represented billings in excess of revenues recognized to
date on long-term contracts Consolidated statements of cash flows Cash and cash equivalents at end of year  net: 2002
    
    
    2001
    
    
    2000Cash on hand and balances with banks
    
    $
    903
    
    
    $
    1,251
    
    
    $
    1,141Short-term investments
    
    
    2,840
    
    
    
    2,153
    
    
    
    426Cash and cash equivalents at end of year-net
    
    $
    3,743
    
    
    $
    3,404
    
    
    $
    1,567


F-28



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##### Table of Contents





Acquisitions of investments and businesses  net of cash acquired: 2002
    
    
    2001
    
    
    2000Cash acquired
    
    $
    
    
    
    $
    
    
    
    $
    (166
    )Total net assets acquired other than cash
    
    
    (29
    )
    
    
    (89
    )
    
    
    (5,453
    )Total purchase price
    
    
    (29
    )
    
    
    (89
    )
    
    
    (5,619
    )Less:Cash acquired
    
    
    
    
    
    
    
    
    
    
    166Non-cash consideration paid other than common share options
and contingent consideration
    
    
    
    
    
    
    
    
    
    
    4,307Common share consideration paid
    
    
    
    
    
    
    
    
    
    
    791Cash consideration contingent upon the achievement of certain
operational milestones
    
    
    
    
    
    
    
    
    
    
    39Acquisitions of investments and businesses  net of cash acquired
    
    $
    (29
    )
    
    $
    (89
    )
    
    $
    (316
    )
 Interest and income taxes paid (recovered): 2002
    
    
    2001
    
    
    2000Interest paid
    
    $
    201
    
    
    $
    252
    
    
    $
    158Income taxes paid (received)
    
    $
    (1,218
    )
    
    $
    18
    
    
    $
    736
 Receivables sales: 2002
    
    
    2001
    
    
    2000Proceeds from new securitizations
    
    $
    562
    
    
    $
    789
    
    
    $
    1,632Proceeds from collections reinvested in revolving period securitizations
    
    $
    276
    
    
    $
    688
    
    
    $
    1,043




|6. |  | Segmented information
|-- |  | ---------------------



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



| |  | Nortel Networks operations are organized around four reportable segments:
Wireless Networks; Enterprise Networks; Wireline Networks; and Optical
Networks. Nortel Networks reportable segments are focused on providing
seamless networking products and service capabilities. These products and
service solutions are used by our service provider and enterprise customers,
including local and long-distance communications companies, wireless service
providers, cable multiple system operators and other communications service
providers, large and small businesses, governments, educational institutions
and other organizations.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

F-29



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##### Table of Contents





| |  | As described in note 18, Nortel Networks access solutions operations were
discontinued during the year ended December 31, 2001. These operations were
previously included as a separate segment within Other. The data included
below excludes amounts related to the access solutions operations.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  | During the three months ended September 30, 2002, Nortel Networks changed the
way it managed its business to streamline and focus more directly on its
customers in four core business areas. Consequently, the former Metro and
Enterprise Networks was split into two new segments, Enterprise Networks and
Wireline Networks, each with its own segment manager reporting directly to
the CEO. In addition, during the three months ended June 30, 2002,
management shifted the accountability for the metro optical portion of the
former Metro and Enterprise Networks segment to Optical Networks (formerly
named Optical Long-Haul Networks). As a result, financial information is
reported on the new basis and historical comparative financial information
has been restated.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-30



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##### Table of Contents





| |  | The following tables set forth information by segment for each of the years
ended December 31:
| |  | ----------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000RevenuesWireless Networks
    
    $
    4,216
    
    
    $
    5,610
    
    
    $
    5,423Enterprise Networks
    
    
    2,569
    
    
    
    3,237
    
    
    
    3,889Wireline Networks
    
    
    2,264
    
    
    
    4,450
    
    
    
    7,774Optical Networks
    
    
    1,464
    
    
    
    3,307
    
    
    
    9,732Other
    
    
    41
    
    
    
    668
    
    
    
    1,018Total
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836Contribution MarginWireless Networks
    
    
    1,186
    
    
    
    491
    
    
    
    1,018Enterprise Networks
    
    
    448
    
    
    
    357
    
    
    
    877Wireline Networks
    
    
    506
    
    
    
    529
    
    
    
    3,003Optical Networks
    
    
    (788
    )
    
    
    (2,955
    )
    
    
    3,205Other
    
    
    (409
    )
    
    
    (951
    )
    
    
    (718
    )Total
    
    $
    943
    
    
    $
    (2,529
    )
    
    $
    7,385Research and development expense
    
    
    (2,205
    )
    
    
    (3,208
    )
    
    
    (3,629
    )In-process research and development expense
    
    
    
    
    
    
    
    
    
    
    (622
    )Amortization of acquired technology
    
    
    (19
    )
    
    
    (574
    )
    
    
    (789
    )Amortization of goodwill
    
    
    
    
    
    
    (2,080
    )
    
    
    (2,491
    )Stock option compensation
    
    
    
    
    
    
    
    
    
    
    (99
    )Special charges
    
    
    (1,699
    )
    
    
    (5,328
    )
    
    
    (265
    )Gain on sale of businesses
    
    
    39
    
    
    
    126
    
    
    
    173Equity in net loss of associated companies
    
    
    (18
    )
    
    
    (150
    )
    
    
    (18
    )Other income (expense)  net
    
    
    (34
    )
    
    
    (367
    )
    
    
    897Interest expense
    
    
    (174
    )
    
    
    (293
    )
    
    
    (169
    )Earnings from continuing operations before income taxes
    
    $
    (3,167
    )
    
    $
    (14,403
    )
    
    $
    373
 Product revenues The following table sets forth external revenues by product for each of the
years ended December 31: 2002
    
    
    2001
    
    
    2000Wireless solutions
    
    $
    4,216
    
    
    $
    5,610
    
    
    $
    5,423Circuit and packet voice solutions
    
    
    3,115
    
    
    
    5,333
    
    
    
    8,751Optical solutions
    
    
    1,639
    
    
    
    3,666
    
    
    
    10,039Data networking and security solutions
    
    
    1,543
    
    
    
    1,995
    
    
    
    2,605Other
    
    
    41
    
    
    
    668
    
    
    
    1,018Total
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836


F-31



---



##### Table of Contents





Geographic information The following table sets forth external revenues by geographic region based
on the location of the customer for each of the years ended December 31: 2002
    
    
    2001
    
    
    2000External revenuesUnited States
    
    $
    5,376
    
    
    $
    8,503
    
    
    $
    16,782EMEA (a)
    
    
    2,561
    
    
    
    4,322
    
    
    
    5,834Canada
    
    
    656
    
    
    
    934
    
    
    
    1,505Other regions
    
    
    1,961
    
    
    
    3,513
    
    
    
    3,715Total
    
    $
    10,554
    
    
    $
    17,272
    
    
    $
    27,836
 (a)
    
    The Europe, Middle East and Africa region (EMEA). Long- lived assets The following table sets forth long-lived assets, representing plant and
equipment  net, goodwill, and intangible assets  net, by geographic region
as at December 31: 2002
    
    
    2001Long-lived assetsUnited States
    
    $
    2,298
    
    
    $
    2,793EMEA
    
    
    409
    
    
    
    769Canada
    
    
    644
    
    
    
    942Other regions
    
    
    134
    
    
    
    249Total
    
    $
    3,485
    
    
    $
    4,753


F-32



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##### Table of Contents





|7. |  | Special charges
|-- |  | ---------------



| |  | During 2002, in light of the continued downturn in both the
telecommunications industry and the economic environment, and capital market
trends impacting Nortel Networks operations and expected future growth rates,
Nortel Networks continued to implement its work plan to streamline its
operations and activities around its core markets and leadership strategies.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Special charges recorded from January 1, 2000 to December 31, 2002 were as
follows:
| |  | -----------------------------------------------------------------------------------



Contract
    
    
    
    
    
    
    Intangiblesettlement
    
    
    Plant and
    
    
    
    
    
    
    assetWorkforce
    
    
    and lease
    
    
    equipment
    
    
    
    
    
    
    impair-reduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    ments
    
    
    TotalProvision balance as at January 1, 2000
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    133
    
    
    
    133Other special charges
    
    
    128
    
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    132Cash drawdowns
    
    
    (83
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (83
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    (133
    )
    
    
    (137
    )Provision balance as at December 31, 2000
    
    $
    45
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    45Goodwill impairment
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2,239
    
    
    $
    2,239Other special charges
    
    
    1,236
    
    
    
    876
    
    
    
    940
    
    
    
    37
    
    
    
    -
    
    
    
    3,089Cash drawdowns
    
    
    (1,001
    )
    
    
    (112
    )
    
    
    
    
    
    
    (8
    )
    
    
    -
    
    
    
    (1,121
    )Non-cash drawdowns
    
    
    14
    
    
    
    
    
    
    
    (940
    )
    
    
    
    
    
    
    (2,239
    )
    
    
    (3,165
    )Provision balance as at December 31,
2001 (a)
    
    $
    294
    
    
    $
    764
    
    
    $
    
    
    
    $
    29
    
    
    $
    -
    
    
    $
    1,087Goodwill impairment
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    264
    
    
    $
    264Other special charges
    
    
    823
    
    
    
    192
    
    
    
    332
    
    
    
    88
    
    
    
    -
    
    
    
    1,435Cash drawdowns
    
    
    (787
    )
    
    
    (324
    )
    
    
    
    
    
    
    (20
    )
    
    
    -
    
    
    
    (1,131
    )Non-cash drawdowns
    
    
    (100
    )
    
    
    
    
    
    
    (332
    )
    
    
    (88
    )
    
    
    (264
    )
    
    
    (784
    )Provision balance as at December 31,
2002 (a)
    
    $
    230
    
    
    $
    632
    
    
    $
    
    
    
    $
    9
    
    
    $
    
    
    
    $
    871
 (a)
    
    At December 31, 2002 and 2001, the short-term provision balance was
$537 and $755, respectively, and the long-term provision balance was
$334 and $332, respectively (included in other liabilities). Regular full-time (RFT) employee notifications included in special charges
were as follows: Employees (approximate)Direct (a)
    
    
    Indirect (b)
    
    
    TotalRFT employee notifications by period:During 2000
    
    
    200
    
    
    
    3,800
    
    
    
    4,000During 2001
    
    
    13,800
    
    
    
    21,700
    
    
    
    35,500During 2002
    
    
    3,300
    
    
    
    8,800
    
    
    
    12,100RFT employee notifications as at December 31, 2002
    
    
    17,300
    
    
    
    34,300
    
    
    
    51,600
 (a)
    
    Direct employees include employees performing manufacturing,
assembly, test and inspection activities associated with the production
of Nortel Networks products.(b)
    
    Indirect employees include employees performing manufacturing
management, sales, marketing, research and development and
administrative activities.


F-33



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| |  | Year ended December 31, 2002
| |  | ----------------------------



| |  | For the year ended December 31, 2002, Nortel Networks recorded total special
charges of $1,699.
| |  | -----------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of $823 were related to severance and benefit
costs associated with approximately 12,100 employees notified of termination
during 2002 which extended across all segments. Workforce reduction charges
include $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 $787 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. The remaining provision is expected to be
substantially drawn down by the end of 2003.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contract settlement and lease costs of $192 include $54 of negotiated
settlements to cancel or renegotiate contracts and $138 of net lease charges
related to a number of leased facilities (comprised of office, warehouse and
manufacturing space), and leased manufacturing equipment no longer required,
across all of Nortel Networks segments. Lease costs represent Nortel
Networks future contractual obligations under its operating leases for those
leases that Nortel Networks cannot terminate. During 2002, Nortel Networks
modified the original disposition plan for certain properties and is pursuing
lease terminations instead of subleasing due to current market conditions.
As at December 31, 2002, the provision balance for contract settlement and
lease costs was drawn down by cash payments of $324, resulting in an ending
provision balance of $632. The remaining provision, net of approximately
$420 in expected sublease revenue, is expected to be substantially drawn down
by the end of 2006.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and equipment write downs of $332 were net of $28 of additional
proceeds from disposals in excess of amounts previously expected. Plant and
equipment charges include write downs of $19 for owned facilities across all
segments, a $26 reversal for certain leasehold improvements and information
technology equipment associated with the exit of leased and owned facilities,
and $339 for certain plant and manufacturing, and R&D related equipment. The
carrying values of the above noted owned facilities have been reflected at
their net realizable value based on market assessments for general purpose
facilities.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and manufacturing related equipment write downs of $339 include $25 for
equipment within global operations, a function that supports all segments,
$266 for specialized plant infrastructure and equipment within Optical
Networks and $48 for specialized equipment including R&D equipment within all
segments. Within global operations, it was determined that there was excess
equipment at a number of system houses that would no longer be required as a
result of the industry and economic environment. As a result, the identified
equipment was written down to its net realizable value. Within Optical
Networks, Nortel Networks performed assessments of certain plant and
equipment due to the current market conditions and the delay in the
anticipated recovery of that segment and concluded that the assets carrying
value was not fully recoverable from estimated future cash flows. As a
result, Nortel Networks recorded $266 to write down the value of this
equipment to its net realizable value. Included in the $266 write down was
$34 related to equipment held for sale, which were part of the Bookham
Technology plc (Bookham) transaction (see note 10). Within other business
segments, $48 of excess equipment was identified that would no longer be
required as a result of the industry and economic environment and the
identified equipment was written down to its net realizable value.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other special charges of $88 relates to inventory write downs, reflecting the
net realizable value of these assets on dispositions, associated with assets
held for sale under SFAS 144 within Optical Networks (see note 10).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Goodwill impairment charges were $264. As a result of the continued decline
in both Nortel Networks overall market value generally and within Optical
Networks specifically, Nortel Networks 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 Networks recorded a goodwill impairment charge of $264.
Fair value was estimated using the 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, reflect managements best estimates.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-34



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| |  | Year ended December 31, 2001
| |  | ----------------------------



| |  | For the year ended December 31, 2001, Nortel Networks recorded total special
charges of $5,328.
| |  | -----------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of $1,236 were related to the cost of severance
and benefits associated with approximately 35,500 employees notified of
termination. The workforce reduction was primarily in the United States,
Canada and EMEA and extended across all segments. As at December 31, 2001,
the workforce reduction provision balance was drawn down by cash payments of
$1,001, offset by $14 of non-cash pension settlement and curtailment costs
attributable to the notified employee group charged against the provision.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contract settlement and lease costs of $876 included $119 of negotiated
settlements to cancel or renegotiate contracts and $757 of net lease charges
related to a number of leased facilities (comprised of office, warehouse and
manufacturing space), and leased manufacturing equipment no longer required,
across all segments. Lease costs represent Nortel Networks future
contractual obligations under its applicable operating leases on leases that
Nortel Networks cannot terminate. As at December 31, 2001, the provision
balance for contract settlement and lease costs was drawn down by cash
payments of $112, resulting in a provision balance of $764, net of
approximately $506 in expected sublease revenues.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and equipment write downs of $940 include write downs of $186 for owned
facilities, $441 for leasehold improvements and certain information
technology equipment associated with the exiting of leased and owned
facilities and $313 for certain plant and manufacturing related equipment.
Owned facility write downs of $186 include $95 for specific owned facilities
across all segments primarily within the United States, Canada and EMEA and
$91 for a specialized manufacturing facility in the United States within
Optical Networks. The carrying values of the above owned facilities have
been reflected at their net realizable value based on market assessments for
general purpose facilities.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and manufacturing related equipment write downs of $313 include $66 for
equipment within global operations, and $247 for specialized plant
infrastructure and equipment within Optical Networks.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Goodwill and intangible asset impairment charges were $2,239 and include a
goodwill impairment charge of $106 related to the remaining net book value of
goodwill associated with the prior acquisitions of MICOM Communications,
Corp. and Dimension Enterprises, Inc. (Dimension). As part of Nortel
Networks work plan to streamline its business, the decision was made to exit
all technologies and consulting services related to these prior acquisitions.
The results related to these prior acquisitions were not material to the
business, results of operations and financial condition of Nortel Networks.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks, as part of its review of financial results during the year
ended December 31, 2001, performed an assessment of the carrying values of
intangible assets recorded in connection with its various acquisitions. The
assessment during that period was performed in light of the significant
negative industry and economic trends impacting Nortel Networks operations
and expected future growth rates, and the adjustment of technology
valuations. The conclusion of the assessment was that the decline in market
conditions within the telecommunications industry was significant and other
than temporary. As a result, Nortel Networks recorded a $2,133 impairment of
goodwill and other intangible assets based on the amount by which the
carrying amount of these assets exceeded their fair value. The impairment
was primarily related to the goodwill within Enterprise Networks, Optical
Networks and Other and was associated with the acquisitions of Qtera
Corporation (Qtera), Photonic Technologies, Inc. (Photonic) and Clarify
Inc. (Clarify).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Fair value was determined based on discounted future cash flows for the
businesses that had separately distinguishable goodwill and intangible asset
balances and whose operations had not yet been fully integrated into Nortel
Networks. The cash flow periods used were five years, the discount rate used
was 20 percent, and the terminal values were estimated based upon terminal
growth rates ranging from 5 to 11 percent reflecting managements best
estimates at the time. The discount rate was based upon Nortel Networks
weighted average cost of capital as adjusted for the risks associated with
the operations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-35



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##### Table of Contents





| |  | Year ended December 31, 2000
| |  | ----------------------------



| |  | For the year ended December 31, 2000, Nortel Networks recorded total special
charges of $265.
| |  | ---------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of $128 consisted of $98 related to approximately
2,000 employees connected with Nortel Networks initiative to strategically
realign resources into high growth areas of the business in response to
shifts in customers needs from older to newer technologies across Nortel
Networks product portfolio. The remaining workforce reduction costs of $30
related to approximately 2,000 employees connected with the outsourcing of
certain information services functions as part of the outsourcing of certain
corporate service functions which began in the third quarter of 1999. The
provision balance of $45 at December 31, 2000 was fully drawn down in 2001.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The intangible asset impairment charge of $133 represented a reduction of the
goodwill related to certain operations in EMEA and resulted from a change in
business mandate for those operations from a product focus to a focus on
distribution channels.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|8. |  | Income taxes
|-- |  | ------------



| |  | At December 31, 2002, Nortel Networks net deferred tax assets, excluding
discontinued operations, were $3,080, reflecting temporary differences
between the financial reporting and tax treatment of certain current assets
and liabilities, and non-current assets and liabilities, plus the tax benefit
of net operating and capital loss carryforwards and tax credit carryforwards.
These carryforwards expire at various dates beginning in 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the year ended December 31, 2002, Nortel Networks recorded a net
income tax benefit of $422 on a pre-tax loss of $3,167. Gross income tax
valuation allowances during the year ended December 31, 2002, were $964
including certain additional income tax valuation allowances of $430. Nortel
Networks assessed positive evidence including forecasts of future taxable
income to support realization of the net deferred tax assets, and negative
evidence including Nortel Networks eight consecutive quarters of tax losses,
and concluded that it was more likely than not, that certain additional tax
valuation allowances of $430 were required. If market conditions change or
future results of operations differ from those expected, future evaluations
may result in adjustments to the valuation allowance.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Changes to tax legislation in the United States, during the year ended
December 31, 2002, extended the net operating loss carryback period from two
to five years. As a result, Nortel Networks was able to carryback available
United States losses from 2001 and utilize approximately $700 of deferred
income tax assets previously recognized, generating additional cash
recoveries of approximately $700 for the year ended December 31, 2002.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-36



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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
(provision) included in the accompanying consolidated statements of
operations for each of the years ended December 31:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Income taxes at Canadian rates
(2002  39.4%, 2001  40.8%, 2000  42.3%)
    
    $
    1,248
    
    
    $
    5,876
    
    
    $
    (158
    )Increase
(reduction) of Canadian taxes applicable to manufacturing profits
    
    
    (55
    )
    
    
    (64
    )
    
    
    36Difference between Canadian rate and rates applicable to subsidiaries in
the United States and other jurisdictions
    
    
    (38
    )
    
    
    (750
    )
    
    
    115Difference between basic Canadian rate and rates applicable to gain (loss)
on sale of businesses
    
    
    2
    
    
    
    (31
    )
    
    
    (30
    )Non-deductible amortization of acquired intangibles and IPR&D expense
    
    
    (90
    )
    
    
    (1,749
    )
    
    
    (1,313
    )Foreign operation tax credit
    
    
    
    
    
    
    979
    
    
    
    Valuation allowances on tax benefits
    
    
    (964
    )
    
    
    (1,331
    )
    
    
    Utilization of losses
    
    
    65
    
    
    
    22
    
    
    
    64Other
    
    
    254
    
    
    
    21
    
    
    
    70Income tax benefit (provision)
    
    $
    422
    
    
    $
    2,973
    
    
    $
    (1,216
    )Details of Nortel Networks income taxes:Earnings (loss) from continuing operations before income taxes:Canadian, excluding gain (loss) on sale of businesses
    
    $
    (1,121
    )
    
    $
    (3,293
    )
    
    $
    863United States and other, excluding gain (loss) on sale of businesses
    
    
    (2,085
    )
    
    
    (11,236
    )
    
    
    (663
    )Gain on sale of businesses
    
    
    39
    
    
    
    126
    
    
    
    173$
    (3,167
    )
    
    $
    (14,403
    )
    
    $
    373Income tax benefit (provision):Canadian, excluding (gain) loss on sale of businesses
    
    $
    54
    
    
    $
    454
    
    
    $
    (229
    )United States and other, excluding (gain) loss on sale of businesses
    
    
    375
    
    
    
    2,601
    
    
    
    (884
    )(Gain) loss on sale of businesses
    
    
    (7
    )
    
    
    (82
    )
    
    
    (103
    )$
    422
    
    
    $
    2,973
    
    
    $
    (1,216
    )Income tax benefit (provision):Current
    
    $
    29
    
    
    $
    1,236
    
    
    $
    (1,420
    )Deferred
    
    
    393
    
    
    
    1,737
    
    
    
    204Income tax benefit (provision)
    
    $
    422
    
    
    $
    2,973
    
    
    $
    (1,216
    )


F-37



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##### Table of Contents





The following table shows the significant components included in deferred
income taxes as at December 31: 2002
    
    
    2001Assets:Tax benefit of loss carryforwards and tax credits
    
    $
    4,407
    
    
    $
    2,958Provision and reserves
    
    
    1,550
    
    
    
    1,677Post-retirement benefits other than pensions
    
    
    104
    
    
    
    381Plant and equipment
    
    
    72
    
    
    
    25Pension plan liabilities
    
    
    285
    
    
    
    49Deferred compensation
    
    
    32
    
    
    
    35Unrealized losses on investments
    
    
    3
    
    
    
    107Other
    
    
    2
    
    
    
    136,455
    
    
    
    5,245Valuation allowance
    
    
    (2,631
    )
    
    
    (1,573
    )3,824
    
    
    
    3,672Liabilities:Acquired technology
    
    $
    
    
    
    $
    8Provision and reserves
    
    
    681
    
    
    
    560Plant and equipment
    
    
    6
    
    
    
    166Other
    
    
    57
    
    
    
    29744
    
    
    
    763Net deferred income tax assets
    
    $
    3,080
    
    
    $
    2,909
 Included in deferred income taxes as at December 31, 2002 was a valuation
allowance on certain deferred income tax assets of approximately $63, which
pertained to certain provisions and loss carryforwards resulting from certain
acquisitions. When utilized by Nortel Networks, the tax benefit of these
amounts will be accounted for as a credit to goodwill, to the extent that
there is remaining goodwill associated with the specific acquisition, rather
than as a reduction of the income tax provision. At December 31, 2002, Nortel Networks 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)
    
    
    Total2003  2006
    
    $
    571
    
    
    $
    
    
    
    $
    279
    
    
    $
    8502007  2009
    
    
    1,564
    
    
    
    
    
    
    
    260
    
    
    
    1,8242010  2011
    
    
    7
    
    
    
    
    
    
    
    398
    
    
    
    4052017  2021
    
    
    2,361
    
    
    
    
    
    
    
    262
    
    
    
    2,623Indefinitely
    
    
    1,013
    
    
    
    3,960
    
    
    
    12
    
    
    
    4,985$
    5,516
    
    
    $
    3,960
    
    
    $
    1,211
    
    
    $
    10,687
 (a)
    
    The capital losses may only be used to offset future capital gains
realized in the United Kingdom. Nortel Networks has recorded a full
valuation allowance against this future tax benefit.(b)
    
    Global investment tax credits of $116, $153 and $151 have been
applied against the income tax provision in 2002, 2001 and 2000,
respectively. Unused tax credits can be utilized primarily to offset
future Canadian income taxes payable.


F-38



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##### Table of Contents





|9. |  | Employee benefit plans
|-- |  | ----------------------



| |  | Pension plans
| |  | -------------



| |  | Nortel Networks maintains various retirement programs covering substantially
all of its employees, consisting of defined benefit, defined contribution and
investment plans.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During 2000, Nortel Networks introduced a balanced capital accumulation and
retirement program (the Balanced Program) and an investor capital
accumulation and retirement program (the Investor Program), to
substantially all of its North American employees and a flexible benefits
plan (the Flexible Benefits Plan) to substantially all of its employees in
the United Kingdom. Those employees who were already a member of one of the
existing defined benefit pension plans (the Traditional Program) could
elect to transfer to one of these new program arrangements, as applicable, or
remain in the existing Traditional Program. With the introduction of the
Balanced Program, the Investor Program, and the Flexible Benefits Plan during
2000, the Traditional Program was closed to new entrants.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2002, the decline in global capital markets and interest rates had a
negative impact on Nortel Networks pension plan assets and obligations. As a
result, Nortel Networks 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
liability previously recognized in the consolidated balance sheet. The
pre-tax effect of this adjustment was to decrease prepaid pension costs by
$23, increase pension liabilities by $696, increase intangible assets by $27,
and increase accumulated other comprehensive loss by $692. Because these
adjustments were non-cash, their effect has been excluded from the
accompanying consolidated statements of cash flows.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Benefits other than pensions
| |  | ----------------------------



| |  | Nortel Networks also provides other benefits, including post-retirement
benefit 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 and 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
Networks-sponsored retiree health care plan at their own cost.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks 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. Plan assets are comprised primarily of common
stocks, bonds, debentures, secured mortgages and property. Included in plan
assets are common shares of Nortel Networks Corporation with an aggregate
market value of $3 in 2002 ($23 in 2001).
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Pension and other benefit costs reflected in the accompanying consolidated
statement of operations are based on the projected benefit method of
valuation.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

F-39



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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 accompanying consolidated balance sheets as at December 31:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Defined benefit plans
    
    
    Post-retirement benefits2002
    
    
    2001
    
    
    2002
    
    
    2001Change in benefit obligation:Benefit obligation  beginning
    
    $
    6,020
    
    
    $
    5,888
    
    
    $
    529
    
    
    $
    479Service cost
    
    
    155
    
    
    
    197
    
    
    
    10
    
    
    
    13Interest cost
    
    
    400
    
    
    
    405
    
    
    
    37
    
    
    
    36Plan participants contributions
    
    
    11
    
    
    
    17
    
    
    
    2
    
    
    
    2Actuarial loss (gain)
    
    
    (23
    )
    
    
    346
    
    
    
    20
    
    
    
    28Acquisition/divestiture/settlements
    
    
    (386
    )
    
    
    (186
    )
    
    
    (3
    )
    
    
    15Benefits paid
    
    
    (315
    )
    
    
    (427
    )
    
    
    (31
    )
    
    
    (23
    )Foreign exchange loss (gain)
    
    
    283
    
    
    
    (220
    )
    
    
    4
    
    
    
    (21
    )Benefit obligation  ending
    
    $
    6,145
    
    
    $
    6,020
    
    
    $
    568
    
    
    $
    529Change in plan assets:Fair value of plan assets  beginning
    
    $
    4,980
    
    
    $
    6,357
    
    
    $
    41
    
    
    $
    46Actual return on plan assets
    
    
    (265
    )
    
    
    (811
    )
    
    
    
    
    
    
    1Employer contributions
    
    
    149
    
    
    
    114
    
    
    
    28
    
    
    
    20Plan participants contributions
    
    
    11
    
    
    
    17
    
    
    
    2
    
    
    
    2Acquisition/divestiture/settlements
    
    
    (423
    )
    
    
    (60
    )
    
    
    
    
    
    
    Benefits paid
    
    
    (315
    )
    
    
    (427
    )
    
    
    (31
    )
    
    
    (23
    )Change in valuation
    
    
    
    
    
    
    (64
    )
    
    
    
    
    
    
    Foreign exchange gain (loss)
    
    
    221
    
    
    
    (146
    )
    
    
    1
    
    
    
    (5
    )Fair value of plan assets  ending
    
    $
    4,358
    
    
    $
    4,980
    
    
    $
    41
    
    
    $
    41Unfunded status of the plans
    
    $
    (1,787
    )
    
    $
    (1,040
    )
    
    $
    (527
    )
    
    $
    (488
    )Unrecognized net plan benefits existing at January 1, 1987
    
    
    (7
    )
    
    
    (10
    )
    
    
    (31
    )
    
    
    Unrecognized prior service cost (credit)
    
    
    19
    
    
    
    24
    
    
    
    
    
    
    
    (40
    )Unrecognized net actuarial losses (gains)
    
    
    1,400
    
    
    
    796
    
    
    
    13
    
    
    
    (8
    )Employer contributions after the measurement date
    
    
    113
    
    
    
    24
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    (262
    )
    
    $
    (206
    )
    
    $
    (545
    )
    
    $
    (536
    )Amount recognized in the accompanying consolidated
balance sheets:Other liabilities
    
    $
    (1,123
    )
    
    $
    (354
    )
    
    $
    (545
    )
    
    $
    (536
    )Other assets  intangible assets
    
    
    41
    
    
    
    14
    
    
    
    
    
    
    
    Other assets  pension assets
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    Foreign currency translation adjustment
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    Accumulated other comprehensive loss
    
    
    801
    
    
    
    109
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    (262
    )
    
    $
    (206
    )
    
    $
    (545
    )
    
    $
    (536
    )
 The following details selected information for defined benefit plans with
accumulated benefit obligations in excess of the fair value of plan assets: 2002
    
    
    2001Benefit obligation
    
    $
    6,145
    
    
    $
    4,795Accumulated benefit obligation
    
    $
    5,523
    
    
    $
    4,268Fair value of plan assets
    
    $
    4,358
    
    
    $
    3,851


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---



##### Table of Contents





| |  | The following details the net pension expense and the underlying assumptions
for the defined benefit plans for each of the years ended December 31:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Pension expense:Service cost
    
    $
    155
    
    
    $
    197
    
    
    $
    182Interest cost
    
    
    400
    
    
    
    405
    
    
    
    394Estimated return on plan assets
    
    
    (418
    )
    
    
    (461
    )
    
    
    (450
    )Amortization of prior service cost
    
    
    8
    
    
    
    8
    
    
    
    10Amortization of net losses (gains)
    
    
    19
    
    
    
    (25
    )
    
    
    2Settlement losses (gains)
    
    
    93
    
    
    
    1
    
    
    
    (7
    )Curtailment losses (gains)
    
    
    40
    
    
    
    16
    
    
    
    (35
    )Net pension expense
    
    $
    297
    
    
    $
    141
    
    
    $
    96Allocation of net pension expense:Continuing operations
    
    $
    297
    
    
    $
    139
    
    
    $
    93Discontinued operations
    
    
    
    
    
    
    2
    
    
    
    3Net pension expense
    
    $
    297
    
    
    $
    141
    
    
    $
    96Weighted average assumptions at end of year:Discount rate
    
    
    6.3
    %
    
    
    6.7
    %
    
    
    7.0
    %Expected rate of return on plan assets
    
    
    7.8
    %
    
    
    7.8
    %
    
    
    8.1
    %Rate of compensation increase
    
    
    3.7
    %
    
    
    4.6
    %
    
    
    4.8
    %
 The following details the net cost components and underlying assumptions of
post-retirement benefits other than pensions for each of the years ended
December 31: 2002
    
    
    2001
    
    
    2000Post-retirement benefit cost:Service cost
    
    $
    10
    
    
    $
    13
    
    
    $
    20Interest cost
    
    
    37
    
    
    
    36
    
    
    
    39Expected return on plan assets
    
    
    (3
    )
    
    
    (3
    )
    
    
    (3
    )Amortization
    
    
    (3
    )
    
    
    (5
    )
    
    
    (2
    )Settlements and curtailments
    
    
    (9
    )
    
    
    (21
    )
    
    
    (26
    )Net post-retirement benefit cost
    
    $
    32
    
    
    $
    20
    
    
    $
    28Allocation of net post-retirement benefit cost:Continuing operations
    
    $
    32
    
    
    $
    20
    
    
    $
    27Discontinued operations
    
    
    
    
    
    
    
    
    
    
    1Net post-retirement benefit cost
    
    $
    32
    
    
    $
    20
    
    
    $
    28Weighted average assumptions at end of year:Discount rate
    
    
    6.8
    %
    
    
    7.0
    %
    
    
    7.5
    %Expected rate of return on plan assets
    
    
    8.0
    %
    
    
    8.0
    %
    
    
    8.0
    %Weighted average health care cost trend rate
    
    
    8.0
    %
    
    
    7.3
    %
    
    
    7.5
    %Weighted average ultimate health care cost trend rate
    
    
    4.7
    %
    
    
    5.1
    %
    
    
    5.1
    %Year in which ultimate health care cost trend rate will be achieved
    
    
    2009
    
    
    2005
    
    
    2004


F-41



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##### Table of Contents





| |  | 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:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Effect on aggregate of service and interest costs1% increase
    
    $
    5
    
    
    $
    5
    
    
    $
    81% decrease
    
    $
    (4
    )
    
    $
    (4
    )
    
    $
    (6
    )Effect on accumulated post-retirement benefit obligations1% increase
    
    $
    57
    
    
    $
    56
    
    
    $
    471% decrease
    
    $
    (46
    )
    
    $
    (46
    )
    
    $
    (38
    )




| |  | Under the terms of the Balanced Program, the Investor Program and the
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 Networks matches a percentage of the
employees contribution up to a certain limit. The cost of these investment
plans was $89, $139 and $124 for the years ended December 31, 2002, 2001 and
2000, respectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Under the terms of the Balanced Program and the Flexible Benefits Plan,
Nortel Networks contributes a fixed percentage of employees eligible earnings
to a pension plan arrangement. The cost of these pension plan arrangements
was $29, $48 and $25 for the year ended December 31, 2002, 2001 and 2000,
respectively.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|10. |  | Divestitures, closures and acquisitions
|--- |  | ---------------------------------------



| |  | Divestitures
| |  | ------------



| |  | On November 8, 2002, Nortel Networks 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 Networks 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 Networks also
transferred approximately 1,100 employees to Bookham in the transaction.
Nortel Networks 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 $1. The transaction included a minimum
purchase commitment with Bookham requiring Nortel Networks to purchase
approximately $120 of product from Bookham between November 8, 2002 and March
31, 2004. Should there be a shortfall, Nortel Networks would make a cash
payment for a portion of the balance (see note 13).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the three months ended September 30, 2002, Nortel Networks classified
the assets sold to Bookham as available for sale and assigned an estimated
fair value of $46 to them resulting in a charge of $122 (see note 7). A
subsequent increase in Bookhams common share price prior to the November 8,
2002 close date, resulted in an increase in value assigned to the
consideration received. As a result, Nortel Networks recorded a gain from
sale of business of $18 during the year ended December 31, 2002 resulting
from the transaction.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As a result of the transaction, Nortel Networks received a 29.8 percent
ownership interest in Bookham. Due to restrictions on Nortel Networks
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.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On November 28, 2001, Nortel Networks sold substantially all of the assets of
its wholly owned subsidiary Clarify, including patents, intellectual property
and trademarks, to Amdocs Limited for approximately $200 in cash, resulting
in a gain of $16.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-42



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##### Table of Contents





| |  | Closures
| |  | --------



| |  | As part of its work plan to streamline its business, Nortel Networks closed
the operations of Photonic and Dimension in 2001 (see note 7).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  | As described in note 7, the amount of goodwill and acquired technology
associated with a number of Nortel Networks prior acquisitions was written
down by $264 during the year ended December 31, 2002 and $2,239 during the
year ended December 31, 2001.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Acquisitions
| |  | ------------



| |  | The following tables set out certain information for acquisitions completed
by Nortel Networks in the years ended December 31, 2000, excluding those
entities acquired which were subsequently included as discontinued operations
(see note 18). All of these acquisitions were accounted for using the
purchase method. The accompanying consolidated financial statements include
the operating results of each of these businesses from the respective dates
of acquisition.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Purchase price allocation
| |  | -------------------------



Net tangibleClosing
    
    
    
    
    
    Purchase
    
    
    
    
    
    
    Acquired
    
    
    
    
    
    
    assetsdate
    
    Acquisition
    
    
    price (e)
    
    
    Goodwill (f)
    
    
    technology (f)
    
    
    IPR&D
    
    
    (liabilities)2000May 12
    
    Photonic (a)
    
    
    32
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    3March 16
    
    Clarify (b)
    
    
    2,114
    
    
    
    1,812
    
    
    
    210
    
    
    
    64
    
    
    
    28January 28
    
    Qtera (c)
    
    
    3,004
    
    
    
    2,412
    
    
    
    
    
    
    
    559
    
    
    
    33January 24
    
    Dimension (d)
    
    
    65
    
    
    
    58
    
    
    
    
    
    
    
    
    
    
    
    7
 (a)
    
    Photonic was a developer of optical component technology for
manipulation and control of the polarization of light.(b)
    
    Clarify was a provider of eBusiness front office solutions.(c)
    
    Qtera was a producer of ultra-long reach optical networking systems.(d)
    
    Dimension was an engineering and business strategy consulting firm.(e)
    
    Includes contingent consideration earned after the closing date.(f)
    
    Nortel Networks amortizes acquired technology over two or three
years. Prior to adopting SFAS 142, goodwill for the above acquisitions
was amortized over three or four years. Form of consideration included in purchase price
allocation Black-ScholesAssumed
    
    
    
    
    
    
    fair value ofCommon
    
    
    stock
    
    
    Assumed
    
    
    assumed stockshares
    
    
    options
    
    
    warrants
    
    
    options andAcquisition
    
    (millions)
    
    
    (millions)
    
    
    (millions)
    
    
    warrants
    
    
    Cash2000Photonic
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    32Clarify
    
    
    31.7
    
    
    
    8.8
    
    
    
    
    
    
    $
    363
    
    
    $
    Qtera
    
    
    28.2
    
    
    
    3.7
    
    
    
    0.9
    
    
    $
    427
    
    
    $
    Dimension
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    37
 In connection with the acquisition of Qtera, approximately 5.2 million Nortel
Networks common shares were issued into escrow related to contingent
consideration. The Black-Scholes fair value included $78 for assumed
warrants. The issued common shares, assumed stock options and warrants
exclude the common shares that were to be issued to the former holders of
assumed stock options and warrants on achievement of certain business
performance objectives.


F-43



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##### Table of Contents





| |  | Other acquisitions
| |  | ------------------



| |  | Nortel Networks Germany
| |  | -----------------------



| |  | Effective January 1, 2000, Nortel Networks increased its ownership interest
in Nortel Networks Germany GmbH & Co. KG (formerly known as Nortel Dasa
Network Systems GmbH & Co. KG), from 50 percent to 58 percent.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks France
| |  | ----------------------



| |  | Effective January 1, 2000, Nortel Networks increased its ownership interest
in Nortel Networks France S.A.S. (formerly known as Matra Nortel
Communications S.A.S.), from 50 percent to 55 percent.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contingent consideration
| |  | ------------------------



| |  | In certain acquisition transactions, Nortel Networks agreed to pay additional
purchase consideration upon the achievement of specific objectives by the
acquired business. The achievement of these objectives results in an
increase in the purchase price of the acquired business for consideration
subsequent to the purchase date, and a corresponding increase at that time to
the goodwill recorded on the acquisition. The maximum contingent
consideration is fixed as at the date of acquisition. The following table
outlines acquisitions completed by Nortel Networks for the years ended
December 31, 2001 and 2000, for which it was possible for contingent
consideration to be earned during the years ended December 31, 2002 and 2001,
if the acquired businesses met the specific performance objectives.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Contingent considerationEarned toAcquisition
    
    Earned 2002
    
    
    Earned 2001
    
    
    Earned 2000
    
    
    date
    
    
    MaximumPhotonic (a)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5Qtera (a)
    
    
    
    
    
    
    
    
    
    
    300
    
    
    
    300
    
    
    
    500Dimension (b)
    
    
    
    
    
    
    13
    
    
    
    15
    
    
    
    28
    
    
    
    34
 (a)
    
    2001 contingent consideration was not earned and remaining contingent
consideration will not be paid.(b)
    
    Remaining contingent consideration is not payable due to the closure
of the Dimension business.


F-44



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##### Table of Contents





|11. |  | Long-term debt and credit facilities
|--- |  | ------------------------------------



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



| |  | At December 31, long-term debt consisted of:
| |  | --------------------------------------------



2002
    
    
    20016.875% Notes due and paid October 1, 2002
    
    $
    
    
    
    $
    3006.00% Notes due September 1, 2003
    
    
    164
    
    
    
    2006.125% Notes due February 15, 2006
    
    
    1,314
    
    
    
    1,5007.40%
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 4.60%
    
    
    95
    
    
    
    138Fair value adjustment attributable to hedged debt obligations
    
    
    80
    
    
    
    19Obligations under capital leases
    
    
    29
    
    
    
    20$
    2,182
    
    
    $
    2,677Less: Long-term debt due within one year
    
    
    233
    
    
    
    384Long-term debt
    
    $
    1,949
    
    
    $
    2,293
 (a)
    
    Notes were issued by Nortel Networks Capital Corporation, an indirect
wholly owned finance subsidiary of Nortel Networks, and are fully and
unconditionally guaranteed by Nortel Networks.


| |  | At December 31, 2002, the amounts of long-term debt payable for each of the
years ending December 31 consisted of:
| |  | ------------------------------------------------------------------------------------------------------------------



2003
    
    $
    2332004
    
    
    212005
    
    
    12006
    
    
    1,4672007
    
    
    1Thereafter
    
    
    459Total long-term debt payable
    
    $
    2,182


| |  | On February 8, 2001, Nortel Networks completed an offering of $1,500 of 6.125
percent notes due on February 15, 2006 (the 6.125 percent Notes). The
6.125 percent Notes pay interest on a semi-annual basis on February 15 and
August 15, which began on August 15, 2001. The 6.125 percent Notes are
redeemable, at any time at Nortel Networks 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 Networks paid $162, to
purchase a portion of its 6.00 percent notes due on September 1, 2003 and the
6.125 percent Notes with carrying values of $36 and $186, respectively. The
early extinguishment of debt resulted in a gain of $60 which is included in
the consolidated statement of operations within Other income (expense)  net.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | At December 31, 2002 and 2001, Nortel Networks had total unused committed
credit facilities of approximately $750 and $4,075, respectively. The $750
April 2000 five year syndicated credit facilities are generally available at
interest rates of LIBOR plus a spread, dependent on the amount drawn under
these credit facilities and, in certain cases, the senior long-term debt
ratings of Nortel Networks.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On December 13, 2002, the $1,510 December 2001 364-day syndicated credit
facilities of Nortel Networks and its subsidiary, Nortel Networks Inc.
(NNI), expired in accordance with their terms and Nortel Networks and NNI
agreed to terminate their $1,175 April 2002 364-day syndicated credit
facilities.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-45



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##### Table of Contents





| |  | On April 12, 2000, NNL and NNI entered into five-year syndicated credit
facilities, which permit borrowings in an aggregate amount of up to $750.
The credit facilities contain a financial covenant that requires the
maintenance of a consolidated tangible net worth of not less than $1,888 at
the consolidated NNL level. These credit facilities also benefit from a
security package over substantially all of NNLs assets and those of most of
its United States and Canadian subsidiaries and either a pledge of shares or
a guarantee by certain of NNLs other subsidiaries. The security was
effective on April 4, 2002 upon the downgrading of NNLs senior long-term
debt ratings to below investment grade, defined as either Baa3 or BBB-, as
determined by Moodys Investors Services, Inc. (Moodys) or Standard &
Poors Ratings Service (S&P), respectively. In addition, Nortel Networks
consolidated public debt securities, as well as Nortel Networks guarantee of
Nortel Networks Corporations 4.25 percent convertible senior notes due on
September 1, 2008, are also secured equally and ratably with the obligations
under Nortel Networks and NNIs $750 April 2000 five year syndicated credit
facilities (see note 22).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|12. |  | Financial instruments and hedging activities
|--- |  | --------------------------------------------



| |  | Risk management
| |  | ---------------



| |  | Nortel Networks 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 Networks enters into foreign
currency forwards, foreign currency swaps, foreign currency option contracts,
interest rate swaps, and equity forward contracts. Nortel Networks does not
hold or issue derivative financial instruments for trading purposes.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Foreign currency risk
| |  | ---------------------



| |  | Nortel Networks enters into option contracts to limit its exposure to
exchange fluctuations on future revenue or expenditure streams, 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. 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 not designated as
hedging instruments 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 notional amounts of option and
forward contracts as at December 31:
| |  | -----------------------------------------------------------------------------------------------------------------



Currency
    
    2002(a)
    
    
    2001Canadian dollar
    
    $
    972
    
    
    $
    1,873British pound
    
    
    8
    
    
    
    79Euro
    
    
    555
    
    
    
    124Other
    
    
    75
    
    
    
    64$
    1,610
    
    
    $
    2,140
 (a)
    
    Expected maturity dates for all notional amounts of option and
forward contracts as at December 31, 2002 is fiscal 2003.


| |  | Interest and dividend rate risk
| |  | -------------------------------



| |  | Nortel Networks enters into interest rate swap contracts to minimize
financing costs on long-term debt and to manage interest rate risk on
existing liabilities and receivables due to interest rate fluctuations.
These contracts swap floating interest rate payments to fixed interest rate
payments or vice versa. These contracts are designated as fair value hedges
only when they are used to swap fixed interest rates to floating interest
rates. These swap contracts have remaining terms to maturity between 9
months and 3.5 years. Nortel Networks from time to time enters into United
States to Canadian dollar cross currency coupon swap contracts, which are not
designated as hedging instruments, to limit its exposure to foreign currency
fluctuations on the cash dividends payable on the outstanding Non-cumulative
Redeemable Class A Preferred Shares Series 7 of Nortel Networks. These
contracts have remaining terms to maturity of 20 years.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-46



---



##### Table of Contents





| |  | The following table provides a summary of interest rate swap contracts and
cross currency coupon swap contracts and their aggregated weighted-average
rates as at December 31:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001Interest rate swap contracts:Received-fixed swaps  notional amount
    
    $
    975
    
    
    $
    375Average fixed rate received
    
    
    6.3
    %
    
    
    6.6
    %Average floating rate paid
    
    
    3.2
    %
    
    
    2.5
    %Cross currency coupon swap contracts:Received-fixed swaps  notional amount
    
    $
    
    
    
    $
    220Average fixed rate received
    
    
    
    
    
    
    4.9
    %Average floating rate paid
    
    
    
    
    
    
    3.2
    %Received-cross currency swaps  notional amount
    
    $
    224
    
    
    $
    Average float rate received (Canadian $)
    
    
    2.9
    %
    
    
    Average float rate paid (United States $)
    
    
    1.5
    %
    
    
    


| |  | During 2002, the terms of the cross currency coupon swap contracts changed
from fixed to floating, to floating to floating, in accordance with the
counterparty agreement. The notional amounts remained unchanged in the
amount of Canadian $350.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 reflects the present value of the potential
gain or loss if settlement had taken place on December 31, 2002; the fair
value of option contracts reflects the cash flows due to or by Nortel
Networks if settlement had taken place on December 31, 2002; and the fair
value of long-term debt instruments reflects a current yield valuation based
on observed market prices as of December 31, 2002. Accordingly, the fair
value estimates are not necessarily indicative of the amounts that Nortel
Networks could potentially realize in a current market exchange.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following table provides the carrying amounts and fair values for all
financial assets and liabilities for which fair value differed from carrying
amount, and fair values recorded for derivative financial instruments in
accordance with SFAS 133, as at December 31:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Carrying
    
    
    Fair
    
    
    Carrying
    
    
    Fairamount
    
    
    value
    
    
    amount
    
    
    valueFinancial liabilities:Long-term debt due within one year
    
    $
    233
    
    
    $
    225
    
    
    $
    384
    
    
    $
    388Long-term debt
    
    $
    1,949
    
    
    $
    1,195
    
    
    $
    2,293
    
    
    $
    2,032Derivative financial instruments net asset
(liability) position:Interest rate swap contracts
    
    $
    80
    
    
    $
    80
    
    
    $
    20
    
    
    $
    20Forward and option contracts
    
    $
    4
    
    
    $
    4
    
    
    $
    (38
    )
    
    $
    (38
    )Cross currency coupon swap contracts
    
    $
    1
    
    
    $
    1
    
    
    $
    (14
    )
    
    $
    (14
    )Other
    
    $
    
    
    
    $
    
    
    
    $
    3
    
    
    $
    3


F-47



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##### Table of Contents





| |  | Credit risk
| |  | -----------



| |  | Credit risk on financial instruments arises from the potential for
counterparties to default on their contractual obligations to Nortel
Networks. Nortel Networks is exposed to credit risk in the event of
non-performance, but does not anticipate non-performance by any of the
counterparties. Nortel Networks 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 accompanying consolidated financial statements. However, Nortel Networks
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 at December 31, 2002. Nortel Networks is also exposed to
credit risk from customers. However, Nortel Networks global orientation has
resulted in a large number of diverse customers, which minimizes
concentrations of credit risk.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other derivatives
| |  | -----------------



| |  | Nortel Networks may invest in warrants to purchase securities of other
companies as a strategic investment. 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 Networks may enter into certain commercial
contracts containing derivative financial instruments.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Hedge ineffectiveness and discontinuance of cash flow hedges determined in
accordance with SFAS 133 had no material impact on the net loss for the year
ended December 31, 2002. No fair value hedges were derecognized or
discontinued for the year ended December 31, 2002.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Receivables sales
| |  | -----------------



| |  | In 2002, 2001 and 2000, Nortel Networks entered into various agreements to
sell certain of its receivables. These receivables were sold at a discount
of $32, $53 and $41 from book value for the years ended December 31, 2002,
2001 and 2000 respectively, at annualized discount rates of approximately 3
percent to 5 percent, 5 percent to 8 percent and 3 percent to 5 percent for
the years ended December 31, 2002, 2001 and 2000, respectively. Certain
receivables have been sold with limited recourse, not exceeding 10 percent,
of $9, $6 and $36 as at December 31, 2002, 2001 and 2000, respectively.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Under certain agreements, Nortel Networks 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.
The amounts associated with any servicing assets approximate Nortel Networks
cost of servicing and, as such, no servicing asset or liability was
recognized. Also, Nortel Networks has not historically experienced
significant credit losses with respect to receivables sold with limited
recourse and as such no liability was recognized.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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, the discount rate used and the cost of servicing the
receivables, the pre-tax impact on the value of the retained interests would
not be significant.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|13. |  | Guarantees and commitments
|--- |  | --------------------------



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



| |  | Nortel Networks has entered into agreements that contain features which meet
the definition of a guarantee under FIN 45. FIN 45 defines a guarantee to be
a contract that contingently requires Nortel Networks to make payments
(either in cash, financial instruments, other assets, common shares of Nortel
Networks 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 other party. Nortel Networks has the following major types
of guarantees that are subject to the disclosure requirements of FIN 45:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (a) | Business sale agreements
| | --- | ------------------------



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



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



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



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



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



| |  | The nature of the intellectual property indemnification obligations
prevents Nortel Networks from making a reasonable estimate of the maximum
potential amount it could be required to pay to its customers and
suppliers. Historically, Nortel Networks has not made any significant
indemnification payments under such agreements and no amount has been
accrued in the accompanying consolidated financial statements with respect
to these indemnification guarantees.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks has entered into agreements with its lessors that
guarantee the lease payments of certain sub-lessees of its facilities to
lessors. Generally, these lease agreements relate to facilities Nortel
Networks vacated prior to the end of the term of its lease. These lease
agreements require Nortel Networks to make lease payments throughout the
lease term if the sub-lessee fails to make scheduled payments. These
lease agreements have expiration dates through June 2012. The maximum
amount that Nortel Networks may be required to pay under these types of
agreements is $45.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has also entered into an agreement to indemnify a certain
lessor against certain additional costs, including financing costs, and
costs incurred relating to construction problems with the building,
through the term of the lease, which expires in May 2013. The maximum
amount that Nortel Networks may be required to pay under this lease
agreement is $77.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In addition, Nortel Networks has entered into agreements to indemnify
certain lessors, through the terms of their leases, which expire through
May 2013, against costs incurred as a result of changes in laws and
regulations (including tax legislation) or in the interpretations of such
laws and regulations, as a result of losses from litigation that may be
suffered by them or, in the case of a particular lessor, if the
transaction becomes invalid. The maximum amount that Nortel Networks may
be required to pay that lessor in the event the transaction becomes
invalid is $77. The maximum potential losses resulting from the other
types of lease guarantees cannot be reasonably estimated.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

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



| |  | Nortel Networks has guaranteed the debt of certain customers. These third
party debt agreements require Nortel Networks to make debt payments
throughout the term of the related debt instrument if the customer fails
to make scheduled debt payments. These third party debt agreements have
expiration dates extending to May 2012. The maximum amount that Nortel
Networks may be required to pay under these types of debt agreements is
$13.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| | (e) | Guarantee of Nortel Networks Corporation debt
| | --- | ---------------------------------------------



| |  | Nortel Networks is the full and unconditional guarantor of Nortel Networks
Corporations $1,800 4.25 percent convertible senior notes due September
1, 2008, in the event that Nortel Networks Corporation does not make
payments for the principal, interest, premium, if any, and other amounts ,
if any, as they are due (see note 19).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The maximum amount that Nortel Networks may be required to pay under this
guarantee is $1,800, plus interest and premium outstanding. No amount has
been accrued in the accompanying consolidated statements with respect to
this guarantee.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | Indemnification of lenders and agents under credit facilities
| | --- | -------------------------------------------------------------



| |  | Under its credit facilities, Nortel Networks has agreed to indemnify its
lenders under such facilities against costs or losses resulting from
changes in laws and regulations which would increase the lenders costs,
and from any legal action brought against the lenders related to the use
of loan proceeds. These indemnifications generally extend for the term of
the credit facilities and do not provide for any limit on the maximum
potential liability.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| | (g) | Other indemnification agreements
| | --- | --------------------------------



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



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



| |  | The nature of such agreements prevents Nortel Networks from making a
reasonable estimate of the maximum potential amount it could be required
to pay to its counterparties. The difficulties in assessing the amount of
liability result primarily from the unpredictability of future changes in
laws, the inability to determine how laws (in particular tax legislation)
apply to counterparties and the unlimited coverage (in time and dollar
amount) offered to counterparties.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



| | (h) | Product warranties
| | --- | ------------------



| |  | As part of the normal sale of product, Nortel Networks has provided its
customers with product warranties. These warranties extend for periods
generally ranging from one to five years from the date of sale. The
following summarizes the accrual of product warranties that is recorded as
part of other accrued liabilities in the accompanying consolidated balance
sheets as at December 31, 2002:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Balance at the beginning of the year
    
    $
    269Payments made during the year
    
    
    (162
    )Warranties issued during the year
    
    
    146Balance at end of year
    
    $
    253




| |  | Bid and performance related bonds
| |  | ---------------------------------



| |  | Nortel Networks has entered into bid and performance related bonds associated
with various contracts. These contracts generally have terms ranging from
two to five years. Performance related bonds generally have a term of twelve
months. Bid bonds generally have a much shorter term. Potential payments
due under these bonds are related to Nortel Networks performance under the
applicable contract. The total amount of bid and performance related bonds
that were available and undrawn was $362, excluding restricted cash and cash
equivalents of $249 (see note 14), as at December 31, 2002 and $1,170 as at
December 31, 2001.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Pursuant to certain financing agreements, Nortel Networks is committed to
provide future financing in connection with purchases of Nortel Networks
products and services. The unfunded commitments were $801 and $1,611 as at
December 31, 2002 and 2001, respectively. Commitments to extend future
financing generally have conditions for funding, fixed expiration or
termination dates and specific interest rates and purposes. Nortel Networks
attempts to limit its financing credit risk by utilizing an internal credit
committee that actively monitors the credit exposure of Nortel Networks.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In addition, pursuant to these financing agreements, Nortel Networks has
provided financing of $292 (net of a provision of $799) and $447 (net of a
provision of $902), as at December 31, 2002 and 2001, respectively, excluding
discontinued operations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | On October 19, 2002, Nortel Networks entered into a number of put option and
call option agreements (the Options) as well as a share exchange agreement
(the Share Exchange) with its partner in three European joint ventures.
The Options allow the minority interest partner in each joint venture to sell
its interest in that joint venture to the other partner at a fixed amount.
The Share Exchange allows each partner to exchange a stipulated number of
shares in its minority interest for a stipulated number of shares in the
other partys minority interest. The Options and the Share Exchange can be
exercised between July 1, 2003 and December 31, 2003 subject to certain terms
and conditions.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | If the Options and the Share Exchange are exercised, Nortel Networks would be
required to deliver to the joint venture partner net consideration of
approximately $114, consisting of approximately $42 in cash, and an in-kind
component of approximately $72, representing the return of a loan note
currently owed to Nortel Networks by an affiliate of the joint venture
partner. If completed, the transactions would result in the acquisition by
Nortel Networks of two joint venture minority interests which would be
accounted for under the purchase method of accounting and the disposition of
its minority interest in the third joint venture. These transactions are not
expected to have a material impact on the business, results of operations,
and financial condition of Nortel Networks.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The written Options are required to be marked to fair value through the
consolidated statement of operations at each period end until they are either
exercised or expire. At December 31, 2002, Nortel Networks estimated the
fair value of the written Options to be approximately $78 (included in the
accompanying consolidated balance sheets within other accrued liabilities).
The impact to the consolidated statement of operations for the year ended
December 31, 2002 after the effect of indirectly related transactions was a
net loss of $49 (included within other income (expense)  net). The
purchased Options and the Share Exchange were initially recorded at fair
value and will be assessed for impairment throughout their term until they
are either exercised or expire.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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.
Accordingly, the fair value estimates are not necessarily indicative of the
amounts that Nortel Networks could potentially realize in current market
exchanges.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks 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 Networks may be required to acquire and pay for
such products up to the prescribed minimum or forecasted purchases.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks entered into an arrangement with a minimum purchase
commitment of $120 with Bookham. The terms of the commitment require Nortel
Networks to purchase $120 of product from Bookham between November 8, 2002
and March 31, 2004. Should there be a shortfall, Nortel Networks would make
a cash payment for a portion of the balance.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Operating leases and other commitments
| |  | --------------------------------------



| |  | At December 31, 2002, the future minimum payments under both operating leases
and outsourcing contracts, net of lease commitments accrued for as part of
restructuring contract settlement and lease costs (see note 7) consisted of:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Operating
    
    
    Outsourcingleases
    
    
    contracts2003
    
    $
    305
    
    
    $
    2912004
    
    
    220
    
    
    
    2732005
    
    
    195
    
    
    
    2702006
    
    
    144
    
    
    
    2682007
    
    
    117
    
    
    
    265Thereafter
    
    
    690
    
    
    
    263Total future minimum payments
    
    $
    1,671
    
    
    $
    1,630


| |  | Rental expense on operating leases for the years ended December 31, 2002,
2001 and 2000 amounted to $465, $748 and $676, respectively.
| |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  | During the year ended December 31, 2002, Nortel Networks entered into sale
leaseback transactions for certain of its properties with carrying values of
approximately $270 which resulted in a loss on disposal of $3.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents





| |  | Expenses related to outsourcing contracts for the years ended December 31,
2002, 2001 and 2000, amounted to $364, $498 and $176, respectively, and are
for services provided to Nortel Networks primarily related to information
services, a portion of payroll, capital services, accounts payable, and
training and resource functions. The minimum amount
payable under Nortel Networks outsourcing contracts is variable to the extent
that Nortel Networks workforce fluctuates from the baseline levels contained
in the contracts.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|14. |  | Restricted cash and cash equivalents
|--- |  | ------------------------------------



| |  | Due to the current general economic and industry environment, and Nortel
Networks current credit ratings, the basis under which customer bid and
performance related bonds and contracts can be obtained has changed,
resulting in (but not limited to) increased cash collateral requirements
and/or increased fees in connection with obtaining new customer bid and
performance related bonds and contracts. As at December 31, 2002,
approximately $249 of cash and cash equivalents was restricted as collateral
for certain customer bid and performance related bonds and contracts.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|15. |  | Capital stock
|--- |  | -------------



| |  | Preferred shares
| |  | ----------------



| |  | Nortel Networks 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 Class B preferred
shares, which rank junior to the Class A preferred shares upon a distribution
of capital or assets, in each case without nominal or par value. Each of the
Class A preferred shares and Class B preferred shares are issuable in one or
more series, each series having such rights, restrictions and provisions as
determined by the Board of Directors of Nortel Networks at the time of issue.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Class A preferred shares have been issued for consideration denominated in
Canadian dollars and are presented in United States 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. At December 31, 2002 and 2001, included in shareholders
equity were the following outstanding Class A preferred shares:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Numberof shares(thousands)
    
    
    $Series 5, issued November 26, 1996 for consideration of C$400
    
    
    16,000
    
    
    $
    294Series 7, issued November 28, 1997 for consideration of C$350
    
    
    14,000
    
    
    $
    242


| |  | In addition, at 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 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 issued approximately 4,090,000 common
shares to Nortel Networks Corporation.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

F-53



---



##### Table of Contents





| |  | December 1, 2001, at Nortel Networks 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 Networks 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, in
certain circumstances conversions may be automatic. Series 7 Shares are
redeemable at any time after December 1, 2002 at Nortel Networks option, at
Canadian $25.50 per share together with declared and unpaid dividends up to,
but extending, the date of redemption. If issued on December 1, 2007, Series
8 Shares will also be redeemable at Nortel Networks 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 is authorized to issue an unlimited number of common shares
without nominal or par value. At December 31, the outstanding number of
common shares included in shareholders equity consisted of:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Number
    
    
    
    
    
    
    Number
    
    
    
    
    
    
    Number(number of shares in thousands)
    
    of shares
    
    
    $
    
    
    of shares
    
    
    $
    
    
    of shares
    
    
    $Balance at beginning of year
    
    
    1,460,979
    
    
    $
    2,111
    
    
    
    1,453,438
    
    
    $
    17,024
    
    
    
    1,377,155
    
    
    $
    11,745Share issuance to parent (a)
    
    
    
    
    
    
    2,287
    
    
    
    
    
    
    
    1,800
    
    
    
    
    
    
    
    Conversion of series 4 preferred
shares (b)
    
    
    
    
    
    
    
    
    
    
    4,090
    
    
    
    61
    
    
    
    
    
    
    
    Reduction of legal stated
capital (c)
    
    
    
    
    
    
    (3,187
    )
    
    
    
    
    
    
    (16,800
    )
    
    
    
    
    
    
    Shareholder dividend reinvestment and
stock purchase plans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    1Stock option plans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,592
    
    
    
    377Acquisitions
    
    
    
    
    
    
    
    
    
    
    3,451
    
    
    
    26
    
    
    
    63,682
    
    
    
    4,901Balance at end of year
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    2,111
    
    
    
    1,453,438
    
    
    $
    17,024
 (a)
    
    During the year ended December 31, 2002, Nortel Networks issued 4
common shares to Nortel Networks Corporation for cash consideration of
$2,287. Nortel Networks Corporation, as the holder of all Nortel
Networks issued and outstanding common shares, approved a reduction in
Nortel Networks legal stated capital of $3,187. On August 15, 2001,
Nortel Networks Corporation completed a private offering of $1,800 of
4.25 percent convertible senior notes and loaned the full proceeds to
Nortel Networks for its general corporate purposes. On September 30,
2001, in accordance with the terms of the loan agreement between Nortel
Networks Corporation and Nortel Networks Limited. Nortel Networks
Corporation converted the entire loan into 1 common share of Nortel
Networks.(b)
    
    During the year ended December 31, 2001, the holders of all 200
Series 4 Shares of Nortel Networks exercised their right to exchange
their Series 4 Shares for common shares of Nortel Networks Corporation.
As a result, Nortel Networks issued approximately 4,090,000 common
shares to Nortel Networks Corporation.(c)
    
    On December 19, 2002, September 27, 2002, August 29, 2002 and June
28, 2002, Nortel Networks Corporation approved a reduction in Nortel
Networks legal stated capital for its common shares in the amount of
$1,190, $672, $525 and $800, respectively. On September 30, 2001 and
June 14, 2001, Nortel Networks Corporation approved a reduction in
Nortel Networks legal stated capital for its common shares in the amount
of $1,800 and $15,000, respectively.


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|16. |  | Accumulated other comprehensive loss
|--- |  | ------------------------------------



| |  | The components of accumulated other comprehensive loss, net of tax, were as
follows:
| |  | ------------------------------------------------------------------------------------

2002
    
    
    2001
    
    
    2000Accumulated foreign currency translation adjustmentBalance at the beginning of the year
    
    $
    (799
    )
    
    $
    (556
    )
    
    $
    (457
    )Adjustment
as of January 1, 2000 due to restatement
    
    
    
    
    
    
    
    
    
    
    29Change in foreign currency translation adjustment (a)
    
    
    99
    
    
    
    (243
    )
    
    
    (128
    )Balance at the end of the year
    
    $
    (700
    )
    
    $
    (799
    )
    
    $
    (556
    )Unrealized gain (loss) on investments  netBalance at the beginning of the year
    
    $
    5
    
    
    $
    45
    
    
    $
    23Change in unrealized gain (loss) on investments
    
    
    19
    
    
    
    (40
    )
    
    
    22Balance at the end of the year (b)
    
    $
    24
    
    
    $
    5
    
    
    $
    45Unrealized derivative gain (loss) on cash flow hedges  netBalance at the beginning of the year
    
    $
    (14
    )
    
    $
    
    
    
    $
    Change in unrealized derivative gain (loss) on cash flow hedges (c)
    
    
    12
    
    
    
    (14
    )
    
    
    Balance at the end of the year
    
    $
    (2
    )
    
    $
    (14
    )
    
    $
    Minimum pension liability (d)Balance at the beginning of the year
    
    $
    (81
    )
    
    $
    
    
    
    $
    Change in minimum pension liability
    
    
    (559
    )
    
    
    (81
    )
    
    
    Balance at the end of the year
    
    $
    (640
    )
    
    $
    (81
    )
    
    $
    Accumulated other comprehensive loss
    
    $
    (1,318
    )
    
    $
    (889
    )
    
    $
    (511
    )


(a)
    
    The changes in the foreign currency translation adjustments are not
adjusted for income taxes since they relate to indefinite investments in
non-United States subsidiaries.(b)
    
    Unrealized gain on investments is net of tax of $2, $3 and $9 for the
years ended December 31, 2002, 2001 and 2000, respectively.(c)
    
    Includes $7 (pre-tax $11) of net derivative losses related to the
adoption of SFAS 133 during the year ending December 31, 2001.
Unrealized derivative gains (loss) on cash flow hedges are net of tax of
$1 and $6 for the years ended December 31, 2002 and 2001, respectively.
During the year ended December 31, 2002, $18 of net derivative gains
were reclassified to selling, general and administrative expense.
Nortel Networks estimates that $4 of net derivative losses included in
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 Networks pension plans (see note 9). The minimum pension
liability amount is presented net of tax of $133 and $28 for the years
ended December 31, 2002 and 2001, respectively.




| |  | The change in unrealized gain (loss) on investments during the year 2001
represented the write down of the value of minority investments due to a
change in Nortel Networks strategic focus as well as an other than temporary
decline in the carrying value caused by a significant downturn in both the
telecommunications industry and the economic environment, resulting in a
charge to other income (expense)  net. During 2002, $6 of unrealized gains
(losses) on investments were reclassified to the statement of operations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|17. |  | Stock-based compensation plans
|--- |  | ------------------------------



| |  | Stock options
| |  | -------------



| |  | Under the Nortel Networks Corporation 2000 Stock Option Plan (the 2000
Plan), options to purchase Nortel Networks Corporation common shares may be
granted to employees and directors of Nortel Networks that entitle the holder
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 United States dollars for United States
options and in Canadian dollars for Canadian options. Generally, options
outstanding at December 31, 2002, vest 33 1/3 percent on the anniversary date
of the grant for three years. The committee of the Board of Directors of
Nortel Networks that administers the 2000 Plan 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.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Under the Nortel Networks Corporation 1986 Stock Option Plan As Amended and
Restated (the 1986 Plan), options to purchase Nortel Networks Corporation
common shares may be granted to employees of Nortel Networks that entitle the
holder 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 in United States dollars for United States options and in
Canadian dollars for Canadian options. Generally, options may be exercised
as follows: options granted in 1997 through 2002 vest 33 1/3
percent on the anniversary date of the grant for three years; and options
granted in 1991 through 1996 vest 50 percent after the first anniversary date
of grant and the remainder after the second anniversary date of grant. The
committee of the Board of Directors of Nortel Networks that administers the
1986 Plan 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 stock appreciation right (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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In January 1995, a key contributor stock option program (the Key Contributor
Program) was established. Under the terms of the Key Contributor Program,
participants are granted an equal number of initial options and replacement
options. The initial options generally vest after five years and expire
after ten years. The replacement options are granted concurrently with the
initial options and also expire after ten years. The replacement options
generally have an exercise price equal to the market value of the common
shares of Nortel Networks Corporation on the day the initial options are
fully exercised, and are generally exercisable commencing thirty-six months
thereafter, provided certain other conditions for exercise, including share
ownership, are met. In 2002 and 2001, there were no options granted pursuant
to the Key Contributor Program.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On June 20, 2001, Nortel Networks commenced a voluntary stock option exchange
program (the Exchange Program) for Nortel Networks employees, whereby
employees could exchange certain then outstanding stock options for new stock
options, based on a prescribed formula. The terms of the Exchange Program
were such that 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. Approximately 93,416,000 stock options were tendered for
exchange and cancelled. Nortel Networks then Board of Directors and its then
board appointed officers were not eligible to participate in the Exchange
Program. On January 29, 2002, Nortel Networks Corporation granted
approximately 52,700,000 new stock options in connection with the Exchange
Program with exercise prices of $7.16 in United States dollars and $11.39 in
Canadian dollars per common share, which was the fair market value of Nortel
Networks Corporation common shares on the date of the grant.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has, in connection with the acquisition of various companies,
assumed the stock option plans of each acquired company. The vesting periods
for these assumed plans may differ from the 2000 Plan and 1986 Plan, but are
not considered to be significant to Nortel Networks overall use of
stock-based compensation.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As of July 1, 2000, Nortel Networks began recording deferred compensation
related to unvested options held by employees of companies acquired in a
purchase acquisition, in accordance with FIN 44 Accounting for Certain
Transactions involving Stock Compensation  an Interpretation of APB No.25
(FIN 44). Deferred compensation is amortized based on the graded vesting
schedule of the awards. For the years ended December 31, 2002, 2001, and
2000, Nortel Networks recorded stock option compensation expense of nil, nil
and $99, respectively. The expense for 2000 primarily related to the impact
of the Arrangement on stock options held by former employees of Nortel
Networks who had transferred to BCE or a BCE affiliated company as a result
of the Arrangement.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Employee stock purchase plans
| |  | -----------------------------



| |  | Nortel Networks has a stock purchase plan for eligible employees in eligible
countries and a stock purchase plan for eligible unionized employees in
Canada (the Employee Stock Purchase Plans). The Employee Stock Purchase
Plans facilitate the acquisition of common shares of Nortel Networks
Corporation at a discount, and the retention of such common shares, by
eligible employees. The Employee Stock Purchase Plans have four offering
periods each year, with each offering period beginning on the first day of
each calendar quarter. Eligible employees may have up to 10 percent of their
eligible compensation deducted from their pay during each offering period to
contribute towards the purchase of
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Nortel Networks Corporation common shares. For North American eligible employees, common shares are purchased at a
purchase price of 85 percent of the market price of the common shares on the
last trading day of the offering period. Nortel Networks contributes an
amount equal to the difference between the market price and the purchase
price. For non-North American eligible employees common shares are 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, except that if the market price on the last trading
day is equal to or less than the average of the high and low on the first
trading day, the purchase price shall be 85 percent of the market price on
the last trading day of the offering period.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|18. |  | Discontinued operations
|--- |  | -----------------------



| |  | During the year ended December 31, 2002, Nortel Networks continued to wind
down its access solutions operations and there has been no change to the
initial disposal strategy or intent to exit the business which was approved
by the Board of Directors on June 14, 2001. However, the continued
deterioration in industry and market conditions has delayed certain disposal
activities beyond the original planned timeframe of one year. In particular,
actions involving negotiations with customers, who have also been affected by
industry conditions, are taking longer than expected. Although disposal
activities continue beyond the one-year period generally contemplated under
APB 30, Nortel Networks continues to present the access solutions operations as discontinued operations in the
accompanying consolidated financial statements. Nortel Networks has disposed
of or transitioned the ownership of certain operations, and operations not
disposed of or so transitioned are expected to be closed. Nortel Networks
now expects to complete this plan by mid 2003, subject to the closing of
specific transactions, the timing of which may continue to be impacted by
customer and business issues and any applicable regulatory requirements.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Pursuant to APB 30, the revenues, costs and expenses, assets and liabilities
and cash flows of Nortel Networks access solutions operations have been
segregated in the accompanying consolidated statements of operations,
consolidated balance sheets and consolidated statements of cash flows, and
are reported as discontinued operations. The following consolidated
financial results for discontinued operations are presented as at December 31
for the consolidated balance sheets and for the period ended December 31 for
the consolidated statements of operations and consolidated statements of cash
flows:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

2002
    
    
    2001
    
    
    2000Revenues
    
    $
    141
    
    
    $
    994
    
    
    $
    2,324Net earnings (loss) from discontinued operations  net of tax (a)
    
    $
    21
    
    
    $
    (340
    )
    
    $
    (414
    )Net loss on disposal of operations  net of tax (b)
    
    
    
    
    
    
    (2,184
    )
    
    
    Net earnings (loss) from discontinued operations  net of tax
    
    $
    21
    
    
    $
    (2,524
    )
    
    $
    (414
    )


(a)
    
    Net earnings (loss) from discontinued operations was net of
applicable income tax benefits of nil, $122, and $96 for the years ended
December 31, 2002, 2001 and 2000, respectively.(b)
    
    Net loss on disposal of operations was net of an applicable income
tax benefit of $596 for the year ended December 31, 2001.


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

2002
    
    
    2001Accounts receivable  net
    
    $
    20
    
    
    $
    110Inventories  net
    
    
    
    
    
    
    66Deferred income taxes
    
    
    146
    
    
    
    348Other current assets
    
    
    45
    
    
    
    175Total current assets of discontinued operations
    
    
    211
    
    
    
    699Intangible assets  net
    
    
    
    
    
    
    17Other long-term assets (a)
    
    
    48
    
    
    
    252Total assets of discontinued operations
    
    $
    259
    
    
    $
    968Current liabilities (a)
    
    $
    44
    
    
    $
    385Long-term liabilities (a)
    
    
    2
    
    
    
    10Total liabilities of discontinued operations
    
    $
    46
    
    
    $
    395


(a)
    
    Other long-term assets, current liabilities and long-term liabilities of
discontinued operations are included in other assets, other accrued liabilities
and other liabilities, respectively, of Nortel Networks consolidated balance
sheets.




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

2002
    
    
    2001
    
    
    2000Cash flows from (used in) discontinued operationsOperating activities
    
    $
    275
    
    
    $
    (706
    )
    
    $
    (701
    )Investing activities
    
    
    100
    
    
    
    57
    
    
    
    (356
    )Net cash from (used in) discontinued operations
    
    $
    375
    
    
    $
    (649
    )
    
    $
    (1,057
    )




| |  | 2002 Activity
| |  | -------------



| |  | During the three months ended June 30, 2002, Arris Group Inc. (Arris Group)
completed a secondary public offering of 15 million common shares held by
Nortel Networks. Following the closing of the offering on June 25, 2002,
Nortel Networks 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 $15 was recorded as a result of this transaction, which is
included in the estimated remaining provisions required for discontinued
operations. During the three months ended March 31, 2002, Nortel Networks
recorded a gain of approximately $13 due to the reduction of Nortel Networks
ownership interest in Arris Group, received for Nortel Networks original
interest in Arris Interactive LLC (Arris), 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, which is
included in the estimated remaining provisions required for discontinued
operations.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On April 21, 2002, Nortel Networks entered into an agreement with Aastra
Technologies Limited to sell certain assets, which were included in
discontinued operations, associated with Nortel Networks 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 Networks
recorded a loss of approximately $43 on the transaction, which reduced the
estimated remaining provisions for discontinued operations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On March 5, 2002, Nortel Networks divested its approximately 46 percent
ownership interest in Elastic Networks Inc. (Elastic Networks) to Paradyne
Networks, Inc. (Paradyne) in exchange for an approximately 8 percent
ownership interest in Paradyne. Nortel Networks recorded a gain of
approximately $7 on the transaction, which is included in the estimated
remaining provisions required for discontinued operations.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | At December 31, 2002, Nortel Networks has customer financing receivables of
$66 (net of provision of $507) for customers included as part of discontinued
operations.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | At December 31, 2002, the remaining accruals of $44 related to the future
contractual obligations and estimated liabilities, and estimated operating
losses during the planned period of disposition, were included in current
liabilities of discontinued operations. The remaining accruals are expected
to be substantially drawn down by cash payments over the period of
disposition, the impact of which is expected to be partially offset by
proceeds from the disposal of certain remaining assets.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 2001 Activity
| |  | -------------



| |  | On June 14, 2001, Nortel Networks Board of Directors approved a plan to
discontinue Nortel Networks access solutions operations consisting of all of
Nortel Networks narrowband and broadband solutions, including copper, cable,
and fixed wireless solutions, as well as Nortel Networks then consolidated
membership interest in Arris and equity investment in Elastic Networks. Also
affected by the decision were Nortel Networks prior acquisitions of Promatory
Communications, Inc. (Promatory), Aptis Communications, Inc. (Aptis) and
Broadband Networks Inc.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In connection with the decision to discontinue the access solutions
operations on June 14, 2001, Nortel Networks recorded a pre-tax loss on
disposal of the access solutions operations of $2,780 in the three months
ended June 30, 2001, which reflected the estimated costs directly associated
with Nortel Networks plan of disposition. The loss reflected: the
write-off of goodwill associated with the acquisitions of Promatory in the
amount of $417; provisions for both short-term and long-term receivables of
$600; a provision for inventories of $381; other asset write-offs totaling
$151; future contractual obligations and estimated liabilities of $1,059; and
estimated operating losses during the planned period of disposition of $172.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On August 24, 2001, Nortel Networks completed a transaction with Zhone
Technologies, Inc. to sell the AccessNode ABM and CDS shelf products and the
Universal Edge 9000 digital loop carrier shelf and remote access shelf
products.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On August 3, 2001, Nortel Networks completed the transfer of its ownership
interest in Arris to Arris Group. As a result, at December 31, 2001, Nortel
Networks owned a 49.2 percent non-controlling interest in Arris Group,
compared to the previous 81.25 percent controlling interest in Arris.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On July 25, 2001, Nortel Networks completed a transaction with GE Industrial
Systems Technology Management Inc., a division of General Electric Company,
to sell the Lentronics JungleMUX SONET multiplexer and TN-1U SDH multiplexer
products.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | At December 31, 2001, the remaining accruals of $329 related to the above
noted future contractual obligations and estimated liabilities, and estimated
operating losses during the planned period of disposition were included in
current liabilities of discontinued operations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|19. |  | Related party transactions
|--- |  | --------------------------



| |  | In the ordinary course of business, Nortel Networks engages in transactions
with certain of its equity-owned investees that are under or are subject to
Nortel Networks significant influence and with joint ventures of Nortel
Networks Corporation and with Nortel Networks Corporation and directly owned
subsidiaries of Nortel Networks Corporation. 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:
| |  | --------------------------------------------------------------------------------------------

2002
    
    
    2001
    
    
    2000Income StatementRevenues
    
    $
    15
    
    
    $
    7
    
    
    $
    673Purchases
    
    $
    52
    
    
    $
    76
    
    
    $
    369Research and development expense
    
    $
    19
    
    
    $
    141
    
    
    $
    52Retained earnings (deficit)Stock option fair value increment
    
    $
    525
    
    
    $
    
    
    
    $
    Balance SheetTrade and other payablesOwing to Nortel Networks Corporation
    
    $
    (47
    )
    
    $
    (164
    )
    
    $
    (131
    )Owing from (to) Nortel Networks Corporation subsidiaries
    
    $
    99
    
    
    $
    (116
    )
    
    $
    (252
    )




| |  | On August 29, 2002, a payment was made by a subsidiary of Nortel Networks to
Nortel Networks Corporation 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 Nortel Networks Corporation stock
options held and exercised by employees of the subsidiary. This payment is
referred to as stock option fair value increment in the accompanying
consolidated statement of shareholders equity and consolidated statement of
cash flows.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In 2001, Nortel Networks completed the sale of substantially all of the
assets in the Cogent Defence Systems business (CDS) to EADS Defence &
Security Networks S.A.S. (EDSN). At that time, Nortel Networks held a 41
percent ownership interest in EDSN and European Aeronautics, Defense and
Space Company (EADS) held the remaining 59 percent. Under the terms of the
agreement, Nortel Networks sold substantially all of its assets in the CDS
business including: fixed assets; accounts receivable; inventory;
intellectual property; and licenses, and 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 Nortel Networks France S.A.S. beginning in
2004. Nortel Networks recorded a gain on the sale of approximately $37,
included in gain on sale of business, and a deferred gain of $26, which is
amortized into gain on sale of business over the life of the assets sold to
EDSN. During the year ended December 31, 2002, Nortel Networks collected the
loan note in the amount of approximately $119. In addition,
the call option was terminated and replaced by a subsequent agreement to
satisfy the remaining consideration owing during 2003. Nortel Networks recognized a gain of $16 on sale of
business during the year ended December 31, 2002, related to the amortization of previously deferred gains and an
additional gain on the cancellation and replacement of the call option.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On August 15, 2001, Nortel Networks Corporation completed a private offering
of $1,800 of 4.25 percent convertible senior notes (the Senior Notes), due
on September 1, 2008. Nortel Networks, as the guarantor of the Senior Notes,
will make payment of the principal, or interest, or premium, if any, or other
amounts, if any, should Nortel Networks Corporation not make such payments as they are due. The guarantee of the
Senior Notes is a direct, unconditional and unsubordinated obligation of
Nortel Networks. Nortel Networks Corporation loaned the full proceeds from
the offering to Nortel Networks for its general corporate purposes. On
September 30, 2001, Nortel Networks Corporation converted the entire loan
into one common share of Nortel Networks (see note 15).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Effective May 1, 2000, in conjunction with the Arrangement, BCEs ownership
interest in Nortel Networks was reduced from approximately 36 percent to a
nominal amount. As a result, BCE and entities that are owned by BCE were no
longer considered related parties immediately after the Arrangement.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|20. |  | Contingencies
|--- |  | -------------



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



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



| |  | On July 17, 2002, a new purported class action lawsuit (the Ontario Claim)
was filed in the Ontario Superior Court of Justice, Commercial List, naming
Nortel Networks Corporation, certain of its current and former officers and
directors, and its auditor as defendants. The factual allegations in the
Ontario Claim are substantially similar to the allegations in the
consolidated amended complaint filed in the United States District Court
described above. The Ontario Claim is on behalf of all Canadian residents
who purchased Nortel Networks 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 April 1, 2002, Nortel Networks Corporation filed a motion to dismiss both
the above consolidated United States shareholder class action and the above
JDS shareholder class action complaints on the grounds that they failed to
state a cause of action under United States federal securities laws. With
respect to the JDS shareholder class action complaint, Nortel Networks
Corporation also moved to dismiss on the separate basis that JDS shareholders
lacked standing to sue Nortel Networks Corporation. On January 3, 2003, the
District Court granted the motion to dismiss the JDS shareholder class action
complaint and denied the motion to dismiss the consolidated United States
class action complaint.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A purported class action lawsuit was filed in the United States District
Court for the Middle District of Tennessee on December 21, 2001, on behalf of
participants and beneficiaries of the Nortel Networks Long-Term Investment
Plan (the Plan) at any time during the period of March 7, 2000 through the filing
date and who made or maintained Plan investments in Nortel Networks
Corporation common shares, under the Employee Retirement Income Security Act
for Plan-wide relief and alleging, among other things, material
misrepresentations and omissions to induce Plan participants to continue to
invest in and maintain investments in Nortel Networks 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 for
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
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents





| |  | 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 of
March 7, 2000 through December 21, 2000. On September 24, 2002, plaintiffs
in the consolidated action filed a motion to consolidate all the actions and
to transfer them to the United States District Court for the Southern
District of New York. The Plaintiff 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.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | On March 4, 1997, Bay Networks, Inc. (Bay Networks), a company acquired on
August 31, 1998, announced that shareholders had filed two separate lawsuits
in the United States District Court for the Northern District of California
(the Federal Court) and the California Superior Court, County of Santa
Clara (the California Court), against Bay Networks and ten of Bay Networks
then current and former officers and directors purportedly on behalf of a
class of shareholders who purchased Bay Networks common shares during the
period of May 1, 1995 through October 14, 1996. On August 17, 2000, the
Federal Court granted the defendants motion to dismiss the federal
complaint. On August 1, 2001, the United States Court of Appeals for the
Ninth Circuit denied the plaintiffs appeal of that decision. On April 18,
1997, a second lawsuit was filed in the California Court, purportedly on
behalf of a class of shareholders who acquired Bay Networks common shares
pursuant to the registration statement and prospectus that became effective
on November 15, 1995. The two actions in the California Court were
consolidated in April 1998; however, the California Court denied the
plaintiffs motion for class certification. In January 2000, the California
Court of Appeal rejected the plaintiffs appeal of the decision. A petition
for review was filed with the California Supreme Court by the plaintiffs and
was denied. In February 2000, new plaintiffs who allege to have been
shareholders of Bay Networks during the relevant periods, filed a motion for
intervention in the California Court seeking to become the representatives of
a class of shareholders. The motion was granted on June 8, 2001 and the new
plaintiffs filed their complaint-in-intervention on an individual and
purported class representative basis alleging misrepresentations made in
connection with the purchase and sale of securities of Bay Networks in violation of California statutory and
common law. On March 11, 2002, the California Court granted the defendants
motion to strike the class allegations. The plaintiffs were permitted to
proceed on their individual claims. The intervenor-plaintiffs are appealing
the dismissal of their class allegations.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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

F-62



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| |  | Environmental matters
| |  | ---------------------



| |  | Nortel Networks manufacturing and research operations are subject to a wide
range of environmental protection laws in various jurisdictions around the
world. Nortel Networks seeks to operate its business in compliance with such
laws, and has a corporate environmental management system standard to promote
such compliance. Moreover, Nortel Networks has a periodic, risk-based,
integrated environment, health and safety audit program.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks environmental program focuses its activities on design for
the environment, supply chain and packaging reduction issues. Nortel
Networks works with its suppliers and other external groups to encourage the
sharing of non-proprietary information on environmental research.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is exposed to liabilities and compliance costs arising from
its past and current generation, management and disposal of hazardous
substances and wastes. At December 31, 2002, the accruals on the
accompanying consolidated balance sheets for environmental matters were $30.
Based on information available as at December 31, 2002, 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 and financial condition of
Nortel Networks.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has remedial activities under way at 12 sites which are
either currently or previously owned or occupied facilities. An estimate of
Nortel Networks 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 $29.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is also listed as a potentially responsible party (PRP)
under the United States Comprehensive Environmental Response, Compensation
and Liability Act (CERCLA) at five Superfund sites in the United States.
An estimate of Nortel Networks 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 $30 referred to above.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Liability under CERCLA may be imposed on a joint and several basis, without
regard to the extent of Nortel Networks involvement. In addition, the
accuracy of Nortel Networks 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 Networks
liability could be greater than its current estimate.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|21. |  | Subsequent events
|--- |  | -----------------



| |  | On February 14, 2003, Nortel Networks announced that it entered into an
agreement with Export Development Canada (EDC) regarding arrangements to
provide for support, on a secured basis, of certain Nortel Networks
obligations arising out of normal course business activities, including
letters of credit, letters of guarantee, indemnity arrangements, performance
bonds, surety bonds, receivables sales, securitizations and similar
instruments issued or entered into for the benefit of Nortel Networks (the
EDC Support Facility).
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The EDC Support Facility provides for up to $750 in support and is comprised
of (i) up to $300 of committed support for performance bonds or similar
instruments (within certain parameters); (ii) up to $150 of uncommitted
support for receivables sales and/or securitizations; and (iii) up to $300 of
additional uncommitted support for performance bonds and receivable sales
and/or securitizations.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks obligations under the EDC Support Facility are secured on an
equal basis under the existing security agreements entered into by Nortel
Networks and various of its subsidiaries that pledge substantially all of the
assets of Nortel Networks in favor of the lenders under Nortel Networks and
NNIs $750 April 2000 five year syndicated credit facilities and the holders
of Nortel Networks Corporations and Nortel Networks public debt (see note
22).
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-63



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##### Table of Contents





|22. |  | Supplemental consolidating financial information
|--- |  | ------------------------------------------------



| |  | As a result of Nortel Networks current credit ratings, various liens,
pledges, and guarantees are effective under certain credit and security
agreements entered into by Nortel Networks and various of its subsidiaries
and will remain effective, notwithstanding the expiration of the $1,510
December 2001 364-day syndicated credit facilities. In addition, in
accordance with the covenants in the trust indentures for all Nortel Networks
current consolidated public debt securities, which represent primarily all of
Nortel Networks consolidated long-term debt at December 31, 2002, all such
public debt securities are also secured equally and ratably with the
obligations under Nortel Networks and NNIs credit facilities by liens on
substantially all of the assets of Nortel Networks and those of most of its
United States and Canadian subsidiaries and by pledges of shares in certain
of Nortel Networks other subsidiaries. In addition, certain of Nortel
Networks wholly owned subsidiaries have guaranteed Nortel Networks
obligations under the credit facilities and outstanding public debt
securities (the Guarantor Subsidiaries). Non-guarantor subsidiaries (the
Non-Guarantor Subsidiaries) represent either wholly owned subsidiaries of
Nortel Networks whose shares have been pledged, or are the remaining
subsidiaries of Nortel Networks which are not providing liens, pledges or
guarantees. Nortel Networks obligations under the EDC Support Facility are
also secured on an equal basis under the security agreements (see note 21).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The liens, pledges, and guarantees described above also apply equally and
ratably to Nortel Networks guarantee of the obligations under Nortel Networks
Corporations Senior Notes.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | The following supplemental consolidating financial data illustrates, in
separate columns, the composition of Nortel Networks, the Guarantor
Subsidiaries, the Non-Guarantor Subsidiaries, eliminations and the
consolidated total as at, and for the years ending, December 31, 2002, 2001
and 2000.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

F-64



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##### Table of Contents





| |  | Supplemental Consolidating Statement of Operations for the year ended December
31, 2002:
| |  | ----------------------------------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    3,043
    
    
    $
    7,867
    
    
    $
    2,858
    
    
    $
    (3,214
    )
    
    $
    10,554Cost of revenues
    
    
    2,650
    
    
    
    5,146
    
    
    
    2,408
    
    
    
    (3,214
    )
    
    
    6,990Gross profit
    
    
    393
    
    
    
    2,721
    
    
    
    450
    
    
    
    
    
    
    
    3,564Selling, general and administrative expense
(excluding stock option compensation)
    
    
    565
    
    
    
    1,811
    
    
    
    245
    
    
    
    
    
    
    
    2,621Research and development expense
    
    
    903
    
    
    
    1,002
    
    
    
    300
    
    
    
    
    
    
    
    2,205Amortization of intangiblesAcquired technology
    
    
    
    
    
    
    20
    
    
    
    (1
    )
    
    
    
    
    
    
    19Special chargesGoodwill impairment
    
    
    
    
    
    
    203
    
    
    
    61
    
    
    
    
    
    
    
    264Other special charges
    
    
    340
    
    
    
    893
    
    
    
    202
    
    
    
    
    
    
    
    1,435Gain on sale of businesses
    
    
    (2
    )
    
    
    (22
    )
    
    
    (15
    )
    
    
    
    
    
    
    (39
    )Operating loss
    
    
    (1,413
    )
    
    
    (1,186
    )
    
    
    (342
    )
    
    
    
    
    
    
    (2,941
    )Equity in net loss of associated companies
    
    
    (1,367
    )
    
    
    (771
    )
    
    
    (11
    )
    
    
    2,131
    
    
    
    (18
    )Other income (expense)  net
    
    
    (13
    )
    
    
    56
    
    
    
    (77
    )
    
    
    
    
    
    
    (34
    )Interest expenseLong-term debt
    
    
    (103
    )
    
    
    
    
    
    
    (27
    )
    
    
    
    
    
    
    (130
    )Other
    
    
    
    
    
    
    (25
    )
    
    
    (19
    )
    
    
    
    
    
    
    (44
    )Earnings (loss) from continuing operations before income taxes
    
    
    (2,896
    )
    
    
    (1,927
    )
    
    
    (475
    )
    
    
    2,131
    
    
    
    (3,167
    )Income tax benefit (provision)
    
    
    151
    
    
    
    121
    
    
    
    150
    
    
    
    
    
    
    
    422Net loss from continuing operations
    
    
    (2,745
    )
    
    
    (1,806
    )
    
    
    (325
    )
    
    
    2,131
    
    
    
    (2,745
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    21
    
    
    
    14
    
    
    
    
    
    
    
    (14
    )
    
    
    21Net loss
    
    
    (2,724
    )
    
    
    (1,792
    )
    
    
    (325
    )
    
    
    2,117
    
    
    
    (2,724
    )Dividends on preferred shares
    
    
    22
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22Net loss applicable to common shares
    
    $
    (2,746
    )
    
    $
    (1,792
    )
    
    $
    (325
    )
    
    $
    2,117
    
    
    $
    (2,746
    )


F-65



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##### Table of Contents





| |  | Supplemental Consolidating Statement of Operations for the year ended December
31, 2001:
| |  | ----------------------------------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    5,069
    
    
    $
    12,716
    
    
    $
    4,813
    
    
    $
    (5,326
    )
    
    $
    17,272Cost of revenues
    
    
    4,595
    
    
    
    10,575
    
    
    
    4,245
    
    
    
    (5,326
    )
    
    
    14,089Gross profit
    
    
    474
    
    
    
    2,141
    
    
    
    568
    
    
    
    
    
    
    
    3,183Selling, general and administrative expense
(excluding stock option compensation)
    
    
    778
    
    
    
    4,103
    
    
    
    831
    
    
    
    
    
    
    
    5,712Research and development expense
    
    
    1,151
    
    
    
    1,651
    
    
    
    406
    
    
    
    
    
    
    
    3,208Amortization of intangiblesAcquired technology
    
    
    
    
    
    
    574
    
    
    
    
    
    
    
    
    
    
    
    574Goodwill
    
    
    22
    
    
    
    1,561
    
    
    
    497
    
    
    
    
    
    
    
    2,080Special chargesGoodwill impairment
    
    
    
    
    
    
    1,256
    
    
    
    983
    
    
    
    
    
    
    
    2,239Other special charges
    
    
    548
    
    
    
    1,759
    
    
    
    782
    
    
    
    
    
    
    
    3,089Gain on sale of businesses
    
    
    (10
    )
    
    
    (109
    )
    
    
    (7
    )
    
    
    
    
    
    
    (126
    )Operating loss
    
    
    (2,015
    )
    
    
    (8,654
    )
    
    
    (2,924
    )
    
    
    
    
    
    
    (13,593
    )Equity in net loss of associated companies
    
    
    (11,500
    )
    
    
    (4,861
    )
    
    
    2
    
    
    
    16,209
    
    
    
    (150
    )Other income (expense)  net
    
    
    435
    
    
    
    (361
    )
    
    
    (61
    )
    
    
    (380
    )
    
    
    (367
    )Interest expenseLong-term debt
    
    
    (144
    )
    
    
    3
    
    
    
    (32
    )
    
    
    
    
    
    
    (173
    )Other
    
    
    (34
    )
    
    
    (71
    )
    
    
    (15
    )
    
    
    
    
    
    
    (120
    )(Loss) earnings from continuing operations before income taxes
    
    
    (13,258
    )
    
    
    (13,944
    )
    
    
    (3,030
    )
    
    
    15,829
    
    
    
    (14,403
    )Income
tax benefit (provision)
    
    
    1,828
    
    
    
    661
    
    
    
    484
    
    
    
    
    
    
    
    2,973Net loss from continuing operations
    
    
    (11,430
    )
    
    
    (13,283
    )
    
    
    (2,546
    )
    
    
    15,829
    
    
    
    (11,430
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (2,524
    )
    
    
    (1,641
    )
    
    
    
    
    
    
    1,641
    
    
    
    (2,524
    )Net loss before cumulative effect of accounting change
    
    
    (13,954
    )
    
    
    (14,924
    )
    
    
    (2,546
    )
    
    
    17,470
    
    
    
    (13,954
    )Cumulative effect of accounting change  net of tax
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15Net loss
    
    
    (13,939
    )
    
    
    (14,924
    )
    
    
    (2,546
    )
    
    
    17,470
    
    
    
    (13,939
    )Dividends on preferred shares
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Net loss applicable to common shares
    
    $
    (13,966
    )
    
    $
    (14,924
    )
    
    $
    (2,546
    )
    
    $
    17,470
    
    
    $
    (13,966
    )


F-66



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##### Table of Contents





| |  | Supplemental Consolidating Statement of Operations for the year ended December
31, 2000:
| |  | ----------------------------------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    8,976
    
    
    $
    22,657
    
    
    $
    6,199
    
    
    $
    (9,996
    )
    
    $
    27,836Cost of revenues
    
    
    7,745
    
    
    
    12,884
    
    
    
    4,413
    
    
    
    (9,996
    )
    
    
    15,046Gross profit
    
    
    1,231
    
    
    
    9,773
    
    
    
    1,786
    
    
    
    
    
    
    
    12,790Selling, general and administrative expense
(excluding stock option compensation)
    
    
    816
    
    
    
    3,771
    
    
    
    818
    
    
    
    
    
    
    
    5,405Research and development expense
    
    
    332
    
    
    
    3,036
    
    
    
    261
    
    
    
    
    
    
    
    3,629In-process research and development expense
    
    
    
    
    
    
    64
    
    
    
    558
    
    
    
    
    
    
    
    622Amortization of intangiblesAcquired technology
    
    
    
    
    
    
    789
    
    
    
    
    
    
    
    
    
    
    
    789Goodwill
    
    
    19
    
    
    
    1,716
    
    
    
    756
    
    
    
    
    
    
    
    2,491Stock option compensation
    
    
    96
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    99Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    133
    
    
    
    
    
    
    
    133Other special charges
    
    
    7
    
    
    
    116
    
    
    
    9
    
    
    
    
    
    
    
    132Gain on sale of businesses
    
    
    (228
    )
    
    
    42
    
    
    
    13
    
    
    
    
    
    
    
    (173
    )Operating
earnings (loss)
    
    
    189
    
    
    
    236
    
    
    
    (762
    )
    
    
    
    
    
    
    (337
    )Equity in net loss of associated companies
    
    
    (1,219
    )
    
    
    (79
    )
    
    
    (63
    )
    
    
    1,343
    
    
    
    (18
    )Other income (expense)  net
    
    
    459
    
    
    
    311
    
    
    
    127
    
    
    
    
    
    
    
    897Interest expenseLong-term debt
    
    
    (54
    )
    
    
    2
    
    
    
    (34
    )
    
    
    
    
    
    
    (86
    )Other
    
    
    6
    
    
    
    (39
    )
    
    
    (50
    )
    
    
    
    
    
    
    (83
    )(Loss) earnings from continuing operations
before income taxes
    
    
    (619
    )
    
    
    431
    
    
    
    (782
    )
    
    
    1,343
    
    
    
    373Income tax benefit (provision)
    
    
    (224
    )
    
    
    (742
    )
    
    
    (250
    )
    
    
    
    
    
    
    (1,216
    )Net loss from continuing operations
    
    
    (843
    )
    
    
    (311
    )
    
    
    (1,032
    )
    
    
    1,343
    
    
    
    (843
    )Net earnings (loss) from discontinued operations
    
    
    (414
    )
    
    
    (269
    )
    
    
    
    
    
    
    269
    
    
    
    (414
    )Net loss
    
    
    (1,257
    )
    
    
    (580
    )
    
    
    (1,032
    )
    
    
    1,612
    
    
    
    (1,257
    )Dividends on preferred shares
    
    
    31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31Net loss applicable to common shares
    
    $
    (1,288
    )
    
    $
    (580
    )
    
    $
    (1,032
    )
    
    $
    1,612
    
    
    $
    (1,288
    )


F-67



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##### Table of Contents





| |  | Supplemental Consolidating Balance Sheet as at December 31, 2002:
| |  | -----------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    251
    
    
    $
    2,382
    
    
    $
    1,110
    
    
    $
    
    
    
    $
    3,743Restricted cash and cash equivalents
    
    
    6
    
    
    
    176
    
    
    
    67
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    270
    
    
    
    1,488
    
    
    
    406
    
    
    
    
    
    
    
    2,164Intercompany/related party accounts receivable
    
    
    4,200
    
    
    
    976
    
    
    
    459
    
    
    
    (5,552
    )
    
    
    83Inventories  net
    
    
    524
    
    
    
    246
    
    
    
    216
    
    
    
    
    
    
    
    986Income taxes recoverable
    
    
    3
    
    
    
    46
    
    
    
    9
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    178
    
    
    
    615
    
    
    
    
    
    
    
    
    
    
    
    793Other current assets
    
    
    108
    
    
    
    290
    
    
    
    59
    
    
    
    
    
    
    
    457Current assets of discontinued operations
    
    
    74
    
    
    
    137
    
    
    
    
    
    
    
    
    
    
    
    211Total current assets
    
    
    5,614
    
    
    
    6,356
    
    
    
    2,326
    
    
    
    (5,552
    )
    
    
    8,744Investments at cost and associated companies at equity
    
    
    1,338
    
    
    
    (8,037
    )
    
    
    118
    
    
    
    6,829
    
    
    
    248Plant and equipment  net
    
    
    409
    
    
    
    752
    
    
    
    303
    
    
    
    
    
    
    
    1,464Goodwill
    
    
    
    
    
    
    1,956
    
    
    
    65
    
    
    
    
    
    
    
    2,021Intangible assets  net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deferred income taxes  net
    
    
    1,062
    
    
    
    1,537
    
    
    
    54
    
    
    
    
    
    
    
    2,653Other assets
    
    
    627
    
    
    
    1,279
    
    
    
    754
    
    
    
    (1,894
    )
    
    
    766Total assets
    
    $
    9,050
    
    
    $
    3,843
    
    
    $
    3,620
    
    
    $
    (617
    )
    
    $
    15,896LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    3
    
    
    $
    25
    
    
    $
    
    
    
    $
    30Trade and other accounts payable
    
    
    356
    
    
    
    429
    
    
    
    85
    
    
    
    
    
    
    
    870Intercompany/related party accounts payable
    
    
    153
    
    
    
    3,288
    
    
    
    2,140
    
    
    
    (5,552
    )
    
    
    29Payroll and benefit-related liabilities
    
    
    32
    
    
    
    383
    
    
    
    84
    
    
    
    
    
    
    
    499Contractual liabilities
    
    
    78
    
    
    
    751
    
    
    
    384
    
    
    
    
    
    
    
    1,213Restructuring
    
    
    113
    
    
    
    308
    
    
    
    116
    
    
    
    
    
    
    
    537Other accrued liabilities
    
    
    637
    
    
    
    1,969
    
    
    
    288
    
    
    
    
    
    
    
    2,894Long-term debt due within one year
    
    
    174
    
    
    
    8
    
    
    
    51
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    1,545
    
    
    
    7,139
    
    
    
    3,173
    
    
    
    (5,552
    )
    
    
    6,305Long-term debt
    
    
    1,603
    
    
    
    34
    
    
    
    312
    
    
    
    
    
    
    
    1,949Deferred income taxes  net
    
    
    263
    
    
    
    95
    
    
    
    8
    
    
    
    
    
    
    
    366Other liabilities
    
    
    813
    
    
    
    1,734
    
    
    
    1,668
    
    
    
    (1,894
    )
    
    
    2,321Minority interest in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    129
    
    
    
    
    
    
    
    1294,224
    
    
    
    9,002
    
    
    
    5,290
    
    
    
    (7,446
    )
    
    
    11,070SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    342
    
    
    
    
    
    
    
    (342
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    6,061
    
    
    
    982
    
    
    
    (7,043
    )
    
    
    1,211Additional paid-in capital
    
    
    22,004
    
    
    
    1,563
    
    
    
    4,065
    
    
    
    (5,628
    )
    
    
    22,004Deficit
    
    
    (17,607
    )
    
    
    (13,897
    )
    
    
    (6,606
    )
    
    
    20,503
    
    
    
    (17,607
    )Accumulated other comprehensive loss
    
    
    (1,318
    )
    
    
    772
    
    
    
    (111
    )
    
    
    (661
    )
    
    
    (1,318
    )Total shareholders equity
    
    
    4,826
    
    
    
    (5,159
    )
    
    
    (1,670
    )
    
    
    6,829
    
    
    
    4,826Total liabilities and shareholders equity
    
    $
    9,050
    
    
    $
    3,843
    
    
    $
    3,620
    
    
    $
    (617
    )
    
    $
    15,896


F-68



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##### Table of Contents





| |  | Supplemental Consolidating Balance Sheet as at December 31, 2001:
| |  | -----------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    (41
    )
    
    $
    2,285
    
    
    $
    1,160
    
    
    $
    
    
    
    $
    3,404Restricted cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accounts receivable  net
    
    
    315
    
    
    
    2,263
    
    
    
    478
    
    
    
    
    
    
    
    3,056Intercompany/related party accounts receivable
    
    
    4,952
    
    
    
    1,054
    
    
    
    586
    
    
    
    (6,592
    )
    
    
    Inventories  net
    
    
    835
    
    
    
    689
    
    
    
    310
    
    
    
    
    
    
    
    1,834Income taxes recoverable
    
    
    343
    
    
    
    442
    
    
    
    5
    
    
    
    
    
    
    
    790Deferred income taxes  net
    
    
    287
    
    
    
    1,080
    
    
    
    34
    
    
    
    
    
    
    
    1,401Other current assets
    
    
    103
    
    
    
    490
    
    
    
    123
    
    
    
    
    
    
    
    716Current assets of discontinued operations
    
    
    245
    
    
    
    454
    
    
    
    
    
    
    
    
    
    
    
    699Total current assets
    
    
    7,039
    
    
    
    8,757
    
    
    
    2,696
    
    
    
    (6,592
    )
    
    
    11,900Investments at cost and associated companies at equity
    
    
    2,789
    
    
    
    (8,073
    )
    
    
    517
    
    
    
    5,028
    
    
    
    261Plant and equipment  net
    
    
    699
    
    
    
    1,350
    
    
    
    401
    
    
    
    
    
    
    
    2,450Goodwill
    
    
    31
    
    
    
    2,117
    
    
    
    135
    
    
    
    
    
    
    
    2,283Acquired technology  net
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    20Deferred income taxes  net
    
    
    411
    
    
    
    1,519
    
    
    
    55
    
    
    
    
    
    
    
    1,985Other assets
    
    
    530
    
    
    
    1,492
    
    
    
    787
    
    
    
    (1,647
    )
    
    
    1,162Total assets
    
    $
    11,499
    
    
    $
    7,182
    
    
    $
    4,591
    
    
    $
    (3,211
    )
    
    $
    20,061LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    168
    
    
    $
    201
    
    
    $
    
    
    
    $
    371Trade and other accounts payable
    
    
    315
    
    
    
    766
    
    
    
    242
    
    
    
    
    
    
    
    1,323Intercompany/related party accounts payable
    
    
    38
    
    
    
    3,406
    
    
    
    3,428
    
    
    
    (6,592
    )
    
    
    280Payroll and benefit-related liabilities
    
    
    63
    
    
    
    449
    
    
    
    102
    
    
    
    
    
    
    
    614Contractual liabilities
    
    
    174
    
    
    
    1,057
    
    
    
    369
    
    
    
    
    
    
    
    1,600Restructuring
    
    
    188
    
    
    
    488
    
    
    
    79
    
    
    
    
    
    
    
    755Other accrued liabilities
    
    
    1,274
    
    
    
    2,596
    
    
    
    149
    
    
    
    
    
    
    
    4,019Long-term debt due within one year
    
    
    313
    
    
    
    63
    
    
    
    8
    
    
    
    
    
    
    
    384Total current liabilities
    
    
    2,367
    
    
    
    8,993
    
    
    
    4,578
    
    
    
    (6,592
    )
    
    
    9,346Long-term debt
    
    
    1,928
    
    
    
    8
    
    
    
    357
    
    
    
    
    
    
    
    2,293Deferred income taxes  net
    
    
    360
    
    
    
    100
    
    
    
    17
    
    
    
    
    
    
    
    477Other liabilities
    
    
    617
    
    
    
    1,233
    
    
    
    1,397
    
    
    
    (1,647
    )
    
    
    1,600Minority interest in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    1185,272
    
    
    
    10,334
    
    
    
    6,467
    
    
    
    (8,239
    )
    
    
    13,834SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    365
    
    
    
    
    
    
    
    (365
    )
    
    
    536Common shares
    
    
    2,111
    
    
    
    950
    
    
    
    386
    
    
    
    (1,336
    )
    
    
    2,111Additional paid-in capital
    
    
    18,805
    
    
    
    6,050
    
    
    
    4,212
    
    
    
    (10,262
    )
    
    
    18,805Deficit
    
    
    (14,336
    )
    
    
    (11,547
    )
    
    
    (6,386
    )
    
    
    17,933
    
    
    
    (14,336
    )Accumulated other comprehensive loss
    
    
    (889
    )
    
    
    1,030
    
    
    
    (88
    )
    
    
    (942
    )
    
    
    (889
    )Total shareholders equity
    
    
    6,227
    
    
    
    (3,152
    )
    
    
    (1,876
    )
    
    
    5,028
    
    
    
    6,227Total liabilities and shareholders equity
    
    $
    11,499
    
    
    $
    7,182
    
    
    $
    4,591
    
    
    $
    (3,211
    )
    
    $
    20,061


F-69



---



##### Table of Contents





| |  | Supplemental Consolidating Statement of Cash Flows for the year ended December
31, 2002:
| |  | ----------------------------------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (2,745
    )
    
    $
    (1,805
    )
    
    $
    (326
    )
    
    $
    2,131
    
    
    $
    (2,745
    )Adjustments to reconcile net loss from
continuing operations to net cash from (used in)
operating activities, net of effects from
acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    86
    
    
    
    406
    
    
    
    69
    
    
    
    
    
    
    
    561Non-cash portion of special charges
and related asset write downs
    
    
    207
    
    
    
    541
    
    
    
    36
    
    
    
    
    
    
    
    784Equity in net loss of associated companies
    
    
    1,367
    
    
    
    771
    
    
    
    12
    
    
    
    (2,132
    )
    
    
    18Stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deferred income taxes
    
    
    (283
    )
    
    
    (307
    )
    
    
    158
    
    
    
    
    
    
    
    (432
    )Other liabilities
    
    
    (1
    )
    
    
    6
    
    
    
    (14
    )
    
    
    
    
    
    
    (9
    )Gain on repurchase of outstanding debt securities
    
    
    (60
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (60
    )Gain (loss) on sale of investments and businesses
    
    
    (2
    )
    
    
    8
    
    
    
    1
    
    
    
    
    
    
    
    7Other  net
    
    
    375
    
    
    
    3
    
    
    
    151
    
    
    
    1
    
    
    
    530Change in operating assets and liabilitiesAccounts receivable
    
    
    21
    
    
    
    690
    
    
    
    181
    
    
    
    
    
    
    
    892Inventories
    
    
    298
    
    
    
    283
    
    
    
    74
    
    
    
    
    
    
    
    655Income taxes
    
    
    193
    
    
    
    1,136
    
    
    
    (73
    )
    
    
    
    
    
    
    1,256Accounts payable and accrued liabilities
    
    
    (662
    )
    
    
    (1,421
    )
    
    
    (132
    )
    
    
    
    
    
    
    (2,215
    )Other changes in operating assets and liabilities
    
    
    (573
    )
    
    
    359
    
    
    
    6
    
    
    
    
    
    
    
    (208
    )Intercompany/related party activity
    
    
    91
    
    
    
    (152
    )
    
    
    61
    
    
    
    
    
    
    
    Net cash from (used in) operating activities
    
    
    (1,688
    )
    
    
    518
    
    
    
    204
    
    
    
    
    
    
    
    (966
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (52
    )
    
    
    (239
    )
    
    
    (44
    )
    
    
    
    
    
    
    (335
    )Proceeds on disposals of plant and equipment
    
    
    16
    
    
    
    390
    
    
    
    
    
    
    
    
    
    
    
    406Increase in restricted cash and cash equivalents
    
    
    (17
    )
    
    
    (148
    )
    
    
    (66
    )
    
    
    
    
    
    
    (231
    )Increase in long-term receivables
    
    
    41
    
    
    
    (190
    )
    
    
    (122
    )
    
    
    
    
    
    
    (271
    )Decrease in long-term receivables
    
    
    25
    
    
    
    180
    
    
    
    97
    
    
    
    
    
    
    
    302Acquisitions of investments and businesses
 net of cash acquired
    
    
    (5
    )
    
    
    (24
    )
    
    
    
    
    
    
    
    
    
    
    (29
    )Proceeds on sale of investments and businesses
    
    
    23
    
    
    
    33
    
    
    
    5
    
    
    
    
    
    
    
    61Net cash from (used in) investing activities
    
    
    31
    
    
    
    2
    
    
    
    (130
    )
    
    
    
    
    
    
    (97
    )Cash flows from (used in) financing activitiesDividends on common and preferred shares
    
    
    (22
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (22
    )Increase (decrease) in notes payable  net
    
    
    
    
    
    
    (174
    )
    
    
    (159
    )
    
    
    
    
    
    
    (333
    )Proceeds from long-term debt
    
    
    
    
    
    
    1
    
    
    
    32
    
    
    
    
    
    
    
    33Repayments of long-term debt
    
    
    (460
    )
    
    
    (5
    )
    
    
    (13
    )
    
    
    
    
    
    
    (478
    )Decrease in capital leases payable
    
    
    (3
    )
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    (9
    )Issuance of common shares
    
    
    2,287
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,287Stock option fair value increment
    
    
    
    
    
    
    (525
    )
    
    
    
    
    
    
    
    
    
    
    (525
    )Net cash from (used in) financing activities
    
    
    1,802
    
    
    
    (709
    )
    
    
    (140
    )
    
    
    
    
    
    
    953Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    13
    
    
    
    45
    
    
    
    16
    
    
    
    
    
    
    
    74Net cash from (used in) continuing operations
    
    
    158
    
    
    
    (144
    )
    
    
    (50
    )
    
    
    
    
    
    
    (36
    )Net cash from discontinued operations
    
    
    134
    
    
    
    241
    
    
    
    
    
    
    
    
    
    
    
    375Net increase (decrease) in cash and cash equivalents
    
    
    292
    
    
    
    97
    
    
    
    (50
    )
    
    
    
    
    
    
    339Cash and cash equivalents at beginning of
period  net
    
    
    (41
    )
    
    
    2,285
    
    
    
    1,160
    
    
    
    
    
    
    
    3,404Cash and cash equivalents at end of period  net
    
    $
    251
    
    
    $
    2,382
    
    
    $
    1,110
    
    
    $
    
    
    
    $
    3,743


F-70



---



##### Table of Contents





| |  | Supplemental Consolidating Statement of Cash Flows for the year ended December
31, 2001:
| |  | ----------------------------------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (11,430
    )
    
    $
    (13,283
    )
    
    $
    (2,546
    )
    
    $
    15,829
    
    
    $
    (11,430
    )Adjustments to reconcile net loss from
continuing operations to net cash from (used in)
operating activities, net of effects from
acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    191
    
    
    
    2,612
    
    
    
    576
    
    
    
    
    
    
    
    3,379Non-cash portion of special charges
and related asset write downs
    
    
    98
    
    
    
    1,477
    
    
    
    1,590
    
    
    
    
    
    
    
    3,165Equity in net loss of associated companies
    
    
    11,500
    
    
    
    4,861
    
    
    
    (2
    )
    
    
    (16,209
    )
    
    
    150Deferred income taxes
    
    
    (1,030
    )
    
    
    (1,528
    )
    
    
    (10
    )
    
    
    
    
    
    
    (2,568
    )Other liabilities
    
    
    (4
    )
    
    
    105
    
    
    
    (23
    )
    
    
    
    
    
    
    78Gain (loss) on sale of investments and businesses
    
    
    69
    
    
    
    214
    
    
    
    (54
    )
    
    
    
    
    
    
    229Other  net
    
    
    (8
    )
    
    
    320
    
    
    
    (470
    )
    
    
    
    
    
    
    (158
    )Change in operating assets and liabilities:Accounts receivable
    
    
    988
    
    
    
    3,692
    
    
    
    1,146
    
    
    
    
    
    
    
    5,826Inventories
    
    
    245
    
    
    
    1,421
    
    
    
    347
    
    
    
    
    
    
    
    2,013Income taxes
    
    
    (446
    )
    
    
    (494
    )
    
    
    (13
    )
    
    
    
    
    
    
    (953
    )Accounts payable and accrued liabilities
    
    
    62
    
    
    
    306
    
    
    
    (253
    )
    
    
    
    
    
    
    115Other changes in operating assets and liabilities
    
    
    (84
    )
    
    
    405
    
    
    
    238
    
    
    
    
    
    
    
    559Intercompany/related party activity
    
    
    (2,539
    )
    
    
    1,788
    
    
    
    371
    
    
    
    380
    
    
    
    Net cash from (used in) operating activities
    
    
    (2,388
    )
    
    
    1,896
    
    
    
    897
    
    
    
    
    
    
    
    405Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (315
    )
    
    
    (833
    )
    
    
    (119
    )
    
    
    
    
    
    
    (1,267
    )Proceeds on disposals of plant and equipment
    
    
    23
    
    
    
    185
    
    
    
    
    
    
    
    
    
    
    
    208Increase in long-term receivables
    
    
    (201
    )
    
    
    (88
    )
    
    
    (444
    )
    
    
    
    
    
    
    (733
    )Decrease in long-term receivables
    
    
    97
    
    
    
    207
    
    
    
    168
    
    
    
    
    
    
    
    472Acquisitions of investments and businesses
 net of cash acquired
    
    
    (13
    )
    
    
    (76
    )
    
    
    
    
    
    
    
    
    
    
    (89
    )Proceeds on sale of investments and businesses
    
    
    6
    
    
    
    403
    
    
    
    195
    
    
    
    
    
    
    
    604Net cash used in investing activities
    
    
    (403
    )
    
    
    (202
    )
    
    
    (200
    )
    
    
    
    
    
    
    (805
    )Cash flows from (used in) financing activitiesDividends on common and preferred shares
    
    
    (27
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (27
    )Increase in notes payable  net
    
    
    12
    
    
    
    34
    
    
    
    39
    
    
    
    
    
    
    
    85Proceeds from long-term debt
    
    
    1,500
    
    
    
    10
    
    
    
    20
    
    
    
    
    
    
    
    1,530Repayments of long-term debt
    
    
    (250
    )
    
    
    (12
    )
    
    
    (207
    )
    
    
    
    
    
    
    (469
    )Decrease in capital leases payable
    
    
    (3
    )
    
    
    (15
    )
    
    
    (5
    )
    
    
    
    
    
    
    (23
    )Issuance of common shares
    
    
    1,800
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,800Net cash from (used in) financing activities
    
    
    3,032
    
    
    
    17
    
    
    
    (153
    )
    
    
    
    
    
    
    2,896Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    (7
    )
    
    
    (4
    )
    
    
    
    
    
    
    (10
    )Net cash from continuing operations
    
    
    242
    
    
    
    1,704
    
    
    
    540
    
    
    
    
    
    
    
    2,486Net cash used in discontinued operations
    
    
    (210
    )
    
    
    (439
    )
    
    
    
    
    
    
    
    
    
    
    (649
    )Net increase in cash and cash equivalents
    
    
    32
    
    
    
    1,265
    
    
    
    540
    
    
    
    
    
    
    
    1,837Cash and cash equivalents at beginning of
period  net
    
    
    (73
    )
    
    
    1,020
    
    
    
    620
    
    
    
    
    
    
    
    1,567Cash and cash equivalents at end of period  net
    
    $
    (41
    )
    
    $
    2,285
    
    
    $
    1,160
    
    
    $
    
    
    
    $
    3,404


F-71



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##### Table of Contents





| |  | Supplemental Consolidating Statement of Cash Flows for the year ended December
31, 2000:
| |  | ----------------------------------------------------------------------------------------

Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (843
    )
    
    $
    (311
    )
    
    $
    (1,032
    )
    
    $
    1,343
    
    
    $
    (843
    )Adjustments to reconcile net loss from
continuing operations to net cash from (used in)
operating activities, net of effects from
acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    228
    
    
    
    2,869
    
    
    
    950
    
    
    
    
    
    
    
    4,047In-process research and
development expense
    
    
    
    
    
    
    64
    
    
    
    558
    
    
    
    
    
    
    
    622Non-cash portion of special charges
and related asset write downs
    
    
    48
    
    
    
    89
    
    
    
    
    
    
    
    
    
    
    
    137Equity in net loss of associated companies
    
    
    1,219
    
    
    
    79
    
    
    
    63
    
    
    
    (1,343
    )
    
    
    18Stock option compensation
    
    
    96
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    99Deferred income taxes
    
    
    (289
    )
    
    
    807
    
    
    
    4
    
    
    
    
    
    
    
    522Other liabilities
    
    
    16
    
    
    
    94
    
    
    
    (5
    )
    
    
    
    
    
    
    105Gain on sale of investments and businesses
    
    
    (19
    )
    
    
    (1,039
    )
    
    
    
    
    
    
    
    
    
    
    (1,058
    )Other  net
    
    
    490
    
    
    
    (256
    )
    
    
    (34
    )
    
    
    
    
    
    
    200Change in operating assets and liabilities:Accounts receivable
    
    
    (523
    )
    
    
    (635
    )
    
    
    167
    
    
    
    
    
    
    
    (991
    )Inventories
    
    
    (239
    )
    
    
    (1,158
    )
    
    
    (183
    )
    
    
    
    
    
    
    (1,580
    )Income taxes
    
    
    25
    
    
    
    (229
    )
    
    
    24
    
    
    
    
    
    
    
    (180
    )Accounts payable and accrued liabilities
    
    
    681
    
    
    
    834
    
    
    
    (585
    )
    
    
    
    
    
    
    930Other changes in operating assets and liabilities
    
    
    (416
    )
    
    
    (448
    )
    
    
    28
    
    
    
    
    
    
    
    (836
    )Intercompany/related party activity
    
    
    393
    
    
    
    (1,231
    )
    
    
    838
    
    
    
    
    
    
    
    Net cash from (used in) operating activities
    
    
    867
    
    
    
    (468
    )
    
    
    793
    
    
    
    
    
    
    
    1,192Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (426
    )
    
    
    (982
    )
    
    
    (430
    )
    
    
    
    
    
    
    (1,838
    )Proceeds on disposals of plant and equipment
    
    
    30
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    33Increase in long-term receivables
    
    
    (645
    )
    
    
    (905
    )
    
    
    (230
    )
    
    
    
    
    
    
    (1,780
    )Decrease in long-term receivables
    
    
    469
    
    
    
    746
    
    
    
    85
    
    
    
    
    
    
    
    1,300Acquisitions of investments and businesses
 net of cash acquired
    
    
    (95
    )
    
    
    (244
    )
    
    
    23
    
    
    
    
    
    
    
    (316
    )Proceeds on sale of investments and businesses
    
    
    242
    
    
    
    1,317
    
    
    
    74
    
    
    
    
    
    
    
    1,633Net cash used in investing activities
    
    
    (425
    )
    
    
    (65
    )
    
    
    (478
    )
    
    
    
    
    
    
    (968
    )Cash flows from (used in) financing activitiesDividends on common and preferred shares
    
    
    (84
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (84
    )Increase in notes payable  net
    
    
    3
    
    
    
    26
    
    
    
    85
    
    
    
    
    
    
    
    114Proceeds from long-term debt
    
    
    3
    
    
    
    82
    
    
    
    22
    
    
    
    
    
    
    
    107Repayments of long-term debt
    
    
    (3
    )
    
    
    (24
    )
    
    
    (42
    )
    
    
    
    
    
    
    (69
    )Increase (decrease) in capital leases payable
    
    
    (4
    )
    
    
    14
    
    
    
    (12
    )
    
    
    
    
    
    
    (2
    )Issuance of common shares
    
    
    206
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    206Net cash from financing activities
    
    
    121
    
    
    
    98
    
    
    
    53
    
    
    
    
    
    
    
    272Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    (16
    )
    
    
    (10
    )
    
    
    
    
    
    
    (25
    )Net cash from (used in) continuing operations
    
    
    564
    
    
    
    (451
    )
    
    
    358
    
    
    
    
    
    
    
    471Net cash used in discontinued operations
    
    
    (617
    )
    
    
    (440
    )
    
    
    
    
    
    
    
    
    
    
    (1,057
    )Net increase (decrease) in cash and cash equivalents
    
    
    (53
    )
    
    
    (891
    )
    
    
    358
    
    
    
    
    
    
    
    (586
    )Cash and cash equivalents at beginning of
period  net
    
    
    (20
    )
    
    
    1,911
    
    
    
    262
    
    
    
    
    
    
    
    2,153Cash and cash equivalents at end of period  net
    
    $
    (73
    )
    
    $
    1,020
    
    
    $
    620
    
    
    $
    
    
    
    $
    1,567


F-72



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##### Table of Contents





| |  | Quarterly Financial Data
(Unaudited)
| |  | ------------------------------------

4th Quarter
    
    
    3rd Quarter
    
    
    2nd Quarter
    
    
    1st Quarter(millions of U.S. dollars)
    
    2002
    
    
    2001
    
    
    2002
    
    
    2001
    
    
    2002
    
    
    2001
    
    
    2002
    
    
    2001RevenuesAs previously reported
    
    $
    2,513
    
    
    $
    3,442
    
    
    $
    2,353
    
    
    $
    3,673
    
    
    $
    2,770
    
    
    $
    4,571
    
    
    $
    2,910
    
    
    $
    5,689As restated*
    
    
    2,520
    
    
    
    3,424
    
    
    
    2,349
    
    
    
    3,676
    
    
    
    2,785
    
    
    
    4,522
    
    
    
    2,900
    
    
    
    5,650Gross profitAs previously reported
    
    
    980
    
    
    
    965
    
    
    
    840
    
    
    
    (10
    )
    
    
    900
    
    
    
    365
    
    
    
    681
    
    
    
    1,814As restated*
    
    
    1,021
    
    
    
    1,058
    
    
    
    849
    
    
    
    41
    
    
    
    955
    
    
    
    332
    
    
    
    739
    
    
    
    1,752Net loss from continuing operationsAs previously reported
    
    
    (254
    )
    
    
    (1,553
    )
    
    
    (1,431
    )
    
    
    (3,270
    )
    
    
    (569
    )
    
    
    (5,381
    )
    
    
    (785
    )
    
    
    (1,351
    )As restated*
    
    
    (172
    )
    
    
    (1,499
    )
    
    
    (1,371
    )
    
    
    (3,199
    )
    
    
    (500
    )
    
    
    (5,378
    )
    
    
    (702
    )
    
    
    (1,354
    )Net earnings (loss) from discontinued operations  net of taxAs previously reported
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,351
    )
    
    
    
    
    
    
    (187
    )As restated*
    
    
    
    
    
    
    1
    
    
    
    2
    
    
    
    14
    
    
    
    3
    
    
    
    (2,351
    )
    
    
    16
    
    
    
    (188
    )Net loss before cumulative effect of
accounting changeAs previously reported
    
    
    (254
    )
    
    
    (1,553
    )
    
    
    (1,431
    )
    
    
    (3,270
    )
    
    
    (569
    )
    
    
    (7,732
    )
    
    
    (785
    )
    
    
    (1,538
    )As restated*
    
    
    (172
    )
    
    
    (1,498
    )
    
    
    (1,369
    )
    
    
    (3,185
    )
    
    
    (497
    )
    
    
    (7,729
    )
    
    
    (686
    )
    
    
    (1,542
    )Cumulative effect of accounting change  net of taxAs previously reported
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15As restated*
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15Net lossAs previously reported
    
    
    (254
    )
    
    
    (1,553
    )
    
    
    (1,431
    )
    
    
    (3,270
    )
    
    
    (569
    )
    
    
    (7,732
    )
    
    
    (785
    )
    
    
    (1,523
    )As restated*
    
    
    (172
    )
    
    
    (1,498
    )
    
    
    (1,369
    )
    
    
    (3,185
    )
    
    
    (497
    )
    
    
    (7,729
    )
    
    
    (686
    )
    
    
    (1,527
    )Dividends on preferred sharesAs previously reported
    
    
    (6
    )
    
    
    (6
    )
    
    
    (6
    )
    
    
    (6
    )
    
    
    (5
    )
    
    
    (7
    )
    
    
    (5
    )
    
    
    (8
    )As restated*
    
    
    (6
    )
    
    
    (6
    )
    
    
    (6
    )
    
    
    (6
    )
    
    
    (5
    )
    
    
    (7
    )
    
    
    (5
    )
    
    
    (8
    )Net loss applicable to common sharesAs previously reported
    
    
    (260
    )
    
    
    (1,559
    )
    
    
    (1,437
    )
    
    
    (3,276
    )
    
    
    (574
    )
    
    
    (7,739
    )
    
    
    (790
    )
    
    
    (1,531
    )As restated*
    
    
    (178
    )
    
    
    (1,504
    )
    
    
    (1,375
    )
    
    
    (3,191
    )
    
    
    (502
    )
    
    
    (7,736
    )
    
    
    (691
    )
    
    
    (1,535
    )* See note 3 to the accompanying consolidated financial statements


F-73



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##### Table of Contents






PART III




ITEM 14. Controls and Procedures

This Item 14 has been updated to reflect the restatements as well as for events and
developments subsequent to December 31, 2002.

(a) Evaluation of Disclosure Controls and Procedures

Subsequent to the evaluation referenced in Nortel
Networks Annual Report on Form 10-K for the year ended
December 31, 2002 filed with the Securities and Exchange
Commission (SEC) on March 10, 2003, Nortel Networks
has re-evaluated the effectiveness of the design and operation of
Nortel Networks disclosure controls and procedures as of the end of
the period covered by this report under the
supervision and with the participation of management, including the President
and Chief Executive Officer and the Chief Financial Officer, pursuant to Rule
13a-15 under the Securities Exchange Act of 1934, as amended (the Exchange
Act), in light of the restatements and the identification of
certain material weaknesses discussed below.

In connection with the comprehensive
and related reviews and work undertaken in connection with the restatements of
Nortel Networks financial statements for the years ended December 31, 2002,
2001 and 2000 and the quarterly periods ended March 31 and June 30, 2003 (as
more fully described in note 3 to the accompanying (audited) consolidated financial statements
and Developments in 2003  Restatements in the
MD&A), Nortel Networks identified a number of deficiencies in
Nortel Networks internal control over financial reporting. In addition, as part of the
communications by Nortel Networks independent auditors Deloitte
& Touche LLP (D&T) to the
Nortel Networks Audit Committee with respect to D&Ts interim audit procedures
for the year ending December 31, 2003, D&T informed the Audit Committee that
they had identified the following reportable conditions each of which
constituted a material weakness (as each such term is defined under standards
established by the American Institute of Certified Public Accountants) in
Nortel Networks internal control:



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



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

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

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

78



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##### Table of Contents



(b) Changes in Internal Control

Nortel Networks initiated, and disclosed in its Quarterly Report on
Form 10-Q for the period ended June 30, 2003, a comprehensive review and
analysis of its assets and liabilities. On October 23, 2003, Nortel Networks
announced it would restate its consolidated financial statements for the years
ended December 31, 2002, 2001 and 2000 and the fiscal quarters ended March 31,
2003 and June 30, 2003. The restatements primarily relate to the determination
by Nortel Networks that $924 of liabilities (primarily accruals and provisions)
carried on its previously reported balance sheet as at
December 31, 2002 needed to
be released to income. These provisions were either initially
recorded incorrectly in prior periods or not properly released or adjusted for
changes in estimates in the appropriate periods. In certain cases, costs were
incorrectly charged to operations rather than to the appropriate provisions.
Following its determination to restate its financial statements, Nortel
Networks also determined that it would correct certain known errors that were
previously not recorded because the amount of the errors was not material to
the consolidated financial statements. Specifically, among other items, Nortel
Networks has made certain revenue adjustments to reflect revenue which should
have been deferred instead of recognized in a particular period. Also, as part
of the restatements, Nortel Networks made adjustments to correct errors
relating to its deferred income tax assets and foreign currency translation
accounts. The net effect of the restatement adjustments to Nortel Networks
accumulated deficit as at December 31, 2002 was $486. Please see
note 3 to the accompanying (audited) consolidated financial statements
and Developments in 2003  Restatements in
the MD&A for further information concerning the restatements and
their impact on Nortel Networks financials statements.

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



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



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



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



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



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

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

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

79



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##### Table of Contents






PART IV




ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

The information set forth in this Item 15 has not been revised to reflect
events and developments subsequent to December 31, 2002, except for Exhibits
12, 23.1, 23.2, 31.1, 31.2 and 32.

1. Financial Statements

The index to the Consolidated Financial Statements
appears on page 77.

2. Financial Statement Schedules

PageQuarterly Financial Data (Unaudited)
    
    
    F-73Independent Auditors Report
    
    
    87II 
    Valuation and Qualifying Accounts and Reserves, Provision for Uncollectibles
    
    
    88Audited Financial Statements and the notes thereto of Nortel Networks S.A.,
prepared in accordance with United States generally accepted accounting
principles, for the three years ended December 31, 2002
    
    
    90


All other schedules are omitted because they are inapplicable or not required.

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, 2002.

3. Reports on Form 8-K

Nortel Networks Limited filed a Current Report on Form 8-K dated October
3, 2002 related to a press release announcing changes to Nortel Networks
Corporations organization reflecting a more streamlined structure focused more
directly around its customers in four key businesses: Wireless Networks;
Wireline Networks; Enterprise Networks; and Optical Networks.

Nortel Networks Limited filed a Current Report on Form 8-K dated October
11, 2002 related to a press release stating that, in a letter from Nortel
Networks Corporations President and Chief Executive Officer to employees
subsequently issued on the same date, Nortel Networks Corporation updated
employees on its third quarter 2002 revenues and its progress on its drive to
achieve profitability.

Nortel Networks Limited filed a Current Report on Form 8-K dated October
22, 2002 related to Nortel Networks Corporations financial results for the
third quarter of 2002.

Nortel Networks Limited filed a Current Report on Form 8-K/A dated
November 7, 2002 related to Nortel Networks Corporations press release
revising the breakdown of its Enterprise Networks and Wireline Networks
historical segment revenues.

Nortel Networks Limited filed a Current Report on Form 8-K dated December
13, 2002 related to the amendments dated as of December 12, 2002, (i) to the U.S. Guarantee and Security
Agreement, the Canadian Guarantee and Security Agreement among Nortel Networks
Limited, Nortel Networks Inc. and the Subsidiary Lien Guarantors party thereto
and JP

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Morgan Chase Bank, as Collateral Agent and, (ii) to certain Foreign
Subsidiary Guarantees dated as of April 4, 2002, among Nortel Networks
(Ireland) Limited, Nortel Networks UK Limited, Nortel Networks (Asia) and JPMorgan Chase Bank, as Collateral Agent.

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

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

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

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4. Exhibit Index

The Items listed as Exhibits 10.2 to 10.7 and 10.27 to 10.38 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.*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).


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ExhibitNumber
    
    Description10.1
    
    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.10.2
    
    Nortel Networks Supplementary Executive Retirement Plan, as
amended effective October 18, 2001 and October 23, 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 (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 (filed as Exhibit 10.5 to Nortel Networks
Limiteds Quarterly Report on Form 10-Q for the quarter ended
June 30, 2001).*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 onForm 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


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ExhibitNumber
    
    Descriptionthereto and JP Morgan 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).*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).


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ExhibitNumber
    
    Description*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 effective July 25, 2002
(filed as Exhibit 10.4 to Nortel Networks Limiteds Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002).*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).10.30
    
    Statement describing eligibility for the Group Life Insurance
Plan for directors who are not salaried employees of Nortel
Networks Corporation.*10.31
    
    Resolutions of the Board of Directors of Nortel Networks Limited
dated January 24, 2002, related to the payment of directors fees
(filed as Exhibit 10.1 to Nortel Networks Limiteds Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002).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.*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
    
    Resolution of the Board of Directors of Nortel Networks Limited
dated July 25, 2002 related to payment of audit committee
chairman fees (filed as Exhibit 10.1 to Nortel Networks Limiteds
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002).*10.35
    
    General description of cash bonus for employees and executives of
Nortel Networks Corporation and Nortel Networks Limited (filed as
Exhibit 10.3 to Nortel Networks Limiteds Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002).


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ExhibitNumber
    
    Description*10.36
    
    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, and November 15, 2000
(filed as Exhibit 10.17 to Nortel Networks Corporations Annual
Report on Form 10-K for the year ended December 31, 2000).*10.37
    
    Nortel Networks Limited Directors Deferred Share Compensation
Plan effective June 30, 1998 and amended and restated as of May
1, 2000 as further amended effective January 1, 2002 (filed as
Exhibit 10.1 to Nortel Networks Limiteds Quarterly Report on
Form 10-Q for the quarter ended March 31, 2002).*10.38
    
    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)).12.
    
    Computation of Ratios.21.
    
    Subsidiaries of the Registrant (filed as Exhibit 21 to Nortel
Networks Limiteds Annual Report on Form 10-K for the year ended
December 31, 2002, filed on March 10, 2003).*23.1
    
    Consent of Deloitte & Touche LLP.23.2
    
    Consent of Deloitte Touche Tohmatsu.24.
    
    Power of Attorney of certain directors and officers (filed as
Exhibit 24 to Nortel Networks Limited Annual Report on Form 10-K
for the year ended December 31, 2002 filed on March 10, 2003).*31.1
    
    Certification of the President and Chief Executive Officer
pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32
    
    Certification of the President and Chief Executive Officer and
Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.


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INDEPENDENT AUDITORS REPORT

To the Shareholders of Nortel Networks Limited

We have audited the consolidated financial statements of Nortel Networks
Limited and its subsidiaries (Nortel Networks) as of December 31, 2002 and
2001, and for each of the three years in the period ended December 31, 2002,
and have issued our report thereon dated February 10, 2003
(February 14, 2003, as to note 21, December 23, 2003,
as to the effects of the restatements described in note 3), (which report expresses an unqualified opinion and includes explanatory
paragraphs relating to the change in method of accounting for
goodwill and the restatements described in note 3); such report is
included elsewhere in this Form 10-K/A. Our audits also included the
consolidated financial statement schedule of Nortel Networks listed in Item 15.
This financial statement schedule is the responsibility of Nortel Networks
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 financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.

/s/ Deloitte & Touche LLP

Chartered Accountants

Toronto, Canada
February 10, 2003 (December 23, 2003, as to the effects of the restatements
described in note 3)

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Schedule II
Consolidated

NORTEL NETWORKS LIMITED
Valuation and Qualifying Accounts and Reserves
Provision For Uncollectibles *
(millions of U.S. dollars)

AdditionsBalance at
    
    
    charged
    
    
    
    
    
    
    Balance atbeginning of
    
    
    to costs
    
    
    
    
    
    
    end ofUS GAAP
    
    year
    
    
    and expenses
    
    
    Deductions **
    
    
    yearYear
2002***
    
    $
    1,540
    
    
    $
    283
    
    
    $
    571
    
    
    $
    1,252Year
2001***
    
    $
    827
    
    
    $
    1,356
    
    
    $
    643
    
    
    $
    1,540Year
2000***
    
    $
    602
    
    
    $
    330
    
    
    $
    105
    
    
    $
    827


|*   |  | Excludes Discontinued Operations                                                                                                                       
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|**  |  | Includes acquisitions and disposals of subsidiaries and divisions and
amounts written off, less recoveries and foreign exchange translation
adjustments
|*** |  | Restated (see note 3 to the
accompanying consolidated financial statements)                                                                            

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INDEPENDENT AUDITORS REPORT

To the Shareholders of Nortel Networks S.A.

We have audited the accompanying balance sheets of Nortel Networks S.A., a
subsidiary of Nortel Networks Limited, as of December 31, 2002 and 2001 and the
related statements of operations, shareholders equity (deficiency) and cash
flows for each of the years in the three-year period ended December 31, 2002
(all expressed in Euros). These financial statements are the responsibility of
Nortel Networks S.A. management. Our responsibility is to express an opinion on
these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the financial position of Nortel Networks S.A. as of December 31,
2002 and 2001 and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America.

As described in note 2, the accompanying
financial statements of Nortel Networks S.A. as of December 31,
2002 and 2001, and for each of the years in the three-year period
ended December 31, 2002, have been restated.

Deloitte Touche Tohmatsu
/s/ Nicholas L.E. ROLT

Nicholas L.E. ROLT
Neuilly, France
February 25, 2003 (December 23, 2003 as to the effects of the restatements described in note 2)

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NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Statements of Operations for the years ended December 31

(thousands of Euros)
    
    2002As
restated*
    
    
    2001As
restated*
    
    
    2000As
restated*Revenues  external
    
    
    214,922
    
    
    
    275,915
    
    
    
    633,274 related parties
    
    
    473,223
    
    
    
    429,643
    
    
    
    671,965688,145
    
    
    
    705,558
    
    
    
    1,305,239Cost of revenues
    
    
    595,637
    
    
    
    809,472
    
    
    
    1,021,100Gross profit (loss)
    
    
    92,508
    
    
    
    (103,914
    )
    
    
    284,139Selling, general and administrative expense
    
    
    31,998
    
    
    
    74,617
    
    
    
    133,148Research and development expense
    
    
    257,585
    
    
    
    253,327
    
    
    
    88,724Special charges
    
    
    58,854
    
    
    
    74,463
    
    
    
    2,046Operating income (loss)
    
    
    (255,929
    )
    
    
    (506,321
    )
    
    
    60,221Other income  net
    
    
    18,962
    
    
    
    46,240
    
    
    
    128,333Foreign exchange gain (loss)
    
    
    (1,557
    )
    
    
    4,442
    
    
    
    (9,882
    )Interest expense
    
    
    (6,524
    )
    
    
    (5,033
    )
    
    
    (6,423
    )Earnings (loss) before income taxes
    
    
    (245,048
    )
    
    
    (460,672
    )
    
    
    172,249Income tax benefit (provision)
    
    
    1,680
    
    
    
    26,198
    
    
    
    (47,340
    )Net earnings (loss)
    
    
    (243,368
    )
    
    
    (434,474
    )
    
    
    124,909* See
note 2


The accompanying notes are an integral part of these financial statements

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NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Balance Sheets as at December 31

(thousands of Euros)
    
    2002As
restated*
    
    
    2001As
restated*ASSETSCurrent assetsCash and cash equivalents
    
    
    66,687
    
    
    
    49,304Accounts receivable (less provisions of 10,589 for 2002, 17,950 for 2001)
    
    
    45,665
    
    
    
    42,187Inventories  net
    
    
    58,385
    
    
    
    94,065Receivables from related parties
    
    
    123,272
    
    
    
    442,459Income taxes recoverable
    
    
    
    
    
    
    91Other current assets
    
    
    99,490
    
    
    
    48,665Total current assets
    
    
    393,499
    
    
    
    676,771Plant and equipment  net
    
    
    126,948
    
    
    
    125,977Investments at cost
    
    
    5,632
    
    
    
    10,494Deferred income taxes  net
    
    
    35,304
    
    
    
    31,305Other assets
    
    
    6
    
    
    
    12Long-term receivable from related party
    
    
    140,010
    
    
    
    Total assets
    
    
    701,399
    
    
    
    844,559LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIENCY)Current liabilitiesNotes payable
    
    
    
    
    
    
    20,533Note payable to related party
    
    
    
    
    
    
    106,048Trade and other accounts payable
    
    
    152,879
    
    
    
    185,511Payables to related parties
    
    
    52,024
    
    
    
    316,803Other accrued liabilities
    
    
    181,934
    
    
    
    161,480Total current liabilities
    
    
    386,837
    
    
    
    790,375Other liabilities
    
    
    1,837
    
    
    
    2,454Long-term note payable to related party
    
    
    200,000
    
    
    
    181,000588,674
    
    
    
    973,829Guarantees and commitments (note 10)SHAREHOLDERS EQUITY (DEFICIENCY)Common shares, without par value  Authorized shares: unlimited;Issued and outstanding shares: 61,308,951 for 2002 and 2,307,286 for 2001
    
    
    306,544
    
    
    
    35,762Additional paid-in capital
    
    
    
    
    
    
    158,174Retained earnings (deficit)
    
    
    (193,819
    )
    
    
    (323,206
    )Total shareholders equity (deficiency)
    
    
    112,725
    
    
    
    (129,270
    )Total liabilities and shareholders equity (deficiency)
    
    
    701,399
    
    
    
    844,559* See
note 2


The accompanying notes are an integral part of these financial statements

91



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NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Statements of Shareholders Equity (Deficiency)

TotalAdditional
    
    
    Retained
    
    

shareholdersCommon
    
    
    paid-in
    
    
    earnings
    
    
    equity(thousands of Euros)
    
    shares
    
    
    capital
    
    
    (deficit)
    
    
    (deficiency)As restated*
    
    
    As restated*
    
    
    As restated*
    
    
    As restated*Balance at December 31, 1999
    
    
    33,244
    
    
    
    111,847
    
    
    
    35,204
    
    
    
    180,295Capital restructuring
    
    
    2,518
    
    
    
    46,327
    
    
    
    (48,845
    )
    
    
    Net earnings
    
    
    
    
    
    
    
    
    
    
    124,909
    
    
    
    124,909Balance at December 31, 2000*
    
    
    35,762
    
    
    
    158,174
    
    
    
    111,268
    
    
    
    305,204Net loss
    
    
    
    
    
    
    
    
    
    
    (434,474
    )
    
    
    (434,474
    )Balance at December 31, 2001*
    
    
    35,762
    
    
    
    158,174
    
    
    
    (323,206
    )
    
    
    (129,270
    )Common shares issued  net
    
    
    485,363
    
    
    
    
    
    
    
    
    
    
    
    485,363Capital restructuring
    
    
    (214,581
    )
    
    
    (158,174
    )
    
    
    372,755
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    (243,368
    )
    
    
    (243,368
    )Balance at December 31, 2002*
    
    
    306,544
    
    
    
    
    
    
    
    (193,819
    )
    
    
    112,725* See note 2


The accompanying notes are an integral part of these financial statements

92



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NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Statements of Cash Flows for the years ended December 31

(thousands of Euros)
    
    2002As
restated*
    
    
    2001As
restated*
    
    
    2000As
restated*Cash flows from (used in) operating activitiesNet earnings (loss)
    
    
    (243,368
    )
    
    
    (434,474
    )
    
    
    124,909Adjustments to reconcile net earnings (loss) to net cash from (used in) operating activities:Amortization and depreciation
    
    
    39,192
    
    
    
    36,117
    
    
    
    43,122Deferred income taxes
    
    
    2,099
    
    
    
    (29,627
    )
    
    
    19,025Write down of investments
    
    
    4,862
    
    
    
    
    
    
    
    Gain (loss) on disposal of assets
    
    
    6,042
    
    
    
    (3,589
    )
    
    
    (17,880
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,478
    )
    
    
    41,307
    
    
    
    (3,721
    )Receivables from related parties
    
    
    319,187
    
    
    
    13,358
    
    
    
    (269,027
    )Inventories
    
    
    35,680
    
    
    
    (8,428
    )
    
    
    15,474Accounts payable and accrued liabilities
    
    
    (11,625
    )
    
    
    (69,339
    )
    
    
    84,095Payables to related parties
    
    
    (264,779
    )
    
    
    212,884
    
    
    
    46,334Income taxes
    
    
    91
    
    
    
    (27,360
    )
    
    
    26,688Other operating assets and liabilities
    
    
    (57,535
    )
    
    
    69,958
    
    
    
    (93,619
    )Net cash used in operating activities
    
    
    (173,632
    )
    
    
    (199,193
    )
    
    
    (24,600
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (47,176
    )
    
    
    (72,934
    )
    
    
    (74,922
    )Proceeds on disposal of plant and equipment
    
    
    419
    
    
    
    6,990
    
    
    
    18,736Net cash used in investing activities
    
    
    (46,757
    )
    
    
    (65,944
    )
    
    
    (56,186
    )Cash flows from (used in) financing activitiesIssuance of common shares
    
    
    204,363
    
    
    
    
    
    
    
    Increase (decrease) in notes payable and receivable to related parties  net
    
    
    53,942
    
    
    
    287,048
    
    
    
    (23,866
    )Increase (decrease) in notes payable  net
    
    
    (20,533
    )
    
    
    9,822
    
    
    
    10,516Net cash from (used in) financing activities
    
    
    237,772
    
    
    
    296,870
    
    
    
    (13,350
    )Net increase (decrease) in cash and cash equivalents
    
    
    17,383
    
    
    
    31,733
    
    
    
    (94,136
    )Cash and cash equivalents, beginning of year  net
    
    
    49,304
    
    
    
    17,571
    
    
    
    111,707Cash and cash equivalents, end of year  net
    
    
    66,687
    
    
    
    49,304
    
    
    
    17,571* See
note 2


The accompanying notes are an integral part of these financial statements

93



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NORTEL NETWORKS S.A.(a Subsidiary of Nortel Networks Limited)
Notes to Financial Statements
(thousands of Euros, unless otherwise stated)



|1. |  | Nortel Networks S.A.
|-- |  | --------------------



| |  | All of the shares of Nortel Networks S.A. are owned by Nortel Networks
Limited (Nortel Networks) and Nortel Networks International Finance &
Holding B.V., which is an indirect wholly owned subsidiary of Nortel
Networks. Nortel Networks S.A. (formerly known as Nortel Matra Cellular
SCA) is a French société anonyme (limited liability company) established in
1992.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. develops wireless network equipment for Nortel
Networks customers. This includes the engineering, configuration and
implementation of various Nortel Networks products for wireless network
applications.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks EMEA S.A. was merged into Nortel Networks Europe S.A., an
indirect subsidiary of Nortel Networks, on June 30, 2000. Nortel Networks
Europe S.A. was subsequently merged into Nortel Networks S.A. on November
30, 2000. Nortel Networks Europe S.A. was comprised of sales organizations
which marketed Nortel Networks products across Europe, the Middle East and
Africa region (EMEA), and enterprise products marketing support groups
for the EMEA region.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Both of these mergers have been accounted for in these financial statements
as if the entities had been combined on December 31, 1998 and, accordingly,
Nortel Networks S.A.s financial statements have been presented for all
periods prior to the mergers to include the results of operations,
financial position and cash flows of the former Nortel Networks Europe S.A.
and the former Nortel Networks EMEA S.A. as though they had always been a
part of Nortel Networks S.A. All transactions between the companies prior
to the merger have been eliminated and there were no material adjustments
to conform the accounting policies of the combined companies.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | In 2001, Nortel Networks entered into an unprecedented period of business
realignment in response to a significant adjustment in the
telecommunications industry. Industry demand for networking equipment
dramatically declined in response to the industry adjustment, severe
economic downturns in various regions around the world and a tightening in
global capital markets. Nortel Networks implemented a company-wide
restructuring plan to streamline its operations and activities around core
markets and operations, which included significant workforce reductions,
global real estate closures and dispositions, substantial write-downs of
its capital assets, goodwill and other intangible assets and extensive
contract settlements with customers and suppliers around the world. As a
result of these actions, Nortel Networks workforce declined significantly
from January 1, 2001 to December 31, 2002 and over the same time period
Nortel Networks significantly reduced its facilities.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Based on the completion of the comprehensive review and certain related
reviews completed by Nortel Networks (collectively, the comprehensive
review), Nortel Networks S.A. has determined that approximately 34,675
and 27,062 of certain liabilities (primarily accruals and provisions)
carried on its previously reported balance sheets as at December 31, 2002
and 2001, respectively, needed to be released to income. These provisions
were either initially recorded incorrectly in prior periods or not properly
released or adjusted for changes in estimates in the appropriate periods.
In certain cases, costs were incorrectly charged to operations rather than
to the appropriate provisions. Following its determination to restate its
financial statements for the periods noted above, Nortel Networks S.A. also
determined that it would correct certain known errors that were previously
not recorded because the amount of the errors was not material to the
consolidated financial statements. Specifically, among other items, Nortel
Networks S.A. has made certain revenue adjustments to reflect revenue which
should have been deferred instead of recognized in a particular period.
Also, as a result of the restatements, Nortel Networks S.A. made
adjustments to its global profit split accounts (see note 7 & 8). The net
effect of all of these adjustments was a reduction in accumulated deficit
of 27,835 and
6,022 as at
December 31, 2002 and 2001, respectively, and a reduction of the
accumulated retained earnings of 1,975 as at December 31, 2000.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



2002
    
    
    2001
    
    
    2000RevenuesAs previously reported
    
    
    689,665
    
    
    
    705,938
    
    
    
    1,305,239Adjustments
    
    
    (1,520
    )
    
    
    (380
    )
    
    
    As restated
    
    
    688,145
    
    
    
    705,558
    
    
    
    1,305,239Earnings (loss)Earnings (loss) before income taxesAs previously reported
    
    
    (266,861
    )
    
    
    (468,669
    )
    
    
    174,224Adjustments
    
    
    21,813
    
    
    
    7,997
    
    
    
    (1,975
    )As restated
    
    
    (245,048
    )
    
    
    (460,672
    )
    
    
    172,249Net earnings (loss)As previously reported
    
    
    (265,181
    )
    
    
    (442,471
    )
    
    
    126,884Adjustments
    
    
    21,813
    
    
    
    7,997
    
    
    
    (1,975
    )As restated
    
    
    (243,368
    )
    
    
    (434,474
    )
    
    
    124,909




| |  | Nortel Networks has also undertaken a series of physical counts and
reconciliations of plant and equipment. While Nortel Networks believes
that the portion of the work completed to date supports the carrying value
of the plant and equipment recorded in its consolidated balance sheet as at
December 31, 2002, the conclusion of this work could result in adjustments
to the carrying value of certain assets.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following presents details by category, aggregating to the net decrease
in net losses or income resulting from the restatement adjustments for the
years ended December 31:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



2002
    
    
    2001
    
    
    2000Contract and customer-related accruals
    
    
    (2,866
    )
    
    
    23,293
    
    
    
    17Special charges related to restructuring actions
    
    
    4,300
    
    
    
    2,087
    
    
    
    Other accruals and provisions
    
    
    8,803
    
    
    
    2,597
    
    
    
    Total accruals and provisions adjustments
    
    
    10,237
    
    
    
    27,977
    
    
    
    17Revenue adjustments
    
    
    (1,520
    )
    
    
    (380
    )
    
    
    Global profit split adjustments
    
    
    13,096
    
    
    
    (19,600
    )
    
    
    (1,992
    )Net Decrease in net (earnings) loss
    
    
    21,813
    
    
    
    7,997
    
    
    
    (1,975
    )




| |  | Descriptions of the categories of the restatement adjustments to Nortel
Networks net (earnings) loss for the years ended December 31, 2002, 2001
and 2000 that were determined as a result of its comprehensive review are
set forth below.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



| |  | Adjustments related to certain contract and customer-related accruals were
approximately (2,866), 23,293 and 17 for the years ended December 31,
2002, 2001 and 2000, respectively. These accruals were identified as
having been accrued in error and were reversed in the appropriate periods.
Nortel Networks S.A. identified situations in which additional accruals
related to certain contracts were recognized when circumstances did not
justify such accruals. Certain of these accruals were not supported by
adequate documentation. In addition, Nortel Networks S.A. identified
situations where accruals had been released in inappropriate periods.
Therefore, certain adjustments have been made to recognize these releases
in the appropriate periods.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | During the period January 1, 2000 to December 31, 2002, Nortel Networks
recorded, prior to the restatement adjustments, 19,962 of special charges
related to workforce reductions, contract settlement and lease costs, plant
and equipment write-downs and other ancillary special charges in connection
with the implementation of specific restructuring actions to streamline its
operations and activities around core markets and operations. As part of
the restatements, Nortel Networks S.A. has reduced special charges by
4,300, 2,087 and  for the years ended December 31, 2002, 2001 and 2000,
respectively. The following table provides details of the total
adjustments related to these special charges for the years ended December
31:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Severance and fringe benefits calculations
    
    
    3,465
    
    
    
    1,535
    
    
    
    Plant and equipment and real estate related adjustments
    
    
    1,104
    
    
    
    552
    
    
    
    Contract settlements
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    (269
    )
    
    
    
    
    
    
    Total adjustments related to special charges (a)
    
    
    4,300
    
    
    
    2,087
    
    
    
    


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



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



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



| |  | The other accruals and provisions all related to research and development
expenses. Nortel Networks S.A. determined that accruals and provisions of
approximately 8,803
and 2,597 for the
years ended December 31, 2002 and
2001, respectively, should not have been recorded as the
appropriate conditions and documentation supporting the establishment of
these accruals and provisions did not exist at the time of such
recognition. The restatement adjustments included the reversal of these
accruals and provisions in the periods in which they were originally
recorded.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Global profit split adjustments (Related party)
| |  | -----------------------------------------------



| |  | As a result of the restatement of the financial results of Nortel Networks,
certain global profit split adjustments were estimated to reflect the
effect of the restatement on the global profit split methodology (see Note
8 for detailed
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

96



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| |  | discussion of the related party transactions). Accordingly,
Nortel Networks S.A. received an additional charge/(credit) of (13,096) in
2002, 19,600 in 2001, and 1,992 in 2000. These adjustments were
allocated to cost of revenue.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks S.A. recognized revenue in circumstances in which such
revenue should have been deferred to later periods. Adjustments primarily
related to the accounting treatment of certain contract related obligations
with a limited number of customers. In these cases, such obligations should
not have been recorded; rather, recognition of revenue should have been
deferred. In the restatements, Nortel Networks S.A. deferred the
recognition of such revenues to the appropriate periods and released
associated accrued costs in the appropriate periods. The net impact for
these adjustments was a 1,520 decrease, a 380 decrease and no changes to
revenues for the years ended December 31, 2002, 2001 and 2000 respectively.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  | Statement of operations for
the year ended December 31, 2002 as restated
| |  | ------------------------------------------------------------------------



| |  | Net loss for the year ended December 31, 2002 was reduced by 21,813 from
265,181 to 243,368. The major components of the reduction included:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | a 8,710 improvement in gross profit which included a 1,520
reduction in revenues which resulted from revenue deferrals and a
10,230 improvement to cost of revenues (which resulted from
adjustments to contract and customer-related accruals of 2,866
offset by 13,096 of
global profit split adjustments for research and
development cost sharing arrangement);
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a 8,803 decrease in research and development expense due to
net decrease in other accruals and provisions;
| | - | -----------------------------------------------------------------------------------------------------------



| |  | a 4,300 decrease in special charges which resulted from the
release of accruals associated with severance and fringe benefits for
terminated employees, plant and equipment write downs and other
ancillary special charges in connection with the implementation of
specific restructuring actions to streamline operations.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Statement of operations for
the year ended December 31, 2001 as restated
| |  | ------------------------------------------------------------------------



| |  | Net loss for the year ended December 31, 2001 was reduced by 7,997 from
442,471 to 434,474. The major components of the reduction included:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  | a 3,313 improvement in gross profit which included a 380
reduction in revenues which resulted from revenue deferrals and a
3,693 improvement to cost of revenues (which resulted from
adjustments to contract and customer-related accruals of 23,293
offset by 19,600 of global profit split adjustments for research and
development cost sharing arrangement);
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a 2,597 decrease in research and development expense due to
net decrease in other accruals and provisions;
| | - | -----------------------------------------------------------------------------------------------------------



| |  | a 2,087 decrease in special charges which resulted from the
release of accruals associated with severance and fringe benefits for
terminated employees and plant and equipment write downs;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Statement of operations for the year ended December 31, 2000 as restated
| |  | ------------------------------------------------------------------------



| |  | Net income for the year ended December 31, 2000 was reduced by 1,975 from
126,884 to 124,909. The major components of the reduction included:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a 1,975 decrease in gross profit due to an increase to cost of
revenues (which resulted from adjustments to contract and
customer-related accruals of 17 offset by 1,992 of global profit split
adjustments for research and development cost sharing arrangement);
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Balance sheets as at December 31, 2002 and 2001 as restated
| |  | -----------------------------------------------------------



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



| |  | The consolidated balance sheets below present the cumulative impact of the
restatement adjustments described above classified by balance sheet line
item as at December 31, 2002 and 2001.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

98



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| |  | Statement of Operations for the year ended December 31
| |  | ------------------------------------------------------



2002Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restated(thousands of Euros)Revenues   external
    
    
    216,442
    
    
    
    (1,520
    )
    
    
    214,922 related parties
    
    
    473,223
    
    
    
    
    
    
    
    473,223689,665
    
    
    
    (1,520
    )
    
    
    688,145Cost of revenues
    
    
    605,867
    
    
    
    (10,230
    )
    
    
    595,637Gross profit (loss)
    
    
    83,798
    
    
    
    8,710
    
    
    
    92,508Selling, general and administrative expense
    
    
    31,998
    
    
    
    
    
    
    
    31,998Research and development expense
    
    
    266,388
    
    
    
    (8,803
    )
    
    
    257,585Special charges
    
    
    63,154
    
    
    
    (4,300
    )
    
    
    58,854Operating income (loss)
    
    
    (277,742
    )
    
    
    21,813
    
    
    
    (255,929
    )Other income  net
    
    
    18,962
    
    
    
    
    
    
    
    18,962Foreign exchange gain (loss)
    
    
    (1,557
    )
    
    
    
    
    
    
    (1,557
    )Interest expense
    
    
    (6,524
    )
    
    
    
    
    
    
    (6,524
    )Earnings (loss) before income taxes
    
    
    (266,861
    )
    
    
    21,813
    
    
    
    (245,048
    )Income tax benefit (provision)
    
    
    1,680
    
    
    
    
    
    
    
    1,680Net earnings (loss)
    
    
    (265,181
    )
    
    
    21,813
    
    
    
    (243,368
    )


99



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| |  | Statement of Operations for the year ended December 31
| |  | ------------------------------------------------------

2001Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restated(thousands of Euros)Revenues  external
    
    
    276,295
    
    
    
    (380
    )
    
    
    275,915 related parties
    
    
    429,643
    
    
    
    
    
    
    
    429,643705,938
    
    
    
    (380
    )
    
    
    705,558Cost of revenues
    
    
    813,165
    
    
    
    (3,693
    )
    
    
    809,472Gross profit (loss)
    
    
    (107,227
    )
    
    
    3,313
    
    
    
    (103,914
    )Selling, general and administrative expense
    
    
    74,617
    
    
    
    
    
    
    
    74,617Research and development expense
    
    
    255,924
    
    
    
    (2,597
    )
    
    
    253,327Special charges
    
    
    76,550
    
    
    
    (2,087
    )
    
    
    74,463Operating income (loss)
    
    
    (514,318
    )
    
    
    7,997
    
    
    
    (506,321
    )Other income  net
    
    
    46,240
    
    
    
    
    
    
    
    46,240Foreign exchange gain (loss)
    
    
    4,442
    
    
    
    
    
    
    
    4,442Interest expense
    
    
    (5,033
    )
    
    
    
    
    
    
    (5,033
    )Earnings (loss) before income taxes
    
    
    (468,669
    )
    
    
    7,997
    
    
    
    (460,672
    )Income tax benefit (provision)
    
    
    26,198
    
    
    
    
    
    
    
    26,198Net earnings (loss)
    
    
    (442,471
    )
    
    
    7,997
    
    
    
    (434,474
    )


100



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| |  | Statement of Operations for the year ended December 31
| |  | ------------------------------------------------------



2000Aspreviously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restated(thousands of Euros)Revenues  external
    
    
    633,274
    
    
    
    
    
    
    
    633,274 related parties
    
    
    671,965
    
    
    
    
    
    
    
    671,9651,305,239
    
    
    
    
    
    
    
    1,305,239Cost of revenues
    
    
    1,019,125
    
    
    
    1,975
    
    
    
    1,021,100Gross profit (loss)
    
    
    286,114
    
    
    
    (1,975
    )
    
    
    284,139Selling, general and administrative expense
    
    
    133,148
    
    
    
    
    
    
    
    133,148Research and development expense
    
    
    88,724
    
    
    
    
    
    
    
    88,724Special charges
    
    
    2,046
    
    
    
    
    
    
    
    2,046Operating income (loss)
    
    
    62,196
    
    
    
    (1,975
    )
    
    
    60,221Other income  net
    
    
    128,333
    
    
    
    
    
    
    
    128,333Foreign exchange gain (loss)
    
    
    (9,882
    )
    
    
    
    
    
    
    (9,882
    )Interest expense
    
    
    (6,423
    )
    
    
    
    
    
    
    (6,423
    )Earnings (loss) before income taxes
    
    
    174,224
    
    
    
    (1,975
    )
    
    
    172,249Income tax benefit (provision)
    
    
    (47,340
    )
    
    
    
    
    
    
    (47,340
    )Net earnings (loss)
    
    
    126,884
    
    
     
   (1,975
    )
    
    
    124,909


101



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| |  | Balance Sheet
| |  | -------------



December 31, 2002Aspreviously
    
    
    
    
    
    
    As(thousands of Euros)
    
    reported
    
    
    Restatement
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    
    66,687
    
    
    
    
    
    
    
    66,687Accounts receivable (less provisions of 10,589 for 2002, 17,950 for 2001)
    
    
    45,665
    
    
    
    
    
    
    
    45,665Inventories  net
    
    
    58,385
    
    
    
    
    
    
    
    58,385Receivables from related parties
    
    
    123,272
    
    
    
    
    
    
    
    123,272Income taxes recoverable
    
    
    
    
    
    
    
    
    
    
    Other current assets
    
    
    99,490
    
    
    
    
    
    
    
    99,490Total current assets
    
    
    393,499
    
    
    
    
    
    
    
    393,499Plant and equipment  net
    
    
    125,292
    
    
    
    1,656
    
    
    
    126,948Investments at cost
    
    
    5,632
    
    
    
    
    
    
    
    5,632Deferred income taxes  net
    
    
    35,304
    
    
    
    
    
    
    
    35,304Other assets
    
    
    6
    
    
    
    
    
    
    
    6Long-term receivable from related party
    
    
    140,010
    
    
    
    
    
    
    
    140,010Total assets
    
    
    699,743
    
    
    
    1,656
    
    
    
    701,399LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIENCY)Current liabilitiesNotes payable
    
    
    
    
    
    
    
    
    
    
    Note payable to related party
    
    
    
    
    
    
    
    
    
    
    Trade and other accounts payable
    
    
    157,982
    
    
    
    (5,103
    )
    
    
    152,879Payables to related parties
    
    
    43,528
    
    
    
    8,496
    
    
    
    52,024Other accrued liabilities
    
    
    211,506
    
    
    
    (29,572
    )
    
    
    181,934Total current liabilities
    
    
    413,016
    
    
    
    (26,179
    )
    
    
    386,837Other liabilities
    
    
    1,837
    
    
    
    
    
    
    
    1,837Long-term note payable to related party
    
    
    200,000
    
    
    
    
    
    
    
    200,000614,853
    
    
    
    (26,179
    )
    
    
    588,674Guarantees
and commitments (note 10)SHAREHOLDERS EQUITY (DEFICIENCY)Common shares, without par value  Authorized shares: unlimited;
Issued and outstanding shares: 61,308,951 for 2002 and 2,307,286 for 2001
    
    
    306,544
    
    
    
    
    
    
    
    306,544Additional paid-in capital
    
    
    
    
    
    
    
    
    
    
    Retained earnings (deficit)
    
    
    (221,654
    )
    
    
    27,835
    
    
    
    (193,819
    )Total shareholders equity (deficiency)
    
    
    84,890
    
    
    
    27,835
    
    
    
    112,725Total liabilities and shareholders equity (deficiency)
    
    
    699,743
    
    
    
    1,656
    
    
    
    701,399


102



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| |  | Balance Sheet
| |  | -------------



December 31, 2001Aspreviously
    
    
    
    
    
    
    As(thousands of Euros)
    
    reported
    
    
    Restatement
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    
    49,304
    
    
    
    
    
    
    
    49,304Accounts receivable (less provisions of 10,589 for 2002, 17,950 for 2001)
    
    
    42,187
    
    
    
    
    
    
    
    42,187Inventories  net
    
    
    94,065
    
    
    
    
    
    
    
    94,065Receivables from related parties
    
    
    442,459
    
    
    
    
    
    
    
    442,459Income taxes recoverable
    
    
    91
    
    
    
    
    
    
    
    91Other current assets
    
    
    48,665
    
    
    
    
    
    
    
    48,665Total current assets
    
    
    676,771
    
    
    
    
    
    
    
    676,771Plant and equipment  net
    
    
    125,425
    
    
    
    552
    
    
    
    125,977Investments at cost
    
    
    10,494
    
    
    
    
    
    
    
    10,494Deferred income taxes  net
    
    
    31,305
    
    
    
    
    
    
    
    31,305Other assets
    
    
    12
    
    
    
    
    
    
    
    12Long-term receivable from related party
    
    
    
    
    
    
    
    
    
    
    Total assets
    
    
    844,007
    
    
    
    552
    
    
    
    844,559LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIENCY)Current liabilitiesNotes payable
    
    
    20,533
    
    
    
    
    
    
    
    20,533Note payable to related party
    
    
    106,048
    
    
    
    
    
    
    
    106,048Trade and other accounts payable
    
    
    187,230
    
    
    
    (1,719
    )
    
    
    185,511Payables to related parties
    
    
    295,211
    
    
    
    21,592
    
    
    
    316,803Other accrued liabilities
    
    
    186,823
    
    
    
    (25,343
    )
    
    
    161,480Total current liabilities
    
    
    795,845
    
    
    
    (5,470
    )
    
    
    790,375Other liabilities
    
    
    2,454
    
    
    
    
    
    
    
    2,454Long-term note payable to related party
    
    
    181,000
    
    
    
    
    
    
    
    181,000979,299
    
    
    
    (5,470
    )
    
    
    973,829Guarantees
and commitments (note 10)SHAREHOLDERS EQUITY (DEFICIENCY)Common shares, without par value  Authorized shares: unlimited;
Issued and outstanding shares: 61,308,951 for 2002 and 2,307,286 for 2001
    
    
    35,762
    
    
    
    
    
    
    
    35,762Additional paid-in capital
    
    
    158,174
    
    
    
    
    
    
    
    158,174Retained earnings (deficit)
    
    
    (329,228
    )
    
    
    6,022
    
    
    
    (323,206
    )Total shareholders equity (deficiency)
    
    
    (135,292
    )
    
    
    6,022
    
    
    
    (129,270
    )Total liabilities and shareholders equity (deficiency)
    
    
    844,007
    
    
    
    552
    
    
    
    844,559


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|3. |  | Significant accounting policies
|-- |  | -------------------------------



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



| |  | The accompanying financial statements of Nortel Networks S.A. have been
prepared in accordance with accounting principles generally accepted in the
United States of America.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As described in note 2, the
statements of operations, shareholders equity and cash flows
for the years ended December 31, 2002, 2001 and 2000 and balance
sheets as at December 31, 2002 and 2001, including the applicable notes, have been restated.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | These financial statements have been prepared on the basis that Nortel
Networks S.A. is a going concern as a result of a pledge of support from
Nortel Networks.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) | Use of estimates
| | --- | ----------------



| |  | Nortel Networks S.A. makes estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities as at the date of the 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 long-term contracts,
allowance for uncollectible accounts receivable and customer
financings, receivables sales, inventory obsolescence, product
warranty, amortization, asset valuations, impairment assessments,
employee benefits, taxes, restructuring and other provisions and
contingencies.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Translation of foreign currencies
| | --- | ---------------------------------



| |  | The functional currency of Nortel Networks S.A. is the Euro for 2002
and 2001 and the French Franc for 2000 (translated into Euros at the
defined rate of 6.55957 French Francs per Euro).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Transactions and financial statement items denominated in a currency
other than Nortel Networks S.A.s functional currency are translated
into the Euro at the exchange rates in effect at the balance sheet date
for monetary assets and liabilities, and at historical exchange rates
for non-monetary assets and liabilities. Revenues and expenses are
translated at average rates for the period, except for amortization and
depreciation
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | which is translated on the same basis as the related assets. Resulting
gains or losses are reflected in net earnings (loss).
| |  | ----------------------------------------------------------------------------------------------------------------------------



| | (c) | Revenue recognition
| | --- | -------------------



| |  | Nortel Networks S.A.s revenues are primarily derived from two sources:
the sale of wireless products and the provision of related services.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. products and services are generally sold as part
of a contract and the terms of the contract, taken as a whole,
determine the appropriate revenue recognition method.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. recognizes revenue under 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 Staff Accounting Bulletin
(SAB) 101 Revenue Recognition in Financial Statements (SAB 101)
depending upon the terms of the contract.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Revenue for hardware sold separately that does not require
significant customization is recognized under SAB 101. Hardware
revenue, net of trade discounts and allowances, is recognized upon
shipment and when all significant contractual obligations have been
satisfied and collection is reasonably assured.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Software revenue is generally recognized under SOP 97-2. Software
revenue under SOP 97-2 is recognized when persuasive evidence of an
arrangement exists, when the software is delivered in accordance with
all terms and conditions of the customer contracts, when the fee is
fixed or determinable and when collection is reasonably assured. For
software arrangements involving multiple elements, Nortel Networks S.A.
allocates revenue to each element based on vendor specific objective
evidence of relative fair values, which are derived by allocating a
value to each element that is based upon the prices charged when the
element is sold separately.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For contracts involving multiple elements, Nortel Networks S.A.
allocates revenue to each element based on relative fair values.
Provided none of the undelivered elements are essential to the
functionality of the delivered elements, 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 101.
Engineering, installation and other services are recognized as the
services are performed.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For long-term contracts, primarily those related to customized network
solutions and network build outs, revenues are recognized under SOP
81-1 using the percentage-of-completion method on the basis of
percentage of costs incurred to date on a contract, relative to the
estimated total 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.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. 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 sales
at the time of shipment to the distribution channel. Accruals for
estimated sales returns and other allowances are recorded at the time
of shipment and are based on contract terms and prior claims
experience.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | Research and development
| | --- | ------------------------



| |  | Research and development costs are charged to net earnings (loss) in
the periods in which they are incurred. Related tax credits are
deducted from the income tax provision.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (e) | Income taxes
| | --- | ------------



| |  | Nortel Networks S.A. 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 consequences of events recognized in the
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
Networks S.A. assesses the realizability of its net deferred tax
assets, and based on all available evidence, both positive and
negative, determines whether it is more likely than not that the
deferred tax assets or a portion thereof will be realized.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | 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 financial statements.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (g) | Inventories
| | --- | -----------



| |  | Inventories are valued at the lower of cost (calculated generally on a
first-in, first-out basis) and market. The cost of finished goods and
work in process is comprised of material, labour and manufacturing
overhead.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (h) | State sponsored pension plans
| | --- | -----------------------------



| |  | All employees are covered for pension entitlements under state
sponsored pension plans, funded by regular contributions that are
reflected in net earnings (loss).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (i) | Warranty costs
| | --- | --------------



| |  | Nortel Networks S.A.s products are covered by standard product
warranty plans generally for 18 months. A liability for the expected
cost of warranty-related claims is established when product is sold and
the related revenue is recognized. The amount of the warranty liability
accrued reflects an estimate of the expected future costs of honoring
certain obligations under the warranty plan. In estimating the
warranty liability, historical material replacement costs and
associated labour to correct the product failure are considered.
Should future product failure rates and/or replacement costs differ
from historical levels, revisions to the estimated warranty liability
may be required.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (j) | Plant and equipment
| | --- | -------------------



| |  | Plant and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated generally using the straight-line method
over the estimated useful lives of the related assets based on the
following rates:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Buildings  30 years;
Leasehold improvements  the lesser of lease term and estimated useful life;
Machinery and equipment  5 to 10 years;
Furniture and fixtures  10 years; and
Computers  5 years.


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| | (k) | Impairment or disposal of long-lived assets (plant and equipment)
| | --- | -----------------------------------------------------------------



| |  | Long-lived assets held and used
| |  | -------------------------------



| |  | Nortel Networks S.A. tests long-lived assets or asset groups 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; 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 current expectation that the asset will more likely than not be
sold or disposed significantly before the end of its estimated
useful life.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Recoverability is assessed based on the carrying amount of the asset
and its fair value which is generally determined based on the sum of
the undiscounted cash flows expected to result from the use and the
eventual disposal of the asset. An impairment loss is recognized
when the carrying amount is not recoverable and 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 commitment to a plan to
sell the assets; the availability of the assets for immediate sale
in their present condition; whether an active program to locate
buyers and other actions to sell the assets has been initiated;
whether the sale of the assets is probable and their transfer is
expected to qualify for recognition as a completed sale within one
year; whether the assets are being marketed at reasonable prices in
relation to their fair value; and how unlikely it is that
significant changes will be made to the plan to sell the assets.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. measures long-lived assets to be disposed of by
sale at the lower of carrying amount and fair value less cost to
sell. Fair value is determined using quoted market prices or the
anticipated cash flows discounted at a rate commensurate with the
risk involved.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Long-lived assets to be disposed of other than by sale
| |  | ------------------------------------------------------



| |  | Nortel Networks S.A. classifies an asset or asset group that will be
disposed of other than by sale as held and used until the disposal
transaction occurs. The asset or asset group continues to be
depreciated based on revisions to its estimated useful life 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.
An impairment loss is recognized when the carrying amount is not
recoverable and exceeds the fair value of the asset.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (l) | Financial instruments
| | --- | ---------------------



| |  | The financial instruments that may subject Nortel Networks S.A. to
concentrations of credit risk are principally comprised of cash and
cash equivalents and trade accounts receivable. The carrying values of
monetary assets and liabilities approximate their fair value. Cash and
cash equivalents are, for the most part, held by three major financial
institutions. Deposits held with banks may exceed the amount of
insurance provided on such deposits. These deposits may generally be
redeemed upon demand. Nortel Networks S.A.s customer base is
dispersed across the main Western European countries. Nortel Networks
S.A. performs ongoing credit evaluations of its customers and maintains
an allowance for potential credit losses for sales in high-risk
countries.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (m) | Receivables sales
| | --- | -----------------



| |  | A gain or loss is recorded 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 value 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. reviews the fair value assigned to retained
interests at each reporting date subsequent to the date of the
transfer. 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
adjustments are recorded in other income  net.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (n) | Stock-based compensation
| | --- | ------------------------



| |  | Under various stock option programs of Nortel Networks Corporation, the
parent company of Nortel Networks, options may be granted to various
eligible employees and directors of Nortel Networks S.A. to purchase
common shares of Nortel Networks Corporation.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Had Nortel Networks S.A. applied the fair value based method in prior
years, regarding the participation of its eligible employees and
directors in the stock option programs of Nortel Networks Corporation,
Nortel Networks S.A.s reported net earnings (loss) would have been
adjusted to the pro forma amounts as indicated below for each of the
three years ended December 31:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

2002
    
    
    2001
    
    
    2000Net earnings (loss)  reported
    
    
    (243,368
    )
    
    
    (434,474
    )
    
    
    124,909Pro forma stock option expense
    
    
    (30,307
    )
    
    
    (42,999
    )
    
    
    (35,213
    )Net earnings (loss)  pro forma
    
    
    (273,675
    )
    
    
    (477,473
    )
    
    
    89,696




| |  | The fair value of Nortel Networks S.A.s stock options used to compute
pro forma net earnings (loss) is the estimated fair value at grant
date, applicable to Nortel Networks S.A., using the Black-Scholes
option-pricing model with the following weighted average assumptions,
related to Nortel Networks Corporation for each of the three years
ended December 31:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Weighted average assumptions
    
    2002
    
    
    2001
    
    
    2000Expected dividend
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.13
    %Expected volatility
    
    
    71.25
    %
    
    
    70.36
    %
    
    
    54.01
    %Risk-free interest rate
    
    
    4.43
    %
    
    
    4.49
    %
    
    
    4.94
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4




| |  | The weighted average fair values of Nortel Networks Corporations stock
options, calculated using the Black-Scholes option-pricing model,
granted during the three years ended December 31, 2002, 2001, and 2000
were U.S. $3.50, U.S. $8.38 and U.S. $27.25 per option, respectively.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Black-Scholes option-pricing model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option-pricing
models require the input of highly subjective assumptions including the
expected price volatility. Nortel Networks S.A. uses expected
volatility rates, which are based on historical volatility rates
trended into future years. Changes in the subjective
input assumptions can materially affect the fair value estimate, and
therefore the existing models do not necessarily provide a reliable
single measure of the fair value of Nortel Networks S.A.s stock
options.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | In December 2002, the Financial Accounting Standards Board (the FASB)
issued SFAS No. 148 Accounting for Stock-Based
Compensation 
Transition and Disclosure (SFAS 148) which amended the transitional
provisions of SFAS 123 for entities choosing to recognize stock-based
compensation under the fair value based method of SFAS 123, rather than
electing to continue to follow the intrinsic value method of APB 25.
Under SFAS 148, Nortel Networks S.A. may adopt the recommendations of
SFAS 123 either (1) prospectively to awards granted or modified after
the beginning of the year of adoption, (2) retroactively with
restatement for awards granted or modified since January 1, 1995, or
(3) prospectively to awards granted or modified since January 1, 1995.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. will commence expensing employee stock-based
compensation using the fair value based method prospectively, as per
SFAS 123, for all awards granted or modified after January 1, 2003, as
permitted under SFAS 148. Stock-based compensation will be measured
using the Black-Scholes option pricing model. The impact of adopting
the fair value based method will depend on various factors including,
but not limited to, the extent to which Nortel Networks S.A. will use
stock-based compensation in the future and the fair value of the
awards, which is dependent on a number of variables including Nortel
Networks Corporations common share price and its historical
volatility. Because there is uncertainty within each of these factors,
the expense to be recognized by Nortel Networks S.A. will vary as a
result of the adoption of the fair value based method.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  | Nortel Networks S.A. currently conducts certain lease financing
transactions through special purpose entities and is in the process of
assessing the structure of these transactions against the criteria set
out in FIN 46. Certain lease financing transactions are structured
through single transaction special purpose entities that currently do
not have sufficient equity at risk as defined in FIN 46. In addition,
Nortel Networks retains certain risks associated with guaranteeing
recovery of approximately 88 percent of the unamortized principal which
is expected to represent the majority of the risks associated with the
special purpose entities activities. This percentage is adjusted over
time as the underlying debt matures. Therefore, it is expected that
unless the existing arrangements are modified prior to July 1, 2003,
Nortel Networks will be required to consolidate the assets, liabilities
and any non-controlling interests of these special purpose entities
effective July 1, 2003. The total assets and total liabilities held by
these entities at December 31, 2002 are approximately 79,000 and
79,000 respectively.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | In December 2002, the FASB issued SFAS 148 which is effective for
years ending after December 15, 2002 (see note 2(n)).
| | --- | -----------------------------------------------------------------------------------------------------------------------



| | (c) | In November 2002, the FASB issued FIN 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45), which requires
elaborating on the disclosures that must be made by a guarantor in its
financial statements about its obligations under certain guarantees.
It also requires that a guarantor recognize, at the inception of
certain types of guarantees, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The disclosure
requirements of FIN 45 are effective for financial statements issued
after December 15, 2002, and have been applied in the presentation of
the accompanying consolidated financial statements. The recognition
requirements of FIN 45 are applicable for guarantees issued or
modified after December 31, 2002. Nortel Networks S.A. has not yet
determined the effect, if any, the recognition requirement will have
on its business, results of operations and financial condition.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | In June 2002, the FASB issued SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), which is
effective for exit or disposal activities initiated after December 31,
2002. SFAS 146 supercedes Emerging Issues Task Force (EITF) Issue
No. 94-3 Liability Recognition for Certain
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

108



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| |  | Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in Restructuring) (EITF 94-3). SFAS 146 requires that costs associated
with an exit or disposal activity be recognized when the liability is
incurred, whereas EITF 94-3 required recognition of a liability when an
entity committed to an exit plan. Therefore the effect of SFAS 146
will be to change the timing of recognizing certain liabilities with no
expected material valuation differences. Plans initiated before
December 31, 2002 continue to be accounted for under EITF 94-3. Nortel
Networks S.A. does not expect the adoption of SFAS 146 to have a
material impact on its business, results of operations and financial
condition.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS 143), which is effective for financial
statements issued for fiscal years beginning after June 15, 2002.
SFAS 143 addresses the recognition and measurement of obligations
associated with the retirement of tangible long-lived assets. Nortel
Networks S.A. does not expect the adoption of SFAS 143 to have a
material impact on its business, results of operations and financial
condition.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

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|4. |  | Financial statement details
|-- |  | ---------------------------



| |  | Statements of operations
| |  | ------------------------



| |  | The following table provides details for the years ended December 31:
| |  | ---------------------------------------------------------------------



| |  | Other income  net:
| |  | -------------------

2002
    
    
    2001
    
    
    2000Royalties (a)
    
    
    26,556
    
    
    
    49,201
    
    
    
    114,987Gain (loss) on disposal of assets
    
    
    (6,042
    )
    
    
    3,589
    
    
    
    17,880Other  net
    
    
    (1,552
    )
    
    
    (6,550
    )
    
    
    (4,534
    )Other income  net
    
    
    18,962
    
    
    
    46,240
    
    
    
    128,333


(a)
    
    Affiliated entities pay royalty fees to Nortel Networks S.A. on
their total Global System for Mobile communications (GSM) technology
sales (5 percent of total GSM sales in 2002, 10 percent in 2001, and
15 percent in 2000).




| |  | Balance sheets
| |  | --------------



| |  | The following tables provide details as at December 31:
| |  | -------------------------------------------------------



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

2002
    
    
    2001Raw materials
    
    
    21,155
    
    
    
    60,302Work in process
    
    
    30,527
    
    
    
    32,004Finished goods
    
    
    6,703
    
    
    
    1,759Inventories  net (a)
    
    
    58,385
    
    
    
    94,065


(a)
    
    Net of inventory provisions of 30,312 and 39,504 as at December
31, 2002 and 2001, respectively. Included in trade and other accounts
payable are accruals of 8,791 at December 31, 2002 for cancellation
charges, for inventory in excess of future demand and for the
settlement of certain other claims related to its contract
manufacturers or suppliers.




| |  | Other current assets:
| |  | ---------------------

2002
    
    
    2001Employee receivables
    
    
    811
    
    
    
    1,855Put option (a)
    
    
    77,500
    
    
    
    Prepaid rent and other
    
    
    17,650
    
    
    
    31,440Other receivables
    
    
    3,529
    
    
    
    15,370Other current assets
    
    
    99,490
    
    
    
    48,665


(a)
    
    See Note 10 for a description of the put option.


110



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##### Table of Contents





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

2002
    
    
    2001Cost:Land and buildings
    
    
    13,726
    
    
    
    13,726Leasehold improvements
    
    
    22,611
    
    
    
    22,630Machinery and equipment
    
    
    203,473
    
    
    
    168,066Furniture and fixtures
    
    
    34,771
    
    
    
    32,879Computers
    
    
    20,119
    
    
    
    26,955Other
    
    
    5,419
    
    
    
    5,346300,119
    
    
    
    269,602Less accumulated depreciation:Buildings
    
    
    (5,404
    )
    
    
    (4,981
    )Leasehold improvements
    
    
    (15,979
    )
    
    
    (15,350
    )Machinery and equipment
    
    
    (105,300
    )
    
    
    (83,063
    )Furniture and fixtures
    
    
    (27,611
    )
    
    
    (16,886
    )Computers
    
    
    (18,487
    )
    
    
    (21,361
    )Other
    
    
    (390
    )
    
    
    (1,984
    )(173,171
    )
    
    
    (143,625
    )Plant and equipment  net
    
    
    126,948
    
    
    
    125,977




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

2002
    
    
    2001Put option (a)
    
    
    77,500
    
    
    
    Contract related
    
    
    33,592
    
    
    
    46,935Outsourcing, selling, general and administration and research & development related
    
    
    24,811
    
    
    
    45,278Product related
    
    
    17,285
    
    
    
    25,877Warranty
    
    
    7,544
    
    
    
    9,270Miscellaneous taxes
    
    
    (2,169
    )
    
    
    6,120Deferred income
    
    
    2,144
    
    
    
    660Other
    
    
    21,227
    
    
    
    27,340Other accrued liabilities
    
    
    181,934
    
    
    
    161,480


(a)
    
    See Note 10 for a description of the put option.




| |  | Statements of cash flows
| |  | ------------------------



| |  | The following tables provide details for the years ended December 31:
| |  | ---------------------------------------------------------------------



| |  | Interest and income taxes paid:
| |  | -------------------------------

2002
    
    
    2001
    
    
    2000Interest paid
    
    
    6,524
    
    
    
    5,033
    
    
    
    6,423Income taxes paid
    
    
    121
    
    
    
    30,271
    
    
    
    2,503


111



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| |  | Receivables sales:
| |  | ------------------

2002
    
    
    2001
    
    
    2000Proceeds from new securitizations
    
    
    
    
    
    
    
    
    
    
    2,015Proceeds from collections
reinvested in revolving period
securitizations
    
    
    12,086
    
    
    
    235,060
    
    
    
    534,397




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



| |  | In accordance with SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, Nortel Networks S.A. is required to
disclose information about its products, services, the geographic area in
which it operates and major customers. Nortel Networks S.A. operates in
one reportable segment, Wireless Networks, which includes the wireless
mobility switching and access products for voice and data communications
that span most major global standards for mobile networks.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Geographic information
| |  | ----------------------



| |  | The following table sets forth external revenues by geographic regions
based on the location of the customer for each of the three years ended
December 31:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

2002
    
    
    2001
    
    
    2000External revenuesFrance
    
    
    119,155
    
    
    
    146,929
    
    
    
    454,960EMEA  excluding France
    
    
    95,168
    
    
    
    127,179
    
    
    
    177,007Other
    
    
    599
    
    
    
    1,807
    
    
    
    1,307Total
    
    
    214,922
    
    
    
    275,915
    
    
    
    633,274




| |  | Major customers
| |  | ---------------



| |  | External revenues include amounts from two separate customers located in
France in the amounts of 56,543 and 54,015 in 2002, 56,501 and 83,563
in 2001, and 250,918 and 189,873 in 2000.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Long-lived assets
| |  | -----------------



| |  | All long-lived assets are located in France.
| |  | --------------------------------------------

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



| |  | During 2002, in light of the continued downturn in both the
telecommunications industry and the economic environment and capital market
trends impacting Nortel Networks S.A.s operations and expected future
growth rates, Nortel Networks S.A. continued to implement its work plan to
streamline its operations and activities around its core markets and
leadership strategies.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Special charges recorded January 1, 2000 to December 31, 2002 were as
follows:
| |  | ------------------------------------------------------------------------------



Contractsettlement
    
    
    Plant andWorkforce
    
    
    and lease
    
    
    equipmentreduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    TotalProvision balance as at January 1, 2000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special charges
    
    
    2,046
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,046Cash drawdowns
    
    
    (2,046
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,046
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Provision balance as at December 31, 2000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special charges
    
    
    27,435
    
    
    
    17,123
    
    
    
    20,754
    
    
    
    9,151
    
    
    
    74,463Cash drawdowns
    
    
    (26,346
    )
    
    
    (176
    )
    
    
    
    
    
    
    (340
    )
    
    
    (26,862
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (20,754
    )
    
    
    
    
    
    
    (20,754
    )Provision balance as at December 31, 2001
    
    
    1,089
    
    
    
    16,947
    
    
    
    
    
    
    
    8,811
    
    
    
    26,847Special charges
    
    
    56,763
    
    
    
    
    
    
    
    8,916
    
    
    
    1,991
    
    
    
    67,670Reversal of prior year amounts
    
    
    
    
    
    
    (161
    )
    
    
    
    
    
    
    (8,655
    )
    
    
    (8,816
    )Cash drawdowns
    
    
    (48,629
    )
    
    
    (11,511
    )
    
    
    
    
    
    
    (1,414
    )
    
    
    (61,554
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (8,916
    )
    
    
    
    
    
    
    (8,916
    )Provision balance as at December 31, 2002
    
    
    9,223
    
    
    
    5,275
    
    
    
    
    
    
    
    733
    
    
    
    15,231




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



Employees (approximately)Direct (a)
    
    
    Indirect (b)
    
    
    TotalRFT employee notifications by period:During 2000
    
    
    
    
    
    
    35
    
    
    
    35During 2001
    
    
    140
    
    
    
    170
    
    
    
    310During 2002
    
    
    21
    
    
    
    468
    
    
    
    489RFT employee notifications as at December 31, 2002
    
    
    161
    
    
    
    673
    
    
    
    834 (a)
    
    Direct employees include employees performing manufacturing,
assembly, test and inspection activities associated with the
production of Nortel Networks products.(b)
    
    Indirect employees include employees performing manufacturing
management, sales, marketing, research and development and
administrative related activities.




| |  | Year ended December 31, 2002
| |  | ----------------------------



| |  | For the year ended December 31, 2002, Nortel Networks S.A. recorded special
charges of 67,670.
| |  | -----------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of 56,763 were related to the cost of
severance and benefits associated with the approximately 489 employees
notified of termination. As at December 31, 2002, the workforce reduction
provision balance has been drawn down by cash payments of 48,629,
resulting in an ending provision balance for workforce reduction of 9,223.
The remaining provision is expected to be substantially drawn down by the
end of 2003.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During 2002, Nortel Networks S.A. recorded a reversal of contract
settlement and lease costs of approximately (161). For certain properties
during 2002, Nortel Networks S.A. modified the original disposition plan
and is pursuing lease terminations instead of subleasing due to current
market conditions. This change reduced sublease income
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | expectations from 945, disclosed at the end of 2001, to nil as at December
31, 2002. Nortel Networks S.A. expects to have disposed substantially all
of these properties by the end of the first quarter of 2004. As at
December 31, 2002, the provision balance for contract settlement and lease
costs has been drawn down by cash payments of 11,511, resulting in an
ending provision balance of 5,275. The remaining provision is expected to
be substantially drawn down by the end of 2004.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and equipment write downs of approximately 8,916 consisted mainly of
the write down to net realizable value of leasehold improvements and
manufacturing equipment.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other consists primarily of contract settlement costs to either cancel or
renegotiate existing supply contracts net of a reversal of 8,655 related
to 2001 charges due to favourable negotiations.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Year ended December 31, 2001
| |  | ----------------------------



| |  | For the year ended December 31, 2001, Nortel Networks S.A. recorded charges
of 74,463 related to streamlining its operations and activities.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of 27,435 were related to the cost of
severance and benefits associated with the approximately 310 employees
notified of termination. As at December 31, 2001, the workforce reduction
provision balance has been drawn down by cash payments of 26,346,
resulting in an ending provision balance for workforce reduction of 1,089.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contract settlement and lease costs of 17,123 included 2,009 of
negotiated settlements to cancel or renegotiate contracts and 15,114 of
net lease charges related to a number of operating leases no longer
required. Lease costs represent Nortel Networks S.A.s future contractual
obligations under its applicable operating leases net of approximately 945
in expected sublease revenue on leases that Nortel Networks S.A. cannot
terminate. As at December 31, 2001, the provision balance for contract
settlement and lease costs was drawn down by cash payments of 176,
resulting in a provision balance of 16,947.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and equipment write downs of approximately 20,754 consisted mainly
of the write down to net realizable value of leasehold improvements and
manufacturing equipment in the Châteaudun facility.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other consists primarily of contract settlement costs to either cancel or
renegotiate existing supply contracts.
| |  | ----------------------------------------------------------------------------------------------------------------



| |  | Year ended December 31, 2000
| |  | ----------------------------



| |  | For the year ended December 31, 2000, Nortel Networks S.A. recorded special
charges in the aggregate of 2,046, representing workforce reduction costs
related to approximately 35 employees in connection with the outsourcing of
certain functions.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The provision balance was fully drawn down in 2000 through cash payments.
| |  | -------------------------------------------------------------------------

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



| |  | The following is a reconciliation of income taxes, calculated at the French
income tax rate, to the income tax benefit (provision) included in the
accompanying statements of operations for the years ended December 31:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



2002
    
    
    2001
    
    
    2000Income taxes at French rates
(2002  35.4%, 2001  36.4%, 2000  37.8%)
    
    
    86,364
    
    
    
    167,872
    
    
    
    (65,057
    )Research and development credit
    
    
    6,098
    
    
    
    6,098
    
    
    
    6,098Foreign tax
    
    
    (2,198
    )
    
    
    (2,948
    )
    
    
    (6,357
    )Change in valuation allowance
    
    
    (83,182
    )
    
    
    (144,764
    )
    
    
    (1,952
    )Utilization of losses
    
    
    
    
    
    
    
    
    
    
    20,828Other (a)
    
    
    (5,402
    )
    
    
    (60
    )
    
    
    (900
    )Income tax benefit (provision)
    
    
    1,680
    
    
    
    26,198
    
    
    
    (47,340
    )Income tax benefit (provision):Current
    
    
    (2,319
    )
    
    
    (3,460
    )
    
    
    (49,284
    )Deferred
    
    
    3,999
    
    
    
    29,658
    
    
    
    1,944
    1,680
    
    
    
    26,198
    
    
    
    (47,340
    ) (a)
    
    Other includes rate differential as well as permanent differences




| |  | The following table shows the significant components included in deferred
income taxes as at December 31:
| |  | ---------------------------------------------------------------------------------------------------------



2002
    
    
    2001Deferred income taxes:Assets:Tax benefit of tax credits
    
    
    12,196
    
    
    
    6,098Tax benefit of losses
    
    
    253,761
    
    
    
    152,837Provisions and reserves
    
    
    14,213
    
    
    
    26,318Other
    
    
    
    
    
    
    624280,170
    
    
    
    185,877Valuation allowance
    
    
    (227,946
    )
    
    
    (144,764
    )52,224
    
    
    
    41,113Liabilities:Plant and equipment
    
    
    16,920
    
    
    
    9,808Net deferred income tax assets
    
    
    35,304
    
    
    
    31,305




| |  | At December 31, 2002, Nortel Networks S.A. had net operating loss
carry-forwards of approximately 653,000 of which approximately 304,000
will expire in 2006, 239,000 will expire in 2007 and 110,000 will carry
forward indefinitely. Nortel Networks S.A. has provided a valuation
allowance on these tax loss carry-forwards and certain deferred income tax
assets of approximately
228,000 as at December 31, 2002.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|8. |  | Related party transactions
|-- |  | --------------------------



| |  | In the ordinary course of business, Nortel Networks S.A. engages in
transactions with Nortel Networks and certain of Nortel Networks
affiliates. These transactions are measured at their exchange amounts.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Transactions with related parties for the years ended December 31 are
summarized as follows:
| |  | --------------------------------------------------------------------------------------------

2002
    
    
    2001
    
    
    2000Billed to related partiesIntercompany revenues
    
    
    473,223
    
    
    
    429,643
    
    
    
    671,965Other income  net
    
    
    26,556
    
    
    
    49,201
    
    
    
    114,987Billed from related partiesCost of revenues
    
    
    85,943
    
    
    
    316,205
    
    
    
    259,055Selling, general and administrative expense
    
    
    38,704
    
    
    
    36,230
    
    
    
    83,060Research and development expense
    
    
    
    
    
    
    
    
    
    
    (68,334
    )Interest expense
    
    
    5,063
    
    
    
    626
    
    
    
    Issuance of common shares
    
    
    485,363
    
    
    
    
    
    
    
    




| |  | The following table shows the balance sheet position in respect of related
parties as at December 31:
| |  | -----------------------------------------------------------------------------------------------------

2002
    
    
    2001Receivables from related partiesDue from Nortel Networks Limited
    
    
    41,568
    
    
    
    188,690Due from affiliates
    
    
    81,704
    
    
    
    253,769Payables to related partiesDue to Nortel Networks Limited
    
    
    10,425
    
    
    
    231,239Due to affiliates
    
    
    41,599
    
    
    
    85,564Long-term notes receivable from Nortel Networks Limited
    
    
    140,010
    
    
    
    Notes payable to related partiesCurrent
    
    
    
    
    
    
    106,048Long-term
    
    
    200,000
    
    
    
    181,000




| |  | Nortel Networks S.A. is charged by Nortel Networks for its share of head
office costs incurred by Nortel Networks that are attributable to the
activities of Nortel Networks S.A. These charges, which are included in
selling, general and administrative expense, amounted to 4,017 and 1,271
in 2001, and 2000, respectively. No specific head office charges have been
received in 2002.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. also participates with Nortel Networks and certain of
Nortel Networks S.A.s affiliates in various agreements with respect to
intercompany product sale and purchase transactions, including research and
development costs. Prior to 2001, the pricing of intercompany transactions
between Nortel Networks S.A. and certain of its affiliates was determined
through the application of various methodologies intended to produce arms
length results and pricing for Nortel Networks S.A. Nortel Networks S.A.
also shared in global research and development costs based on the benefits
derived from the research and development utilized in its geographic
market. Accordingly, Nortel Networks S.A. received a credit of
approximately 68,000 to its research and development expense in 2000.
Effective January 1, 2001, the global research and development cost sharing
methodology was replaced with a global profit split methodology based upon
the historical research and development costs of the participants, and
further intended to produce arms length results for Nortel Networks S.A.
Under that methodology, Nortel Networks S.A.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | received a charge in 2001,
which was allocated to cost of revenues, of approximately
135,400.
Similarly in 2002, Nortel Networks S.A. received a credit of approximately
15,344 which was also allocated to cost of revenues.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On December 31, 2002, Nortel Networks provided Nortel Networks S.A. with a
subordinated loan in the aggregate amount of 200,000. This loan is
classified as a long-term intercompany note payable. The repayment of the
loan, in case of bankruptcy, insolvency or liquidation, is subordinated to the prior
repayment of any of Nortel Networks S.A.s existing or future secured and
unsecured creditors. Nortel Networks S.A. may repay the whole or any part
of the outstanding amount of the loan subject to notifying Nortel Networks
in advance of its irrevocable decision to make the repayment. The loan
bears interest at a rate per annum equal to Euribor rate plus one percent.
Interest is payable at the end of each interest period, subject to Nortel
Networks S.A. having positive net earnings and the interest payments not
exceeding 40 percent of the positive net earnings.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On December 19, 2002, Nortel Networks S.A. provided Nortel Networks with a
revolving loan in the amount of 140,010. This loan is classified as a
long-term intercompany note receivable. The loan bears interest at a rate
per annum equal to Euribor rate plus one percent. Interest is accrued and
due unless an amount larger than the outstanding amount of advances is
outstanding under the subordinated loan.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | At December 31, 2001, Nortel Networks S.A. had a revolving note payable
with an affiliated company in the amount of 106,048. This payable was
settled in full in 2002.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|9. |  | Financial Instruments
|-- |  | ---------------------



| |  | Share pledge
| |  | ------------



| |  | The security agreements that were entered into in connection with the
December 2001 364-day syndicated credit facilities of Nortel Networks and
its subsidiary, Nortel Networks Inc. (NNI), provided for the granting of
security in the event that Nortel Networks debt ratings fell below
investment grade. The security included pledges by Nortel Networks and
Nortel Networks International Finance & Holding B.V. of their shares of
Nortel Networks S.A.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The security became effective in the second quarter of 2002, following the
downgrade by Moodys Investors Services, Inc. (Moodys) of Nortel
Networks senior long-term debt to below investment grade. At that time,
the security became effective in respect of the December 2001 364-day
syndicated credit facilities, which have since expired, as well as any
other credit facilities and public debt securities of Nortel Networks
which, by their terms, required that the security also apply to them. This
included: the April 2002 364-day revolving credit facilities of Nortel
Networks and NNI, which have since been terminated; the April 2000 five
year syndicated credit facilities of Nortel Networks and NNI; Nortel
Networks consolidated outstanding public debt securities; and Nortel
Networks guarantee of Nortel Networks Corporations 4.25 percent
convertible senior notes due September 1, 2008. See note 13 for additional
facilities of Nortel Networks in respect of which the security has become
effective.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | If Nortel Networks senior long-term debt rating by Moodys returns to Baa2
(with a stable outlook) and the rating by Standard & Poors Ratings Service
returns to BBB (with a stable outlook), the security will be released in
full. If both the April 2000 five year syndicated credit facilities and
such other facilities in respect of which the security has become effective
(see note 12) are terminated or expire, the security will be released in
full.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Receivables sales
| |  | -----------------



| |  | In 2002, 2001 and 2000, Nortel Networks S.A. has entered into various
agreements to sell certain of its receivables. These receivables were sold
at a discount of 52, 1,939 and 6,199 from book value for the years
ended December 31, 2002, 2001 and 2000 respectively, at annualized discount
rates of approximately 3 to 4 percent, 5 percent to 6 percent and 3 percent
to 5 percent for the years ended December 31, 2002, 2001 and 2000,
respectively. This program was discontinued in February 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 unfavourable variations of up to 20
percent in credit losses, the discount rate used and the cost of servicing
the receivables, the pre-tax impact on the value of retained interests
would not be significant.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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



| |  | Nortel Networks S.A. has entered into agreements that contain features
which meet the definition of a guarantee under FIN 45. FIN 45 defines a
guarantee to be a contract that contingently requires Nortel Networks S.A
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 other party.
Nortel Networks S.A. has the following major types of guarantees that are
subject to the disclosure requirements of FIN 45.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. has entered into agreements that guarantee the lease
payments of certain sub-lessees of its facilities to lessors. Generally,
these lease agreements relate to facilities Nortel Networks S.A. vacated
prior to the end of the term of its lease. These lease agreements require
Nortel Networks S.A. to make lease payments throughout the lease term if
the sub-lessee fails to make scheduled payments. These lease agreements
have expiration dates of April 2007. The maximum amount that Nortel
Networks S.A. may be required to pay under these types of agreements is
approximately 5,000.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks S.A. has also entered into an agreement to indemnify a
certain lessor against certain additional costs, including financing costs,
and costs incurred relating to construction problems with the building,
through the term of the lease, which expires in May 2013. The maximum
amount that Nortel Networks S.A. may be required to pay under this lease
agreement is approximately 79,000.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In addition, Nortel Networks S.A. has entered into an agreement to
indemnify a certain lessor, through the term of the lease, which expires in
May 2013, against costs incurred as a result of changes in laws and
regulations (including tax legislation) or in the interpretations of such
laws and regulations, as a result of losses from litigation that may be
suffered by them or if the transaction becomes invalid. The maximum
amount that Nortel Networks may be required to pay if the transaction
becomes invalid is approximately 79,000. The maximum potential losses
resulting from the other types of lease guarantees cannot be reasonably
estimated.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Bid and performance bonds
| |  | -------------------------



| |  | Nortel Networks S.A. has entered into bid and performance bonds related to
various contracts. These contracts generally have terms ranging from two
to five years. Performance related bonds generally have a term of twelve
months. Bid bonds generally have a much shorter term. Potential payments
due under these bonds are related to Nortel Networks S.A.s performance
under the applicable contract. The total amount of bid and performance
bonds that were available and undrawn was 31,650, as at December 31, 2002
and 29,374 as at December 31, 2001.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | On October 19, 2002 Nortel Networks S.A. granted a put option (the Put
Option) to the minority interest partners of one of Nortel Networks
European joint ventures. The Put Option allows the minority interest
partners to sell their interest in the joint venture to Nortel Networks
S.A. at a fixed amount of approximately 124,000, consisting of a cash
component of approximately 52,000, and an in-kind component of
approximately 72,000, representing the return of a loan note currently
owed to Nortel Networks by an affiliate of the joint venture partners. The
minority interest may exercise the Put Option anytime between July 1, 2003
and September 30, 2003 subject to certain terms and conditions.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Effective the same date, Nortel Networks granted a put option (the Second
Put Option) to Nortel Networks S.A. The Second Put Option allows Nortel
Networks S.A. to sell to Nortel Networks the joint venture interest
acquired if the Put Option is exercised under the same terms and conditions
as the Put Option.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Put Option is required to be marked to fair value through the statement
of operations at each period end until it is either exercised or expires.
In addition, Nortel Networks S.A.s accounting policy regarding purchased
options requires that the Second Put Option be marked to fair value through
the statement of operations at each period end
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | until it is either exercised or expires. At December 31, 2002, Nortel Networks S.A. estimated the fair
value of the Put Option and the Second Put Option (the Options) to be
approximately 77,500, (included in the balance sheets within other accrued
liabilities and other current assets). The net impact to the statements of
operations for the year ended December 31, 2002 is nil.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The estimated fair values of the Options were based on an estimate of the
current fair values of the respective joint venture 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. Accordingly,
the fair value estimates are not necessarily indicative of the amounts that
Nortel Networks S.A. could potentially realize in current market exchanges.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Operating leases and other
commitments
| |  | --------------------------------------



| |  | At December 31, 2002, the future minimum payments under both operating
leases and outsourcing contracts for the years ending December 31 consisted
of:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

Operating
    
    
    Outsourcingleases
    
    
    contracts2003
    
    
    11,848
    
    
    
    19,6642004
    
    
    9,262
    
    
    
    18,8872005
    
    
    7,396
    
    
    
    17,4832006
    
    
    7,396
    
    
    
    17,2602007
    
    
    7,396
    
    
    
    17,049Thereafter
    
    
    33,284
    
    
    
    33,489Total future minimum payments
    
    
    76,582
    
    
    
    123,832




| |  | All figures exclude value added taxes.
| |  | --------------------------------------



| |  | Rental expense on operating leases for the years ended December 31, 2002,
2001 and 2000 amounted to 27,441, 31,960 and 21,243, respectively.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | Included in the operating lease payments are annual payments of
approximately 7,000 relating to the lease of Nortel Networks S.A.s
headquarters in Châteaufort, France. The lease is for a base term of 12
years, commencing on May 3, 2001. The lease is with a special purpose
vehicle leasing company owned by a group of financial institutions. Nortel
Networks S.A. is responsible for all obligations relating to the
maintenance and operation of the property and has the option of purchasing
the property at an option price, which is the estimated market value,
commencing on the fifth anniversary of the commencement date of the lease.
At the end of the lease term, Nortel Networks S.A. may elect to purchase
the property at the option price, renew the lease on terms mutually agreed
to with the lessor, or terminate the lease. Nortel Networks has guaranteed
a portion of the residual value of the lease.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Expenses related to outsourcing contracts for the years ended December 31,
2002, 2001 and 2000 amounted to 23,341, 16,026 and 1,709, respectively,
and are for services provided to Nortel Networks S.A. primarily related to
information services, accounts payable and purchasing. The minimum amount
payable under Nortel Networks S.A.s outsourcing contracts is variable to
the extent that Nortel Networks S.A.s workforce fluctuates from the
baseline levels contained in the contracts.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|11. |  | Shareholders equity
|--- |  | --------------------



| |  | On May 21, 2002, Nortel Networks S.A. issued 11,677,519 common shares to
Nortel Networks and 6,451,612 shares to Nortel Networks International
Finance and Holdings B.V. for net proceeds of 281,000 which was comprised
of intercompany notes payable.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On December 16, 2002 Nortel Networks S.A. issued 40,872,534 common shares
to Nortel Networks for net proceeds of 204,363 comprised of cash.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  | On May 21, 2002 Nortel Networks S.A.s board of directors approved a
reorganization of Nortel Networks S.A.s capital accounts that resulted in
the reduction of accumulated deficit of 372,755, the reduction of
additional paid-in capital of 158,174, and the reduction of common shares
of 214,581.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Capital accounts for December 31, 2000 have been reclassified to present
the reorganization of Nortel Networks S.A.s capital accounts performed
during 2000 that resulted in the reduction of retained earnings of 48,845,
the increase in additional paid-in capital of 46,327, and addition to
common shares of 2,518.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|12. |  | Stock-based compensation plans
|--- |  | ------------------------------



| |  | Stock options
| |  | -------------



| |  | Under the Nortel Networks Corporation 2000 Stock Option Plan (the 2000
Plan), options to purchase Nortel Networks Corporation common shares may
be granted to employees and directors of Nortel Networks S.A. that entitle
the holder 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 United States dollars for
United States options and in Canadian dollars for Canadian options.
Generally, options outstanding at December 31, 2002 vest 33 1/3 percent on
the anniversary date of the grant for three years. The committee of the
Nortel Networks Corporation and Nortel Networks Boards of Directors that
administers the 2000 Plan 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.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Under the Nortel Networks Corporation 1986 Stock Option Plan As Amended and
Restated (the 1986 Plan), options to purchase Nortel Networks Corporation
common shares may be granted to employees of Nortel Networks S.A. that
entitle the holder 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 in United States dollars for United
States options and in Canadian dollars for Canadian options. Generally,
options may be exercised as follows: options granted in 1997 through 2002
vest 33 1/3 percent on the anniversary date of the grant for three years;
and options granted in 1991 through 1996 vest 50 percent after the first
anniversary date of grant and the remainder after the second anniversary
date of grant. The committee of the Nortel Networks Corporation and Nortel
Networks Boards of Directors that administers the 1986 Plan 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 stock appreciation right (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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In January 1995, a key contributor stock option program (the Key
Contributor Program) was established. Under the terms of the Key
Contributor Program, participants are granted an equal number of initial
options and replacement options. The initial options generally vest after
five years and expire after ten years. The replacement options are granted
concurrently with the initial options and also expire after ten years. The
replacement options generally have an exercise price equal to the market
value of the common shares of Nortel Networks Corporation on the day the
initial options are fully exercised, and are generally exercisable
commencing thirty-six months thereafter, provided certain other conditions
for exercise, including share ownership, are met.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On June 20, 2001, Nortel Networks Corporation commenced a voluntary stock
option exchange program (the Exchange Program) whereby its employees,
including employees of Nortel Networks S.A., could exchange certain then
outstanding stock options for new stock options, based on a prescribed
formula. The terms of the Exchange Program were such that 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.
Approximately 2,400,000 of Nortel Networks S.A.s employees stock options
were tendered for exchange and cancelled. Nortel Networks Corporations
then Board of Directors and its then board appointed officers were not
eligible to participate in the Exchange Program. On January 29, 2002,
Nortel Networks Corporation granted approximately 1,600,000 new stock
options to Nortel Networks S.A.s employees in connection with the Exchange
Program with an exercise price of $7.39 in United States dollars per common
share which price was set in accordance with the Exchange Program.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Employee stock purchase plans
| |  | -----------------------------



| |  | Nortel Networks Corporation has a stock purchase plan for eligible
employees in eligible countries (the Employee Stock Purchase Plan). The
Employee Stock Purchase Plan facilitates the acquisition of common shares
of Nortel Networks Corporation at a discount, and the retention of such
common shares, by eligible employees. The Employee Stock Purchase Plan has
four offering periods each year, with each offering period beginning on the
first day of each calendar quarter. Eligible employees may 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. For non-North American eligible
employees common shares are 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, except that if the market price on the last trading
day is equal to or less than the average of the high and low on the first
trading day, the purchase price shall be 85 percent of the market price on
the last trading day of the offering period. Nortel Networks contributes
an amount equal to the difference between the market price and the purchase
price. The common shares are purchased by an independent broker through
the facilities of the Toronto and/or New York stock exchanges, and held by
a custodian on behalf of the plan participants. Compensation expense is
recognized for Nortel Networks Corporations portion of the contributions.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks Company Savings
Plan
| |  | ------------------------------------



| |  | Eligible employees of Nortel Networks S.A. and other direct or indirect
subsidiaries of Nortel Networks in France, including joint ventures in
which Nortel Networks holds an interest of greater than 50% as of October
30, 2002, may elect to participate in the Nortel Networks Company Savings
Plan (the PEE) instead of the Employee Stock Purchase Plan. Under the
PEE, which is a collective savings scheme governed by French labour law,
participants hold units of a Nortel Networks collective investment fund
which is invested mainly in common shares of Nortel Networks Corporation,
and the remainder in liquid assets. Participants may make voluntary
contributions up to 10% of their eligible gross earnings, and the employer
contributes an amount equal to 25% of each participants contributions, up
to certain maximum amounts per participant per year. The employer
contributions are subject to welfare surtaxes but exempt from social
security charges and income tax in France. The common shares are purchased
on a monthly basis by the plan custodian, through the facilities of the New
York Stock Exchange.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|13. |  | Subsequent events
|--- |  | -----------------



| |  | Nortel Networks S.A. has announced further workforce restructuring for 2003
impacting 218 positions (of which 218 represented redundancies) as part of
Nortel Networks overall work plan, which is expected to result in a
restructuring charge of approximately 24 million. Affected employees will
be notified in the first quarter of 2003.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On February 14, 2003, Nortel Networks entered into an agreement with Export
Development Canada (EDC) regarding arrangements to provide for support,
on a secured basis, of certain obligations arising out of normal course
business activities, including letters of credit, letters of guarantee,
indemnity arrangements, performance bonds, surety bonds, receivables sales,
securitizations and similar instruments issued or entered into for the
benefit of Nortel networks (the EDC Support Facility). The EDC Support
Facility provides for up to U.S. $750 million in support and is comprised
of (i) up to U.S. $300 million of committed support for performance bonds
or similar instruments (within certain parameters); (ii) up to U.S. $150
million of uncommitted support for receivables sales and/or
securitizations; and (iii) up to U.S. $300 million of additional
uncommitted support for performance bonds and receivable sales and/or
securitizations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks obligations under the EDC Support Facility are secured on
an equal and ratable basis under the security agreements entered into by
Nortel Networks and various of its subsidiaries, including the pledge of
shares of Nortel Networks S.A. (see note 9). Nortel Networks may provide
EDC with cash collateral (or any other alternative collateral acceptable to
EDC), in an amount equal to the total amount of its outstanding obligations
and undrawn commitments and expenses under the EDC Support Facility, in
lieu of the security provided under the security agreements.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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SIGNATURES

Pursuant to the requirements of Section 13 or15(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 23rd day of December, 2003.

NORTEL NETWORKS LIMITEDBy:
    
    FRANK A. DUNN(Frank A. Dunn, President and Chief 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 23rd day of December, 2003.

Signature
    
    TitlePrincipal Executive OfficerFRANK A. DUNN
(FRANK A. DUNN)
    
    President and Chief Executive Officer, and a DirectorPrincipal Financial OfficerDOUGLAS C. BEATTY
(DOUGLAS C. BEATTY)
    
    Chief Financial OfficerPrincipal Accounting OfficerMICHAEL J. GOLLOGLY

(MICHAEL J. GOLLOGLY)
    
    Controller


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Directors:

J.J. BLANCHARD*

(J.J. BLANCHARD)
    
    R.A. INGRAM*

(R.A. INGRAM)R.E. BROWN*

(R.E. BROWN)
    
    W.A. OWENS*

(W.A. OWENS)J.E. CLEGHORN*

(J.E. CLEGHORN)
    
    G. SAUCIER*

(G. SAUCIER)F.A. DUNN*

(F.A. DUNN)
    
    S.H. SMITH, JR.*

(S.H. SMITH, JR.)L.Y. FORTIER*

(L.Y. FORTIER)
    
    L.R. WILSON*

(L.R. WILSON)By:*
    
    DEBORAH J. NOBLE
(DEBORAH J. NOBLE, as attorney-in fact)
December 23, 2003


123