##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K þ
    
    Annual report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
 December 31, 2003
 o
    
    Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
 
 Commission file number 000-30758 Nortel Networks Limited(Exact name of registrant as specified in its charter) Canada
    
    62-12-62580(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)8200 Dixie Road, Suite 100, Brampton, Ontario, Canada
    
    L6T 5P6(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number including area code: (905) 863-0000 Securities registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registeredGuarantees of Nortel Networks Corporations
    
    New York Stock Exchange4.25% Convertible Senior Notes Due 2008
 Securities registered pursuant to Section 12(g) of the Act: Title of each class:   Common Shares without nominal or par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to filing requirements for the past 90 days. Yes          No ü Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.  ̈ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes ü          No At December 31, 2004, 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.




---



##### Table of Contents



EXPLANATORY NOTE Nortel Networks Limited previously announced the need to restate its consolidated financial
statements for the years ended December 31, 2002 and 2001 and each of its first three quarterly
periods for 2003. The consolidated statements of operations, changes in equity and comprehensive income (loss) and
cash flows for the years ended December 31, 2002 and 2001 and the consolidated balance sheet as of
December 31, 2002, including the applicable notes, contained in this Annual Report on Form 10-K
have been restated. A number of Nortel Networks past filings with the United States Securities and Exchange Commission
remain subject to ongoing review by the United States Securities and Exchange Commissions Division
of Corporation Finance. In addition, the Second Restatement involved the restatement of Nortel
Networks consolidated financial statements for 2001 and 2002 and the first, second and third
quarters of 2003. Amendments to Nortel Networks prior filings with the United States Securities and
Exchange Commission would be required in order for Nortel Networks to be in full compliance with
Nortel Networks reporting obligations under the Securities Exchange Act of 1934. However, Nortel
Networks does not believe that it will be feasible to amend Nortel Networks Annual Report on Form
10-K/A for the year ended December 31, 2002, or 2002 Form 10-K/A and our 2003 Quarterly Reports due
to, among other factors, identified material weaknesses in Nortel Networks internal control over
financial reporting, the significant turnover in Nortel Networks finance personnel, changes in
accounting systems, documentation weaknesses, a likely inability to obtain third party
corroboration in certain cases due to the substantial industry adjustment in recent years and the
passage of time generally. In addition, disclosure in the 2002 Form 10-K/A and 2003 Form 10-Qs
would in large part repeat the disclosure expected to be contained in this report and the 2004 Form
10-Qs. Accordingly, Nortel Networks does not plan to amend our 2002 Form 10-K/A and 2003 Form
10-Qs. Nortel Networks believes that it has included in this report all information needed for
current investor understanding. Ongoing United States Securities and Exchange Commission review
may require Nortel Networks to amend this Annual Report on Form 10-K or Nortel Networks other
public filings. For a description of the restatements, see Restatement in note 3 of the accompanying audited
consolidated financial statements and Item 7 Managements Discussion and Analysis of Financial
Condition and Results of Operations  Developments in 2003 and 2004  Nortel Networks Audit
Committee Independent Review; restatements; related matters contained in this Annual Report on
Form 10-K.




---



TABLE OF CONTENTS PAGEPART IITEM 1.
    
    Overview
    
    
    1Developments in 2003 and 2004
    
    
    2Networking solutions
    
    
    6Enterprise Networks
    
    
    11Wireline Networks
    
    
    14Optical Networks
    
    
    17Sales and distribution
    
    
    20Backlog
    
    
    20Product standards, certification and regulations
    
    
    21Sources and availability of materials
    
    
    21Seasonality
    
    
    22Strategic alliances, acquisitions and minority investments
    
    
    23Research and development
    
    
    23Intellectual property
    
    
    24Employee relations
    
    
    25Environmental matters
    
    
    26Financial information by operating segment and product category
    
    
    26Financial information by geographic area
    
    
    26Working capital
    
    
    26Risk factors
    
    
    27ITEM 2.
    
    Properties
    
    
    28ITEM 3.
    
    Legal Proceedings
    
    
    29ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    33PART IIITEM 5.
    
    Market for the Registrants Common Equity and Related Stockholder Matters
    
    
    34Securities authorized for issuance under equity compensation plans
    
    
    34ITEM 6.
    
    Selected Financial Data (Unaudited)
    
    
    35ITEM 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    38Business Overview
    
    
    40Developments in 2003 and 2004
    
    
    44Results of operations  continuing operations
    
    
    57Results of operations  discontinued operations
    
    
    75Liquidity and capital resources
    
    
    76Off-balance sheet arrangements
    
    
    83Application of critical accounting estimates
    
    
    84Accounting changes and recent accounting pronouncements
    
    
    92Market risk
    
    
    93Equity price risk
    
    
    94Environmental matters
    
    
    95Legal Proceedings
    
    
    95Risk factors/forward looking statements
    
    
    95ITEM 7A.
    

Quantitative and Qualitative Disclosures about Market Risk
    
    
    113ITEM 8.
    
    Consolidated Financial Statements and Supplementary Data
    
    
    114ITEM 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    115ITEM 9A.
    
    Controls and Procedures
    
    
    115
  i




---



##### Table of Contents



PAGEPART IIIITEM 10.
    
    Directors and Executive Officers of the Registrant
    
    
    140Directors of the registrant
    
    
    140Executive officers and certain other non executive board appointed officers of the Registrant
    
    
    144Section 16(a) beneficial ownership reporting compliance
    
    
    146ITEM 11.
    
    Executive Compensation
    
    
    147Summary compensation table
    
    
    147Annual cash incentive awards
    
    
    153Voluntary undertaking
    
    
    154Option grants in 2004 and 2003
    
    
    154Aggregate option exercises in 2004 and 2003 and year-end option values
    
    
    155Long-term incentive plans awards in last two fiscal years
    
    
    158Retirement plans
    
    
    159Certain employment arrangements
    
    
    162Compensation of directors
    
    
    164Compensation committee interlocks and insider participation
    
    
    165ITEM 12.
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    166Security ownership of certain beneficial owners
    
    
    166Security ownership of directors and management
    
    
    166ITEM 13.
    
    Certain Relationships and Related Transactions
    
    
    169Indebtedness of management
    
    
    169Related party transactions
    
    
    170ITEM 14.
    
    Principal Accountant Fees and Services
    
    
    170Audit fees
    
    
    170Audit related fees
    
    
    171Tax Fees
    
    
    171All other fees
    
    
    171PART IVITEM 15.
    
    Exhibits, Financial Statement Schedules and Reports on Form 8-K
    
    
    172SIGNATURES
    
    
    227
 All dollar amounts in this document are in United States dollars unless otherwise stated. NORTEL NETWORKS, NORTEL NETWORKS LOGO, NT, the GLOBEMARK, BUSINESS WITHOUT BOUNDARIES, DMS, OPTERA
and UNIVERSAL EDGE are trademarks of Nortel Networks. ACCESSNODE is a trademark of Zhone Technologies Inc. CDMA2000 is a trademark of the Telecommunications Industry Association. CDMAONE  design mark is a trademark of the CDMA Development Group, Inc. JUNGLEMUX is a trademark of GE Industrial Systems Technology Management Inc. MOODYS is a trademark of Moodys Investors Service, Inc. RCMP is a trademark of the Royal Canadian Mounted Police. S&P and STANDARD & POORS are trademarks of The McGraw-Hill Companies, Inc. ii




---



##### Table of Contents



PART I 
  ITEM 1.
    
    Business Overview Nortel Networks Limited is a recognized leader in delivering communications capabilities that
enhance the human experience, ignite and power global commerce, and secure and protect the worlds
most critical information. We offer converged multimedia networks that use innovative packet,
wireless, voice and optical technologies and are underpinned by high standards of security and
reliability. For both service providers and enterprises, these networks help to drive increased
profitability and productivity by reducing costs and enabling new business and consumer services
opportunities. We refer to the communications technology, infrastructure and related professional
services that we supply as networking solutions. Our business consists of the design,
development, manufacture, assembly, marketing, sale, licensing, installation, servicing and support
of these networking solutions. A substantial portion of our business has a technology focus and is
dedicated to research and development. This focus forms a core strength and a factor that we
believe differentiates us from many of our competitors. We envision a network society where people
will be able to connect and interact with information and with each other instantly, simply and
reliably, accessing data, voice and multimedia communications services and sharing experiences
anywhere, anytime. Our networking solutions enable our service provider and enterprise customers to provide their own
customers or employees with services to communicate locally, regionally or globally through the use
of data, voice and multimedia communications. Our service provider customers include local and
long-distance communications companies, wireless service providers and cable operators. Our
networking solutions enable our service provider customers to deploy reliable, robust networks that
create opportunities to provide revenue-generating services and cost savings. Our enterprise
customers include large and small businesses, governments and institutions. Our networking
solutions enable our enterprise customers to deploy secure networks with seamless connectivity that
provide opportunities for cost efficiency and increased productivity. During 2003 and up to September 30, 2004, we conducted our business through the following four
reportable segments: Wireless Networks; Enterprise Networks; Wireline Networks; and Optical
Networks. We refer you to the descriptions of each of these segments below. Effective October 1,
2004, we established a new organizational structure that included, among other things, combining
the businesses of our four segments into two business organizations: (i) Carrier Networks and
Global Operations; and (ii) Enterprise Networks. We are reviewing the impact of these changes to
our reportable segments under applicable accounting standards. The new structure reflects the
evolution of the network transformation to converged networks. For financial information by
reporting segment and product category, see Segment 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,
or MD&A. The Companys principal executive offices are located at 8200 Dixie Road, Suite 100, Brampton,
Ontario, Canada, L6T 5P6, telephone number (905) 863-0000. The Company was incorporated in Canada
as the Northern Electric Company, Limited on January 5, 1914. The Company participated in a
corporate amalgamation with two of its wholly owned subsidiaries on January 14, 1982. The Company
changed its name to Northern Telecom Limited on March 1, 1976, to Nortel Networks Corporation on
April 29, 1999, and to Nortel Networks Limited on May 1, 2000. On May 1, 2000, the Company
participated in a Canadian court-approved plan of arrangement with Nortel Networks Corporation,
previously known as New Nortel Inc., and BCE Inc., the largest shareholder of the Company prior to
the plan of arrangement, and changed its name to Nortel Networks Limited, or NNL. In connection
with the plan of arrangement, the Company became the principal operating subsidiary of Nortel
Networks Corporation. 1




---



##### Table of Contents



Where we say we, us, our or Nortel Networks, we mean Nortel Networks Limited or Nortel
Networks Limited and its subsidiaries, as applicable. References to the Company mean, Nortel
Networks Limited without its subsidiaries. Where we refer to the industry, we mean the
telecommunications industry. The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and all amendments to those reports available free of charge under Investor Relations
on our website at www.nortel.comas soon as reasonably practicable after we electronically file
this material with, or furnish this material to, the United States Securities and Exchange
Commission, or SEC. We have adopted a Code of Ethics known as Living the Values: A Guide to
Ethical Business Practices at Nortel Networks. We make our Code of Ethics, and all amendments to
and waivers of (in accordance with applicable laws) our Code of Ethics, available free of charge
under Corporate Information on our website at www.nortel.comor by writing to our corporate
secretary at Nortel Networks Limited, 8200 Dixie Road, Suite 100, Brampton, Ontario L6T 5P6.
Information contained on our website is not incorporated by reference into our annual report on
Form 10-K. 
 Developments in 2003 and 2004 Business environment In 2003, customer spending remained cautious as a result of tightened capital markets, mainly in
the first half of 2003, and customers realigning capital spending with their current levels of
revenues and profits in order to maximize their return on invested capital. We experienced
continued industry adjustment and capital spending restrictions by our service provider customers.
In 2003, many of our customers continued to focus on conserving capital, decreasing their debt
levels, reducing costs and/or increasing the capacity utilization rates and efficiency of their
existing networks. Also, excess network capacity and competition continued to exist in the
industry, which led to continued pricing pressures on the sale of certain of our products. During the second half of 2003 and into 2004, we began to experience a period of relative industry
stability following an unprecedented period of business realignment that commenced in 2001 in
response to a significant industry adjustment. Throughout the second half of 2003 and into 2004,
we announced several new contracts across all of our reportable segments, but primarily in our
Wireless Networks segment, as certain service provider customers began to expand and upgrade their
existing networks. The period of relative industry stability that had characterized the second half of 2003 continued
into 2004. The moderate growth in 2004 has primarily been a result of customers increasing their
investments in:  
    
    voice over packet technologies;
    
    third generation wireless technologies; and
    
    expansion and enhancement of existing networks due to subscriber growth and competitive
pressures. In 2004, spending in these areas of our business has been partially offset by customers limiting
their investments in mature technologies as they focus on maximizing return on investment capital.
In addition, we have continued to experience pricing pressures on sales of certain of our products
as a result of increased competition, particularly from low cost competitors. Further, while
customer support generally remains strong, the ongoing restatement activities and the internal
restructuring and realignment programs initiated in August 2004 have adversely impacted business
performance in 2004. Nortel Networks Audit Committee Independent Review; restatements; related matters In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to a comprehensive review and analysis of our assets and liabilities, or
the 2




---



##### Table of Contents



Comprehensive Review, which resulted in the restatement (effected in December 2003) of our
consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the
quarters ended March 31, 2003 and June 30, 2003, or the First Restatement . In late October 2003, the Audit Committees of the Boards of Directors of Nortel Networks and
NNC, or the Audit Committee, initiated an independent review of the facts and circumstances leading
to the First Restatement, or the Independent Review, and engaged the law firm now known as Wilmer
Cutler Pickering Hale & Dorr LLP, or WCPHD, to advise it in connection with the Independent Review.
The Audit Committee sought to gain a full understanding of the events that caused significant
excess liabilities to be maintained on the balance sheet that needed to be restated, and to
recommend that our Board of Directors adopt, and direct management to implement, necessary remedial
measures to address personnel, controls, compliance and discipline. In January 2005, the Audit
Committee reported the findings of the Independent Review, together with its recommendations for
governing principles for remedial measures that were developed for the Audit Committee by WCPHD.
Each of our and NNCs Boards of Directors has adopted these recommendations in their entirety and
directed our management to develop a detailed plan and timetable for their implementation, and will
monitor their implementation. As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in depth the concerns identified by WCPHD regarding provisioning activity and to review
certain provision releases. That examination, and other errors identified by management, led to the
restatement (effected today) of our financial statements for the years ended December 31, 2002 and
2001 and the quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003
and 2002, or the Second Restatement, and our revision of previously announced unaudited results for
the year ended December 31, 2003. The need for the Second Restatement resulted in delays in filing
our and NNCs 2003 Annual Reports on Form 10-K, or the 2003 Annual Reports, and Quarterly Reports
on Form 10-Q for the first, second and third quarters of 2004, or the 2004 Quarterly Reports,
beyond the SECs required filing dates in 2004. We refer to the 2003 Annual Reports and the 2004
Quarterly Reports together as the Reports. Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted for as part of the Second Restatement. In
particular, management identified certain errors related to revenue recognition and undertook a
process of focused revenue reviews. As described in more detail in the Controls and Procedures
section of this report, in light of the resulting adjustments to revenues previously reported in
relevant periods, the Audit Committee has determined to review the facts and circumstances leading
to the restatement of these revenues for specific transactions identified in the Second
Restatement. This review will have a particular emphasis on the underlying conduct that led to the
initial recognition of these revenues. The Audit Committee will seek a full understanding of the
historic events that required the revenues for these specific transactions to be restated and will
consider any appropriate additional remedial measures, including those involving internal controls
and processes. The Audit Committee has engaged WCPHD to advise it in connection with this review.
See Risk factors/forward looking statements. The key developments in 2004 with respect to the foregoing matters are the following:  
    
    In connection with the Independent Review, we terminated for cause (i) our former
president and chief executive officer, former chief financial officer and former
controller in April 2004 and (ii) seven additional senior finance employees with
significant responsibilities for our financial reporting as a whole or for their
respective business units and geographic regions in August 2004.
    
    We are under investigation by the SEC and the Ontario Securities Commission, or
OSC, Enforcement Staff and have received a U.S. federal grand jury subpoena for the
production of certain documents sought in connection with an ongoing criminal
investigation being conducted by the U.S. Attorneys Office for the Northern
District of Texas, Dallas Division. Further, the Integrated Market Enforcement
Team of the Royal Canadian Mounted Police, or RCMP, has advised us that it would be
commencing a criminal investigation into Nortel Networks financial 3




---



##### Table of Contents



accounting situation. In addition, numerous class action complaints have been
filed against Nortel Networks, including class action complaints under the
Employee Retirement Income Security Act, or ERISA. In addition, a derivative
action complaint has been filed against Nortel Networks. See Contingencies
in note 22 in the accompanying consolidated financial statements.
    
    As a result of the delay in filing the Reports, we
and NNC were not in compliance with our obligations
to deliver the Reports under our and NNCs public
debt indentures and were required to seek waivers
from Export Development Corporation, or EDC, under
the EDC Support Facility. If we and NNC fail to file
all of the Reports by January 15, 2005, EDC will have
the right, on such date (absent a further waiver in
relation to the delayed filings and certain
additional breaches under the EDC Support Facility,
or the Related Breaches), to (i) terminate the EDC
Support Facility; and (ii) exercise certain rights
against collateral or require us to cash
collateralize all existing support. In addition, the
Related Breaches will continue beyond the filing of
the Reports. These delays have also resulted in our
inability to use, in its current form, the remaining
approximately $800 million of capacity under our
shelf registration statement filed with the SEC for
various types of securities. In addition, these
delays resulted in our termination of our $750
million April 2000 five year credit facilities. See
Liquidity and capital resources in the MD&A section
of this report.
    
    The OSC issued an order prohibiting all trading by
directors, officers and certain current and former
employees in the securities of Nortel Networks
Corporation and NNL. The order remains in effect
until two full business days following the receipt by
the OSC of all filings required to be made by us and
NNC pursuant to Ontario securities laws.
    
    We postponed our Annual Shareholders Meeting for 2003 due to the delay in filing our 2003
financial statements.
    
    As a result of the delayed filing of certain of the Reports, NNC
is in breach of the continued listing requirements of the Toronto
Stock Exchange, or TSX, and the New York Stock Exchange, or NYSE.
Although each of the TSX and NYSE has verbally confirmed that it
has not commenced, nor has any intention of commencing, any
suspension or delisting procedures in respect of NNCs and our
listed securities, the commencement of any suspension or delisting
procedures by either exchange remains, at all times, at the
discretion of such exchange and would be publicly announced by the
exchange. The NYSE granted us and NNC an extension of up to March
31, 2005 to file our 2003 Annual Reports, during which time the
Nortel Networks Corporation common shares and our and NNCs other
securities will remain listed on the NYSE. The extension is
subject to review by the NYSE on an ongoing basis.
    
    We suspended as of March 10, 2004: the purchase of Nortel Networks
Corporation common shares under the stock purchase plans for
eligible employees in eligible countries that facilitate the
acquisition of Nortel Networks Corporation common shares; the
exercise of outstanding options granted under Nortel Networks
Corporation 2000 Stock Option Plan, or the 2000 Plan, and the
Nortel Networks Corporation 1986 Stock Option Plan as amended and
restated, or the 1986 Plan, or the grant of any additional options
under those plans, or the exercise of outstanding options granted
under employee stock option plans previously assumed by us in
connection with mergers and acquisitions; and the purchase of
units in a Nortel Networks stock fund or purchase of Nortel
Networks Corporation common shares under our defined contribution
and investment plans, until such time as, at the earliest, we are
in compliance with U.S. and Canadian regulatory securities filing
requirements.
    
    On April 28, 2004, Standard and Poors, or S&P, downgraded its
ratings on NNL, including its long-term corporate credit ratings
from B to B- and its preferred shares ratings from CCC to
CCC-. At the same time, it revised its outlook to developing
from negative. On April 28, 2004, Moodys Investors Service,
Inc. changed its outlook to potential downgrade from uncertain.
See Liquidity and capital resources  Credit ratings in the MD&A
section of this report. 4




---



##### Table of Contents



Strategic plan On August 19, 2004, we first announced a new strategic plan which contains the following principal
components:  
    
    a renewed commitment to best corporate practices and ethical conduct, including the
establishment of the office of a chief ethics and compliance officer which has been filled
on an interim basis pending the permanent appointment of Susan E. Shepard, as now
announced;
    
    a streamlined organizational structure to reflect alignment with carrier converged networks;
    
    an increased focus on the enterprise market and customers;
    
    optimized research and development programs for highly secure, available and reliable
converged networks;
    
    the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;
    
    the establishment of a chief marketing officer to drive overall marketing strategy;
    
    the strategic review of embedded services to assess opportunities in the professional
services business; and
    
    a distinct focus on government and defense customers. Our strategic plan also includes a work plan involving focused workforce reductions of
approximately 3,250 employees, a voluntary retirement program, real estate optimization and other
cost containment actions such as reductions in information services costs, outsourced services and
other discretionary spending. Approximately 64% of employee actions related to the focused
workforce reduction were completed by the end of 2004, including approximately 55% that were
notified of termination or acceptance of voluntary retirement, with the remainder comprising
voluntary attrition of employees that were not replaced. The remainder of employee actions are
expected to be completed by June 30, 2005. In addition, however, we continue to hire in certain
strategic areas such as investments in the finance organization. Our intention is that our
strategic plan will enable us to build on our market leadership in developing the converged
networks of the future and improve business efficiency and operating cost performance in an
increasingly competitive market. It is our intention to be optimally positioned to maximize
strategic opportunities as they arise and leverage our acknowledged strengths in high reliability
networks and strong customer loyalty. We continue to drive the business forward with a focus on
costs, cash and revenues as strategic goals. We remain committed to our business strategy of
technology and solutions evolution in helping our customers transform their networks and implement
new applications and services to drive improved productivity. Other business developments We engaged in a number of activities in 2003 and 2004, in part to respond to the industry
environment and in part to address various business matters that arose during those periods. Some
of our activities and other business developments included:  2003  
    
    realigning our business activities in France and Germany;
    
    reducing undrawn customer financing commitments;
    
    entering into an agreement with EDC regarding arrangements to provide support for
certain of our performance-related obligations; and
    
    substantially completing the wind-down of our discontinued access solutions operations. 5




---



##### Table of Contents



2004  
    
    the announcement of our planned divestiture of substantially all of our remaining
manufacturing operations to Flextronics International Ltd., or Flextronics;
    
    the contribution of certain assets and liabilities of our directory and operator
services business in return for a 24% interest in VoltDelta, Resources LLC;
    
    the entering into an agreement with Foundry Networks, Inc., or Foundry, to settle
outstanding patent infringement claims and counterclaims by us and Foundry; and
    
    a strategic arrangement with Bharat Sanchar Nigram Limited to establish a wireless
network in India. For information on these and other developments in 2003, see Special charges in note 7,
Acquisitions, divestitures and closures in note 10, Long-term debt, credit and support
facilities in note 11 and Subsequent events in note 22 of the accompanying consolidated
financial statements and Developments in 2003 and 2004 in the MD&A section of this report. 
 Networking solutions Networking In our industry, networking refers to:  
    
    the connecting of two or more communications devices, such as telephones and personal
computers, across short or long distances to create a network;
    
    the connecting of two or more networks; or
    
    the connecting of equipment used in a network. Network components A telecommunications network generally consists of equipment and software that enable network
access, core networking and network services. Network access equipment and software enables
information to enter or exit a network, and resides with or near an end-user of the network.
Network access can be obtained through the use of either wireline cable (such as fiber optic,
copper wire or coaxial) or wireless radio signals. Core networking equipment and software direct, route or switch the data, voice and multimedia
communications signals from one part of the network to another. Core network equipment and
software also transport communications signals to and from network access equipment and other core
networking equipment located in another location. These functions are carried out primarily
through the use of routers, circuit and packet switches, and fiber optic technologies. Network services consist of various user capabilities that are enabled through the use of software
elements in a network. User capabilities may be configured to extend throughout the network and
include features such as location-based services, security services, calling features and
multimedia services. Network services can be personalized to suit the users needs and to support
various applications. Networking solutions Our networking solutions include network equipment, software and other technologies that
enable communications between two or more points defining a network through the use of data, voice
and multimedia networking. Our networking solutions may consist of a combination of products and
services provided by our four reportable segments consisting of Wireless Networks, Enterprise
Networks, Wireline Networks and Optical Networks. For a discussion of our recent establishment of
a new organizational 6




---



##### Table of Contents



structure that includes, among other things, combining the businesses of our four segments into two
business organizations, see Business  Overview. Networking solutions can be circuit-based or packet-based. Our circuit-based networking solutions
consist of technologies that require a separate network circuit to be maintained for each
communications signal for the duration of the transmission. Our packet-based networking solutions
consist of technologies which involve the conversion of a data, voice or multimedia communications
signal into pieces, or packets, that are directed or routed through the network independently and
then re-assembled at the destination. This enables large numbers of communications signals to be
directed or routed simultaneously and more efficiently than in circuit networking. Our data
networking solutions consist of products and services designed to enable the transportation of data
information across a network. Our security solutions consist of products and services designed to
ensure that information can be securely transported across a network and to prevent unauthorized
users from being able to disrupt the network. Wireless Networks includes network access and core networking solutions for voice and data
communications that span second and third generation wireless technologies and most major global
standards for mobile networks. Enterprise Networks includes circuit and packet voice solutions,
and data networking and security solutions used by our enterprise customers. Wireline Networks
includes circuit and packet voice solutions, and data networking and security solutions used by our
service provider customers. Optical Networks includes metropolitan, regional and long-haul optical
transport and switching solutions and managed broadband services. Within each of our reportable
segments, our networking solutions also consist of related professional services which may include:
strategic planning, network design and engineering; network optimization; network operations
planning and consulting; and installation and ongoing technical support. For more information about our networking solutions, please refer to our segment descriptions
below. Wireless Networks Products Wireless networking, also known as mobility networking, refers to communications networks that
enable end-users to be mobile while they send and receive voice and data communications using
wireless devices, such as cellular telephones, personal digital assistants and other computing and
communications devices. These networks use specialized network access equipment and specialized
core networking equipment that enable an end-user to be connected and identified when not in a
fixed location. The technology for wireless communications networks has evolved and continues to
evolve, through various technology generations. Our existing wireless solutions span second and third generation wireless technologies and most
major global digital standards for mobile networks. The majority of wireless communications
networks existing today are still based on second generation, or 2G, wireless technologies, which
consist of circuit switching technology with modest data transmission capabilities. However, third
generation, or 3G, networks have been launched in several regions. 3G wireless technologies
consist of packet networking technology with high-speed data, voice and multimedia transmission
capabilities. We support all of the following primary international standards for wireless communications
networks:  
    
    Time Division Multiple Access, or TDMA, is a 2G wireless standard supported mainly in
the United States, Canada and the Caribbean and Latin America region, or CALA.
    
    Code Division Multiple Access, or CDMA, is a 2G wireless standard, also known as IS-95
or cdmaOne, and is supported globally. CDMA networks are evolving to 3G according to the
CDMA 3G 1xRTT (single channel (1x) Radio Transmission Technology) standard, also known as
CDMA2000, for voice and high-speed data mobility. CDMA 3G 1xEV-DO, or Evolution Data 7




---



##### Table of Contents



Optimized, and CDMA 3G 1xEV-DV, or Evolution Data and Voice, are extensions of CDMA 3G
standards for high speed wireless networks for data, voice and multimedia communications.
    
    Global System for Mobile communications, or GSM, is a 2G wireless standard supported
globally. GSM networks are evolving to carry data, as well as voice, with the
introduction of General Packet Radio Standard, or GPRS. GPRS is viewed as a 2.5G
technology that provides faster and therefore increased data transmission capabilities.
Enhanced Data Rates for Global Evolution, or EDGE, is a further evolution of GSM systems
to support higher data speeds. In addition to higher data speeds, EDGE provides increased
voice capacity for existing GSM operators. An additional variant of this standard, called
GSM-R, focuses on the delivery of communications and control services for railway systems.
    
    Universal Mobile Telecommunications System, or UMTS, is now a commercial standard for
3G networks based on Wideband CDMA, or WCDMA, technology. UMTS combines WCDMA-based radio
access with packet switching technology to yield high capacity, high speed wireless
networks for data, voice and multimedia communications. We also offer a range of related professional services to our customers. Network access Radio network access equipment uses radio waves to provide wireless access to the subscribers
device, enabling the wireless subscriber to connect to the network to send and receive data, voice
and multimedia communications. The key network elements in radio access are base station
transceivers or access points and base station/radio network controllers. We offer our customers a
wide range of base station transceivers and base station controllers for all of the standards that
we support. Core networking Core networking equipment directs, routes or switches communications signals within a
service providers wireless communications network. The key network elements in the core part of a
wireless communications network are mobile switching centers, home location registers and packet
data serving nodes.  
    
    Mobile switching centers direct or switch data, voice and multimedia communications
signals from one network circuit to another and also support advanced voice services like
3-way calling, calling party number/name delivery, call holding and call redirection.
    
    A home location register is a database that contains subscriber data, such as
provisioning and service information, and dynamic information, such as the wireless
handsets current location.
    
    Packet data serving nodes are hardware and software network equipment elements that
aggregate and manage data communications between wireless subscriber devices and
public/private data networks, such as the Internet. Packet data serving nodes deliver
valuable network services including content-based billing, security, virtual private
networks and quality of service. Our mobile switching centers, home location registers and packet data serving nodes support all of
the primary international standards for wireless communications networks. 8




---



##### Table of Contents



Product development Our wireless networking products in development include the next evolution of our CDMA 3G,
GSM/GPRS/EDGE, wireless local area network, or WLAN, and UMTS products.  
    
    Our CDMA 3G 1xRTT products are generally available and have been deployed in several
commercial networks in all our geographic regions. Our CDMA 3G 1xEV-DO product is
currently being deployed by several large operators in the United States and Brazil and is
generally available for commercial deployment. We are currently working with the various
standards bodies to finalize the specifications for CDMA 3G 1xEV-DV.
    
    There are several GSM/GPRS/EDGE products that are being developed to allow GSM
operators to offer higher data rates on existing GSM spectrum allocations. We have
successfully completed customer trials of Adaptive MultiRate, or AMR, base station
transceivers. AMR allows service providers to use the radio spectrum allocated to them
more efficiently to support more customers on the same network.
    
    The enhanced version of our GSM base station controller, the GSM BSC 3000 (formerly,
the BSCe3), became generally available for commercial deployment in 2003. Our EDGE base
station transceivers, including both hardware and software, are currently in customer
trials and are being deployed by several customers in the United States.
    
    Our UMTS radio network access and core networking products are generally available and
have been launched by several operators in the Europe, Middle East and Africa region, or
EMEA, and in the United States. Our UMTS networking products have been deployed in the
initial launch of the first commercial UMTS network to be deployed in the United States.
We are continuing to develop our UMTS solutions for use in the Asia Pacific (including
Greater China) region.
    
    We are working at establishing strategic relationships with other companies for
research, development and manufacture of equipment that conforms to the Chinese 3G
TD-SCDMA standard.
    
    We continue to work on developing access technologies such as UMTS-HSDPA, or High Speed
Downlink Packet Access, 1x-EV, or single channel Evolution, OFDM, or Orthogonal Frequency
Division Multiplexing, and MIMO, or Multiple Input Multiple Output, antenna technologies
to increase the speed and efficiency of broadband wireless access from 3G networks
deployed today.
    
    Our Wireless Mesh Network solution, designed to allow our customers to reduce the costs
of high-speed wireless data transport from wireless access networks to wired broadband
networks, is now generally available and has been deployed in the United States and Asia
Pacific.
    
    Our enterprise grade WLAN access products are generally available for commercial
deployment by our wireless service provider customers. Markets We anticipate that demand for wireless networking equipment will be driven by continued
subscriber and traffic growth, and the effectiveness of 2.5G and 3G wireless networking systems.
There are two key aspects to the migration from 2G wireless communications technologies to 2.5G and
3G wireless communications technologies. The first is that all current 3G technologies, including
CDMA 3G and UMTS, are based on spread spectrum technology. The second is that the migration from
2G to 2.5G and 3G technologies is largely based on a transition from circuit switching technologies
in 2G core networks to packet-based networking technologies in 3G core networks. We believe that
our extensive experience in deploying CDMA wireless communications networks, combined with our
expertise in packet-based networking for wireline networks, will be a competitive strength during
the migration from 2G wireless communications networks to 2.5G and 3G wireless communications
networks. Commercial CDMA 3G networks have been launched in the United States, Canada, CALA and the Asia
Pacific region. CDMA networks operating in the 450 MHz radio spectrum are also expanding into
Central and Eastern Europe. GPRS and UMTS networks have already been launched in EMEA, the Asia
Pacific 9




---



##### Table of Contents



region and the United States. In addition, EDGE has been launched to support higher speed
transmission of data in the United States and also by several operators in Western Europe and the
Asia Pacific region. GSM-R has already been deployed by many countries across the world, including
member states of the European Union, China and India. The GSM-R market is one of the fastest
growing segments of the overall wireless market. In the United States, Canada and CALA, usage rates of wireless communications services continue to
increase, and we anticipate that capital spending decisions by wireless service providers will be
driven by capacity requirements, new wireless subscribers, increased use of wireless devices for
Internet access and technology migration from 2G wireless technologies to 2.5G and 3G wireless
technologies. We also anticipate that the migration from 2G to 2.5G and 3G wireless will initially
be driven by CDMA 3G 1xRTT and 1xEV-DO deployment for CDMA-based networks, and by GPRS, EDGE and
UMTS deployment for GSM- and TDMA-based networks. Within EMEA, wireless subscriber growth remains slower in many Western European countries, largely
due to relatively high wireless subscriber penetration levels. However, other parts of EMEA
continue to grow their subscriber base due to the lower market penetration for wireless services.
Investment decisions by wireless service providers in Western Europe are being driven by
anticipated growth in wireless data communications services. As a result, infrastructure spending
in Western Europe is currently primarily driven by the migration from GSM to GPRS and UMTS
technologies, and the associated migration from circuit switching technologies to packet-based
networking technologies. In the Asia Pacific region, we anticipate that capital spending by wireless service providers will
be driven by the migration to 3G technologies in Japan and Korea, and by continued growth in
wireless subscribers in the Peoples Republic of China, or China. Growth in China may be further
driven by anticipated new national licenses for 3G. However, the timing of the issuance of new
national licenses for 3G in China is uncertain. The issuance of new national licenses for 3G in
China is also expected to impact the entire 3G market. Many countries in South and South East Asia
have very low wireless subscriber penetration levels, and are expected to experience increased
wireless subscriber growth over the next five years. India is also anticipated to be a major
wireless infrastructure market in the next five years. Customers Our Wireless Networks customers are wireless service providers, and their customers are the
subscribers for wireless communications services. The top 20 global wireless service providers
collectively account for a majority of all wireless subscribers around the world. We are currently
focused on increasing our market presence among the top global wireless service providers. None of
our Wireless Networks customers represented more than 10% of Nortel Networks consolidated revenues
in 2003. Competition Our major competitors in the global wireless infrastructure business have traditionally
included Telefonaktiebolaget LM Ericsson, Nokia Corporation, Siemens Aktiengesellschaft, Motorola,
Inc. and Lucent Technologies Inc. Nokia and Siemens compete in the sale of GSM and UMTS equipment,
whereas Lucent competes in the sale of CDMA and UMTS equipment. Motorola is a competitor in the
sale of GSM, UMTS and CDMA equipment. Ericsson competes in the sale of equipment for all of the
major wireless communications technologies. More recently, Samsung Electronics Co., Ltd. has
emerged as a competitor in the sale of CDMA systems, and Huawei Technologies Co., Ltd. and ZTE
Corporation have emerged as competitors for GSM, CDMA and UMTS systems in China and many other
developing countries. NEC Corporation and Fujitsu Limited have emerged as competitors for UMTS
equipment. The primary global factors of competition for our Wireless Networks products include:  
    
    technology leadership, product features and availability;
    
    product quality and reliability; 10




---



##### Table of Contents




    
    conformity to existing and emerging regulatory and industry standards;
    
    warranty and customer support;
    
    price and cost of ownership;
    
    interoperability with other networking products;
    
    network management capabilities;
    
    traditional supplier relationships, particularly in EMEA and the Asia Pacific region;
    
    regulatory certification; and
    
    provision of customer financing. We intend to compete with our traditional and emerging competitors as the global market for
wireless networking equipment migrates to 3G technologies. 
 Enterprise Networks Products Our Enterprise Networks solutions portfolio provides data, voice and multimedia communications
solutions for our enterprise customers. We also provide our enterprise customers with related
professional services. Circuit and packet voice solutions Our voice portfolio includes a broad range of circuit and packet voice communications
solutions.  
    
    Our communications servers and remote gateway products provide converged data, voice
and multimedia communications systems, using voice over internet protocol, or IP, or
session initiation protocol, or SIP, for service providers and enterprises. SIP is a
standard protocol for initiating an interactive user session that involves multimedia
elements such as video, voice, chat, gaming and virtual reality. Our enterprise solutions
can be used by customers building new networks and customers who want to transform their
existing communications network into a more cost effective, packet-based network
supporting data, voice and multimedia communications.
    
    Our customer premises-based circuit and packet telephone switching systems are designed
for small, medium and large commercial enterprises and government agencies. These systems
provide or can be configured with multiple applications, including voice communications
features, such as voice messaging, call waiting and call forwarding, as well as advanced
voice services, converged multimedia applications and other networking capabilities.
    
    Our customer contact center, messaging and interactive voice and web service solutions
are advanced communications tools designed to work with our customer premises-based
solutions. These tools enable employees to efficiently and productively communicate with
business contacts and other employees regardless of where they are located, the applicable
time zone or whether they choose to interact over the telephone or the Internet. Data networking and security solutions We offer a broad range of data networking (packet switching and routing) and security
solutions for our enterprise customers. Our packet switching and routing systems include data
switching systems, aggregation products, virtual private network gateways and routers, including:  
    
    Our data switches, secure routers and associated security products provide data
switching designed to allow our customers to provide Internet data security and IP
services including IP routing, virtual private networks, deep packet inspection, firewall
applications, policy management and data traffic flow management. These products also
enable our customers to manage and prioritize 11




---



##### Table of Contents



the Internet content that is provided to end-users and balance the amount of communications
traffic on multiple Internet servers.
    
    Our Ethernet switch portfolio is a series of high performance packet switches for our
enterprise customers small to large local area networks that use the Ethernet, a standard
computer networking protocol for local area networks.
    
    Our multi-protocol routers offer high-speed, high-capacity and medium-capacity data
switching to support a wide range of data communications technologies, including
multi-protocol label switching, asynchronous transfer mode, IP and frame relay services.
Our Ethernet routing switches deliver IP routing and switching.
    
    Our portfolio of WLAN service switching products is designed to provide secure and
efficient transmission of WLAN data and voice traffic for mobile users. Our WLAN voice
products integrate with our communications servers and gateway products to provide a
wireless voice over IP solution for our customers.
    
    Our portfolio of optical network switching products is designed to extend the range of
storage area networks to enable our customers to consolidate their data servers. Our
products enable enterprises to deploy these storage area networks in alternate locations,
providing geographic redundancy as part of their business continuity strategy. Product development We are currently focused on developing products that support the continuing evolution of voice
and data communications systems toward converged or combined data, voice and multimedia networks,
including:  
    
    The continued development of our multimedia communication server for enterprise, a
product that provides the capability to deliver converged data, voice and multimedia
applications and enhanced networking capabilities.
    
    Additions to the applications in our communications server products to allow
integration of voice over IP, voice extensible markup language, new operating systems and
servers, and voice recognition speech products.
    
    New developments in data networking products that will deliver resiliency, enable
increased data network traffic and provide suitable service levels and network
connectivity and power to devices over the same line.
    
    The development of the next generation web platform, which will feature higher
performance, scalability (that is, the ability to grow a service or capability with
incremental cost) and integrated applications.
    
    Enhancements to our security portfolio including the new secure sockets layer, or SSL,
and switching products and a new high-end secure router product. In addition, we have
entered into and continue to pursue strategic relationships that enhance our end-to-end
security solutions.
    
    Updates to our customer premises-based telephone systems to support our software that
enables those systems to function entirely as a packet-based system or as a hybrid packet
and circuit switching system. Markets We offer Enterprise Networks products to enterprises around the world. With the growth of
data, voice and multimedia communications over the public telephone network, the public Internet
and private voice and data communications networks, there is an increasing opportunity to converge
disparate networks towards a single, high performance network that can support various types of
communications traffic and applications. We believe that in order to meet the growing demand for increased capacity at lower per-minute
rates, enterprises will transition their circuit-based voice communications to more cost effective
packet-based technologies. As a result, we anticipate growth in demand for packet-based networking
equipment that 12




---



##### Table of Contents



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 rate of growth 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, WLANs 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 line of communication servers and
remote gateway products that enable conversion from voice communication networks to packet-based
networks supporting data, voice and multimedia communications. In EMEA, our customers are
beginning to invest in new technologies, such as voice over IP. In the Asia Pacific region,
Enterprise Networks customers are investing in networking equipment to improve the connections
among their regional sites and branch offices. In CALA, enterprises are continuing to drive demand
for networking equipment that supports the growing use of the Internet in the region. Customers We offer our products and services to a broad range of enterprise customers around the world,
including large businesses and their branch offices, small businesses and home offices, as well as
government agencies, educational and other institutions and utility organizations. Key industry
sectors for our business customers include the telecommunications, high-technology manufacturing,
government (including the defense sector) and financial services sectors. We also serve customers
in the healthcare, retail, education, hospitality, services, transportation and other industry
sectors. We are currently focused on increasing our market presence with enterprise customers. In
particular, we intend to focus on leading enterprise customers with high performance networking
needs. Certain of our service provider customers 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 represented
more than 10% of Nortel Networks consolidated revenues in 2003. Competition Our principal competitors in the sale of our Enterprise Networks solutions are Cisco Systems,
Inc., Avaya Inc., Siemens, Alcatel S.A., and NEC Corporation. Avaya is our largest competitor in
the sale of voice equipment while Cisco is our largest competitor in the sale of data networking
equipment to enterprises. We also compete with smaller companies that address specific niches,
such as Juniper Networks, Inc., 3Com Corporation, Foundry Networks, Inc., Extreme Networks, Inc.
and Enterasys Networks, Inc. in data networking; and Mitel Networks Corporation in Internet-based
voice communications solutions. We expect competition to remain intense as enterprises look for
ways to maximize the effectiveness of their existing networks while reducing ongoing capital
expenditures and operating costs. The principal global factors of competition in the sale of our Enterprise Networks solutions
include:  
    
    technology leadership, product features and availability;
    
    product quality and reliability;
    
    conformity to existing and emerging regulatory and industry standards;
    
    sales distribution and channel marketing strategy;
    
    warranty and customer support;
    
    price and cost of ownership;
    
    interoperability with other networking products;
    
    installed base of product;
    
    alternative solutions offered to enterprises by service providers;
    
    the leveraging of existing customer-supplier relationships; and 13




---



##### Table of Contents




    
    the availability of distribution channels. 
 Wireline Networks Products Our Wireline Networks portfolio addresses the demand by our service provider customers for
cost efficient data, voice and multimedia communications solutions. Our wireline solutions,
including related professional services, simplify network architectures by bringing data, voice,
multimedia and emerging broadband applications for revenue generating services together on one
packet network. Circuit and packet voice solutions We are a leader in the development and deployment of highly scalable circuit switched and
secure voice over packet solutions such as voice over IP for wireline and wireless service
providers around the world. Our voice over packet solutions offer service providers opportunities
for new revenue sources and sustainable operating and capital cost reduction, as well as high
levels of reliability and network resiliency. Our solutions include the following:  
    
    Our wireline voice over packet network solutions for service providers, which include
softswitches and media gateways. The portfolio provides the complete range of voice over
packet solutions, including local, toll, long-distance and international gateway
capabilities, and enables voice applications to run on the new multi-services packet
network. These solutions leverage more efficient packet-based, as opposed to
circuit-based, technologies that drive reduced capital and operational costs for service
providers and provide a platform for the delivery of new revenue-generating services, such
as Centrex IP and voice over IP virtual private networks.
    
    Our multimedia communications services portfolio allows our customers to deploy new,
enhanced multimedia services, including video, collaboration and personal agent services.
The portfolio includes a SIP-based application server that can enable an interactive user
session involving multimedia elements. For example, personal agent services allow users
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 portfolio is a family of digital, circuit-based telephone switches that
provides local, toll, long-distance and international gateway capabilities for service
providers. Our DMS systems enable service providers to connect end-users making local and
long-distance telephone calls. The DMS family of products can evolve to voice over packet
solutions.
    
    Our Nortel Networks Developers Partner Program helps to drive the interoperability of
our voice over IP multimedia communications and DMS portfolios with third party vendors
including infrastructure and application companies. These solutions work alone or in combination with each other to provide traditional voice services,
advanced packet voice services and enhanced multimedia services to service providers around the
world. Data networking and security solutions We offer a wide range of data networking (packet switching and routing) solutions to our
service provider customers. Our wide area network, or WAN, solutions and IP service routers enable
our service provider customers to offer connectivity solutions and high value services to both
enterprises and residential customers. Connectivity solutions include packet services such as:
frame relay; Asynchronous Transfer Mode, or ATM; Ethernet; and IP access for digital subscriber
line and cable users. High-value services, such as IP virtual private networks, enable an
enterprise to connect with other enterprise sites and remote users and to securely connect with
business partners. These high-value services also provide enhanced network capabilities, such as
network security, network address translation and class of service, that enable 14




---



##### Table of Contents



service providers to offer a wide range of networking services beyond basic connection to the
network. In 2004, we announced a new multiservice provider edge networking device that allows
service providers to converge multiple networks at the network edge to enable the delivery of
voice, data, multimedia and wireless services over a single, converged network. When we refer to
the network edge, we are referring to the point at which access networks meet the core network. Product development Research and development investments are focused on creating new and improving existing,
packet-based residential and business services for wireline and wireless service providers. Also,
we continue to develop products that support the evolution of data, voice and multimedia
communications systems toward converged or combined voice and data networks, including:  
    
    Enhancements to our voice over packet solutions that will allow service providers to
connect any business telephone system, using standard voice over IP protocols, into a
common dialing plan with connectivity to the public switched telephone network.
Additional enhancements to our packet voice solutions will continue to focus on
interoperability with other manufacturers equipment, including gateway and integrated
access device manufacturers, as well as on meeting the needs of the Asian and European
markets. We continue to make improvements to our softswitch portfolio by utilizing the
latest commercial technology to provide our customers with converged wireline and wireless
service support, superior application choices, integrated network management and linear
scalable capacity.
    
    Enhancements to the MCS 5200, part of our multimedia communications portfolio, that
will allow a service provider to offer intelligent multimedia services across any
manufacturers circuit switches. Additionally, development will focus on increasing the
breadth and usability of 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 businesses that use next generation telephones designed for
use in IP networks.
    
    Enhancements to our IP services router that enable an increase in the number of
residential subscribers and virtual private network sites that can be supported, and the
amount of bandwidth that can be applied to an enterprise site. Development will also
focus on enhancing the ability of our service provider customers to provide additional
revenue-generating services.
    
    A focus on cable standards compliance to enhance our solutions for the cable operator
markets in the United States, Canada and EMEA, including support for the open cable
standard protocol for cable media gateways.
    
    Enhancements to our WAN switch portfolio to improve interoperability with other
vendors products. In addition, development will focus on enhancing the migration to
converged networks which simultaneously support data, voice and multimedia.
    
    Continued development of a multiservice provider edge networking device designed to
converge multiple communications services operating at the IP or multi-protocol label
switching network edge. This device is currently undergoing customer trials and is not
yet generally available. As well, we continue to develop enhancements to our existing
line of WAN switch and IP service router products that are intended to efficiently
aggregate different types of data traffic at the network edge.
    
    Continued integration of a service provider core network router into our voice over
packet portfolio to enable us to provide a complete end-to-end solution. Markets With the growth of data, voice and multimedia communications over the public telephone
network, the public Internet and private voice and data communications networks, there is an
increasing opportunity to converge disparate networks towards a single, high performance packet
network that can support most 15




---



##### Table of Contents



types of communications traffic and applications. Converged voice and data networks also provide
an opportunity for service providers to offer new revenue-generating services while reducing their
ongoing operational costs year over year as they incorporate packet-based technology in their
networks. We believe our advantage lies in our ability to transition and upgrade our customers
installed base of voice and data network solutions to a multimedia IP network. To meet the growing demand for new revenue generating services and network efficiency, we
anticipate growth in demand for packet-based networking equipment that supports the convergence of
data, voice and multimedia communications over a single communications network and that provides
greater network capacity, reliability, speed, quality and performance. We anticipate a continued
increase in deployments of service provider voice over IP networks worldwide. While we anticipate
growth in voice over IP networks, we also anticipate a decline in legacy voice networks. Cable operators and new Internet telephone service providers are entering the voice and data
markets and are increasing the competitive pressure on established service providers. For example,
cable operators provide high speed data services as well as voice services by using voice over IP
technology. Similarly, established service providers are using existing broadband networks and
expanding those broadband networks to offer bundled services such as telephone, high speed Internet
and television services across those broadband networks. The market for our Wireline Networks products is global. Service providers are expected over the
long term to continue to modernize with packet-based networks and converge voice and data
communications networks in order to deploy new revenue-generating service offerings. We anticipate
an increased emphasis by service providers towards end-user networks in addition to their efforts
to modernize the inter-connection of those networks. In EMEA, we also continue to see market
demand for certain networking products, including equipment for voice over IP and equipment for
virtual private networking. In EMEA, we anticipate continued opportunities with alternate
operators, cable operators and wireless operators and anticipate new opportunities in emerging
markets. In the Asia Pacific region, we continue to see market demand for certain networking products,
including equipment for voice over IP and multimedia services and equipment for virtual private
networking. Deregulation in China has created opportunities for new entrants who are building out
their networks with packet-based technologies. In CALA, service providers are also focused on
implementing voice over IP technology to enable opportunities for additional growth, network
efficiency and revenue-generating services. There is also a growing demand for voice over IP
technology among cable operators in CALA. Customers We offer our Wireline Networks products and services to a wide range of wireline and wireless
service providers around the world. We are focused on increasing our market presence with key
global service providers which we currently expect to account for a substantial proportion of
service provider capital spending in 2004 and beyond. Our service provider customers include local
and long distance telephone companies, wireless service providers, cable operators and other
communications service providers. We also offer applicable data networking and security solutions from our Wireline Networks to
enterprises for private networking, as well as to service providers and system integrators that in
turn build, operate and manage networks for their customers such as businesses, government agencies
and utility organizations. None of our Wireline Networks customers represented more than 10% of
Nortel Networks consolidated revenues in 2003. Competition Our principal competitors in the Wireline Networks business are large communications companies
such as Siemens, Alcatel, Cisco and Lucent. In addition, we compete with smaller companies that
address specific niches within this market, such as Sonus Systems Limited, BroadSoft, Inc. and
Taqua Inc. in packet and Internet-based voice communications solutions; Juniper and Laurel
Networks, Inc. in multiservice provider 16




---



##### Table of Contents



edge solutions; and Ciena Corporation (which acquired Wavesmith Networks, Inc. in 2003) in
multiservice WAN solutions; and Redback Networks Inc. in aggregation products. Certain competitors
are also strong on a regional basis, such as ZTE Corporation and Huawei in the Asia Pacific region.
Some niche competitors are partnering with larger companies to enhance their product offerings and
large communications competitors are also looking for these partnerships or alliances to complete
their product offerings. No one competitor is dominant in the Wireline Networks market. The primary global factors of competition for our wireline products include:  
    
    technology leadership, product features and availability;
    
    price and total cost of ownership;
    
    ability to create new revenue-generating services for service providers and cable operators;
    
    conformity to existing and emerging regulatory and industry standards;
    
    installed base of products and customer relationships;
    
    network management capabilities;
    
    product quality and reliability; and
    
    warranty and customer support. Competition remains intense as a result of reduced investment in existing legacy networks by
service providers, the continued consolidation in the service provider industry, and the continued
focus by suppliers on selling to large service providers with financial resources. 
 Optical Networks Products Our Optical Networks solutions portfolio addresses the varying optical communication needs of
service providers and enterprises. Optical networks transport data, voice and multimedia
communications within and between cities, countries or continents by transmitting communications
signals in the form of light waves through fiber optic cables. Optical networking is the most
common method for transporting communications signals between the various locations within a
service providers network and is unmatched for delivering vast amounts of data reliably and
cost-effectively with service and bandwidth flexibility and scalability. Our optical networking solutions are designed to provide metropolitan, regional and long-haul,
high-capacity transport and switching of data, voice and multimedia communications signals. These
solutions include photonic Dense Wavelength Division Multiplexing, or DWDM, transmission solutions,
synchronous optical transmission solutions, optical switching solutions and network management and
intelligence software. We also offer our customers a variety of related professional services.
Our solutions include the following:  
    
    Our photonic networking DWDM solutions allow multiple light wave signals to be
transmitted on the same fiber optic strand simultaneously by using different wavelengths
of light to distinguish specific signals, thereby increasing the capacity and flexibility
of a network. Our long-haul DWDM line systems span distances up to 2,000 kilometers and
our metro DWDM series provides 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, or SONET, standard, which is the most common
standard in the United States and Canada and some countries in the Asia Pacific region,
and the Synchronous Digital Hierarchy, or SDH, standard, which is the most common standard
in EMEA and many other countries. Our synchronous next-generation SONET/SDH solutions
comprise multi-service optical platforms that integrate diverse protocols and technologies
to deliver services over a cost effective, scalable and reliable converged services
network. 17




---



##### Table of Contents




    
    Our optical switching solutions enable communication signals in optical fibers to be
selectively directed or switched from one network circuit to another.
    
    Our network management software and intelligence solutions are designed to give our
customers the ability to monitor and improve the performance of their networks. Our Optical Networks solutions enable customers to enhance and transform their networks towards a
scalable and reliable network for delivering diverse high speed data and voice communication
services. Such network transformation is expected to increase deployment of managed broadband
services, such as:  
    
    Optical Ethernet solutions that combine the strengths of the Ethernet network computing
protocol with those of optical communications. Optical Ethernet solutions transport
communications signals carrying Ethernet packets in the form of light waves through fiber
optic cables between locations within a city or between cities.
    
    Optical storage connectivity solutions, which allow the interconnection of data centers
for the efficient preservation and sharing of business-critical data to ensure business
continuity and disaster recovery.
    
    Managed wavelength solutions, which offer multiple protocol and transmission speed
networking capability to reliably interconnect business sites. In addition, in February 2004, we announced strategic alliances with Calix Networks, Inc., ECI
Telecom Ltd. and KEYMILE AG that will expand our broadband networking solutions portfolio and
enable our service provider customers to deliver a new set of emerging broadband services to their
enterprise and residential end-users. Product development We are focused on developing next generation optical networking systems, including the
evolution of our next generation SONET/SDH systems, our metro DWDM systems and our optical
long-haul line and terminal solutions. In 2003, we:  
    
    introduced an advanced metro optical network product, our Optical Multiservice Edge
6500, that enables the convergence of multiple platforms onto a single platform enabling
reduced network costs and enhanced functionality;
    
    enhanced the capabilities of our existing metro optical network products to enable new
storage area solutions that address emerging enterprise business continuity requirements;
and
    
    introduced a new long-haul product that utilizes photonic networking DWDM technology,
which assists customers in lowering their network costs by providing improved optical
performance. We continue to develop and enhance our Optical Networks portfolio, including by:  
    
    enhancing our optical Ethernet portfolio by introducing new Ethernet switching and
transport capabilities designed to improve the productivity of our enterprise customers
and the services offered by our service provider customers;
    
    introducing in 2004, a new common photonic layer product that simplifies and automates
the deployment and operation of medium and long-haul optical links;
    
    introducing the second release of our high density optical switching system to provide
additional customer applications; and
    
    investing in improving the density, capacity and flexibility of our optical long-haul
transmission systems. We also continue to invest in core technologies, such as efficient service adaptation, aggregation,
switching and management, that enable our customers worldwide to deploy innovative optical
networking services 18




---



##### Table of Contents



which we believe will lead the networking transformation towards high performance packet-based
networks. Markets We are a leading provider of optical networking products to service providers and enterprises
around the world. Compared to the last few years, the global optical market has stabilized.
Service providers remain focused on maximizing return on invested capital by increasing their
capacity utilization rates and the efficiency of their existing networks. Some service providers
have delayed the deployment of next generation products. However, there remain opportunities to
deliver new technologies and services that enable service providers to offer additional
revenue-generating services. We also expect that enterprises will continue to generate demand for
optical networking solutions that enable them to operate their networks more efficiently. The outlook for optical equipment sales may be further impacted by service providers preferring to
lease excess network capacity from others or purchase assets from other operators rather than
making capital investments in their own networks. We expect that any additional capital spending
by our customers will continue to be directed toward opportunities that enhance customer
performance, generate revenue and reduce costs in the near term. However, as service providers
begin to more effectively utilize and eventually exceed their network capacity, we expect that they
may incrementally enhance that capacity. The timing and impact of these developments remain
difficult to predict. The market for our Optical Networks solutions is global. In the United States and Canada, new
networks are not currently being built by service providers in anticipation of market demand, but
are instead being built to more closely align with actual end-user demand. Several service
providers in the United States have announced plans to deploy optical fiber networks to allow
access to these networks by residential end-users. Within EMEA, the building of pan-European
optical networks by service providers is now mature and many service providers have begun to focus
on building their metropolitan and regional optical networks. We expect that the increased usage
of broadband wireless data provided by 3G networks may eventually drive the increased deployment of
optical networks. The demand for additional and enhanced services by enterprises is increasing in
Europe and may also encourage service providers to invest in the creation of networks that offer
services such as optical Ethernet and storage connectivity. In EMEA, European government-sponsored
service providers and networking equipment suppliers enjoy favorable positions within many European
countries. In the Asia Pacific region, the industry is continuing to develop and may provide a significant
market for new optical networking equipment over the next several years. As a result, there has
been an increased focus on the Asia Pacific region by virtually all suppliers of optical networking
equipment. Similar to what is occurring in Europe within the EMEA region, the Asia Pacific region
may experience increased demand for additional and enhanced services by enterprises which may
encourage service providers to invest in the creation of networks that offer services such as
optical Ethernet and storage connectivity. In CALA, where a few service providers account for a
significant percentage of the industry, the building of national optical network infrastructures is
largely complete. Customers Our Optical Networks business is primarily focused on offering our optical networking
solutions to service providers around the world. The service provider customers for our optical
networking products include local and long-distance telephone companies, cable operators, Internet
service providers and other communications service providers. We are currently focused on
increasing our market presence with key service provider customers worldwide, which we expect to
account for a substantial proportion of service provider optical capital spending. We are also focused on enterprises and we continue to provide optical solutions for private
enterprise networking and also for service providers to build and operate custom dedicated networks
for enterprises. We leverage numerous channels for delivering optical networking solutions to
enterprises from our own 19




---



##### Table of Contents



direct sales force for large enterprises and governments and through distributors, resellers and
partners to offer our solution to medium-sized enterprises and smaller enterprises. None of our
Optical Networks customers represented more than 10% of Nortel Networks consolidated revenues in
2003. Competition Our major competitors in the sale of optical networking equipment include Alcatel, Lucent,
Siemens, Fujitsu Limited, Marconi plc, Cisco, Huawei, NEC, Ciena and ADVA International Inc.
Market position in the global market for optical networking equipment can fluctuate significantly
on a quarter-by-quarter basis. However, we continue to be a leading global provider of optical
networking equipment. No one competitor is dominant in the optical networking equipment market. The primary global factors of competition for our Optical Networks products include:  
    
    technology leadership, product features and availability;
    
    product quality and reliability;
    
    conformity to existing and emerging regulatory and industry standards;
    
    warranty and customer support;
    
    price and cost of ownership;
    
    interoperability with other networking products;
    
    network management capabilities;
    
    traditional supplier relationships, particularly in EMEA and the Asia Pacific region; and
    
    regulatory certification, particularly for incumbent local and long-distance telephone
companies. Our focus is on increasing market share relative to our competitors. 
 Sales and distribution All of our reportable segments use the Nortel Networks direct sales force to market and sell
to customers around the world. The Nortel Networks global sales force operates on a regional basis
and markets and sells our products and services to customers located in the following regional
areas: Canada; United States; CALA; EMEA; and Asia Pacific. Our sales office bases for our direct
sales force are aligned with our customers on a country and regional basis. We have dedicated sales account teams for certain major service provider customers. These
dedicated teams are located close to the customers main purchasing locations. In addition, teams
within the regional sales groups are dedicated to our enterprise customers. Our Enterprise
Networks sales teams work directly with the top regional enterprises, and are also responsible for
managing regional distribution channels. We also have centralized marketing, product management
and technical support teams dedicated to individual product lines that support the global sales and
support teams. In the Asia Pacific region, particularly in China, we also use agents to interface with our
customers. In addition, we have some small non-exclusive distribution agreements with distributors
in EMEA, CALA and the Asia Pacific region. In Enterprise Networks, certain service providers,
system integrators, value-added resellers and stocking distributors act as non-exclusive
distribution channels for our products. 
 Backlog Our backlog was approximately $3.3 billion and $3.3 billion as of September 30, 2004 and
September 30, 2003, respectively. A majority of backlog consists of orders confirmed with a
binding purchase order or contract for our network solutions typically scheduled for delivery to
our customers within the next twelve months. A significant portion of backlog may also include
orders that relate to revenue that has been 20




---



##### Table of Contents



deferred for periods longer than twelve months. However, orders are subject to possible
rescheduling by customers. Although we believe that the orders included in the backlog are firm,
we may elect to permit cancellation of orders without penalty where management believes that it is
in our best interest to do so. Prior to including orders in backlog, customers must have approved
credit status. However, from time to time, some customers may become unable to pay for or finance
their purchases in which case the order is removed from our backlog. 
 Product standards, certification and regulations Our products are subject to equipment standards, registration and certification in Canada, the
United States, the European Union and other countries. We design and manufacture our products to
satisfy a variety of regulatory requirements and protocols established to, for instance, avoid
interference among users of radio frequencies and to permit interconnection of equipment. For
example, our equipment must satisfy the United States Federal Communications Commissions, or FCC,
emissions testing requirements, and must be certified to safety, electrical noise and
communications standards compliance. Different regulations and regulatory processes exist in each
country. In order for our products to be used in some jurisdictions, regulatory approval and, in some cases,
specific country compliance testing and re-testing may be required. The delays inherent in this
regulatory approval process may force us to reschedule, postpone or cancel introduction of products
or new capabilities in certain geographic areas, and may result in reductions in our sales. The
failure to comply with current or future regulations or changes in the interpretation of existing
regulations in a particular country could result in the suspension or cessation of sales in that
country or require us to incur substantial costs to modify our products to comply with the
regulations of that country. To support our compliance efforts, we work with consultants and
testing laboratories as necessary to ensure that our products comply with the requirements of
Industry Canada in Canada, the FCC in the United States and the European Telecommunications
Standards Institute in Western Europe, as well as with the various regulations of other countries.
For additional information, see Environmental Matters. The operations of our service provider customers are subject to extensive country-specific
telecommunications regulations. In the United States, on February 20, 2003, the FCC announced a
decision in its triennial review proceeding of the agencys rules regarding unbundled network
elements. The text of the FCCs order and reasons for the decision were released on August 21,
2003. The FCC decision, subsequent judicial review of the decision and the FCCs reconsideration
of its decision and subsequent adoption on December 15, 2004 of new unbundling rules in response to
the remand by the U.S. Court of Appeals for the D.C. Circuit are affecting, and may continue to
affect, the decisions of certain of our United States-based service provider customers regarding
investment in their telecommunications infrastructure. These unbundled network elements rules
and/or material changes in other country-specific telecommunications regulations at any time or
from time to time may affect capital spending by service providers in the United States and/or
around the world, and this may in turn affect the United States and/or global markets for
networking solutions. 
 Sources and availability of materials Since 1999, our manufacturing and supply chain strategy has evolved and has resulted in the
gradual transformation of our traditional manufacturing model, in which our products were primarily
manufactured and assembled in-house, to primarily an outsourced model which relies on electronic
manufacturing services, or EMS, suppliers. By the end of 2003, most of our manufacturing
activities had been divested to leading EMS suppliers. We have continued to pursue an outsourced
manufacturing model and in January 2004 announced our intention to divest substantially all of our
remaining manufacturing activities. On June 29, 2004, we announced that we had reached an
agreement with Flextronics to divest substantially all of Nortel Networks remaining manufacturing operations, located in Canada and Brazil, with the
anticipation that Flextronics will also acquire similar operations in France and Northern Ireland,
subject to the completion of the required information and consultation processes. For recent
developments in the 21




---



##### Table of Contents



evolution of our supply chain strategy, see Developments in 2003 and 2004 in the MD&A section of
this report. We believe that the use of an outsourced manufacturing model has enabled us to benefit from leading
manufacturing technologies, leverage existing resources from around the world, lower our cost of
sales, adjust to fluctuations in market demand and decrease our investment in plant, equipment and
inventories. We continue to retain in-house all strategic management and overall control
responsibilities associated with our various supply chains, including all customer interfaces,
customer service, order management, quality assurance, product cost-management, new product
introduction, and network solutions integration, testing and fulfillment. Through our existing manufacturing model, we are generally able to obtain sufficient materials and
components from global sources to meet the needs of our four reportable segments. In each of our
reportable segments, we:  
    
    make significant purchases of electronic components and assemblies, optical components,
original equipment manufacturer, or OEM, products, software products, outsourced
assemblies and other materials and components from many domestic and foreign sources;
    
    develop and maintain alternative sources for certain essential materials and
components; and
    
    occasionally maintain special inventories of components internally or request that they
be maintained by suppliers to satisfy customer demand or to minimize effects of possible
market shortages. Comparing 2003 to 2002, we observed fewer instances of supply surpluses because of adjustments to
eliminate excess capacity. In 2003, we continued our focus on inventory management and component
cost reduction. In 2004, we continued to purchase, manufacture, or otherwise obtain sufficient
components and materials to supply our products, systems and networks within customary delivery
periods. For more information on our supply arrangements, see Commitments in note 14 of the accompanying
consolidated financial statements and Developments in 2003 and 2004 and Liquidity and capital
resources  Contractual cash obligations  Outsourcing contracts in the MD&A section of this
report. 
 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. The industry adjustment and economic downturn in the United States and
elsewhere in 2001 and 2002 affected our customers traditional purchasing patterns, the demand for
our products and services and the traditional seasonality of our business. In 2003, we began to
experience a period of relative industry stability. While our customers increased their purchasing
levels in the fourth quarter of 2003, our customers continued to spend cautiously. We experienced a
seasonal decline in revenues in the first quarter of 2004 compared to the fourth quarter of 2003,
followed by growth in the second quarter of 2004 compared to the first quarter of 2004 in all of
our four reportable segments. There will be a sequential decline in revenue in the third quarter
of 2004 compared to the second quarter of 2004 and we expect that the fourth quarter of 2004 will
be the strongest quarter in 2004. The quarterly profile of our business results in 2004 is not
expected to be consistent across all of our reportable segments and there is no assurance that our
results of operations for any quarter will necessarily be consistent with our historical quarterly
profile or indicative of our expected results in future quarters. See Results of operations 
continuing operations  2004 and 2005 and Risk factors/forward looking statements in the MD&A
section of this report. 22




---



##### Table of Contents



Strategic alliances, acquisitions and minority investments We use strategic alliances to deliver certain solutions to our customers. These alliances are
typically formed to fill product or service gaps in areas that support our core businesses. We
believe strategic alliances also augment our access to potential new customers. We intend to
continue to pursue strategic alliances with businesses that offer technology and/or resources that
would enhance our ability to compete in existing markets or exploit new market opportunities. In 2003, we increased our then existing majority positions in certain companies to 100% ownership.
See Developments in 2003 and 2004  Ownership adjustment in our French and German operations in
the MD&A section of this report. However, we did not make any material acquisitions in 2003 or in
2004. In the future, we may consider selective opportunistic acquisitions of companies with
resources and product or service offerings capable of providing us with additional enhancements to
our networking solutions or access to new markets. For information regarding the risks associated
with strategic alliances and acquisitions, see Risk factors/forward looking statements in the
MD&A section of this report. We continue to hold minority investments in certain start-up businesses with technology, products
or services that, at the time of investment, had the potential to fulfill key existing or emerging
market opportunities. When minority investments are no longer required to maintain our strategic
relationship, or the relationship is no longer strategic to our core businesses, we intend to exit
such investments at an opportune time. Our investment activity remained at a low level in 2003 and in 2004. We may make selective
minority investments in start-up ventures and certain other companies where we believe the
relationship could lay the foundation for future alliances that would support our customer
solutions. In certain circumstances, we may also acquire an equity position in a company as
consideration for a divested business. See Developments in 2003 and 2004  Directory and operator
services business in the MD&A section of this report. 
 Research and development In order to remain among the technology leaders in anticipated growth areas, we intend to
continue to make strategic investments in our research and development activities. Our research
and development activities  specifically, research, design and development, systems engineering
and other product development activities  represent focused investments to drive market leadership
across our product portfolios. We refer you to the four Product development discussions
contained in the descriptions of Wireless Networks, Enterprise Networks, Wireline Networks and
Optical Networks above. Our research and development investments are focused on network transformation and next generation
products and solutions including wireless voice and data, voice over packet, multimedia services
and applications, broadband networking and network security. We also conduct network planning and
systems engineering on behalf of, or in conjunction with, major customers. Although we derive many
of our products from substantial internal research and development activities, we supplement this
with technology acquired or licensed from third parties. Our research and development forms a core strength and is a factor differentiating us from many of
our competitors. As at December 31, 2003, we employed approximately 13,500 regular full-time
research and development employees (excluding employees on notice of termination) including
approximately:  
    
    5,310 regular full-time research and development employees in Canada;
    
    4,910 regular full-time research and development employees in the United States;
    
    2,400 regular full-time research and development employees in EMEA; and
    
    880 regular full-time research and development employees in other countries. 23




---



##### Table of Contents



In August and September 2004, we announced a new strategic plan that includes a focused workforce
reduction of approximately 3,250 employees, or about 10% of our workforce. It is expected that
approximately 1,400 regular full-time research and development employees will be affected by the
workforce reduction, which is expected to principally affect employees in Wireline Networks and
Optical Networks. See Employee relations. We also conduct research and development activities through affiliated laboratories in other
countries. The following table sets forth our consolidated expenses for research and development for each of
the three fiscal years ended December 31: (millions of dollars)
    
    2003
    
    
    2002
    
    
    2001R&D expense
    
    $
    1,965
    
    
    $
    2,084
    
    
    $
    3,128R&D costs incurred on behalf of others (a)
    
    
    72
    
    
    
    49
    
    
    
    68Total
    
    $
    2,037
    
    
    $
    2,133
    
    
    $
    3,196
 (a)
    
    These costs included research and development charged to our customers pursuant to
contracts that provided for full recovery of the estimated cost of development, material,
engineering, installation and all other applicable costs, which were accounted for as contract
costs. 
 Intellectual property Our intellectual property is fundamental to Nortel Networks and the business of each of our
four reportable segments. In particular, our success is dependent upon our proprietary technology.
We generate, maintain, utilize and enforce a substantial portfolio of intellectual property
rights, including trademarks, and an extensive portfolio of patents covering significant
innovations arising from research and development activities. In all of our reportable segments,
we use our intellectual property rights to protect our investments in research and development
activities, to strengthen our leadership positions, to protect our good name, to promote our brand
name recognition, to enhance our competitiveness and to otherwise support our business goals and
objectives. However, our intellectual property rights may be challenged, invalidated or
circumvented, or fail to provide us with significant competitive advantages. See Risk
factors/forward looking statements in the MD&A section of this report. The duration and level of
protection of our intellectual property rights are dependent upon the laws and requirements of the
jurisdictions providing or controlling those rights. As of December 31, 2003, we and our parent, Nortel Networks Corporation, had on a consolidated
basis, approximately:  
    
    3,200 United States patents;
    
    2,800 patents in other countries; and
    
    6,200 pending patent applications worldwide. We were granted 464 United States patents in 2003. 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,
2003, we and our parent, Nortel Networks Corporation, owned on a consolidated basis approximately
120 registered trademarks in 24




---



##### Table of Contents



the United States, and approximately 2,040 registered trademarks in other countries. In addition,
as of December 31, 2003, we had approximately 160 pending trademark registrations worldwide. 
 Employee relations At December 31, 2003, we employed approximately 34,970 regular full-time employees (excluding
employees on notice of termination), including approximately:  
    
    12,800 regular full-time employees in the United States;
    
    9,430 regular full-time employees in Canada;
    
    7,840 regular full-time employees in EMEA; and
    
    4,900 regular full-time employees in other countries. We also employ individuals on a regular part-time basis and on a temporary full-time basis. In
addition, we engage the services of contractors as required. As part of our resizing activities to further reduce our cost structure and streamline operations,
we notified for termination and provisioned for the exit of
approximately 1,700 regular full-time
employees during 2003. As well, divestitures and outsourcing affecting non-core businesses
completed or entered into in 2003 resulted in additional reductions. On June 29, 2004, we
announced that we had reached an agreement with Flextronics to divest certain manufacturing
operations in Canada and Brazil, with the anticipation that Flextronics will also acquire similar
operations in France and Northern Ireland, subject to the completion of the required information
and consultation process. Under the terms of the agreement, it is intended that approximately
2,500 Nortel Networks employees would transfer to Flextronics by the end of June 2005. In
addition, in August and September 2004 we announced a new strategic plan, including a new
streamlined organizational structure which will lead to an anticipated reduction in employees of
approximately 3,250, or about 10% of the workforce. Approximately 64% of employee actions related
to the focused workforce reduction were completed by the end of 2004, including approximately 55%
that were notified of termination or acceptance of voluntary retirement, with the remainder
comprising voluntary attrition of employees that were not replaced. The remainder of employee
actions are expected to be completed by June 30, 2005. In addition, however, we continue to hire
in certain strategic areas such as investments in the finance organization. The workforce
reduction will be subject to completion of the appropriate information and consultation processes
with the relevant employee representatives in certain jurisdictions, as required by law. For
additional information, see Sources and availability of materials, Special charges in note 7 of
the accompanying consolidated financial statements and Results of operations  continuing
operations  Operating expenses  Special charges in the MD&A section of this report. At December 31, 2003, labor contracts covered approximately five percent of our employees
worldwide. At the same date, five labor contracts covered approximately ten percent of our
employees in Canada including:  
    
    one labor contract covering approximately eight 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 renewed, ratified and became effective August 16, 2003;
    
    one labor contract covering approximately ten percent of Canadian unionized employees
which was renewed, ratified and became effective June 19, 2003;
    
    one labor contract covering approximately 64% of Canadian unionized employees which was
renewed, ratified and became effective April 13, 2004; and
    
    one labor contract covering approximately 18% of Canadian unionized employees which
expires in 2008. 25




---



##### Table of Contents



At December 31, 2003, labor contracts covered approximately four percent of our employees in EMEA
and all of our employees in Brazil. These labor contracts generally have a one-year term, and
primarily relate to remuneration. We have no labor contracts in the United States. We believe our employee relations are generally positive. Employee morale continues to be an area
of focus as a result of ongoing workforce reductions associated with our restructuring activities
occurring since 2001, the recent reductions resulting from our strategic plan announced in August
and September 2004, and the restatement of our financial results and related matters. Although the
recruitment and retention of technically skilled employees in recent years was highly competitive
in the global networking industry, the economic conditions during the past few years have lessened
the competition for skilled employees in our industry. We do, however, believe that our ability to
recruit and retain skilled employees will continue to be critical to our future success. During
2003, approximately 1,200 regular full-time employees were hired globally. From the beginning of
2004 until November 30, 2004, approximately 2,300 regular full-time employees were hired. See Risk
factors/forward looking statements in the MD&A section of this report. 
 Environmental matters Our operations are subject to a wide range of environmental laws in various jurisdictions
around the world. We seek to operate our business in compliance with such laws. In Europe, we
expect to become subject to new product content laws and product takeback and recycling
requirements that will require full compliance by 2006. We expect that these laws will require us
to incur additional compliance costs. Although costs relating to environmental matters have not
resulted in a material adverse effect on our business, results of operations, financial condition
and liquidity in the past, there can be no assurance that we will not be required to incur such
costs in the future. We have a corporate environmental management system standard and an
environmental program to promote compliance. We also have a periodic, risk-based, integrated
environment, health and safety audit program. As part of our environmental program, we attempt to
evaluate and assume responsibility for the environmental impacts of our products throughout their
life cycles. Our environmental program focuses on design for the environment, supply chain and
packaging reduction issues. We work with our suppliers and other external groups to encourage the
sharing of non-proprietary information on environmental research. For additional information on
environmental matters, see Contingencies  Environmental matters in note 21 of the accompanying
consolidated financial statements. 
 Financial information by operating segment and product category For financial information by operating segment and product category, see Segment information
in note 6 of the accompanying consolidated financial statements and Results of operations 
continuing operations  Segment revenues in the MD&A section of this report. 
 Financial information by geographic area For financial information by geographic area, see Segment information in note 6 of the
accompanying consolidated financial statements and Results of
operations  continuing operations  Geographic revenues in the MD&A section of this report. 
 Working capital For a discussion of our working capital practices, see Long-term debt, credit and support
facilities in note 11 of the accompanying consolidated financial statements and Liquidity and
capital resources in the MD&A section of this report. 26




---



##### Table of Contents



Risk factors THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD LOOKING INFORMATION THAT IS SUBJECT TO
IMPORTANT RISKS AND UNCERTAINTIES. THE RESULTS OR EVENTS PREDICTED IN THESE STATEMENTS MAY DIFFER
MATERIALLY FROM ACTUAL RESULTS OR EVENTS. RESULTS OR EVENTS COULD DIFFER FROM CURRENT EXPECTATIONS
AS A RESULT OF A WIDE RANGE OF RISK FACTORS. FOR INFORMATION REGARDING SOME OF THE RISK FACTORS
INVOLVED IN OUR BUSINESS AND OPERATIONS, SEE RISK FACTORS/FORWARD LOOKING STATEMENTS IN THE MD&A
SECTION OF THIS REPORT. 27




---



##### Table of Contents



ITEM 2.
    
    PROPERTIES At December 31, 2003, we operated 204 sites around the world occupying approximately 13.6
million square feet. The following table sets forth additional information regarding these sites: Number of SitesType of Site*
    
    
    Owned
    
    
    
    Leased
    
    
    
    Geographic LocationsManufacturing and repair
    
    
    
    7
    
    
    
    
    
    
    
    
    All geographic regionsDistribution centers
    
    
    
    
    
    
    
    
    6
    
    
    
    United States, Canada, EMEA and the Asia Pacific regionOffices
(administration, sales
and field service)
    
    
    
    3
    
    
    
    
    172
    
    
    
    All geographic regionsResearch and development
    
    
    
    3
    
    
    
    
    13
    
    
    
    United States, Canada, EMEA and the Asia Pacific regionTOTAL**
    
    
    
    13
    
    
    
    
    191
  *
    
    Indicates the primary use of the site. A number of our sites are mixed-use facilities.**
    
    Excludes approximately 8.7 million square feet, consisting primarily of leased and/or vacant
property designated as part of a planned square footage
reduction in connection with our restructuring activities that commenced in 2001. At December
31, 2003, approximately 2.8 million square feet of such
property was sub-leased.
 At December 31, 2003, we and our parent, Nortel Networks Corporation, primarily used, on a
consolidated basis, the facilities approximately as follows:  
    
    21% by Wireless Networks;
    
    12% by Enterprise Networks;
    
    10% by Wireline Networks;
    
    6% by Optical Networks;
    
    29% by global operations; and
    
    22% by one or more of our reporting segments and/or corporate facilities. In 2003, we continued to reduce the number of sites and square footage of our global facilities to
better align ourselves with current market conditions. We believe our facilities are suitable and
adequate, and have sufficient capacity to meet our current needs. We continue to evaluate our
future real estate needs based on the current industry environment and taking into account our
business requirements. In 2004, we purchased land and two buildings that were previously leased by
Nortel Networks. Our strategic plan announced in August and September 2004 includes the reduction
of approximately 2 million square feet of occupied space as a result of workforce reductions and
improved space utilization through the consolidation of locations. We expect the square footage
reduction to be completed by the end of 2005. For additional details, see Special charges in note 7 and Long-term debt, credit and support
facilities in note 11 of the accompanying consolidated financial statements, and Liquidity and
capital resources  Sources of liquidity in the MD&A section of this report. Security over substantially all of our assets, including certain real estate assets in North
America, became effective in April 2002 under certain credit and security agreements entered into
by us and several of our subsidiaries. For additional details regarding these agreements and the
security, see Long-term debt, credit and support facilities in note 11, Subsequent events in
note 22 and Supplemental consolidating financial information in note 23 of the accompanying
consolidated financial statements and 28




---



##### Table of Contents



Developments in 2003 and 2004  Credit facilities and security agreements and Liquidity and
capital resources  Sources of liquidity  Available support facility in the MD&A section of this
report. 
  ITEM 3.
    
    LEGAL PROCEEDINGS Subsequent to the February 15, 2001 announcement in which NNC provided revised guidance for
financial performance for the 2001 fiscal year and the first quarter of 2001, NNC and certain of
its then current officers and directors were named as defendants in more than twenty-five purported
class action lawsuits. These lawsuits in the U.S. District Courts for the Eastern District of New
York, for the Southern District of New York and for the District of New Jersey and the provinces of
Ontario, Quebec and British Columbia in Canada, on behalf of shareholders who acquired Nortel
Networks Corporation securities as early as October 24, 2000 and as late as February 15, 2001,
allege, among other things, violations of U.S. federal and Canadian provincial securities laws.
These matters also have been the subject of review by Canadian and U.S. securities regulatory
authorities. On May 11, 2001, the defendants filed motions to dismiss and/or stay in connection
with the three proceedings in Quebec primarily based on the factual allegations lacking substantial
connection to Quebec and the inclusion of shareholders resident in Quebec in the class claimed in
the Ontario lawsuit. The plaintiffs in two of these proceedings in Quebec obtained court approval
for discontinuances of their proceedings on January 17, 2002. The motion to dismiss and/or stay
the third proceeding was heard on November 6, 2001 and the court deferred any determination on the
motion to the judge who will hear the application for authorization to commence a class proceeding.
On December 6, 2001, the defendants filed a motion seeking leave to appeal that decision. The
motion for leave to appeal was dismissed on March 11, 2002. On October 16, 2001, an order in the
Southern District of New York was filed consolidating twenty-five of the related U.S. class action
lawsuits into a single case, appointing class plaintiffs and counsel for such plaintiffs. The
plaintiffs served a consolidated amended complaint on January 18, 2002. On December 17, 2001, the
defendants in the British Columbia action served notice of a motion requesting the court to decline
jurisdiction and to stay all proceedings on the grounds that British Columbia is an inappropriate
forum. The motion has been adjourned at the plaintiffs request to a future date to be set by the
parties. A class action lawsuit against NNC was also filed in the U.S. District Court for the Southern
District of New York on behalf of shareholders who acquired the securities of JDS Uniphase
Corporation (JDS) between January 18, 2001 and February 15, 2001, alleging violations of the same
U.S. federal securities laws as the above-noted lawsuits. On April 1, 2002, NNC filed a motion to dismiss both the above consolidated U.S. shareholder class
action and the above JDS shareholder class action complaints on the grounds that they failed to
state a cause of action under U.S. federal securities laws. With respect to the JDS shareholder
class action complaint, NNC also moved to dismiss on the separate basis that JDS shareholders
lacked standing to sue NNC. On January 3, 2003, the District Court granted the motion to dismiss
the JDS shareholder class action complaint and denied the motion to dismiss the consolidated U.S.
class action complaint. Plaintiffs appealed the dismissal of the JDS shareholder class action
complaint. On November 19, 2003, oral argument was held before the Second Circuit on the JDS
shareholders appeal of the dismissal of their complaint. On May 19, 2004, the Second Circuit
issued an opinion affirming the dismissal of the JDS shareholder class action complaint and on July
14, 2004 the Second Circuit denied plaintiffs motion for rehearing. On October 12, 2004, the
plaintiffs filed a petition for writ of certiorari in the U.S. Supreme Court. On November 12,
2004, the defendants filed Brief for the Respondents in Opposition, and on November 22, 2004, the
plaintiffs filed Reply to Brief in Opposition. With respect to the consolidated U.S. shareholder
class action, the plaintiffs served a motion for class certification on March 21, 2003. On May 30,
2003, the defendants served an opposition to the motion for class certification. Plaintiffs reply
was served on August 1, 2003. The District Court held oral arguments on September 3, 2003 and
issued an order granting class certification on September 5, 2003. On September 23, 2003, the
defendants filed a motion in the Second Circuit for permission to appeal the class certification
decision. The plaintiffs opposition to the motion was filed on October 2, 2003. On November 24,
2003, the Second Circuit denied the motion. On March 10, 2004, the District Court approved the
form of notice to the class which was published and mailed. 29




---



##### Table of Contents



On July 17, 2002, a new purported class action lawsuit (the Ontario Claim) was filed in the
Ontario Superior Court of Justice, Commercial List, naming NNC, certain of its current and former
officers and directors and its auditors as defendants. The factual allegations in the Ontario
Claim are substantially similar to the allegations in the consolidated amended complaint filed in
the U.S. District Court described above. The Ontario Claim is on behalf of all Canadian residents
who purchased Nortel Networks Corporation securities (including options on Nortel Networks
Corporation securities) between October 24, 2000 and February 15, 2001. The plaintiffs claim
damages of Canadian $5,000, plus punitive damages in the amount of Canadian $1,000, prejudgment and
postjudgment interest and costs of the action. On September 23, 2003, the Court issued an order
allowing the plaintiffs to proceed to amend the Ontario Claim and requiring that the plaintiffs
serve class certification materials by December 15, 2003. On September 24, 2003, the plaintiffs
filed a notice of discontinuance of the original action filed in Ontario. On December 12, 2003,
plaintiffs counsel requested an extension of time to January 21, 2004 to deliver class
certification materials. On January 21, 2004, plaintiffs counsel advised the Court that the two
representative plaintiffs in the action no longer wished to proceed, but counsel was prepared to
deliver draft certification materials pending the replacement of the representative plaintiffs. On
February 19, 2004, the plaintiffs counsel advised the Court of a potential new representative
plaintiff. On February 26, 2004, the defendants requested the Court to direct the plaintiffs
counsel to bring a motion to permit the withdrawal of the current representative plaintiffs and to
substitute the proposed representative plaintiff. On June 8, 2004, the Court signed an order
allowing a Second Fresh as Amended Statement of Claim that substituted one new representative
plaintiff, but did not change the substance of the prior claim. A purported class action lawsuit was filed in the U.S. District Court for the Middle District of
Tennessee on December 21, 2001, on behalf of participants and beneficiaries of the Nortel 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 (ERISA) for Plan-wide relief and
alleging, among other things, material misrepresentations and omissions to induce Plan participants
to continue to invest in and maintain investments in Nortel Networks Corporation common shares in
the Plan. A second purported class action lawsuit, on behalf of the Plan and Plan participants for
whose individual accounts the Plan purchased Nortel Networks Corporation common shares during the
period from October 27, 2000 to February 15, 2001 and making similar allegations was filed in the
same court on March 12, 2002. A third purported class action lawsuit, on behalf of persons who are
or were Plan participants or beneficiaries at any time since March 1, 1999 to the filing date and
making similar allegations, was filed in the same court on March 21, 2002. The first and second
purported class action lawsuits were consolidated by a new purported class action complaint, filed
on May 15, 2002 in the same court and making similar allegations, on behalf of Plan participants
and beneficiaries who directed the Plan to purchase or hold shares of certain funds, which held
primarily Nortel Networks Corporation common shares, during the period from March 7, 2000 through
December 21, 2001. On September 24, 2002, plaintiffs in the consolidated action filed a motion to
consolidate all the actions and to transfer them to the U.S. District Court for the Southern
District of New York. The plaintiffs then filed a motion to withdraw the pending motion to
consolidate and transfer. The withdrawal was granted by the District Court on December 30, 2002.
A fourth purported class action lawsuit, on behalf of the Plan and Plan participants for whose
individual accounts the Plan held Nortel Networks Corporation common shares during the period from
March 7, 2000 through March 31, 2001 and making similar allegations, was filed in the U.S. District
Court for the Southern District of New York on March 12, 2003. On March 18, 2003, plaintiffs in
the fourth purported class action filed a motion with the Judicial Panel on Multidistrict
Litigation to transfer all the actions to the Southern District of New York for coordinated or
consolidated proceedings pursuant to 28 U.S.C. section 1407. On June 24, 2003, the Judicial Panel
on Multidistrict Litigation issued a transfer order transferring the Southern District of New York
action to the Middle District of Tennessee (the Consolidated ERISA Action). On September 12,
2003, the plaintiffs in all the actions filed a consolidated class action complaint. On October
28, 2003, the defendants filed a motion to dismiss the complaint and a motion to stay discovery
pending disposition of the motion to dismiss. On March 30, 2004, the plaintiffs filed a motion for
certification of a class consisting of participants in, or beneficiaries of, the Plan who held
shares of the NNC Stock Fund during the period from March 7, 2000 through March 31, 2001. On April
27, 2004, the Court granted the defendants motion to stay discovery pending resolution of
defendants motion to dismiss. On June 15, 30




---



##### Table of Contents



2004, the plaintiffs filed a First Amended Consolidated Class Action Complaint that added
additional current and former officers and employees as defendants and expanded the purported class
period to extend from March 7, 2000 through to June 15, 2004. On March 4, 1997, Bay Networks, Inc. (Bay Networks), a company acquired on August 31, 1998,
announced that shareholders had filed two separate lawsuits in the U.S. District Court for the
Northern District of California (the Federal Court) and the California Superior Court, County of
Santa Clara (the California Court), against Bay Networks and ten of Bay Networks then current
and former officers and directors purportedly on behalf of a class of shareholders who purchased
Bay Networks common shares during the period of May 1, 1995 through October 14, 1996. On August
17, 2000, the Federal Court granted the defendants motion to dismiss the federal complaint. On
August 1, 2001, the U.S. Court of Appeals for the Ninth Circuit denied the plaintiffs appeal of
that decision. On April 18, 1997, a second lawsuit was filed in the California Court, purportedly
on behalf of a class of shareholders who acquired Bay Networks common shares pursuant to the
registration statement and prospectus that became effective on November 15, 1995. The two actions
in the California Court were consolidated in April 1998; however, the California Court denied the
plaintiffs motion for class certification. In January 2000, the California Court of Appeal
rejected the plaintiffs appeal of the decision. A petition for review was filed with the
California Supreme Court by the plaintiffs and was denied. In February 2000, new plaintiffs who
allege to have been shareholders of Bay Networks during the relevant periods, filed a motion for
intervention in the California Court seeking to become the representatives of a class of
shareholders. The motion was granted on June 8, 2001 and the new plaintiffs filed their
complaint-in-intervention on an individual and purported class representative basis alleging
misrepresentations made in connection with the purchase and sale of securities of Bay Networks in
violation of California statutory and common law. On March 11, 2002, the California Court granted
the defendants motion to strike the class allegations. The plaintiffs were permitted to proceed
on their individual claims. The intervenor-plaintiffs appealed the dismissal of their class
allegations. On July 25, 2003, the California Court of Appeal reversed the trial courts dismissal
of the intervenor-plaintiffs class allegations. On September 3, 2003, the defendants filed a
petition for review with the California Supreme Court seeking permission to appeal the Court of
Appeal decision. On October 22, 2003, the California Supreme Court denied, without opinion, the
defendants petition for review. On December 22, 2003, the plaintiffs served their motion for
certification of a class of purchasers of Bay Networks common shares from July 25, 1995 through to
October 14, 1996. Hearing of the plaintiffs motion for class certification was held on May 4,
2004. On July 27, 2004, the Court entered an Amended Order Denying Motion of Intervenor Plaintiffs
for Class Certification and Setting Further Hearing. On August 9, 2004, the intervenor-plaintiffs
obtained Court approval to dismiss their claims and this action and, on September 30, 2004, the
Court entered dismissal with prejudice of the entire action of all parties and all causes of
action. Subsequent to the March 10, 2004 announcement in which NNC indicated it was likely that it and
Nortel Networks would need to revise its previously announced unaudited results for the year ended
December 31, 2003, and the results reported in certain of its quarterly reports for 2003, and to
restate its previously filed financial results for one or more earlier periods, NNC and certain of
its then current and former officers and directors were named as defendants in 27 purported class
action lawsuits. These lawsuits in the U.S. District Court for the Southern District of New York
on behalf of shareholders who acquired Nortel Networks Corporation securities as early as February
16, 2001 and as late as May 15, 2004, allege, among other things, violations of U.S. federal
securities laws. These matters are also the subject of investigations by Canadian and U.S.
securities regulatory and criminal investigative authorities. On June 30, 2004, the Court signed
Orders consolidating the 27 class actions and appointing lead plaintiffs and lead counsel. The
plaintiffs filed a consolidated class action complaint on September 10, 2004, alleging a class
period of April 24, 2003, through and including April 27, 2004. On November 5, 2004, Nortel
Networks Corporation and the Audit Committee Defendants filed a motion to dismiss the consolidated
class action complaint. On May 18, 2004, a purported class action lawsuit was filed in the U.S. District Court for the
Middle District of Tennessee on behalf of participants and beneficiaries of the Plan at any time
during the period of December 23, 2003 through the filing date and who made or maintained Plan
investments in Nortel Networks Corporation common shares, under the ERISA for Plan-wide relief and
alleging, among other 31




---



##### Table of Contents



things, breaches of fiduciary duty. On September 3, 2004, the Court signed a stipulated order
consolidating this action with the Consolidated ERISA Action described above. On June 16, 2004, a
second purported class action lawsuit, on behalf of the Plan and Plan participants for whose
individual accounts the Plan purchased Nortel Networks Corporation common shares during the period
from October 24, 2000 to June 16, 2004, and making similar allegations, was filed in the U.S.
District Court for the Southern District of New York. On August 6, 2004, the Judicial Panel on
Multidistrict Litigation issued a conditional transfer order to transfer this action to the U.S.
District Court for the Middle District of Tennessee for coordinated or consolidated proceedings
pursuant to 28 U.S.C. section 1407 with the Consolidated ERISA Action described above. On August
20, 2004, plaintiffs filed a notice of opposition to conditional transfer order with the Judicial
Panel. On December 6, 2004, the Judicial Panel denied the opposition and ordered the action
transferred to the U. S. District Court for the Middle District of Tennessee for coordinated or
consolidated proceedings with the Consolidated ERISA Action above. On July 28, 2004, Nortel Networks and NNC, and certain directors and officers, and certain former
directors and officers, of Nortel Networks and NNC, were named as defendants in a purported class
proceeding in the Ontario Superior Court of Justice on behalf of shareholders who acquired Nortel
Networks Corporation securities as early as November 12, 2002 and as late as July 28, 2004. This
lawsuit alleges, among other things, breaches of trust and fiduciary duty, oppressive conduct and
misappropriation of corporate assets and trust property in respect of the payment of cash bonuses
to executives, officers and employees in 2003 and 2004 under the NNC Return to Profitability bonus
program and seeks damages of Canadian $250 and an order under the Canada Business Corporations Act
directing that an investigation be made respecting these bonus payments. On July 30, 2004, a shareholders derivative complaint was filed in the U.S. District Court for the
Southern District of New York against certain directors and officers, and certain former directors
and officers, of NNC alleging, among other things, breach of fiduciary duties owed to NNC during
the period from 2000 to 2003 including by causing NNC to engage in unlawful conduct or failing to
prevent such conduct; causing NNC to issue false statements; and violating the law. Except as otherwise described herein, in each of the matters described above, the plaintiffs are
seeking an unspecified amount of monetary damages. Nortel Networks is also a defendant in various other suits, claims, proceedings and investigations
which arise in the normal course of business. Nortel Networks is unable to ascertain the ultimate aggregate amount of monetary liability or
financial impact to Nortel Networks of the above matters which, unless otherwise specified, seek
damages from the defendants of material or indeterminate amounts or could result in fines and
penalties. 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, financial condition and liquidity of Nortel Networks. Nortel Networks or NNC, as
applicable, and any named directors and officers of Nortel Networks or NNC, as applicable, intend
to vigorously defend these actions, suits, claims and proceedings. On April 5, 2004, NNC announced that the SEC had issued a formal order of investigation in
connection with NNCs previous restatement of its financial results for certain periods, as
announced in October 2003, and NNCs announcements in March 2004 regarding the likely need to
revise certain previously announced results and restate previously filed financial results for one
or more earlier periods. The matter had been the subject of an informal SEC inquiry. On April 13,
2004, NNC announced that it had received a letter from the staff of the Ontario Securities
Commission (OSC) advising that there is an OSC Enforcement Staff investigation into the same
matters that are the subject of the SEC investigation. On May 14, 2004, NNC announced that it had received a Federal Grand Jury Subpoena for the
production of certain documents, including financial statements and corporate, personnel and
accounting records, prepared during the period from January 1, 2000 to the date of the subpoena.
The materials sought are pertinent to an ongoing criminal investigation being conducted by the U.S.
Attorneys Office for the Northern District of Texas, Dallas Division. 32




---



##### Table of Contents



On August 16, 2004, NNC received a letter from the Integrated Market Enforcement Team of the Royal
Canadian Mounted Police (RCMP) advising NNC that the RCMP would be commencing a criminal
investigation into NNCs financial accounting situation. Environmental matters Nortel Networks operations are subject to a wide range of environmental laws in various
jurisdictions around the world. Nortel Networks seeks to operate its business in compliance with
such laws. In 2004, Nortel Networks expects to become subject to new European product content laws
and product takeback and recycling requirements that will require full compliance by 2006. It is
expected that these laws will require Nortel Networks to incur additional compliance costs.
Although costs relating to environmental matters have not resulted in a material adverse effect on
the business, results of operations, financial condition and liquidity in the past, there can be no
assurance that Nortel Networks will not be required to incur such costs in the future. Nortel
Networks has a corporate environmental management system standard and an environmental program 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. As of December 31, 2003,
the accruals on the consolidated balance sheet for environmental matters were $33. Based on
information available as of December 31, 2003, management believes that the existing accruals are
sufficient to satisfy probable and reasonably estimable environmental liabilities related to known
environmental matters. Any additional liability that may result from these matters, and any
additional liabilities that may result in connection with other locations currently under
investigation, are not expected to have a material adverse effect on the business, results of
operations, financial condition and liquidity of Nortel 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 $33. Nortel Networks is also listed as a potentially responsible party (PRP) under the U.S.
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) at six Superfund
sites in the U.S. An estimate of Nortel 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 $33 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. 
  ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 33




---



##### Table of Contents



PART II 
  ITEM 5.
    
    MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common shares of the Company are no longer listed and posted for trading on any stock
exchange. Nortel Networks Corporation is the sole holder of 100% of the issued and outstanding
common shares of the Company. The common shares of Nortel Networks Corporation are listed and
posted for trading on the New York Stock Exchange in the United States and on the Toronto Stock
Exchange in Canada. 
 Securities authorized for issuance under equity compensation plans Not applicable. 34




---



##### Table of Contents



ITEM 6.
    
    Selected Financial Data (Unaudited)
 The selected financial data presented below was derived from Nortel Networks Limiteds audited
consolidated financial statements and related notes thereto included elsewhere in this Annual
Report on Form 10-K except for the summarized balance sheet data as of December 31, 2001 and 2000.
Readers should note the following information regarding the selected financial data presented
below. Nortel Networks Limited has restated its previously reported consolidated financial statements for
the fiscal years ended December 31, 2002 and 2001 and the quarters ended March 31, June 30 and
September 30, 2003. The selected financial data presented below includes all such restatements and
covers the years ended December 31, 2003, 2002 and 2001 as well as selected balance sheet data as
of December 31, 2003, 2002, 2001 and 2000. In connection with the restatement of the fiscal years
ended December 31, 2002 and 2001, and the quarters ended March 31, June 30 and September 30, 2003,
Nortel Networks identified certain adjustments to its previously reported consolidated financial
statements for periods prior to fiscal 2001. The net effect of the adjustments relating to periods
prior to fiscal 2001 have been reflected in the selected financial data presented below as
adjustments to accumulated deficit as of December 31, 2000. The disclosure presented below
addresses the adjustments identified in the Second Restatement that related to the periods prior to
2001. Except for selected balance sheet data as of December 31, 2000, financial data for the years ended
December 31, 2000 and 1999 has not been restated or presented in the selected financial data
presented below. Due to the identified material weaknesses in our internal controls over financial
reporting, significant turnover in Nortel Networks finance personnel, changes in accounting
systems, documentation weaknesses, a likely inability to obtain third party corroboration in
certain cases due to the substantial industry adjustment in recent years and the passage of time
generally, Nortel Networks has determined that extensive additional efforts over an extended period
of time would be required to restate its 2000 and 1999 selected financial data. Nortel Networks
also believes that selected financial data for these periods would not be meaningful to investors
due to the significant industry adjustment in the telecommunications industry beginning in 2001,
which significantly impacted Nortel Networks financial results in 2001 and subsequent periods and
limits the relevance of financial results in periods prior to 2001 for purposes of analysis of
trends in subsequent periods. Previously reported financial information for 2000 and 1999 should  not be relied upon. See the Controls and Procedures  Additional Background  Second Restatement  Estimates; Omissions of 1999 and 2000 Selected Financial Data;
Decisions Not to Amend Certain Previous Filings section of this report. 35




---



##### Table of Contents



(millions of U.S. dollars)
    
    2003
    
    
    2002
    
    
    2001As restated*
    
    
    As restated*Results of OperationsRevenues
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763Research and development expense
    
    
    1,965
    
    
    
    2,084
    
    
    
    3,128Special chargesGoodwill impairment
    
    
    
    
    
    
    264
    
    
    
    2,239Other special charges
    
    
    285
    
    
    
    1,358
    
    
    
    2,939Operating earnings (loss)
    
    
    152
    
    
    
    (2,398
    )
    
    
    (12,619
    )Other income (expense)  net
    
    
    433
    
    
    
    (28
    )
    
    
    (519
    )Income tax benefit (expense)
    
    
    33
    
    
    
    438
    
    
    
    2,573Net earnings (loss) from continuing operations
    
    
    430
    
    
    
    (2,163
    )
    
    
    (11,006
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    184
    
    
    
    (101
    )
    
    
    (2,031
    )Cumulative effect of accounting changes  net of tax
    
    
    (12
    )
    
    
    
    
    
    
    15Dividends on preferred shares
    
    
    35
    
    
    
    26
    
    
    
    27Net earnings (loss) applicable to common shares
    
    
    567
    
    
    
    (2,290
    )
    
    
    (13,049
    )(millions of U.S. dollars)
    
    
    2003
    
    
    
    2002
    
    
    
    2001
    
    
    
    2000**As restated*
    
    
    As restated*
    
    
    As restated*Financial Position as of December 31Total assets
    
    $
    16,456
    
    
    $
    16,714
    
    
    $
    20,971
    
    
    $
    33,211Total debt
    
    
    2,227
    
    
    
    2,433
    
    
    
    3,410
    
    
    
    2,452Minority interests in subsidiary companies
    
    
    80
    
    
    
    94
    
    
    
    118
    
    
    
    148Preferred shares
    
    
    536
    
    
    
    536
    
    
    
    536
    
    
    
    609Common shareholders equity
    
    
    5,654
    
    
    
    4,644
    
    
    
    5,512
    
    
    
    16,810
 See notes 4, 7 and 10 to the accompanying consolidated financial statements for the impact of
accounting changes, special charges and acquisitions, divestitures and closures, respectively, that affect the comparability of the above selected
financial data.  *
    
    See note 3 to the accompanying consolidated financial statements.**
    
    Total assets as of December 31, 2000 increased by $1,888 as a result of the Second
Restatement, primarily due to increases in inventories  net and deferred income taxes  net.
Accumulated deficit as of December 31, 2000, increased by $1,399 as a result of the Second
Restatement, as further described below.
 The following information provides detailed disclosure in respect of each material component
of the Second Restatement adjustments to the accumulated deficit as of December 31, 2000: Summary of Second Restatement Adjustments on Accumulated Deficit as of December 31, 2000: (millions of U.S. dollars)
    
    TotalAdjustmentsRevenues
    
    $
    (3,379
    )Cost of revenues
    
    
    (1,214
    )Gross profit
    
    
    (2,165
    )Income tax benefit
    
    
    623Foreign exchange
    
    
    (187
    )Other adjustments
    
    
    330Net increase to accumulated deficit
    
    $
    (1,399
    )
 36




---



##### Table of Contents



Revenues and cost of revenues adjustments Revenues were impacted by various errors related to revenue recognition resulting in a
cumulative decrease of $3,379 for the years prior to 2001. The net impact to cost of revenues
related to these revenue adjustments and other items was a cumulative decrease of $1,214 for the
years prior to 2001. Revenues were recognized on certain sales for which it was subsequently determined that the
criteria for revenue recognition under SAB 101 or SOP 97-2, as applicable, had not been met,
including arrangements in which legal title or risk of loss on products did not transfer to the
buyer until full payment was received, and arrangements where delivery had not occurred. Revenues
and related cost of revenues for these arrangements should have been deferred to later periods when
title or risk of loss had passed and all criteria for revenue recognition had been met. Therefore,
adjustments were made to defer revenues and related cost of revenues from the periods in which they
were originally recorded and to recognize them in the periods in which all revenue recognition
criteria were met. Revenues were recognized on certain sales for which it was subsequently determined that the
criteria for revenue recognition under SOP 97-2 had not been met, including arrangements in which
the criteria for fixed or determinable fees was not met. Revenues and related cost of revenues for
these agreements were deferred to later periods when payments became due and all criteria for
revenue recognition had been met. In certain multiple element arrangements, total arrangement fees were recognized as revenue at the
time of delivery of software or hardware, but prior to the delivery of future contractual or
implicit PCS or other services. Revenues should have been allocated to these future deliverables based on their fair value and recognized ratably over
the PCS period or as the future obligations were performed. Adjustments were made to appropriately
allocate revenue among the accounting units and recognize the allocated revenue in accordance with
the applicable revenue recognition guidance. In certain circumstances where the criteria to treat
delivered software and hardware elements and undelivered PCS services as separate accounting units
were not met, the entire arrangement fee was deferred and recognized over the PCS period. Revenues were also recognized for certain contracts that involved undelivered elements as a result
of product development delays. The lack of relative fair value for the undelivered element meant
that revenues and cost of revenues for all products delivered should have been deferred until the
undelivered element was delivered. As originally recorded, revenues were recognized upon delivery
of an alternative product and costs were accrued for the undelivered element. To correct for these
items, related cost provisions were reversed and revenues and associated cost of revenues were
recognized in the appropriate periods when all elements had been delivered. Revenues were recognized upon product delivery to a certain reseller who lacked economic substance
apart from Nortel Networks. Revenue should have been deferred and only recognized by Nortel
Networks upon sale by the reseller to an end customer. Correction of this resulted in revenues and
cost of revenues being deferred with ultimate recognition in 2001. Other adjustments included corrections related to errors in the application of
percentage-of-completion accounting for certain contracts, specific contracts with reciprocal
arrangements that should have been treated as a reduction of revenues, and other errors related to
non-cash incentives and concessions provided to customers and other calculation errors. Other adjustments The income tax benefit as a result of the restatement decreased the accumulated deficit by
$623. The determination of the functional currency for certain entities was re-examined, and as a
result Nortel Networks determined that the accounting for certain global headquarter functions
needed to be restated back to 1986 to reflect a U.S. dollar functional currency designation. This
resulted in an increase of $187 to accumulated deficit and a decrease to accumulated other
comprehensive loss as of December 31, 2000. Other adjustments of $330 included the corrections of
errors in respect to each of intercompany related items, the accounting associated with sales of
receivables, the calculation of the valuation of deferred compensation on a certain acquisition and
various other adjustments. Reflected in these adjustments were reclassifications of certain items
to or from cost of revenues. 37




---



ITEM 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations  Table of Contents
 
 Business overview
    
    
    40Our business
    
    
    40Our segments
    
    
    40Our business environment
    
    
    41How we measure performance
    
    
    42Our strategic plan and outlook
    
    
    43Developments in 2003 and 2004
    
    
    442003 consolidated results summary
    
    
    44Nortel Networks Audit Committee Independent Review; restatements; related matters
    
    
    45Comprehensive Review and First Restatement
    
    
    45Independent Review
    
    
    45Second Restatement
    
    
    45Material weaknesses in internal control over financial
reporting identified in Second Restatement
    
    
    51Revenue Independent Review
    
    
    52Personnel actions
    
    
    52EDC Support Facility
    
    
    52Credit facilities and security agreements
    
    
    53Debt securities
    
    
    53Shelf registration statement
    
    
    54Credit ratings
    
    
    54Regulatory actions and pending litigation
    
    
    54Stock-based compensation plans
    
    
    54Evolution of our supply chain strategy
    
    
    55Other business developments
    
    
    55Ownership adjustment in our French and German operations
    
    
    55Customer financing commitments
    
    
    56Sale of Entrust shares
    
    
    56Real estate
    
    
    56Customer contract settlement
    
    
    56Directory and operator services business
    
    
    56Bharat Sanchar Nigram Limited contract
    
    
    56Patent infringement settlement
    
    
    56Customer financing arrangements
    
    
    57Results of operations  continuing operations
    
    
    57Segment revenues
    
    
    57Geographic revenues
    
    
    57Consolidated revenues
    
    
    57Wireless Networks revenues
    
    
    59Enterprise Networks revenues
    
    
    61Wireline Networks revenues
    
    
    63Optical Networks revenues
    
    
    64Gross profit and gross margin
    
    
    66Segment gross profit and gross margin
    
    
    67Operating expenses
    
    
    68Selling, general and administrative expense
    
    
    68Segment selling, general and administrative expense
    
    
    68Research and development expense
    
    
    69Segment research and development expense
    
    
    70Segment contribution margin
    
    
    71Segment Management EBT
    
    
    71
  38




---



##### Table of Contents



Amortization of intangibles
    
    
    71Special charges
    
    
    72Gain (loss) on sale of businesses and assets
    
    
    73Other income (expense)  net
    
    
    74Interest expense
    
    
    74Income tax benefit (expense)
    
    
    75Net earnings (loss) from continuing operations
    
    
    75Results of operations  discontinued operations
    
    
    75Liquidity and capital resources
    
    
    76Cash flows
    
    
    76Uses of liquidity
    
    
    78Contractual cash obligations
    
    
    78Customer financing
    
    
    79Joint ventures/minority interests
    
    
    80Discontinued operations
    
    
    80Sources of liquidity
    
    
    80Credit facilities
    
    
    80Available support facility
    
    
    80Shelf registration statement and base shelf prospectus
    
    
    81Credit ratings
    
    
    82Off-balance sheet arrangements
    
    
    83Bid, performance related and other bonds
    
    
    83Receivables securitization and certain lease financing transactions
    
    
    83Other indemnifications or guarantees
    
    
    84Application of critical accounting estimates
    
    
    84Revenue recognition
    
    
    85Provisions for doubtful accounts
    
    
    86Provisions for inventory
    
    
    87Income taxes
    
    
    88Tax asset valuation
    
    
    88Tax contingencies
    
    
    88Goodwill valuation
    
    
    89Pension and post-retirement benefits
    
    
    90Special charges
    
    
    91Other contingencies
    
    
    91Accounting changes and recent accounting pronouncements
    
    
    92Accounting changes
    
    
    92Recent accounting pronouncements
    
    
    93Market risk
    
    
    93Equity price risk
    
    
    94Environmental matters
    
    
    95Legal proceedings
    
    
    95Risk factors/forward looking statements
    
    
    95Risks relating to our restatements and related matters
    
    
    95Risks relating to our business
    
    
    102
 39




---



##### Table of Contents



Managements Discussion and Analysis of Financial Condition and Results of Operations You should read this Managements Discussion and Analysis of Financial Condition and Results
of Operation, or MD&A, in combination with the accompanying audited consolidated financial
statements prepared in accordance with accounting principles generally accepted in the United
States, or U.S. GAAP. As discussed herein, this MD&A gives effect to the Second Restatement as
described below in Developments in 2003 and 2004  Nortel Networks Audit Committee Independent
Review; restatements; related matters and in Restatement in note 3 of the accompanying audited
consolidated financial statements. A number of our and Nortel Networks Corporations past filings
with the United States Securities and Exchange Commission, or SEC, remain subject to ongoing review
by the SECs Division of Corporation Finance. In addition, the Second Restatement involved the
restatement of our consolidated financial statements for 2001 and 2002 and the first, second and
third quarters of 2003. Amendments to our prior filings with the SEC would be required in order for
us to be in full compliance with our reporting obligations under the Exchange Act. However, we do
not believe that it will be feasible to amend our Annual Report onForm 10-K/Afor the year ended
December 31, 2002, or 2002Form 10-K/A,and our 2003Form 10-Qs, due to, among other factors,
identified material weaknesses in our internal control over financial reporting, the significant
turnover in our finance personnel, changes in accounting systems, documentation weaknesses, a
likely inability to obtain third party corroboration in certain cases due to the substantial
industry adjustment in recent years and the passage of time generally. In addition, disclosure in
the 2002Form 10-K/Aand 2003Form 10-Qswould in large part repeat the disclosure expected to be
contained in this report and the 2004Form 10-Qs. Accordingly, we do not plan to amend our 2002
Form 10-K/A and 2003Form 10-Qs. We believe that we have included in this report all information
needed for current investor understanding. Ongoing SEC review may require us to amend this Annual
Report onForm 10-Kor our other public filings further. See Risk factors/forward looking
statements. This section contains forward looking statements and should be read in conjunction with the risk
factors described below under Risk factors/forward looking statements. All dollar amounts in
this MD&A are in millions of United States, or U.S., dollars unless otherwise stated. Where we say we, us, our or Nortel Networks, we mean Nortel Networks Limited or Nortel
Networks Limited and its subsidiaries, as applicable, and where we refer to the industry, we mean
the telecommunications industry. 
 Business overview 
 Our business Nortel Networks is a recognized leader in delivering communications capabilities that enhance
the human experience, ignite and power global commerce, and secure and protect the worlds most
critical information. Serving both service provider and enterprise customers, we deliver innovative
technology solutions encompassing end-to-end broadband, Voice over IP, multimedia services and
applications, and wireless broadband solutions designed to help people solve the worlds greatest
challenges. Our business consists of the design, development, manufacture, assembly, marketing,
sale, licensing, installation, servicing and support of these networking solutions. A substantial
portion of our business has a technology focus and is dedicated to research and development, or
R&D. This focus forms a core strength and is a factor that we believe differentiates us from many
of our competitors. We envision a networked society where people are able to connect and interact
with information and with each other instantly, simply and reliably, accessing data, voice and
multimedia communications services and sharing experiences anywhere, anytime. We are the principal direct operating subsidiary of Nortel Networks Corporation, or NNC. NNC holds
all of our outstanding common shares but none of our outstanding preferred shares. NNCs common
shares are publicly traded on the New York Stock Exchange, or NYSE, and Toronto Stock Exchange, or
TSX, under the symbol NT. 
 Our segments During 2003 and up to September 30, 2004, our operations were organized into four reportable
segments as follows:  
    
    Wireless Networks  Our Wireless Networks segment provides communications networks that
enable end-users to be mobile while they send and receive voice and data communications
using wireless devices, such as cellular telephones, personal digital assistants and other
computing and communications devices. Our Wireless Networks 40




---



##### Table of Contents



customers are wireless service providers, and their customers are the subscribers for
wireless communications services.
    
    Enterprise Networks  Our Enterprise Networks segment provides data, voice and
multimedia communications solutions for our enterprise customers. Our Enterprise Networks
customers consist of a broad range of enterprise customers around the world, including
large businesses and their branch offices, small businesses and home offices, as well as
government agencies, educational and other institutions and utility organizations.
    
    Wireline Networks  Our Wireline Networks segment addresses the demand by our service
provider customers for cost efficient data, voice and multimedia communications solutions.
We offer our Wireline Networks products and services to a wide range of wireline and
wireless service providers around the world. Our service provider customers include local
and long distance telephone companies, wireless service providers, cable operators and
other communication service providers. We also provide services to our data networking and
security customers which consist of system integrators that in turn build, operate and
manage networks for their customers, such as businesses, government agencies and utility
organizations.
    
    Optical Networks  Our Optical Networks segment solutions transport data, voice and
multimedia communications within and between cities, countries or continents by
transmitting communications signals in the form of light waves through fiber optic cables.
Our Optical Networks business is primarily focused on offering our optical networking
solutions to service providers around the world. The service provider customers for our
optical networking products include local and long-distance telephone companies, cable
operators, Internet service providers and other communications service providers. Effective October 1, 2004, we established a new streamlined organizational structure that included,
among other things, combining the businesses of our four segments into two business organizations:
(i) Carrier Networks and Global Operations, and (ii) Enterprise Networks. We are reviewing the
impact of these changes on our reportable segments under Statement of Financial Accounting
Standards, or SFAS, No. 131, Disclosures about segments of an enterprise and related information. 
 Our business environment In 2001, we entered into an unprecedented period of business realignment in response to a
significant adjustment in the industry. Industry demand for networking equipment dramatically
declined in response to the industry adjustment, severe economic downturns in various regions
around the world and a tightening in global capital markets. We implemented a company-wide
restructuring plan to streamline our operations and activities around core markets and operations,
which included significant workforce reductions, global real estate closures and dispositions,
substantial write-downs of our capital assets, goodwill and other intangible assets and extensive
contract settlements with customers and suppliers around the world. As a result of these actions,
our workforce declined significantly from January 1, 2001 to December 31, 2003 and over the same
time period, we significantly reduced our facilities. In 2003, customer spending remained cautious
as a result of tightened capital markets mainly in the first half of 2003 and customers realigning
capital spending with their current levels of revenues and profits in order to maximize their
return on invested capital. We experienced continued industry adjustment and capital spending
restrictions by our service provider customers. Also, excess network capacity and competition
continued to exist in the industry which led to continued pricing pressures on the sale of certain
of our products. During the second half of 2003 and in 2004, we began to experience a period of relative industry
stability. Throughout the second half of 2003 and in 2004, we announced several new contracts
across all of our reportable segments, but primarily in our Wireless Networks segment, as certain
service provider customers began to expand and upgrade their existing networks. In 2004, however,
we continued to experience pricing pressures on sales of certain products across all of our
reportable segments primarily as a result of increased competition. As first announced on August 19, 2004, we have put in place a new strategic plan that recognizes
these industry dynamics and the evolution of the converged network (see Our strategic plan and
outlook). In an increasingly cost-competitive environment, we are taking steps that we believe
will better position us to grow market share and improve our results and cash generation. As part
of our strategic plan, we also announced a focused workforce reduction of approximately 3,250
employees. In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to a comprehensive review and analysis of our assets and liabilities, or
the Comprehensive Review, which resulted in the restatement (effected in December 2003) of our
consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the
quarters ended March 31, 2003 and June 30, 2003, or the First Restatement. In late October 2003,
the Audit Committees of our and NNCs Boards of Directors, or the Audit Committee, initiated an
independent review of the facts and circumstances leading to the First Restatement, or the
Independent Review, and engaged the law firm now known 41




---



##### Table of Contents



as Wilmer Cutler Pickering Hale & Dorr LLP, or WCPHD, to advise it in connection with the
Independent Review. The Audit Committee sought to gain a full understanding of the events that
caused significant excess liabilities to be maintained on the balance sheet that needed to be
restated, and to recommend that our Board of Directors adopt, and direct management to implement,
necessary remedial measures to address personnel, controls, compliance and discipline. In January
2005, the Audit Committee reported the findings of the Independent Review, together with its
recommendations for governing principles for remedial measures that were developed for the Audit
Committee by WCPHD. Each of our and NNCs Boards of Directors has adopted these recommendations in
their entirety and directed our management to develop a detailed plan and timetable for their
implementation, and will monitor their implementation. As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in-depth the concerns identified by WCPHD regarding provisioning activity and to review
certain provision releases. That examination, and other errors identified by management, led to the
restatement (effected today) of our financial statements for the years ended December 31, 2002 and
2001 and the quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003
and 2002, or the Second Restatement, and our revision of previously announced unaudited results for
the year ended December 31, 2003. The need for the Second Restatement resulted in delays in filing
our and NNCs 2003 Annual Reports on Form 10-K, or the 2003 Annual Reports, and Quarterly Reports
on Form 10-Q for the first, second and third quarters of 2004, or the 2004 Quarterly Reports,
beyond the SECs required filing dates in 2004. We refer to the 2003 Annual Reports and the 2004
Quarterly Reports together as the Reports. Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue recognition and undertook a process of
revenue reviews. As described in more detail in the Controls and Procedures section of this
report, in light of the resulting adjustments to revenues previously reported in relevant periods,
the Audit Committee has determined to review the facts and circumstances leading to the restatement
of these revenues for specific transactions identified in the Second Restatement. This review will
have a particular emphasis on the underlying conduct that led to the initial recognition of these
revenues. The Audit Committee will seek a full understanding of the historic events that required
the revenues for these specific transactions to be restated and will consider any appropriate
additional remedial measures, including those involving internal controls and processes. The Audit
Committee has engaged WCPHD to advise it in connection with this review. See Risk factors/forward
looking statements. Over the course of the Second Restatement process, we and our independent auditors identified a
number of material weaknesses in our internal control over financial reporting. Further, in
connection with the Independent Review, we terminated for cause our former president and chief
executive officer, former chief financial officer and former controller in April 2004 and seven
additional senior finance employees with significant responsibilities for our financial reporting
as a whole for their respective business units and geographic areas in August 2004. We are subject
to significant pending civil litigation and ongoing regulatory and criminal investigations in the
U.S. and Canada, which could require us to pay substantial judgments, settlements, fines or other
penalties. We are currently in a challenging transitional period in connection with the completion of our
restatement activity and as we implement the new strategic plan. We believe that our strategic plan
will enable us to build on our market leadership in developing the converged networks of the future
and improve business efficiency and operating cost performance in an increasingly competitive
market. 
 How we measure performance Each reportable segment is allocated resources and assets based on whether projected customer
demand would support additional investment. We make adjustments to reduce resources and assets
within a reportable segment in response to market conditions or where opportunities for improved
efficiencies present themselves. Our president and chief executive officer, or 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 our management
reporting system. In 2003, we reported that the primary financial measure used by the former chief
operating decision maker in assessing performance and allocating resources to the segments was
contribution margin, a measure that was comprised of gross profit less selling, general and
administrative expense, or SG&A. In April 2004, our and NNCs boards of directors appointed a new
CEO. Commencing in the second quarter of 2004, the primary financial measure used by our CEO in
assessing performance and allocating resources to the segments is management earnings (loss) before
income taxes, or Management EBT, a measure that includes contribution margin, R&D expense, interest
expense, other 42




---



##### Table of Contents



income (expense)  net, minority interest  net of tax and equity in net loss of associated
companies  net of tax. As a result of the change in the primary financial measure used to assess
the performance of our segments during the period in which the Reports have been delayed, and
because both contribution margin and Management EBT were available to the former chief operating
decision maker during 2003, we have determined that it is appropriate to disclose both contribution
margin and Management EBT for the periods presented. See Segment information  General
description in note 6 of the accompanying consolidated financial statements. From a liquidity perspective, we maintain strict controls over our sources and uses of cash. We
also focus on the liquidity and cash flows of our customers in an effort to minimize our credit
risk. We closely monitor our inventory levels, both in our manufacturing facilities as well as at
our contract manufacturers, in an effort to minimize our exposure to excess supply and subsequent
cash costs incurred as a result of excess capacity. 
 Our strategic plan and outlook On August 19, 2004, we announced a new strategic plan intended to enable us to build on our
market leadership in developing the converged networks of the future and improve business
efficiency and operating cost performance in an increasingly competitive market. We provided
further details concerning the strategic plan on September 30, 2004 and December 14, 2004. It is
our intention to be optimally positioned to maximize strategic opportunities as they arise and
leverage our acknowledged strengths in high reliability networks and strong customer loyalty. We
continue to drive our business forward with a focus on costs, cash and revenues as strategic goals.
We remain committed to our business strategy of technology and solutions evolution in helping our
customers transform their networks and implement new applications and services to drive improved
productivity, reduced costs and revenue growth. The principal components of the strategic plan are:  
    
    a renewed commitment to best corporate practices and ethical conduct, including the
establishment of the office of a chief ethics and compliance officer, which has been filled
on an interim basis pending the permanent appointment of Susan E. Shepard, as now
announced;
    
    a streamlined organizational structure to reflect alignment with carrier converged networks;
    
    an increased focus on the enterprise market and customers;
    
    optimized R&D programs for highly secure, available and reliable converged networks;
    
    the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;
    
    the establishment of a chief marketing officer to drive overall marketing strategy;
    
    the strategic review of embedded services to assess opportunities in the professional services business; and
    
    a distinct focus on government and defense customers. Our strategic plan also includes a work plan involving focused workforce reductions of
approximately 3,250 employees, a voluntary retirement program, real estate optimization and other
cost containment actions such as reductions in information services costs, outsourced services and
other discretionary spending. Our workforce actions are focused to disproportionately protect
customer and sales facing roles as well as continue our focus on new innovative solutions.
Approximately 64% of employee actions related to the focused workforce reduction were completed by
the end of 2004, including approximately 55% that were notified of termination or acceptance of
voluntary retirement, with the remainder comprised of voluntary attrition of employees that were
not replaced. The remainder of employee actions are expected to be completed by June 30, 2005. In
addition, however, the Company continues to hire in certain strategic areas such as investments in
the finance organization. These focused headcount reductions are intended to result in ongoing cost
reductions in R&D and SG&A expenses and cost of sales. These actions are subject to the completion
of required jurisdictional consultation and regulatory approvals. This workforce reduction is in
addition to the workforce reduction that will result from our agreement with Flextronics
International Ltd., or Flextronics (for more information, see Evolution of our supply chain
strategy). We expect the real estate actions to be completed by the end of 2005. We estimate charges to the income statement associated with our overall work plan in the aggregate
of approximately $450 comprised of approximately $220 with respect to the workforce reductions and
approximately $230 with respect to the real estate actions. No charges are expected to be recorded
with respect to the other cost containment actions. Approximately 25% of the aggregate income
statement charges were incurred in 2004 with the remainder expected to be incurred in 2005. 43




---



##### Table of Contents



The associated cash costs of the work plan of approximately $430 are expected to be split
approximately equally between the workforce reductions and real estate actions. Approximately 10%
of these cash costs were incurred in 2004 and approximately 40% are expected to be incurred in
2005. The remaining 50% of the cash costs relates to the real estate actions and are expected be
incurred in 2006 through to 2022 for ongoing lease costs related to impacted real estate
facilities. In addition to the above, we also expect to incur capital cash costs of approximately $50 in 2005
for facility improvements related to the real estate actions. We anticipate cost savings from the implementation of the work plan of approximately $500 in 2005,
which is expected to increase on an annualized basis beyond 2005 as the full impact of the work
plan is realized. We expect that this work plan will primarily be funded with cash from
operations. We expect that our consolidated revenues in 2004 will be slightly lower compared with 2003. The
2003 consolidated revenues included revenues that were deferred from prior periods. We see growth
opportunities in emerging markets such as China and India. Further, we believe security and
reliability for service provider networks are increasingly important to governments, defense
interests and enterprises around the world. 
 Developments in 2003 and 2004 
 2003 consolidated results summary During 2003, we began to experience a period of relative industry stability following an
unprecedented period of business realignment that commenced in 2001 in response to a significant
industry adjustment. In 2003, our consolidated revenues were $3,266 in the fourth quarter, $2,344
in the third quarter, $2,288 in the second quarter and $2,295 in the first quarter. Although our
revenues declined 7% in 2003 ($10,193 in 2003 compared to $10,994 in 2002), this decline
represented a substantial improvement from the revenue decline of 41% experienced in 2002 compared
to 2001 ($10,994 in 2002 compared to $18,763 in 2001). As well, throughout the second half of 2003,
we announced several new contracts across all of our reportable segments, but primarily in our
Wireless Networks segment, as certain service provider customers began to expand and upgrade their
existing networks. Our gross margin increased to 42.5% in 2003 compared to 35.1% in 2002, an improvement of
approximately 7 percentage points. SG&A expense declined 24% in 2003 compared to 2002 and R&D
expense declined 6% in 2003 compared to 2002. The percentage declines in SG&A and R&D expense were
primarily due to actions taken to better align our expenses with the volume of business in 2003.
Our R&D expense did not decline to the same extent as our SG&A expense on a percentage basis due to
our technology focus and commitment to invest in next generation solutions. Special charges
substantially declined in 2003 compared to 2002, primarily as a result of a substantial reduction
in charges associated with workforce reductions and goodwill impairment related to our
restructuring work plan initiated in 2001. Our discontinued operations
contributed $184 of net earnings in 2003 compared to a net loss of $101
in 2002. The $184 of net earnings was primarily the result of the completion of a number of
transactions in 2003 associated with the wind-down activities of our discontinued operations. As a result of these improvements, we reported net earnings before cumulative effect of accounting
changes of $614 in 2003 compared to a net loss before cumulative effect of accounting changes of
$2,264 in 2002. Throughout 2003, we maintained our strong liquidity position. In 2003, our cash and cash
equivalents, or cash, increased $186 from $3,742 at December 31, 2002 to $3,928 at December 31,
2003. The improvement was primarily due to an increase in cash of $379 from our discontinued
operations, an increase in cash of $78 from our operating activities and favorable foreign exchange
impacts of $176. These increases in cash were partially offset by $362 of cash used in our
financing activities and $85 used in our investing activities. As of December 31, 2003, our long
term debt totaled $2,210. 44




---



##### Table of Contents



Nortel Networks Audit Committee Independent Review; restatements; related matters 
  Comprehensive Review and First Restatement In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to the Comprehensive Review, which resulted in the First Restatement.
See notes 3 and 22 of the accompanying consolidated financial statements and the Controls and
Procedures section of this report. In connection with the Comprehensive Review, Deloitte & Touche LLP, or D&T, our independent
auditors, informed the Audit Committee on July 24, 2003 of a reportable condition that did not
constitute a material weakness in our internal control over financial reporting (throughout this
report, unless otherwise indicated, reportable condition and material weakness have the
meanings as formerly set forth under standards established by the American Institute of Certified
Public Accountants, or AICPA). Later, on November 18, 2003, as part of the communications by D&T
to the Audit Committee with respect to D&Ts interim audit procedures for the year ended December
31, 2003, D&T informed the Audit Committee that it had identified certain reportable conditions,
each of which constituted a material weakness in our internal control over financial reporting.
These material weaknesses identified in the First Restatement were also later identified in
connection with the Second Restatement together with certain additional material weaknesses in our
internal control over financial reporting, as described in greater detail in the Controls and
Procedures section of this report. 
  Independent Review In late October 2003, the Audit Committee initiated the Independent Review and engaged WCPHD
to advise it in connection with the Independent Review in order to gain a full understanding of the
events that caused significant excess liabilities to be maintained on the balance sheet that needed
to be restated, and to recommend that our Board of Directors adopt, and direct management to
implement, necessary remedial measures to address personnel, controls, compliance and discipline.
The Independent Review focused initially on events relating to the establishment and release of
contractual liability and other related provisions (also called accruals, reserves, or accrued
liabilities) in the second half of 2002 and the first half of 2003, including the involvement of
senior corporate leadership. As the Independent Review evolved, its focus broadened to include
specific provisioning activities in each of the business units and geographic regions. In light of
concerns raised in the initial phase of the Independent Review, the Audit Committee expanded the
review to include provisioning activities in the third and fourth quarters of 2003. As discussed more fully in the Controls and Procedures section of this report, the Independent
Review concluded that [i]n summary, former corporate management (now terminated for cause) and
former finance management (now terminated for cause) in the Companys finance organization
endorsed, and employees carried out, accounting practices relating to the recording and release of
provisions that were not in compliance with [U.S. GAAP] in at least four quarters, including the
third and fourth quarters of 2002 and the first and second quarters of 2003. In three of those
four quarters  when Nortel was at, or close to, break even  these practices were undertaken to
meet internally imposed . . . targets. While the dollar value of most of the individual
provisions was relatively small, the aggregate value of the provisions made the difference between
a profit and a reported loss, on a pro forma basis, in the fourth quarter of 2002 and the
difference between a loss and a reported profit, on a pro forma basis, in the first and second
quarters of 2003. 
  Second Restatement As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in depth the concerns identified by WCPHD regarding provisioning activity and to review
provision releases, down to a low threshold. That examination, and other errors identified by
management, led to the Second Restatement. Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue recognition and undertook a process of
revenue reviews, resulting in adjustments to previously reported revenues during the periods 1999
through 2003. Other accounting practices that management examined and adjusted as part of the
Second Restatement included, among other things, the following:  
    
    intercompany balances that did not eliminate upon consolidation and related provisions;
    
    our foreign exchange accounting, as part of the plan to address our identified material
weakness related to foreign currency translation; 45




---



##### Table of Contents




    
    special charges relating to inventory impairment, contract settlement costs and other charges; and
    
    the accounting treatment of certain elements of discontinued operations.  Years ended December 31, 2002 and 2001 The following tables present the impact of the Second Restatement adjustments on our
previously reported consolidated statements of operations data for the years ended December 31,
2002 and 2001. The Second Restatement adjustments related primarily to the following items, each
of which reflect a number of related adjustments that have been aggregated for disclosure purposes,
and are described in the paragraphs following the tables below. See Restatement in note 3 of
the accompanying consolidated financial statements.  
    
    revenues and cost of revenues;
    
    foreign exchange;
    
    intercompany balances;
    
    special charges;
    
    other;
    
    reclassifications; and
    
    discontinued operations.  Consolidated Statement of Operations data for the year ended December 31, 2002 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    10,554
    
    
    $
    440
    
    
    $
    10,994Gross profit
    
    
    3,564
    
    
    
    291
    
    
    
    3,855Operating earnings (loss)
    
    
    (2,941
    )
    
    
    543
    
    
    
    (2,398
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    (3,149
    )
    
    
    533
    
    
    
    (2,616
    )Net earnings (loss) from continuing operations
    
    
    (2,745
    )
    
    
    582
    
    
    
    (2,163
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    21
    
    
    
    (122
    )
    
    
    (101
    )Net earnings (loss)
    
    
    (2,724
    )
    
    
    460
    
    
    
    (2,264
    )Dividends on preferred shares
    
    
    22
    
    
    
    4
    
    
    
    26Net earnings (loss) applicable to common shares
    
    $
    (2,746
    )
    
    $
    456
    
    
    $
    (2,290
    )
  Consolidated Statement of Operations data for the year ended December 31, 2001 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    17,272
    
    
    $
    1,491
    
    
    $
    18,763Gross profit
    
    
    3,183
    
    
    
    1,069
    
    
    
    4,252Operating earnings (loss)
    
    
    (13,593
    )
    
    
    974
    
    
    
    (12,619
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    (14,253
    )
    
    
    831
    
    
    
    (13,422
    )Net earnings (loss) from continuing operations
    
    
    (11,430
    )
    
    
    424
    
    
    
    (11,006
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (2,524
    )
    
    
    493
    
    
    
    (2,031
    )Net earnings (loss)
    
    
    (13,939
    )
    
    
    917
    
    
    
    (13,022
    )Dividends on preferred shares
    
    
    27
    
    
    
    
    
    
    
    27Net earnings (loss) applicable to common shares
    
    $
    (13,966
    )
    
    $
    917
    
    
    $
    (13,049
    )
 46




---



##### Table of Contents



Revenues and cost of revenues Revenues and cost of revenues were impacted by various errors related to revenue recognition,
corrections to foreign exchange accounting, intercompany related items, special charges and other
adjustments, including financial statement reclassifications. The net impact to revenues of the
adjustments was an increase of $440 and $1,491 for the years ended December 31, 2002 and 2001,
respectively. The net impact to cost of revenues related to these revenue adjustments, and the
other corrections, was an increase of $149 and $422 for the years ended December 31, 2002 and 2001,
respectively. The Second Restatement adjustments to revenues and cost of revenues related
primarily to the following items:  
    
    incorrect application of SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue
Recognition (preceded by SAB 101), or SAB 104, or AICPA Statement of Position, or SOP,
97-2, Software Revenue Recognition, or SOP 97-2, the most significant of which related
to revenue that should have been deferred until title or risk of loss had passed, or
products had been delivered;
    
    incorrect recognition of revenue upon product delivery to a certain reseller; and
    
    various other adjustments, primarily related to specific contracts and transactions
and errors related to non-cash incentives and concessions provided to customers.  Foreign exchange As part of the plan to address a material weakness reported in our Quarterly Report on Form 10-Q
for the period ended September 30, 2003, a review of foreign exchange accounting was undertaken.
The net impact was an increase to pre-tax loss of $57 and $113 for the years ended December 31, 2002
and 2001, respectively. The significant items were as follows:  
    
    we re-examined the determination of the functional currency for certain entities based
on the guidance under SFAS No. 52, Foreign Currency Translation, or SFAS No. 52. As a
result, we identified four instances in which the functional currency designation of an
entity was incorrect. These revisions resulted in increases or decreases to other income
(expense)  net; and
    
    we identified two instances of incorrect treatment of foreign currency translation gains
and losses arising from significant intercompany positions. The net impact of the
adjustments was an increase or decrease to other income (expense)  net, with an offset to
accumulated other comprehensive loss.  Intercompany balances Historically, we had certain intercompany balances that did not eliminate upon consolidation , or
out-of-balance positions, and had recorded provisions accordingly. As part of the Second
Restatement, we reviewed these provisions and determined that they should not have been recorded.
We recorded adjustments in the appropriate periods to reverse these provisions and to correct the
significant out-of-balance positions. The net impact of the adjustments to correct the
significant out-of-balance positions was a decrease of $36 and an increase of $42 to the previously
reported pre-tax loss for the years ended December 31, 2002 and 2001, respectively.  Special charges As part of the Second Restatement, we reclassified inventory impairments of $88 to cost of
revenues, previously incorrectly classified as special charges. We also determined that certain
items were either recorded in special charges in error or, although correctly recorded when
originally recognized, were not adjusted in the appropriate subsequent periods for changes in
estimates and/or assumptions. The adjustments to special charges for all of these items were a
decrease of $77 and $150 for the years ended December 31, 2002 and 2001, respectively.  Other We recorded other adjustments primarily to correct certain accruals, provisions and other
transactions, which were either initially recorded incorrectly in prior periods, or not properly
released or adjusted for changes in estimates and/or assumptions in the appropriate subsequent
periods. These adjustments decreased the net loss for the year ended December 31, 2002 by $324 and
increased the net loss for the year ended December 31, 2001 by $47, and included tax and minority
interests impacts of all Second Restatement adjustments. The adjustment to income tax benefit, substantially all as a result of the Second Restatement
adjustments, was an increase of $16 and a decrease of $400 for the years ended December 31, 2002
and 2001, respectively. The adjustment to minority 47




---



##### Table of Contents



interests as a result of the Second Restatement adjustments was an increase of $31 and a decrease
of $12 for the years ended December 31, 2002 and 2001, respectively.  Reclassifications As a result of the restatement process, various presentation inconsistencies were identified.
Adjustments were made to appropriately reflect certain items in the statement of operations. The
reclassifications were made for royalty expense, gain (loss) on sale of businesses and assets,
minority interests  net of tax (now reported separately), and other items including certain
functional spending and specific expenses.  Discontinued operations As a result of the restatement process, the initial provision for loss on disposal of the access
solutions discontinued operations recorded in June 2001, and the subsequent activity during 2001
through 2004 were re-examined. We concluded that the net loss on disposal of operations recognized
in the second quarter of 2001 was overstated by $738, of which $520 comprised items that should
have been charged to continuing operations. In addition, other adjustments were necessary to
correct certain items that were either initially recorded incorrectly, or not properly released or
adjusted for changes in estimates in the appropriate periods subsequent to the second quarter of
2001. The net impact of all of these changes on net loss from discontinued operations  net of tax
was an increase of $122 and a decrease of $493 for the years ended December 31, 2002 and 2001,
respectively, and an increase to net loss of $122 and $43 for the years ended December 31, 2002 and
2001, respectively.  First, second and third quarters of 2003 The following tables present the impact of the Second Restatement adjustments on our
previously reported consolidated statements of operations data for the first, second and third
quarters of 2003 (the fourth quarter of 2003 had not been previously reported). The Second
Restatement adjustments are described in the paragraphs following the tables below. 48




---



##### Table of Contents



Consolidated Statement of Operations data for the three months ended March 31, 2003 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    2,376
    
    
    $
    (81
    )
    
    $
    2,295Gross profit
    
    
    1,052
    
    
    
    (145
    )
    
    
    907Operating earnings (loss)
    
    
    (70
    )
    
    
    (129
    )
    
    
    (199
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    (95
    )
    
    
    (42
    )
    
    
    (137
    )Net earnings (loss) from continuing operations
    
    
    (103
    )
    
    
    (70
    )
    
    
    (173
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    164
    
    
    
    (31
    )
    
    
    133Net earnings (loss)
    
    
    53
    
    
    
    (105
    )
    
    
    (52
    )Dividends on preferred shares
    
    
    (5
    )
    
    
    (3
    )
    
    
    (8
    )Net earnings (loss) applicable to common shares
    
    $
    48
    
    
    $
    (108
    )
    
    $
    (60
    )
 Consolidated Statement of Operations data for the three months ended June 30, 2003 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    2,340
    
    
    $
    (52
    )
    
    $
    2,288Gross profit
    
    
    1,023
    
    
    
    (142
    )
    
    
    881Operating earnings (loss)
    
    
    143
    
    
    
    (193
    )
    
    
    (50
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    143
    
    
    
    (165
    )
    
    
    (22
    )Net earnings (loss) from continuing operations
    
    
    109
    
    
    
    (141
    )
    
    
    (32
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (2
    )
    
    
    (6
    )
    
    
    (8
    )Net earnings (loss)
    
    
    107
    
    
    
    (147
    )
    
    
    (40
    )Dividends on preferred shares
    
    
    (7
    )
    
    
    (2
    )
    
    
    (9
    )Net earnings (loss) applicable to common shares
    
    $
    100
    
    
    $
    (149
    )
    
    $
    (49
    )
 Consolidated Statement of Operations data for the three months ended September 30, 2003 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    2,266
    
    
    $
    78
    
    
    $
    2,344Gross profit
    
    
    1,177
    
    
    
    (58
    )
    
    
    1,119Operating earnings (loss)
    
    
    165
    
    
    
    (82
    )
    
    
    83Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    240
    
    
    
    (46
    )
    
    
    194Net earnings (loss) from continuing operations
    
    
    186
    
    
    
    (53
    )
    
    
    133Net earnings (loss) from discontinued operations  net of tax
    
    
    44
    
    
    
    (12
    )
    
    
    32Net earnings (loss)
    
    
    230
    
    
    
    (65
    )
    
    
    165Dividends on preferred shares
    
    
    (6
    )
    
    
    (3
    )
    
    
    (9
    )Net earnings (loss) applicable to common shares
    
    $
    224
    
    
    $
    (68
    )
    
    $
    156
 49




---



##### Table of Contents



Consolidated Statement of Operations data for the nine months ended September 30, 2003 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    6,982
    
    
    $
    (55
    )
    
    $
    6,927Gross profit
    
    
    3,252
    
    
    
    (345
    )
    
    
    2,907Operating earnings (loss)
    
    
    238
    
    
    
    (404
    )
    
    
    (166
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    288
    
    
    
    (253
    )
    
    
    35Net earnings (loss) from continuing operations
    
    
    192
    
    
    
    (264
    )
    
    
    (72
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    206
    
    
    
    (49
    )
    
    
    157Net earnings (loss)
    
    
    390
    
    
    
    (317
    )
    
    
    73Dividends on preferred shares
    
    
    (18
    )
    
    
    (8
    )
    
    
    (26
    )Net earnings (loss) applicable to common shares
    
    $
    372
    
    
    $
    (325
    )
    
    $
    47
  Revenues and cost of revenues Revenues and cost of revenues were impacted by various errors related to revenue recognition,
corrections to foreign exchange accounting, intercompany related items, special charges and other
adjustments, including financial statement
reclassifications. The net impact to revenues of the adjustments was a decrease of $81, a decrease
of $52 and an increase of $78 for the first, second and third quarters of 2003, respectively. The
net impact to cost of revenues related to these revenue adjustments, and the other corrections, was
an increase of $64, $90 and $136 for the first, second, and third quarters of 2003, respectively.
The Second Restatement adjustments to revenues and cost of revenues in each of these periods
related primarily to the following items:  
    
    incorrect application of SAB 104 or SOP 97-2, the most significant of which related
to revenue that should have been deferred until title or risk of loss had passed, or
products had been delivered;
    
    incorrect application of AICPA SOP 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts, or SOP 81-1, with respect to
percentage-of-completion accounting for certain long-term constructions contracts; and
    
    various other adjustments, primarily related to specific contracts and transactions,
including two transactions recorded in the first quarter of 2003 which should have been
recorded in 2002.  Foreign exchange As part of the plan to address a material weakness reported in our Quarterly Report on Form 10-Q
for the period ended September 30, 2003, a review of foreign exchange accounting was undertaken.
The net impact to pre-tax loss was a decrease of $90 and $7, and an increase of $13 for the first,
second, and third quarters of 2003, respectively. The significant items were as follows:  
    
    we re-examined the determination of the functional currency for certain entities
based on the guidance under SFAS No. 52. As a result, we identified four instances in
which the functional currency designation of an entity was incorrect. These revisions
resulted in increases or decreases to other income (expense)  net;
    
    we identified two instances of incorrect treatment of significant intercompany
positions. The net impact of the adjustments was an increase or decrease to other
income (expense)  net, with an offset to accumulated other comprehensive loss; and
    
    we identified errors in the revaluation of certain foreign denominated customer
financing provisions within discontinued operations, which increased other income and
decreased net earnings from discontinued operations.  Intercompany balances Historically, we had certain intercompany balances that did not eliminate upon consolidation, or
out-of-balance positions, and had recorded provisions accordingly. As part of the Second
Restatement, we reviewed these provisions and determined that they should not have been recorded.
We recorded adjustments in the appropriate periods to reverse these provisions and to 50




---



##### Table of Contents



correct the
significant out-of-balance positions. The net impact of these adjustments was an increase of $6,
$15 and $4 to pre-tax loss for the first, second, and third quarters of 2003, respectively.  Special charges As part of the Second Restatement, we reviewed the components of special charges and recorded an
increase to special charges of $29, a decrease of $21 and an increase of $11 for the first, second
and third quarters of 2003, respectively. We determined that certain items were either recorded in
special charges in error or, although correctly recorded when originally recognized, were not
adjusted in the appropriate subsequent periods for changes in estimates and/or assumptions. These
items related to contract settlement costs, plant and equipment impairment costs, and severance
and fringe benefit related costs.  Other We recorded other adjustments primarily to correct certain accruals, provisions and other
transactions, which were either initially recorded incorrectly in prior periods, or not properly
released or adjusted for changes in estimates and/or assumptions in the appropriate subsequent
periods. The impact of these adjustments was an increase of $10, $97 and $15 to the pre-tax loss
for the first, second, and third quarters of 2003, respectively, primarily due to increased cost of
revenues for customer and contract related accruals, warranty costs, and other accruals.  Reclassifications As a result of the restatement process, various presentation inconsistencies were identified.
Adjustments were made to appropriately reflect certain items in the statement of operations. The
reclassifications were made for royalty expense, gain (loss) on sale of businesses and assets, and
other items including certain functional spending and specific expenses.  Discontinued operations As a result of the restatement process, the initial provision for loss on disposal of the access
solutions discontinued operations recorded in June 2001, and the subsequent activity during 2001
through 2004 were re-examined. We concluded that the net loss on disposal of operations recognized
in the second quarter of 2001 was overstated by $738, of which $520 comprised items that should
have been charged to continuing operations. In addition, other adjustments were necessary to
correct certain items that were either initially recorded incorrectly, or not properly released or
adjusted for changes in estimates in the appropriate periods subsequent to the second quarter of
2001. The net impact of all of these changes on net earnings from discontinued operations  net of
tax was a decrease of $31, $6 and $12 for the first, second, and third quarters of 2003,
respectively. This was primarily due to the elimination of a gain in the first quarter of 2003 of
$90 on redemption of an investment interest due to the reversal in an earlier period of a full
valuation allowance that had been recorded against the investment
interest when acquired partially offset by an increase of $37 for
corrections to accrued liabilities. 
  Material weaknesses in internal control over financial reporting identified in Second Restatement As described above and in the Controls and Procedures section of this report, two material
weaknesses in our internal control over financial reporting were identified at the time of the
First Restatement. Over the course of the Second Restatement process, we and D&T identified a
number of additional material weaknesses in our internal control over financial reporting, as
further described in the Controls and Procedures section of this report. D&T confirmed to the
Audit Committee these material weaknesses, listed below, on January 10, 2005:  
    
    lack of compliance with written Nortel Networks procedures for monitoring and adjusting
balances related to certain accruals and provisions, including restructuring charges and
contract and customer accruals;
    
    lack of compliance with Nortel Networks procedures for appropriately applying
applicable GAAP to the initial recording of certain liabilities including those described
in SFAS No. 5, Accounting for Contingencies, or SFAS No. 5, and to foreign currency
translation as described in SFAS No. 52;
    
    lack of sufficient personnel with appropriate knowledge, experience and training in
U.S. GAAP and lack of sufficient analysis and documentation of the application of U.S.
GAAP to transactions, including but not limited to revenue transactions; 51




---



##### Table of Contents




    
    lack of a clear organization and accountability structure within the accounting
function, including insufficient review and supervision, combined with financial reporting
systems that are not integrated and which require extensive manual interventions;
    
    lack of sufficient awareness of, and timely and appropriate remediation of, internal
control issues by Nortel Networks personnel; and
    
    an inappropriate tone at the top, which contributed to the lack of a strong control
environment; as reported in the Independent Review Summary set forth in the Controls and
Procedures section of this report, there was a Management tone at the top that
conveyed the strong leadership message that earnings targets could be met through
application of accounting practices that finance managers knew or ought to have known were
not in compliance with U.S. GAAP and that questioning these practices was not acceptable. Upon completion of managements assessment of our internal control over financial reporting as at
December 31, 2004 pursuant to SOX 404, we currently expect to conclude that the first five of
these six material weaknesses continue to exist at December 31, 2004. We continue to identify,
develop and begin to implement remedial measures to address them, as described in the Controls and
Procedures section of this report. See also notes 3 and 22 to the accompanying consolidated
financial statements. 
  Revenue Independent Review Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue
recognition and undertook a process of revenue reviews. In light of the resulting adjustments to
revenues previously reported, the Audit Committee has determined to review the facts and
circumstances leading to the restatement of these revenues for specific transactions identified in
the Second Restatement. The review will have a particular emphasis on the underlying conduct that
led to the initial recognition of these revenues. The Audit Committee will seek a full
understanding of the historic events that required the revenues for these specific transactions to
be restated and will consider any appropriate additional remedial measures, including those
involving internal controls and processes. The Audit Committee has engaged WCPHD to advise it in
connection with this review. 
  Personnel actions In connection with the Independent Review, we have, among other actions, terminated for cause:  
    
    our former president and chief executive officer, former chief financial officer and
former controller in April 2004 (the former chief financial officer and former controller
having been placed on paid leaves of absence in March 2004) and
    
    seven additional senior finance employees with significant responsibilities for our
financial reporting as a whole or for their respective business units and geographic
regions in August 2004. Each of these former members of management had responsibility for their respective positions at the
time of the Comprehensive Review and First Restatement. The Board of Directors determined that
each of these individuals had significant responsibilities for our financial reporting as a whole,
or for their respective business units and geographic regions, and that each was aware, or ought to
have been aware, that our provisioning activity, described above, did not comply with U.S. GAAP. 
  EDC Support Facility The delayed filing of the Reports with the SEC, the trustees under our and NNCs public debt
indentures and Export Development Canada, or EDC, gave EDC the right to (i) terminate its
commitments under the $750 EDC support facility, or the EDC Support Facility, relating to certain
of our performance related obligations arising out of normal course business activities, and (ii)
exercise certain rights against the collateral pledged under related security agreements or require
us to cash collateralize all existing support. We obtained waivers from EDC with respect to these
and related matters to permit continued access to the EDC Support Facility in accordance with its
terms while we complete our filing obligations with respect to the Reports. The waivers have also
applied to certain additional breaches under the EDC Support Facility relating to the delayed
filings and the restatements and revisions to our and NNCs prior financial results, or the Related
Breaches. In connection with such waivers, EDC reclassified the previously committed $300
revolving small bond sub-facility of the EDC 52




---



##### Table of Contents



Support Facility as uncommitted support during the
waiver period. The $300 revolving small bond facility will not become committed support until all
of the Reports have been filed with the SEC and we obtain a permanent waiver of the Related
Breaches. As we and NNC will not have filed all of the Reports by January 15, 2005, EDC will have the right,
on such date, (absent a further waiver in relation to the delayed filings and the Related
Breaches), to (i) terminate the EDC Support Facility and (ii) exercise certain rights against
collateral or require us to cash collaterize all existing support. In addition, the Related Breaches will continue beyond the filing of the Reports. Accordingly, EDC
will have the right (absent a further waiver of the Related Breaches) beginning on January 15, 2005
to terminate or suspend the EDC Support Facility or exercise certain rights against collateral
notwithstanding the filing of the Reports. While we are seeking a permanent waiver from EDC in
connection with the Related Breaches, there can be no assurance that we will receive any waiver or
as to the terms of any such waiver. As of December 31, 2004, approximately $296 of outstanding support under the EDC Support
Facility was outstanding, $212 of which was outstanding under the revolving small bond
sub-facility. See Available support facility and Risk factors/forward looking statements. 
  Credit facilities and security agreements On April 28, 2004, we terminated our and Nortel Networks Inc., or NNI, $750 April 2000 five
year credit facilities, or the Five Year Facilities. Absent such termination, the banks would have
been permitted, upon 30 days notice, to terminate their
commitments under the Five Year Facilities as a result of our failure to file our 2003 Annual
Report on Form 10-K by April 29, 2004. Upon termination, the Five Year Facilities were undrawn. As a result of the termination of the Five Year Facilities, certain foreign security agreements
entered into by us and various of our subsidiaries, under which shares of certain of our
subsidiaries incorporated outside of the U.S. and Canada were pledged in favor of the banks under
the Five Year Facilities, EDC and the holders of our and NNCs outstanding public debt securities,
also terminated in accordance with their terms (see note 22 of the accompanying consolidated
financial statements). In addition, the guarantees by certain subsidiaries incorporated outside of
the U.S. and Canada terminated in accordance with their terms. Because certain of the foreign
security agreements, including those relating to Nortel Networks S.A., were in place as of December
31, 2003, we have included Nortel Networks S.A. financial statements in this report notwithstanding
the subsequent termination of these agreements. Security agreements remain in place under which
substantially all of our assets located in the U.S. and Canada and those of most of our U.S. and
Canadian subsidiaries, including the shares of certain of our U.S. and Canadian subsidiaries, are
pledged in favor of EDC and the holders of our and NNCs outstanding public debt securities. In
addition, the guarantees by certain of our wholly owned subsidiaries, including NNI, most of our
Canadian subsidiaries, Nortel Networks (Asia) Limited, Nortel Networks (Ireland) Limited and Nortel
Networks U.K. Limited, of our obligations under the EDC Support Facility and our and NNCs
outstanding public debt securities, remain in place. See Liquidity and capital resources. 
  Debt securities As a result of the delay in filing the Reports, we and NNC have not been in compliance with
our obligations to deliver the Reports to the trustees under our and NNCs public debt indentures.
As of December 31, 2004, approximately $1,800 of our notes (or our subsidiaries notes) and $1,800
of NNCs convertible debt securities were outstanding. These delays have not resulted in an automatic event of default and acceleration of the outstanding
long-term debt and such default and acceleration cannot occur unless notice by holders of at least
25% of the outstanding principal amount of any relevant series of debt securities of such
non-compliance is provided to us or NNC, as applicable, and we or NNC, as applicable, fail to file
and deliver the relevant Report within 90 days after such notice is provided, all in accordance
with the terms of the indentures. While such notice could have been given at any time after March
30, 2004, neither we nor NNC has received a notice to the date of this report. As a result of the
continuing delay in filing certain of our Reports, we and NNC continue to be in breach of our
obligations under our and NNCs public debt indentures, as described above. If notice were given
and acceleration of our debt securities were to occur, we may be unable to meet our payment
obligations. Based on publicly available information, we have reason to believe that more than 25% of the
outstanding principal amount of the $150 of 7.875% notes due June 2026 issued by one of our
subsidiaries and guaranteed by us are held by one holder, or a group of related holders. Other than
with respect to that series of debt securities, based on such publicly available 53




---



##### Table of Contents



information,
neither we nor NNC are aware of any holder, or group of related holders, that holds at least 25% of
the outstanding principal amount of any relevant series of debt securities. However, based on such
publicly available information, we have reason to believe that there is sufficient concentration
among holders of the $150 of 7.40% notes due June 2006 issued by us that the acquisition of a
relatively small additional amount of these notes by certain holders could result in a holder or a
group of related holders holding 25% or more of the outstanding principal amount of these notes.
See Liquidity and capital resources and Risk factors/forward looking statements. 
  Shelf registration statement Owing to the delayed filing of the Reports, we are currently unable to use, in its current
form, the remaining approximately $800 of capacity under our shelf registration statement filed
with the SEC for various types of securities. See Liquidity and capital resources and Risk
factors/forward looking statements. 
  Credit ratings On April 28, 2004, Standard and Poors, or S&P, downgraded its ratings on us, including our
long-term corporate credit ratings from B to B- and our preferred shares rating from CCC to
CCC-. At the same time, it revised its outlook to developing from negative. On April 28, 2004,
Moodys Investors Service, Inc., or Moodys, changed its outlook to potential downgrade from
uncertain. See Credit ratings and Risk factors/forward looking statements. 
  Regulatory actions and pending litigation We are under investigation by the SEC and the Ontario Securities Commission, or OSC,
Enforcement Staff. In addition, Nortel Networks has received a U.S. federal grand jury subpoena
for the production of certain documents sought in connection with an ongoing criminal investigation
being conducted by the U.S. Attorneys Office for the Northern District of Texas, Dallas Division.
Further, the Integrated Market Enforcement Team of the Royal Canadian Mounted Police., or RCMP, has
advised us that it would be commencing a criminal investigation into our financial accounting
situation. We will continue to cooperate fully with all authorities in connection with these
investigations and reviews. See Legal proceedings and Risk factors/forward looking statements. In addition, numerous class action complaints have been filed against us and NNC, including class
action complaints under the Employee Retirement Income Security Act, or ERISA. In addition, a
derivative action complaint has been filed against us and NNC. These pending civil litigation
actions and regulatory and criminal investigations are significant and if decided against us, could
materially adversely affect our financial condition and liquidity by requiring us to pay
substantial judgments, settlements, fines or other penalties. See Liquidity and capital
resources, Legal proceedings and Risk factors/forward looking statements. On May 31, 2004, the OSC issued a final order prohibiting all trading by our directors, officers
and certain current and former employees in the securities of Nortel Networks Corporation and
Nortel Networks Limited. This order will remain in effect until two full business days following
the receipt by the OSC of all filings required to be made by us and NNC pursuant to Ontario
securities laws. We and NNC continue to provide periodic updates to the NYSE and the TSX concerning our and
NNCs delay in filing certain of the Reports. The NYSE granted us and NNC an extension of up to
March 31, 2005 to file our 2003 Annual Reports, during which the Nortel Networks Corporation common
shares and our and NNCs other securities remain listed on the NYSE. To the date of this report,
neither the NYSE nor the TSX has commenced any suspension or delisting procedures in respect of
Nortel Networks Corporation common shares or other of our or NNCs listed securities. The
commencement of any suspension or delisting procedure by either exchange remains, at all times, at
the discretion of such exchange, and would be publicly announced by the exchange. See Risk
factors/forward looking statements. 
  Stock-based compensation plans As a result of NNCs March 10, 2004 announcement that we and NNC would need to delay the
filing of our 2003 Annual Reports, we suspended as of March 10, 2004: the purchase of Nortel
Networks Corporation common shares under the stock purchase plans for eligible employees in
eligible countries that facilitate the acquisition of Nortel Networks Corporation common shares;
the exercise of outstanding options granted under the Nortel Networks Corporation 2000 Stock Option
Plan, or the 2000 Plan, or Nortel Networks Corporation 1986 Stock Option Plan as amended and
restated, or the 1986 Plan, or the 54




---



##### Table of Contents



grant of any additional options under those plans, or the
exercise of outstanding options granted under employee stock option plans previously assumed by us
in connection with mergers and acquisitions; and the purchase of units in a Nortel Networks stock
fund or purchase of Nortel Networks Corporation common shares under our defined contribution and
investments plans, until such time as, at the earliest, that we and NNC are in compliance with U.S.
and Canadian regulatory securities filing requirements. 
 Evolution of our supply chain strategy Over the last five years, we have divested most of our manufacturing activities to Electronic
Manufacturing Services, or EMS, suppliers. On June 29, 2004, we announced an agreement with
Flextronics regarding the divestiture of substantially all of our remaining manufacturing
operations, including product integration, testing and repair operations carried out in our Systems
Houses in Calgary and Montreal, Canada and Campinas, Brazil, as well as certain activities related
to these locations, including the management of the supply chain, related suppliers, and
third-party logistics. In Europe, Flextronics has made an offer to purchase similar operations at
our Monkstown, Northern Ireland and Chateaudun, France Systems Houses, subject to the completion of
the required information and consultation process. Under the terms of the agreement and offer, Flextronics will also acquire our global repair
services, as well as certain design assets in Ottawa, Canada and Monkstown related to hardware and
embedded software design, and related product verification for certain established optical
products. We have entered into a four year supply agreement with Flextronics for manufacturing services
(whereby Flextronics will
manage approximately $2,500 of our annual cost of sales) and a three year supply agreement for
design services. The transfer of the optical design operations and related assets in Ottawa and
Monkstown closed in the fourth quarter of 2004. The portions of the transaction related to the
manufacturing activities in Montreal and Calgary are expected to close in the first and second
quarters of 2005, respectively. The balance of the transaction is expected to close on separate
dates occurring during the first half of 2005. These transactions are subject to customary
conditions and regulatory approvals. The successful completion of the agreement and offer with Flextronics will result in the transfer
of approximately 2,500 of our employees to Flextronics. We expect to receive cash proceeds ranging
from approximately $675 to $725, which will be allocated to each separate closing and, with respect
to each closing, will be paid on an installment basis up to nine months thereafter. Such payments
will be subject to a number of adjustments, including from potential post-closing date asset
valuations and potential post-closing indemnity payments. Flextronics also has the ability in
certain cases to exercise rights to sell back to us certain inventory and equipment after the
expiration of a specified period (of up to fifteen months) following each respective closing date.
We do not expect such rights to be exercised with respect to any material amount of inventory
and/or equipment. The cash proceeds estimate is comprised of approximately $475 to $525 for
inventory and equipment and $200 for intangible assets. The cash proceeds would be partially
offset by related estimated transaction costs (including transition, potential severance, and
information technology implementation and real estate costs) of approximately $200. We also announced that we plan to create Solutions Operations Centers in Calgary and Montreal and,
pending the completion of information and consultation processes in Europe, in Monkstown and
Chateaudun. These centers are expected to have overall responsibility for the strategic management
and control of our various supply chains, including all customer interfaces, customer service,
order management, quality assurance, product cost management, new product introduction, and network
solutions integration, testing and fulfillment. We believe that the use of an outsourced manufacturing model has enabled us to benefit from leading
manufacturing technologies, leverage existing resources from around the world, lower our cost of
sales, quickly adjust to fluctuations in market demand and decrease our investment in plant,
equipment and inventories. We continue to retain in-house all strategic management and overall
control responsibilities associated with our various supply chains, including all customer
interfaces, customer service, order management, quality assurance, product cost-management, new
product introduction, and network solutions integration, testing and fulfillment. 
 Other business developments 
  Ownership adjustment in our French and German operations On September 18, 2003, consistent with our overall global business strategy, we realigned our
business activities in France and Germany by increasing our ownership in our core businesses in
these countries. As a result of this realignment, we 55




---



##### Table of Contents



acquired the 42% minority interest in Nortel
Networks Germany GmbH & Co. KG and the 45% minority interest in Nortel Networks France S.A.S., or
NNF, previously held by European Aeronautic Defence and Space Company EADS N.V., or EADS, our
former partner in three European joint ventures. At the completion of these transactions, our
ownership in each company increased to 100%. These companies are responsible for the sales and
marketing of our products in Germany and France. At the same time, EADS increased its ownership in
EADS Telecom S.A.S. (formerly EADS Defence and Security Networks S.A.S.), or EADS Telecom, from 59%
to 100% as a result of acquiring our equity ownership in that company. For additional information,
see Nortel Networks Germany and Nortel Networks France in note 10 of the accompanying
consolidated financial statements. 
  Customer financing commitments During 2003, we reduced our undrawn customer financing commitments by $651 primarily as a
result of the expiration or cancellation of commitments and changing customer business plans. As
of December 31, 2003, approximately $108 of the $177 in undrawn commitments was not available for
funding under the terms of our financing agreements. For additional information, see Customer
financing. 
  Sale of Entrust shares On February 3, 2004, we sold approximately 7 million common shares of Entrust Inc., or
Entrust, for cash consideration of $33, resulting in a gain of $18. In connection with this
transaction, we no longer hold any equity interest in Entrust. 
  Real estate On March 1, 2004, we purchased land and two buildings for $87 that were previously leased by
us, which leases expired on February 28, 2004. As a result, we extinguished a debt of $87. 
  Customer contract settlement On May 7, 2004, we received $80 in proceeds from the sale of certain assets in connection with
a customer contract settlement in Latin America. This resulted in a gain of $78, which will be
included in (gain) loss on sale of businesses and assets for the three months ended June 30, 2004. 
  Directory and operator services business On August 2, 2004, we completed the contribution of certain assets and liabilities of our
directory and operator services, or DOS, business to VoltDelta, Resources LLC, or VoltDelta, a
wholly owned subsidiary of Volt Information Sciences, Inc., or VIS, in return for a 24% interest in
VoltDelta. After a period of two years, we and VIS each have an option to cause us to sell our
VoltDelta shares to VIS for proceeds ranging from $25 to $70. As a result of this transaction,
approximately 160 of our DOS employees in North America and Mexico joined VoltDelta. We recorded a
gain on sale of businesses and assets of approximately $50 in the third quarter of 2004. 
  Bharat Sanchar Nigram Limited contract In August 2004, we entered into a contract with Bharat Sanchar Nigram Limited to establish a
wireless network in India. Our commitments to date for orders received under this contract have
resulted in an estimated project loss of approximately $130, which has been recorded in the third
quarter of 2004. 
  Patent infringement settlement On October 26, 2004, we entered into an agreement with Foundry Networks, Inc., or Foundry, to
settle outstanding patent infringement claims and counterclaims by us and Foundry. As part of the
settlement, we granted Foundry a four year license under certain patents and Foundry paid $35 to
us. 56




---



##### Table of Contents



Customer financing arrangements On December 15 and 16, 2004, we sold certain notes receivable and convertible notes receivable
that had been received as a result of the restructuring of a customer financing arrangement for
cash proceeds of $116. The net carrying amount of the notes receivable and convertible notes
receivable was $56. On December 23, 2004, a customer financing arrangement was restructured. The notes receivable that
were restructured had a net carrying amount as of December 31, 2003 of $13, net of provisions for
doubtful accounts of $147 ($55 of the provision is included in discontinued operations). We are
currently assessing the value of the restructured notes receivable and expect that an increase in
value from the net carrying amount has occurred. 
 Results of operations  continuing operations 
 Segment revenues The following table summarizes our revenues for 2003, 2002 and 2001 by segment: For the years ended December 31,
    
    
    2003 vs 2002
    
    
    2002 vs 20012003
    
    
    2002
    
    
    2001
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    4,389
    
    
    $
    4,161
    
    
    $
    5,699
    
    
    $
    228
    
    
    
    5
    
    
    $
    (1,538
    )
    
    
    (27
    )Enterprise Networks
    
    
    2,589
    
    
    
    2,415
    
    
    
    3,143
    
    
    
    174
    
    
    
    7
    
    
    
    (728
    )
    
    
    (23
    )Wireline Networks
    
    
    2,005
    
    
    
    2,572
    
    
    
    4,327
    
    
    
    (567
    )
    
    
    (22
    )
    
    
    (1,755
    )
    
    
    (41
    )Optical Networks
    
    
    1,179
    
    
    
    1,815
    
    
    
    5,014
    
    
    
    (636
    )
    
    
    (35
    )
    
    
    (3,199
    )
    
    
    (64
    )Other(a)
    
    
    31
    
    
    
    31
    
    
    
    580
    
    
    
    
    
    
    
    
    
    
    
    (549
    )
    
    
    (95
    )Consolidated
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763
    
    
    $
    (801
    )
    
    
    (7
    )
    
    $
    (7,769
    )
    
    
    (41
    )
 (a)
    
    Other represented miscellaneous business activities and corporate functions. 
 Geographic revenues The following table summarizes our geographic revenues based on the location of the customer: For the years ended December 31,
    
    
    2003 vs 2002
    
    
    2002 vs 20012003
    
    
    2002
    
    
    2001
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeUnited States
    
    $
    5,424
    
    
    $
    5,809
    
    
    $
    10,059
    
    
    $
    (385
    )
    
    
    (7
    )
    
    $
    (4,250
    )
    
    
    (42
    )EMEA(a)
    
    
    2,366
    
    
    
    2,500
    
    
    
    4,352
    
    
    
    (134
    )
    
    
    (5
    )
    
    
    (1,852
    )
    
    
    (43
    )Canada
    
    
    587
    
    
    
    648
    
    
    
    1,078
    
    
    
    (61
    )
    
    
    (9
    )
    
    
    (430
    )
    
    
    (40
    )Asia Pacific
    
    
    1,307
    
    
    
    1,484
    
    
    
    2,258
    
    
    
    (177
    )
    
    
    (12
    )
    
    
    (774
    )
    
    
    (34
    )CALA(b)
    
    
    509
    
    
    
    553
    
    
    
    1,016
    
    
    
    (44
    )
    
    
    (8
    )
    
    
    (463
    )
    
    
    (46
    )Consolidated
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763
    
    
    $
    (801
    )
    
    
    (7
    )
    
    $
    (7,769
    )
    
    
    (41
    )
 (a)
    
    The Europe, Middle East and Africa region, or EMEA.(b)
    
    The Caribbean and Latin America region, or CALA. 57




---



##### Table of Contents



Consolidated revenues The following chart summarizes our quarterly revenues during 2003 and 2002: (CHART)  2003 vs. 2002 Our consolidated revenues declined 7% in 2003 compared to 2002. There were substantial
declines in Wireline Networks and Optical Networks while Wireless Networks increased 5% and
Enterprise Networks increased 7%. The decline was primarily due to the continued industry
adjustment and capital spending restrictions experienced by our service provider customers. As
well, the decline in 2003 was attributable to tightened capital markets mainly experienced in the
first half of 2003 as customer spending remained cautious, with many of our customers realigning
capital spending with their current levels of revenues and profits in order to maximize their
return on invested capital. Many of our customers continued to focus on conserving capital,
decreasing their debt levels, reducing costs and/or increasing the capacity utilization rates and
efficiency of existing networks. Also, excess network capacity and competition continued to exist
in the industry which led to continued pricing pressures on the sale of certain of our products. From a geographic perspective, the 7% decline in revenues in 2003 compared to 2002 was due to a:  
    
    7% decline in revenues in the U.S. primarily due to capital spending
restrictions experienced by our service provider customers and their focus on capital and
cash flow management in 2003 as well as tightened capital markets mainly during the first
half of 2003. This was partially offset by the release of certain software including the
general availability of Succession 3.0 in the fourth quarter of 2003 which triggered the
recognition of associated revenues
deferred from prior periods. In addition, revenues increased due to the recognition of
deferred revenues associated with certain data switch upgrades. Further, Global System for
Mobile communications, or GSM, and Code Division Multiple Access, or CDMA, customers
upgraded and expanded their existing networks in the second half of 2003;
    
    12% decline in revenues in Asia Pacific due to capital spending restrictions
by our service provider customers;
    
    5% decline in revenues in EMEA primarily due to capital spending restrictions
by service provider and enterprise customers and tightened capital markets mainly during
the first half of 2003 which was partially offset by increases in revenue related to new
GSM contracts with certain service providers and the impact of favorable foreign exchange
effects associated with the euro;
    
    9% decline in revenues in Canada primarily due to capital spending
restrictions experienced by our service provider customers and their focus on capital and
cash flow management, the completion of certain customer deployments as well as tightened
capital markets mainly during the first half of 2003, which was partially offset by the
impact of favorable foreign exchange effects associated with the Canadian dollar; and
    
    8% decline in revenues in CALA primarily due to the completion of a major
contract in the first quarter of 2002 and continued capital spending restrictions
experienced by our service provider customers, which was partially offset by increases in
revenue related to new GSM contracts with certain service providers.  2002 vs. 2001 Our consolidated revenues declined 41% in 2002 compared to 2001. Following a period of rapid
infrastructure build-out and strong economic growth in 1999 and 2000, we saw severe economic
downturns in various regions around the world and 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. 58




---



##### Table of Contents



From a geographic perspective, the 41% decline in revenues in 2002 compared to 2001 was primarily
due to a 42% decline in the U.S., a 43% decline in EMEA, a 34% decline in Asia Pacific, a 46%
decline in CALA and a 40% decline in Canada. All regional declines in 2002 compared to 2001 were
primarily the result of the factors mentioned above.  2004 and 2005 We expect that our consolidated revenues in 2004 will be slightly lower compared with 2003.
The 2003 consolidated revenues included revenues that were deferred from prior periods. Although we
expect a slight decline of consolidated revenues in 2004 as compared to 2003, we saw growth in
several areas in 2004 primarily as a result of customers increasing their investments in:  
    
    voice over packet technologies;
    
    third generation wireless technologies; and
    
    expansion and enhancement of existing networks due to subscriber growth and competitive pressures. The period of relative industry stability that had characterized the second half of 2003 continued
into 2004. For 2005, we expect revenue growth over 2004 primarily due to continued growth in the
above areas. Spending in these areas of our business has been partially offset by customers limiting their
investment in mature technologies as they focus on maximizing return on investment capital. In
addition, we have continued to experience pricing pressures on sales of certain of our products as
a result of increased competition particularly from low cost suppliers. Further, while customer
support generally remains strong, we believe the ongoing restatement activities and the internal
restructuring and realignment programs initiated in August 2004 have adversely impacted business
performance in 2004. Consolidated revenues for the third and fourth quarters of 2004 reflect certain of these trends,
with third quarter 2004 consolidated revenues lower than previously announced preliminary unaudited
consolidated revenues for the second quarter of 2004. Our fourth quarter is expected to be our
strongest quarter in 2004. Our quarterly results of operations will not necessarily be consistent
with our historical quarterly profile or indicative of our expected results in future quarters.
See Risk factors/forward looking statements for other factors that may affect our revenues. 
 Wireless Networks revenues The following chart summarizes recent quarterly revenues for Wireless Networks: (CHART)  2003 vs. 2002 Wireless Networks revenues increased 5% in 2003 compared to 2002 due to a 31% increase in the
second half of 2003 partially offset by a 17% decrease in the first half of 2003 compared to the
same periods in 2002. The 31% increase in the second half of 2003 was primarily due to increased
spending by our wireless service provider customers on our GSM, CDMA and UMTS technologies as a
result of new contracts with certain customers and other customers expanding their existing
networks to meet increased subscriber demand. The 17% decline in the first half of 2003 was
primarily due to the ongoing focus by wireless service providers on capital and cash flow
management and increased competition for customers by wireless service providers. As a result,
many of our customers heavily scrutinized their capital expenditure requirements and postponed or
reduced their capital spending during the first six months of 2003. CDMA revenues increased in 2003 compared to 2002 due to a substantial increase in revenues in the
second half of 2003 59




---



##### Table of Contents



compared to the same period in 2002. This substantial increase was partially
offset by a decrease in the first half of 2003 compared to the same period in 2002. The substantial increase in CDMA revenues in the second half of 2003 compared to the same period in
2002 was primarily due to a substantial increase in the U.S. and Canada as a result of our
customers expanding their existing networks and upgrading their existing networks to higher data
speeds. The substantial increase in the U.S. and Canada was partially offset by a substantial
decrease in EMEA. This substantial decline was primarily due to the completion of key customer
network deployments during the first half of 2003, which had been underway in 2002. The decrease in CDMA revenues in the first half of 2003 compared to the same period in 2002 was
primarily due to a substantial decline in Canada and a decline in the U.S. as customers continued
to experience capital spending restrictions as a result of their continued focus on capital and
cash flow management. In Asia Pacific, CDMA revenues increased substantially in the first half of
2003 compared to the same period in 2002 primarily due to new contracts with certain service
provider customers and other customers expanding their existing networks to meet increased
subscriber demand. GSM revenues increased significantly in 2003 compared to 2002 due to a substantial increase in
revenues in the second half of 2003 compared to the same period in 2002. This substantial increase
was partially offset by a significant decrease in the first half of 2003 compared to the same
period in 2002. The substantial increase in GSM revenues in the second half of 2003 compared to the same period in
2002 was primarily due to a substantial increase in the U.S. and EMEA. The substantial increase in
the U.S was primarily due to accelerated network expansions with certain service providers to meet
increased subscriber demand. The substantial increase in EMEA was mainly due to new contracts with
certain service provider customers and other customers expanding their existing networks. The significant decrease in GSM revenues in the first half of 2003 compared to the same period in
2002 was primarily due to substantial declines in Canada and Asia Pacific and a significant decline
in the U.S. The substantial decline in Asia Pacific was mainly due to a decline in the overall
growth rate of GSM technology deployments by wireless service providers in the second half of 2002
and the first half of 2003. As of the beginning of the first quarter of 2003, many of our GSM
customers in Asia Pacific had completed their current network deployments and, as a result, they
had sufficient capacity to meet additional subscriber demand. The substantial decline in Canada
and the significant decline in the U.S. were mainly due to
the completion of network deployments by certain service providers. In EMEA and CALA, GSM revenues
increased substantially in the first half of 2003 primarily due to new contracts with certain
service providers. Universal Mobile Telecommunications Systems, or UMTS, revenues increased substantially in 2003
compared to 2002. This substantial increase was primarily due to new contracts with certain
service providers and the continued transition to this next generation technology. Time Division Multiple Access, or TDMA, revenues declined substantially in 2003 compared to 2002
primarily due to the continued transition to newer wireless technologies. The substantial decline
was primarily due to customers in the U.S. and CALA continuing to migrate from the mature TDMA
technology to GSM and CDMA technologies. In 2003, TDMA revenues accounted for less than 6% of
total Wireless Networks revenues, down from 11% in 2002. From a geographic perspective, the 5% increase in Wireless Networks revenues in 2003 compared to
2002 was primarily due to a:  
    
    6% increase in the U.S. primarily due to certain of our major GSM and CDMA
customers upgrading and expanding their existing networks to meet increased subscriber
demand in the second half of the year;
    
    15% increase in EMEA primarily due to new GSM contracts with certain service
providers and other customers expanding their existing networks to meet increased
subscriber demand; and
    
    15% increase in CALA primarily due to new GSM contracts with certain service
providers and other customers expanding their existing networks to meet increased
subscriber demand; partially offset by
    
    16% decline in Canada primarily due to the completion of key customer network
deployments, customers focus on capital and cash flow management and a slower subscriber
growth.  2002 vs. 2001 The 27% decline in Wireless Networks revenues in 2002 compared to 2001 was primarily due to a
continued deterioration in 60




---



##### Table of Contents



wireless service providers financial condition, slower subscriber
growth and increased competition for customers by service providers which resulted in the decision
of many wireless service providers to delay capital expenditures. CDMA revenues declined in 2002 compared to 2001 primarily due to continued capital spending
constraints and financial difficulties experienced by our customers globally. In 2002, we
continued to experience significant pricing pressures on our CDMA technologies in the U.S. and CALA
resulting from the increased competition for customers. TDMA revenues declined substantially in 2002 compared to 2001 primarily due to a substantial
decline in the U.S. and CALA as customers migrated from TDMA to CDMA and GSM technologies as a
result of TDMA technology and networks being in their maturity stage. Continued capital spending
constraints and financial difficulties experienced by our customers globally also contributed to
the TDMA revenue declines. In 2002, we continued to experience significant pricing pressures on
our TDMA technologies in the U.S. resulting from the increased competition for customers. TDMA
revenues continued to be a smaller portion of Wireless Networks in 2002 compared to 2001. GSM revenues declined substantially in 2002 compared to 2001 due to substantial declines in Asia
Pacific and EMEA. These substantial declines were primarily due to a continued deterioration in
wireless service providers financial condition and slower subscriber growth, and delays in capital
expenditures. Also in Asia Pacific, 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 Asia Pacific. In 2002, 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 Asia
Pacific, 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 focus
on improving their financial performance, limited their spending on network deployments. As a
result, 3G network deployments suffered delays in EMEA in 2002. From a geographic perspective, the 27% decline in Wireless Networks revenues in 2002 compared to
2001 was primarily due to a 54% decline in revenues in Asia Pacific, a 16% decline in revenues in
the U.S., a 25% decline in revenues in EMEA and a 27% decline in revenues in CALA. The declines in
all regions were mainly due to the continued deterioration in wireless
service providers financial condition and subscriber growth and increased competition for
customers by service providers which resulted in the decision of many wireless service providers to
delay capital expenditures.  2004 and 2005 During 2003 and 2004, Wireless Networks revenues continued to be primarily generated by sales
of CDMA and GSM technologies. Also, revenues associated with our TDMA technology continued to
decline in 2004 compared to 2003 due to the continued transition to newer wireless technologies.
Regarding our UMTS technology, revenues have grown compared to 2003 as a result of contracts
announced in the second half of 2003 and in 2004 and the continued transition to this next
generation technology. We expect a growing percentage of our Wireless Networks revenues to come
from our UMTS technology. While we have seen encouraging indicators in certain areas of the
wireless market, we can provide no assurance that these growth areas that have begun to emerge will
continue in the future. 
 Enterprise Networks revenues The following chart summarizes recent quarterly revenues for Enterprise Networks: (CHART) 61




---



##### Table of Contents



2003 vs. 2002 Enterprise Networks revenues increased 7% in 2003 compared to 2002 due to a substantial
increase in the circuit and packet voice portion of this segment offset by a significant decrease
in the data networking and security portion of this segment. Revenues from the circuit and packet voice portion of this segment increased substantially in 2003
compared to 2002.We experienced a substantial increase in revenues associated with our
traditional circuit switching and interactive voice response products primarily due to the release
of certain software including Succession 3.0. The general availability of this software in the
fourth quarter of 2003 triggered the recognition of associated revenues deferred from prior
periods, resulting in a net increase in revenues of $150 in 2003. In addition, there was a
substantial increase in revenues associated with our Internet Protocol, or IP, telephony solutions
as customers continued to migrate towards converged packet voice solutions. Revenues associated with the data networking and security portion of this segment decreased
significantly in 2003 compared to 2002. The significant decrease in revenues was primarily due to
a decline in new service contracts and service contract renewals, a decline in revenues associated
with our legacy routing portfolio and a decline in revenue from certain of our data networking
products primarily due to pricing pressures driven by increased competition. This was partially
offset by a net increase in previously deferred revenues associated with certain data switch
upgrades of approximately $60 in 2003. Enterprise Networks revenues declined sequentially in the first and second quarters of 2003 and
increased sequentially in the third and fourth quarters of 2003. The sequential declines in the
first half of 2003 were primarily due to customers having sufficient network capacity, continued
capital spending restrictions by our customers and delays associated with the establishment of new
channel relationships to address demand from small and medium sized enterprise customers. The
sequential increases in revenues in the second half of 2003 were primarily due to a sequential
increase in revenues associated with our IP telephony solutions as our customers continued to
migrate toward packet voice solutions as well as revenue recognized due to the release of certain
software including Succession 3.0 in the fourth quarter of 2003. Further, we experienced
sequential revenue increases in the third and fourth quarters of 2003 from our interactive voice
response and security products as a result of certain new product releases in the second half of
2003. From a geographic perspective, the 7% increase in Enterprise Networks revenues in 2003 compared to
2002 was primarily
due to a:  
    
    14% increase in revenues in the U.S. primarily due to the release of certain
software including the general availability of Succession 3.0 in the fourth quarter of 2003
which triggered the recognition of associated revenues deferred from prior periods. In
addition, revenues increased due to the recognition of deferred revenues associated with
certain data switch upgrades; partially offset by
    
    18% decline in revenues in CALA primarily due to the reduction of inventory by
the distribution network in the region and the unfavorable economic conditions in certain
countries.  2002 vs. 2001 The 23% 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 substantially in 2002
compared to 2001. The substantial decline was primarily due to reductions in customer spending in
the U.S. and EMEA. Revenues for traditional circuit switching products did begin to show signs of
improvement in the U.S. 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 IP telephony solutions, 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 significant declines in 2002
compared to 2001. The significant decline 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. 62




---



##### Table of Contents



From a geographic perspective, the 23% decline in Enterprise Networks revenues in 2002 compared to
2001 was primarily due to a 27% decline in the U.S., a 22% decline in EMEA and an 8% decline in
Asia Pacific. These declines were all primarily due to the ongoing industry adjustment, the
overall economic conditions and uncertainties surrounding the technology evolution of next
generation products.  2004 and 2005 During 2004, our Enterprise Networks customers have continued to increase the deployment of
voice over packet technologies in their communications networks. We expect that data, voice and
multimedia communications will continue to converge, and enterprises will look for ways to maximize
the effectiveness of their existing networks while reducing ongoing capital expenditures and
operating costs. Also, we anticipate that demand will continue to decline for our traditional
circuit switching products, however, it is difficult to determine the extent to which future
declines in demand will occur as a result of the migration to voice over packet technologies. In
2005, we are focused on increasing our market presence with enterprise customers. In particular,
we are focusing on leading enterprise customers with high performance networking needs. While we
have seen encouraging indicators in certain parts of the enterprise market, we can provide no
assurance that the growth areas that have begun to emerge will continue in the future. 
 Wireline Networks revenues The following chart summarizes recent quarterly revenues for Wireline Networks: (CHART)  2003 vs. 2002 Wireline Networks revenues declined 22% in 2003 compared to 2002. This decline was primarily
due to a substantial reduction in capital spending by our service provider customers as a result of
the continued industry adjustment. Revenues from the circuit and packet voice portion of this segment decreased substantially in 2003
compared to 2002 primarily due to a substantial decrease in our traditional circuit switching
product revenues and also uncertainty related to the impact of the Federal Communications
Commission, or FCC, decision regarding the regulation of the availability of unbundled network
elements, or UNEs, released on August 21, 2003 and subsequent judicial review and FCC
reconsideration of the decision. The substantial decline in our circuit switching revenues was
primarily due to the continuing impact of capital spending restrictions experienced by our service
provider customers during 2003 and tightened capital markets mainly during the first half of 2003.
Revenues from our packet voice solutions increased substantially across all regions except EMEA in
2003 compared to 2002 primarily due to new service provider contracts throughout 2003. Revenues from the data networking and security portion of this segment decreased significantly in
2003 compared to 2002 primarily due to substantial declines in the U.S. and Asia Pacific and a
significant decline in CALA. In these regions, we experienced a decline in demand for our mature
products primarily due to the ongoing shift towards IP-based technology. From a geographic perspective, the 22% decline in Wireline Networks revenues in 2003 compared to
2002 was primarily due to a:  
    
    32% decline in revenues in the U.S. primarily due to the continuing impact of
capital spending restrictions experienced by our service provider customers, tightened
capital markets mainly during the first half of 2003 and also uncertainty related to the
impact of the FCC decision regarding the regulation of the availability of UNEs;
    
    43% decline in revenues in CALA primarily due to the completion of a major
contract in the first quarter of 2002 63




---



##### Table of Contents



and continued capital spending restrictions
experienced by our service provider customers; and
    
    5% decline in revenues in EMEA primarily due to a reduction in capital
spending by service provider customers during 2003 and tightened capital markets mainly
during the first half of 2003; partially offset by
    
    15% increase in Canada primarily due to increased revenues from our packet
voice solutions primarily due to new service provider contracts throughout 2003.  2002 vs. 2001 The 41% 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. 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. From a geographic perspective, the 41% decline in Wireline Networks revenues in 2002 compared to
2001 was primarily due to a 41% decline in the U.S., a 32% decline in EMEA, a 57% decline in CALA,
and a 39% decline in Asia Pacific. The declines in all regions were primarily attributable to the
substantial reduction in spending by our service provider customers as a result of the factors
mentioned above.  2004 and 2005 In 2004, our service provider customers continued to increase the deployment of packet-based
technologies in their communications networks as they looked for ways to optimize their existing
networks and offer new revenue generating services while limiting capital expenditures and
operating costs. However, the timing of when service provider customers will deploy packet-based
technologies on a wider scale is still unclear. Further, it is difficult to determine the effect
the FCC decision regarding the regulation of the availability of UNEs and subsequent adoption on
December 15, 2004 of new unbundling rules in response to the remand by the U.S. Court of Appeals
for the D.C. Circuit will have on our business. The demand for our traditional circuit switching
products has continued to decline as certain service providers continued to reduce their capital
expenditures on these legacy technologies. While we have seen encouraging indicators in certain
areas of the wireline service provider market, we can provide no assurance that the growth areas
that have begun to emerge will continue in the future. 
 Optical Networks revenues The following chart summarizes recent quarterly revenues for Optical Networks: (CHART) 64




---



##### Table of Contents



2003 vs. 2002 Optical Networks revenues declined 35% in 2003 compared to 2002. The decline was primarily
the result of the continuing industry adjustment, excess capacity, tightened capital markets mainly
during the first half of 2003 and reductions in capital spending by our EMEA, U.S. and Canada
customers in both the long-haul and metro optical portions of this segment. Revenues in the long-haul portion of this segment declined substantially in 2003 compared to 2002.
The substantial decline was primarily due to the continuing industry adjustment, excess capacity,
tightened capital markets mainly during the first half of 2003 and continued capital spending
restrictions in the U.S., Canada and EMEA as customers continued to focus on maximizing return on
invested capital by increasing the capacity utilization rates and efficiency of existing networks.
In Asia Pacific, optical long-haul revenues declined substantially in 2003 compared to 2002
primarily due to the completion of network build-outs for certain customers in 2002 that were not
repeated in 2003. In addition, significant excess inventories continued to exist in this portion
of the segment which resulted in ongoing pricing pressures across all regions. In the fourth quarter of 2002, we sold certain optical components assets to Bookham Technology plc,
or Bookham. As a result, our results in 2003 in the long-haul portion of this segment do not
reflect revenues generated from these assets. In 2002, revenues generated from the optical
components assets sold to Bookham were approximately 3% of the total Optical Networks revenues of
$1,815. Revenues in the metro optical portion of this segment were relatively flat in 2003 compared to
2002. This was primarily due to a substantial decrease in EMEA partially offset by an increase in
revenues in the U.S. and a substantial increase in Asia Pacific. The substantial decrease in EMEA
was primarily the result of the continued industry adjustment, tightened capital
markets mainly during the first half of 2003 and customer spending restrictions. The increase in
revenues in the U.S. and the substantial increase in Asia Pacific were primarily due to new
customer contracts during the first half of 2003 for expansions of existing networks to meet
increased customer demand. From a geographic perspective, the 35% decline in Optical Networks revenues in 2003 compared to
2002 was primarily due to a:  
    
    35% decline in the U.S., 40% decline in EMEA and a 32% decline in Canada
primarily related to a substantial reduction in capital spending as a result of the
continuing industry adjustment, tightened capital markets mainly during the first half of
2003 and customers continuing to focus on maximizing return on invested capital; and
    
    33% decline in Asia Pacific primarily related to contractual issues
experienced with certain customers in the fourth quarter of 2003 and the completion of
network build-outs for certain customers in the long-haul portion of this segment in 2002
that were not repeated in 2003.  2002 vs. 2001 The 64% decline in Optical Networks revenues in 2002 compared to 2001 was primarily the result
of substantial reductions in capital spending by our major U.S. and EMEA customers. These
reductions were partially offset by a significant increase in Asia Pacific revenues primarily due
to new customer contracts for expansions of existing networks to meet increased customer demand. 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 were 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 was primarily due to a decline in demand for mature
products. This substantial 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 then 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 65




---



##### Table of Contents



compared to
2001. From a geographic perspective, the 64% decline in Optical Networks revenues in 2002 compared to
2001 was primarily due to a 76% decline in revenues in U.S., a 61% decline in revenues in EMEA and
a 72% decline in revenues in CALA. The declines in all these regions were primarily due to the
continued industry adjustment, including industry consolidation, capital spending constraints and
the redeployment of assets in 2001 and 2002.  2004 and 2005 During 2004, our major customers in the optical long-haul portion of Optical Networks remained
focused on maximizing return on their invested capital by increasing the capacity utilization rates
and efficiency of existing networks. We expect that any additional capital spending by those
customers in the near term will be increasingly directed to opportunities that enhance customer
performance, revenue generation and cost reduction. We see an increase in demand for metro Dense Wavelength Division Multiplexing, or metro DWDM. This
increase is primarily due to new network deployments by certain customers and other customers
expanding their networks, driven by emerging applications such as Cable Video on Demand, all of
which have resulted in a need for low cost, high capacity connectivity between network sites. As a
result, we expect that the metro optical portion of this segment will continue to represent a
larger percentage of overall Optical Networks revenues. While we have seen encouraging indicators
in certain parts of the optical market, we can provide no assurance that the growth areas that have
begun to emerge will continue in the future. 
 Gross profit and gross margin For the years ended December 31,
    
    
    2003 vs 2002
    
    
    2002 vs 20012003
    
    
    2002
    
    
    2001
    
    
    Change
    
    
    % Change
    
    
    Change
    
    
    % ChangeGross profit
    
    $
    4,332
    
    
    $
    3,855
    
    
    $
    4,252
    
    
    $
    477
    
    
    
    12
    
    
    $
    (397)
    
    
    
    (9
    )Gross margin
    
    
    42.5
    %
    
    
    35.1
    %
    
    
    22.7
    %
    
    7.4pts
    
    
    
    
    
    
    12.4pts
 Gross margin improved 7.4 percentage points in 2003 compared to 2002 primarily due to:  
    
    an increase related to continued improvements in our cost structure primarily
as a result of favorable supplier pricing and changes in product mix that resulted in
increased volumes of certain products with higher margins; and
    
    an increase of approximately 4 percentage points related to reduced inventory
provisioning and contract and customer settlement costs. In 2003, we recorded
approximately $299 of incremental inventory provisions compared to approximately $689 of
similar incremental charges in 2002; partially offset by
    
    pricing pressures on certain of our products; and
    
    an increase in expense related to our employee return to profitability, or RTP, and regular bonus plans. Gross margin improved 12.4 percentage points in 2002 compared to 2001 primarily due to:  
    
    an increase of approximately 9 percentage points related to reduced inventory
provisioning and contract and customer settlement costs. In 2002, we recorded
approximately $689 of incremental inventory provisions compared to approximately $1,631 of
similar incremental charges in 2001;
    
    improvements in our cost structure to more closely reflect our sales volume
and as a result of favorable supplier pricing; partially offset by
    
    pricing pressures on certain of our products. While we cannot predict the extent to which changes in product mix and pricing pressures will
impact our gross margin, we continue to see the effects of improvements in our product costs
primarily due to favorable material pricing. Considering the impacts of our strategic plan
described under Business overview  Our strategic plan and outlook and the higher costs
associated with initial customer deployments in emerging markets, we expect that gross margin will
trend in the range of 40% to 44% through 2005. See Risk factors/forward looking statements for
factors that may affect our gross margins. 66




---



##### Table of Contents



Segment gross profit and gross margin  Wireless Networks Wireless Networks gross margin improved by approximately 6 percentage points in 2003 compared to
2002 primarily due to:  
    
    changes in product mix mainly related to increased volumes of certain products
with higher margins;
    
    improvements in our product costs primarily as a result of favorable material
pricing which was partially offset by reductions in the selling price of certain products;
and
    
    improvements in other operations related costs; partially offset by
    
    an increase in contract-related costs including customer trials. Wireless Networks gross margin improved by approximately 15 percentage points in 2002 compared to
2001 primarily due to:  
    
    changes in product mix mainly related to increased volumes of certain products with higher margins;
    
    improvements in our product costs primarily as a result of favorable material pricing;  
    
    reduced inventory provisioning as a result of our inventory levels being
better aligned to customer demand and a decrease in other contract and customer settlement
costs; and
    
    improvements in other operations related costs.  Enterprise Networks Enterprise Networks gross margin improved by approximately 5 percentage points in 2003 compared to
2002 and was relatively flat in 2002 compared to 2001 primarily due to:  
    
    improvements in our product costs primarily as a result of favorable material pricing;
    
    changes in product mix mainly related to increased volumes of certain products with higher margins;
    
    reductions in other operations related costs including product defects, customer service and warranty costs; and
    
    reduced inventory provisioning as a result of our inventory levels being
better aligned to customer demand and a decrease in other contract and customer settlement
costs; partially offset by
    
    reductions in the selling price of certain of our products.  Wireline Networks Wireline Networks gross margin declined by approximately 4 percentage points in 2003 compared to
2002 primarily due to:  
    
    changes in product mix mainly related to decreased volumes of certain products
with higher margins; partially offset by
    
    improvements in our cost structure as a result of favorable supplier pricing and design improvements;
    
    reductions in other operations related costs, mainly in the U.S. and Canada; and
    
    reduced inventory provisioning as a result of our inventory levels being better aligned to customer demand. Wireline Networks gross margin improved by approximately 14 percentage points in 2002 compared to
2001 primarily due to:  
    
    improvements in our cost structure as a result of favorable supplier pricing and design improvements;
    
    reductions in other operations related costs, mainly in the U.S. and Canada; and
    
    reduced inventory provisioning as a result of our inventory levels being better aligned to customer demand.  Optical Networks Optical Networks gross margin improved by approximately 24 percentage points in 2003 compared to
2002 primarily due to:  
    
    reduced inventory provisioning and other contract and customer settlement costs throughout 2003 including a 67




---



##### Table of Contents



reduction in accruals of $53 associated with a certain
customer bankruptcy settlement;
    
    reductions in operations related costs throughout 2003 mainly in the U.S.,
Canada and EMEA;
    
    improvements in our cost structure primarily as a result of favorable supplier
pricing which were partially offset by continued pricing pressures on the sale of certain
products;
    
    the sale of certain optical components assets to Bookham and, as a result, our
2003 gross margin excluded the impact of excess capacity of those optical components
assets; and
    
    reduced warranty charges in 2003. Optical Networks gross margin declined by approximately 4 percentage points in 2002 compared to
2001 primarily due to:  
    
    pricing pressures on the sale of certain products; partially offset by
    
    reduced inventory provisioning and other contract and customer settlement costs in 2002. 
 Operating expenses 
  Selling, general and administrative expense For the years ended December 31,
    
    
    2003 vs 2002
    
    
    2002 vs 20012003
    
    
    2002
    
    
    2001
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeSG&A expense
    
    $
    1,931
    
    
    $
    2,532
    
    
    $
    6,010
    
    
    $
    (601
    )
    
    
    (24
    )
    
    $
    (3,478
    )
    
    
    (58
    )As % of revenues
    
    
    18.9
    %
    
    
    23.0
    %
    
    
    32.0
    %
    
    (4.1 pts
    )
    
    
    
    
    
    (9.0 pts
    )
 SG&A expense declined $601 in 2003 compared to 2002 primarily due to:  
    
    the continued impact of our workforce reductions and associated reductions in
other related costs such as information services and real estate; and
    
    a net decrease of $471 (recovery of $179 in 2003 and expense of $292 in 2002)
related to decreased provisioning for trade and customer financing receivables; partially
offset by
    
    an increase of approximately $120 related to our RTP and regular bonus plans
in 2003 compared to 2002;
    
    an increase due to significant foreign exchange impacts associated with the
Canadian dollar, euro and British pound; and
    
    an increase related to our stock-based compensation, including restricted
stock unit and stock option programs, both of which are not allocated across all of our
reportable segments. SG&A expense declined $3,478 in 2002 compared to 2001 primarily due to:  
    
    the impact of workforce reductions which, in turn, resulted in a reduction in
other related costs including information services and real estate; and
    
    a decrease of $1,497 (expense of $292 in 2002 and expense of $1,789 in 2001)
related to decreased provisioning for trade and customer financing receivables. Overall in 2004, we expect increased SG&A expense compared to 2003 primarily as a result of net
trade and customer financing receivable recoveries of $179 that were included in our SG&A expense
in 2003 that are not expected to be repeated in 2004, negative foreign exchange impacts, increases
in our stock-based compensation programs and costs of approximately $115 related to our restatement
activities. Although we expect increased SG&A expense in 2004 compared to 2003, through the
implementation of our strategic plan, we expect to reduce operating expenses (both SG&A and R&D
expense) to 35% of revenues or lower on an annualized basis in 2005. See Business overview  Our
strategic plan and outlook. 68




---



##### Table of Contents



Segment selling, general and administrative expense  Wireless Networks Wireless Networks SG&A expense decreased substantially in 2003 compared to 2002 primarily due to:  
    
    the continued impact of our workforce reductions and organizational
realignment across all regions and associated reductions in other related costs such as
information services and real estate; and
    
    a decrease in provisioning for trade and customer financing receivables. Wireless Networks SG&A expense decreased substantially in 2002 compared to 2001 primarily due to:  
    
    the continued impact of our workforce reductions and organizational
realignment across all regions and associated reductions in other related costs such as
information services and real estate; partially offset by
    
    an increase in provisioning for trade and customer financing receivables.  Enterprise Networks Enterprise Networks SG&A expense decreased in 2003 compared to 2002 and decreased substantially in
2002 compared to 2001 primarily due to:  
    
    the continued impact of our workforce reductions, primarily in the U.S. and
Canada, and associated reductions in other related costs such as information services and
real estate; and
    
    a decrease in provisioning for trade receivables.  Wireline Networks Wireline Networks SG&A expense decreased substantially in 2003 compared to 2002 and in 2002
compared to 2001 primarily due to:  
    
    a decrease in provisioning for trade and customer financing receivables; and
    
    the continued impact of our workforce reductions, primarily in the U.S. and
Canada, and associated reductions in other related costs such as information services and
real estate.  Optical Networks Optical Networks SG&A expense decreased substantially in 2003 compared to 2002 and in 2002 compared
to 2001 primarily due to:  
    
    the continued impact of our workforce reductions across all regions and
associated reductions in other related costs such as information services and real estate;
    
    reduction in accruals of approximately $4 associated with a certain customer bankruptcy settlement; and
    
    a decrease in provisioning for trade and customer financing receivables. In addition, Optical Networks SG&A expense decreased substantially in 2003 compared to 2002 due to
a reduction in accruals in 2003 associated with a customer contract settlement. 
  Research and development expense For the years ended December 31,
    
    
    2003 vs 2002
    
    
    2002 vs 20012003
    
    
    2002
    
    
    2001
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeR&D expense
    
    $
    1,965
    
    
    $
    2,084
    
    
    $
    3,128
    
    
    $
    (119
    )
    
    
    (6
    )
    
    $
    (1,044
    )
    
    
    (33
    )As % of revenues
    
    
    19.3
    %
    
    
    19.0
    %
    
    
    16.7
    %
    
    (0.3 pts
    )
    
    
    
    
    
    2.3 pts
 R&D expense decreased $119 in 2003 compared to 2002 and decreased $1,044 in 2002 compared to
2001 primarily due to our workforce reductions and a reduced level of R&D activity consistent with
the volume of business. The $119 decline in 2003 compared to 2002 was net of increases in R&D
expense due to significant foreign exchange impacts associated with the Canadian dollar, euro and
British pound in 2003 and increases in expenses associated with our RTP and regular bonus plans. Our continued strategic investments in R&D are aligned with technology leadership in anticipated
growth areas. Although we experienced a substantial decline in demand for our networking equipment
in 2001 through 2003, we maintained a 69




---



##### Table of Contents



technology focus and commitment to invest in new innovative
solutions where we believed we would achieve the greatest future benefit from this investment. As
a result, our R&D expense as a percentage of our consolidated revenues remained relatively flat at
19.3% in 2003 compared to 19.0% in 2002, both of which were up from 16.7% in 2001. We expect to continue to manage R&D expense according to the requirements of our business,
allocating resources and investment where customer demand dictates, and reducing resources and
investment where opportunities for improved efficiencies present themselves. Our R&D efforts are
currently focused on secure and reliable converged networks including:  
    
    packetization of voice and multimedia IP telephony solutions services;
    
    services edge capability to realize simplification of customer network
operations and broadband access technologies, including wireless and wireline; and
    
    enhanced network security to ensure the level of reliability and performance
that has traditionally existed in carrier networks. We expect that our R&D expense as a percentage of revenue in 2004 will be similar to 2003 and 2005
will be lower than 2004 as we seek to achieve ongoing cost reductions in R&D as part of our
strategic plan first announced in August 2004. See Business overview  Our strategic plan and
outlook. 
  Segment research and development expense  Wireless Networks Wireless Networks R&D expense increased slightly in 2003 compared to 2002 primarily due to:  
    
    significant unfavorable foreign exchange impacts associated with the Canadian
dollar and euro; partially offset by
    
    the continued impact of our workforce reductions;
    
    transitioning R&D activities into lower cost markets; and
    
    focused cost-savings initiatives. Wireless Networks R&D expense decreased in 2002 compared to 2001 primarily due to:  
    
    reductions in our UMTS R&D programs as a result of delays in commercial
launches by wireless carriers in EMEA; and
    
    focused cost-savings initiatives; partially offset by
    
    continued investment in the development of new products.  Enterprise Networks Enterprise Networks R&D expense was up slightly in 2003 compared to 2002 primarily due to:  
    
    unfavorable foreign exchange impacts associated with the Canadian dollar;
partially offset by
    
    the continued impact of our workforce reductions that targeted a level of R&D
that was more representative of the volume of our business. Enterprise Networks R&D expense decreased substantially in 2002 compared to 2001 primarily due to:  
    
    the continued impact of our workforce reductions that targeted a level of R&D
expense that was more representative of the volume of our business; and
    
    effectively prioritizing investment in data products and increased outsourcing
activity.  Wireline Networks Wireline Networks R&D expense decreased significantly in 2003 compared to 2002 and decreased
substantially in 2002 compared to 2001 primarily due to:  
    
    the continued impact of our workforce reductions that targeted a level of R&D
expense that was more representative of the volume of our business; and 70




---



##### Table of Contents




    
    effectively prioritizing investment in data products and increased outsourcing
activity.  Optical Networks Optical Networks R&D expense decreased substantially in 2003 compared to 2002 and in 2002 compared
to 2001 primarily due to:  
    
    the continued impact of our workforce reductions that targeted a level of R&D
expense that was more representative of the volume of our business. 
  Segment contribution margin For the years ended December 31,
    
    
    2003 vs 2002
    
    
    2002 vs 20012003
    
    
    2002
    
    
    2001
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    1,573
    
    
    $
    1,104
    
    
    $
    515
    
    
    $
    469
    
    
    
    42
    
    
    $
    589
    
    
    
    114Enterprise Networks
    
    
    574
    
    
    
    314
    
    
    
    284
    
    
    
    260
    
    
    
    83
    
    
    
    30
    
    
    
    11Wireline Networks
    
    
    612
    
    
    
    740
    
    
    
    614
    
    
    
    (128
    )
    
    
    (17
    )
    
    
    126
    
    
    
    21Optical Networks
    
    
    
    
    
    
    (743
    )
    
    
    (1,458
    )
    
    
    743
    
    
    
    100
    
    
    
    715
    
    
    
    49Other
    
    
    (358
    )
    
    
    (92
    )
    
    
    (1,713
    )
    
    
    (266
    )
    
    
    (289
    )
    
    
    1,621
    
    
    
    95Total
    
    $
    2,401
    
    
    $
    1,323
    
    
    $
    (1,758
    )
    
    $
    1,078
    
    
    
    81
    
    
    $
    3,081
    
    
    
    175
 As a result of the gross margin and SG&A expense changes discussed above, our total segment
contribution margin improved by $1,078 in 2003 compared to 2002 and by $3,081 in 2002 compared to
2001. See Segment information in note 6 of the accompanying consolidated financial statements. 
  Segment Management EBT For the years ended December 31,
    
    
    2003 vs 2002
    
    
    2002 vs 20012003
    
    
    2002
    
    
    2001
    
    
    $ Change
    
    
    % Change
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    695
    
    
    $
    256
    
    
    $
    (456
    )
    
    $
    439
    
    
    
    171
    
    
    $
    712
    
    
    
    156Enterprise Networks
    
    
    317
    
    
    
    54
    
    
    
    (79
    )
    
    
    263
    
    
    
    487
    
    
    
    133
    
    
    
    168Wireline Networks
    
    
    170
    
    
    
    185
    
    
    
    (199
    )
    
    
    (15
    )
    
    
    (8
    )
    
    
    384
    
    
    
    193Optical Networks
    
    
    (258
    )
    
    
    (1,227
    )
    
    
    (2,352
    )
    
    
    969
    
    
    
    79
    
    
    
    1,125
    
    
    
    48Other
    
    
    (243
    )
    
    
    (232
    )
    
    
    (2,760
    )
    
    
    (11
    )
    
    
    (5
    )
    
    
    2,528
    
    
    
    92Total
    
    $
    681
    
    
    $
    (964
    )
    
    $
    (5,846
    )
    
    $
    1,645
    
    
    
    171
    
    
    $
    4,882
    
    
    
    84
 The changes in segment Management EBT are a result of the gross margin, SG&A expense and R&D
expense changes discussed above. See Segment information in note 6 of the accompanying
consolidated financial statements for a reconciliation of segment Management EBT to net earnings
(loss) from continuing operations. 
  Amortization of intangibles On January 1, 2002, we adopted the provisions of SFAS 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. The amortization of goodwill for 2001 primarily reflected the charges related to the acquisitions
of Bay Networks, Inc., Qtera Corporation, and Clarify Inc. The net carrying value of goodwill was $2,125 on December 31, 2003 and $2,019 on December 31, 2002. 71




---



##### Table of Contents



Special charges  During 2003, we continued to implement our restructuring work plan initiated in 2001. In
addition, as described below, certain exit activities were initiated in 2003. Special charges
recorded from January 1, 2001 to December 31, 2003 were as follows: Contract
    
    
    
    
    
    
    
    
    
    
    Intangiblesettlement
    
    
    Plant and
    
    
    
    
    
    
    assetWorkforce
    
    
    and lease
    
    
    equipment
    
    
    
    
    
    
    impair-reduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    ments
    
    
    TotalProvision balance as of January 1, 2001
    
    $
    45
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    45Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,239
    
    
    
    2,239Other special charges
    
    
    1,156
    
    
    
    897
    
    
    
    969
    
    
    
    39
    
    
    
    
    
    
    
    3,061Revisions to prior accruals
    
    
    45
    
    
    
    (106
    )
    
    
    (59
    )
    
    
    (2
    )
    
    
    
    
    
    
    (122
    )Cash drawdowns
    
    
    (992
    )
    
    
    (110
    )
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    (1,110
    )Non-cash drawdowns
    
    
    14
    
    
    
    
    
    
    
    (910
    )
    
    
    
    
    
    
    (2,239
    )
    
    
    (3,135
    )Foreign exchange and other adjustments
    
    
    11
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7Provision balance as of December 31, 2001
    
    $
    279
    
    
    $
    677
    
    
    $
    
    
    
    $
    29
    
    
    $
    
    
    
    $
    985Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    264
    
    
    
    264Other special charges
    
    
    928
    
    
    
    210
    
    
    
    383
    
    
    
    
    
    
    
    
    
    
    
    1,521Revisions to prior accruals
    
    
    (126
    )
    
    
    18
    
    
    
    (55
    )
    
    
    
    
    
    
    
    
    
    
    (163
    )Cash drawdowns
    
    
    (778
    )
    
    
    (286
    )
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    (1,084
    )Non-cash drawdowns
    
    
    (100
    )
    
    
    
    
    
    
    (328
    )
    
    
    
    
    
    
    (264
    )
    
    
    (692
    )Foreign exchange and other adjustments
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Provision balance as of December 31, 2002 (a)
    
    $
    204
    
    
    $
    620
    
    
    $
    
    
    
    $
    9
    
    
    $
    
    
    
    $
    833Other special charges
    
    
    198
    
    
    
    63
    
    
    
    74
    
    
    
    
    
    
    
    
    
    
    
    335Revisions to prior accruals
    
    
    (42
    )
    
    
    20
    
    
    
    (28
    )
    
    
    
    
    
    
    
    
    
    
    (50
    )Cash drawdowns
    
    
    (267
    )
    
    
    (275
    )
    
    
    
    
    
    
    (9
    )
    
    
    
    
    
    
    (551
    )Non-cash drawdowns
    
    
    (41
    )
    
    
    
    
    
    
    (46
    )
    
    
    
    
    
    
    
    
    
    
    (87
    )Foreign exchange and other adjustments
    
    
    12
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39Provision balance as of December 31, 2003 (a)
    
    $
    64
    
    
    $
    455
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    519
 (a)
    
    As of December 31, 2003 and 2002, the short-term provision balance was $205 and $499,
respectively, and the long-term provision balance was $314 and $334, respectively, which
was included in long-term provisions, as a component of other liabilities. We implemented our work plan to streamline our operations and activities around our core
markets and leadership strategies during 2001 in light of the significant downturn in both the
telecommunications industry and the economic environment, and capital market trends impacting our
operations and expected future growth rates. This work plan was adjusted during 2001, 2002 and
2003 to reflect the continued decline in the industry and economic environment, and in the capital
markets. In addition, we initiated activities in 2003 to exit certain leased facilities and leases
for assets no longer used across all segments. In 2003, we recorded special charges of $285, net of revisions of $50, related to our restructuring
work plan and contract settlement and lease costs. Workforce reduction charges of $198 related to
the cost of severance and benefits associated with approximately 1,700 employees notified of
termination during 2003 which extended across all segments. Net revisions of $42 to reduce prior
accruals primarily related to termination benefits where actual costs were lower than our original
estimates across all segments. During 2003, the workforce reduction provision balance was drawn
down by cash payments of $267 and by a non-cash pension settlement loss of $41. The remaining
provision is expected to be substantially drawn down by the end of 2005. Contract settlement and
lease costs were $63 and consisted of negotiated settlements to cancel or renegotiate contracts and
net lease charges related to leased facilities (comprised of office, warehouse and manufacturing
space) and leased furniture that were identified as no longer required across all segments. These
lease costs, net of anticipated sublease income, included non-cancelable lease terms from the date
leased facilities ceased to be used and termination penalties. In addition to these charges were
revisions to prior accruals of $20 resulting primarily from changes in estimates for sublease
income and costs to vacate certain properties, across all segments. During 2003, the provision
balance for contract settlement and lease costs was drawn down by cash payments of $275. The
remaining provision, net of approximately $317 in estimated sublease income, is expected to be
substantially drawn down by the end of 2013. Also, we recorded charges of $74 related to current
period write downs to fair value less costs to sell for various 72




---



##### Table of Contents



leasehold improvements and excess
Optical Networks equipment held for sale. Net revisions of $28 to reduce prior accruals related to
adjustments in our original plans or estimates for the closure of certain facilities. In 2003, we
concluded that an impairment of our goodwill did not exist and no write down was recorded. In 2002, we recorded special charges of $1,622, net of revisions of $163, related to our
restructuring work plan and contract settlement and lease costs. Workforce reduction charges of
$928 were related to the cost of severance and benefits associated with the approximately 12,100
employees notified of termination which was primarily in the U.S., Canada and EMEA and extended
across all segments. Net revisions of $126 to reduce prior accruals primarily related to
termination benefits where actual costs were lower than our original estimates across all segments.
Workforce reduction charges included $124 for pension and post-retirement benefits other than
pension, settlement and curtailment costs. During 2002, the workforce reduction provision balance
was drawn down by cash payments of $778 and by $100 of non-cash pension and post-retirement
benefits other than pension, settlement and curtailment costs attributable to the notified employee
group charged against the provision. Contract settlement and lease costs of $210 consisted of
negotiated settlements to cancel or renegotiate contracts and net lease charges related to leased
facilities (comprised of office, warehouse and manufacturing space) and leased manufacturing
equipment that were no longer required, across all segments. In addition to these charges were net
revisions of $18 primarily from changes in estimates for sublease income and costs to vacate
certain properties, across all segments. During the year ended December 31, 2002, the provision
balance for contract settlement and lease costs was drawn down by cash payments of $286. The
remaining provision balance was net of approximately $402 in estimated sublease revenue. Plant and
equipment charges of $383 were related to current period write downs to fair value less costs to
sell for various owned facilities and plant and manufacturing related equipment. These charges
included $266 related to specialized plant infrastructure and equipment within Optical Networks and
the remaining charges for facilities and equipment arising across all segments. Offsetting these
charges were revisions of $55 to prior write downs of assets held for sale related primarily to
additional proceeds from disposals of equipment from Optical Networks and other segments in excess
of amounts previously expected and adjustments to original plans or estimated amounts for certain
facility closures across all segments. In 2002, we also completed the SFAS 142 transitional impairment test and concluded at that time
that there was no impairment of recorded goodwill, as the fair values of our reporting units
exceeded their carrying amounts as of January 1, 2002. Therefore, the second step of the
transitional impairment test under SFAS 142 was not required to be performed in 2002. However, as
a result of the continued decline in 2002 in both our overall market value generally and within
Optical Networks specifically, we evaluated the goodwill associated with the businesses within
Optical Networks for potential impairment. The conclusion of those evaluations was that the fair
value associated with these businesses could no longer support the carrying value of the remaining
goodwill associated with them. As a result, we recorded a goodwill write down of $264 in 2002. In 2001, we recorded special charges of $5,178, net of revisions, related to our restructuring work
plan and write downs of goodwill and other assets. These special charges related to workforce
reduction costs of $1,156, contract settlement and lease costs of $897, plant and equipment write
downs of $969, other charges of $39 and a goodwill write down
of $2,239. On December 31, 2003, our workforce was 35,160. In 2004 and into 2005, our focus is on managing
each of our businesses based on financial performance, the market and customer priorities. In the
third quarter of 2004, we announced a strategic plan that includes a work plan involving focused
workforce reductions and a voluntary retirement program relating in the aggregate to approximately
3,250 employees, real estate optimization and other cost containment actions such as reductions in
information services costs, outsourced services and other discretionary spending. Expected cash
costs in connection with this work plan are approximately $430. See Business overview  Our
strategic plan and outlook. For additional information on expected future cash outflows related to special charges, see
Liquidity and capital resources  Uses of liquidity. For additional information related to our
restructuring activities, see Special charges in note 7 of the accompanying consolidated
financial statements. 
 Gain (loss) on sale of businesses and assets In 2003, gain on sale of businesses and assets of $4 was primarily due to the recognition of
the remaining unamortized deferred gain related to the sale of substantially all of the assets of
our Cogent Defence Systems, or CDS, business during the year ended December 31, 2001. The
remaining unamortized deferred gain of $23 was recognized as a result of the sale of our 41%
interest in EADS Telecom as discussed in Developments in 2003 and 2004  Other business
developments  Ownership adjustment in our French and German operations. This gain was partially
offset by a loss due to retirement of 73




---



##### Table of Contents



fixed assets. In 2002, gain on sale of businesses and assets of $4 was primarily related to:  
    
    a gain of $29 on the sale of certain assets relating to our optical components business
to Bookham; and
    
    a gain of $41 related to a previously deferred gain associated with the sale of
substantially all of the assets of our CDS business to EADS Telecom as well as the
cancellation and replacement of a call option to acquire an additional approximate 7%
ownership interest in NNF which was originally included as part of the consideration
received on the sale of these assets; partially offset by
    
    a loss of $68 due to retirement of fixed assets. In 2001, gain on sale of
businesses and assets related to net gains of $100 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
restructuring work plan. For additional information relating to these asset sales, see Acquisitions, divestitures and
closures in note 10 and Commitments in note 14 of the accompanying consolidated financial
statements. 
 Other income (expense)  net In 2003, other income  net was $433, which primarily included:  
    
    gain of $96 related to the sale of our interest in EADS Telecom in conjunction with the
changes in ownership of our French and German operations;
    
    interest income of $75 on our short-term investments;
    
    gain of $30 related to a certain customer bankruptcy settlement;
    
    a payment of $25 received from a settlement related to intellectual property use;
    
    foreign exchange gains of $83 primarily related to day-to-day transactional activities;
    
    gain of $6 related to sale of our interest in Bookham;
    
    gain of $31 related to the sale of Arris Group, Inc., or Arris Group, shares. For
additional information on our investment in Arris Group see
Results of operations  discontinued operations;
    
    gain of $10 related to sale of certain minority investments;
    
    dividend income of $19 on our short-term investments; and
    
    royalty income of $15 from patented technology. In 2002, other expense  net of $28 was primarily related to a foreign exchange loss of $84 and a
$39 loss on the sale or write down of certain minority investments, partially offset by interest
income of $88 on our short-term investments. In 2001, other expense  net of $519 was primarily related to a foreign exchange loss of $161 and a
$368 loss on the sale or write down of certain minority investments. This write down occurred
during the third quarter of 2001 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 then 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. 
 Interest expense In 2003, interest expense decreased $66 ($124 in 2003 compared to $190 in 2002) primarily due
to a reduction in the outstanding balances of our notes payable and long-term debt. In 2002, interest expense decreased $94 ($190 in 2002 compared to $284 in 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. Interest rates on our outstanding notes payable and long term debt remained relatively flat during
these periods. 74




---



##### Table of Contents



Our quarterly interest expense in the first quarter of 2004 and the second quarter of 2004 was $32
and $28, respectively. We expect that the quarterly interest expense for the remainder of 2004
will remain at similar levels. 
 Income tax benefit (expense) In 2003, we recorded a tax benefit of $33 on pre-tax earnings of $461 from continuing
operations before minority interests and equity in net loss of associated companies. This tax
benefit resulted from tax audit settlements and the benefit of various R&D related tax incentives.
This benefit was partially offset by income tax provisions in certain taxable jurisdictions and
various corporate minimum related income taxes. In 2002, we recorded a tax benefit of $438 on a pre-tax loss of $2,616 from continuing operations
before minority interests and equity in net loss of associated companies. Our valuation allowances
on tax benefits recorded in 2002 were $724. 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 a portion of our deferred income tax asset would not be realized. As of December 31, 2003, we have substantial loss carryforwards and valuation allowances in our
significant tax jurisdictions. These loss carryforwards will serve to minimize our future cash
income related taxes. We will continue to assess the valuation allowance recorded against our deferred tax assets on a
quarterly basis. The valuation allowance is in accordance with SFAS No. 109, Accounting for
Income Taxes, which requires that a tax valuation allowance be established when it is more likely
than not that some portion or all of a companys deferred tax assets will not be realized. Our
valuation allowance is primarily attributed to ongoing industry concerns. Given the magnitude of
our valuation allowance, future adjustments to this allowance based on actual cash results could
result in a significant adjustment to our effective tax rate. For additional information, see
Application of critical accounting estimates  Income
Taxes  Tax asset valuation. 
 Net earnings (loss) from continuing operations As a result of the items discussed above under Results of operations  continuing
operations, net earnings from continuing operations were $430 in 2003. This amount represented an
improvement of $2,593 compared to our net loss from continuing operations of $2,163 in 2002. Also,
our net loss from continuing operations improved by $8,843 in 2002 compared to our net loss from
continuing operations of $11,006 in 2001. 
 Results of operations  discontinued operations In 2003, we completed a number of transactions including the sale of certain assets and common
shares of businesses associated with our discontinued operations as well as the restructuring
and/or collection of trade and customer financing receivables and a certain promissory note
receivable. We continued to wind-down our access solutions operations and recorded net earnings
from discontinued operations of $184 (net of tax) related to the sale of certain components of this
business and other associated wind-down activities. We also continued to reassess the remaining
provisions associated with our discontinued operations and recorded any resulting gains or losses
in net earnings (loss) from discontinued operations in the period in which they occurred. As of December 31, 2003, there was 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 prolonged
deterioration in the industry and market conditions during 2002 and 2003 delayed certain disposal
activities beyond the original planned timeframe of one year. In particular, actions involving
negotiations with customers, who were also affected by industry conditions, took longer than
expected. Although disposal activities continued beyond the one-year period, we continue to
present the access solutions operations as discontinued operations in the accompanying consolidated
financial statements. As of December 31, 2003, we had substantially completed the wind-down of our
access solutions operations. Net earnings from discontinued
operations of $184 (net of tax)
primarily related to a number of transactions in 2003 as follows, as
well as gains of $68
associated with provision reassessments:  
    
    a gain of $14 on the sale of certain assets related to our fixed wireless access
operations to Airspan Networks, Inc. for cash consideration of $13 on December 23, 2003; 75




---



##### Table of Contents




    
    a gain of $17 in the fourth quarter of 2003 associated with a cash settlement of $17
related to a certain note receivable which had been previously reserved;
    
    a gain of $12 on March 24, 2003 from the sale of 8 million common shares of Arris Group,
back to Arris Group for cash consideration of $28 pursuant to a March 11, 2003 agreement.
In addition, on March 18, 2003, we assigned our membership interest in Arris Interactive
LLC, or Arris, to ANTEC Corporation, an Arris Group company, for cash consideration of $88,
resulting in a loss of $2. Also in connection with these transactions, we received $11
upon the settlement of a sales representation agreement with Arris Group and recorded a
gain of $11; and
    
    a gain of $66 in the first quarter of 2003 from the settlement of certain trade and
customer financing receivables, the majority of which was previously provisioned. Following the March 2003 Arris Group transactions, we reduced our interest in Arris Group to 18.8%,
and ceased equity accounting for the investment. As a result, we reclassified our remaining
ownership interest in Arris Group as an available-for-sale investment within continuing operations
effective in the second quarter of 2003. We continued to dispose of our interest in Arris Group in
2003 and the gain or loss on the sale of shares subsequent to the first quarter of 2003 was
included in other income (expense)  net. We sold 9 million common shares of Arris Group on
November 24, 2003. As of December 31, 2003, we owned 5 million Arris Group common shares or 6.6%
of Arris Groups outstanding common shares. For additional information, see Discontinued operations in note 19 of the accompanying
consolidated financial statements and Other income (expense)  net. 
 Liquidity and capital resources 
 Cash flows The following table summarizes our cash flows by activity and cash on hand as of December 31: 2003
    
    
    2002Net cash from (used in) operating activities of continuing operations
    
    $
    78
    
    
    $
    (994
    )Net cash from (used in) investing activities of continuing operations
    
    
    (85
    )
    
    
    86Net cash from (used in) financing activities of continuing operations
    
    
    (362
    )
    
    
    809Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    176
    
    
    
    74Net cash from (used in) continuing operations
    
    
    (193
    )
    
    
    (25
    )Net cash from (used in) discontinued operations
    
    
    379
    
    
    
    350Net increase (decrease) in cash and cash equivalents
    
    
    186
    
    
    
    325Cash and cash equivalents at beginning of period
    
    
    3,742
    
    
    
    3,417Cash and cash equivalents at end of period
    
    $
    3,928
    
    
    $
    3,742
 In 2003, we continued to strengthen our liquidity position. As of December 31, 2003, our
primary source of liquidity was cash. At December 31, 2003, we had cash of $3,928 excluding $63 of
restricted cash and cash equivalents. We believe this cash will be sufficient to fund the changes
to our business model in accordance with the strategic plan (see Business overview  Our strategic
plan and outlook), manage our investments and meet our customer commitments for at least the next
12 months. However, if capital spending by service providers and other customers changes from what
we currently expect, we may be required to adjust our current business model. As a result, our
revenues and cash flows may be materially lower than we expect and we may be required to further
reduce our investments or take other measures in order to meet our cash requirements. In the
future, we may seek additional funds from liquidity generating transactions and other sources of
external financing. We continue to routinely monitor the capital markets for opportunities to
improve our capital structure and financial flexibility. Our ability and willingness to access the
capital markets is based on many factors including market conditions and overall financial
objectives. Currently, our ability is limited due to the impact of the delay in filing the Reports
and the findings of the Independent Review and related matters. We cannot provide any assurance
that our net cash requirements will be as we currently expect, that we will continue to have access
to the EDC Support Facility when and as needed or that liquidity generating transactions or
financings will be available to us on acceptable terms. In addition, we have not assumed the need
to make any payments in respect of judgments, settlements, fines or other penalties in connection 76




---



##### Table of Contents



with our pending civil litigation or investigations related to the First Restatement and Second
Restatement, which could have a material adverse effect on our financial condition or liquidity,
other than anticipated professional fees and expenses. See Risk factors/forward looking statements. In 2003, our cash flows from operating activities were $78 due to net earnings from continuing
operations of $430, less adjustments of $131 for non-cash and other items and $221 related to the
change in our operating assets and liabilities. The use of cash of $221 resulting from the change
in our operating assets and liabilities was primarily due to:  
    
    net cash of $200 from a reduction in restricted cash and cash equivalents primarily due
to the release of restricted cash upon the utilization of our EDC Support Facility as well
as the release of other restrictions on cash through cancellation, renegotiation and/or
fulfillment of our contractual obligations with certain customers;
    
    net cash of $25 from income taxes; and
    
    net cash of $437 from inventory primarily related to product shipments exceeding
additions to inventories during 2003; more than offset by
    
    $302 related to accounts receivable primarily due to a significant increase in billings
in the fourth quarter of 2003 as a result of the substantial increase in revenues in the
fourth quarter of 2003 compared to the fourth quarter of 2002;
    
    $551 in restructuring related cash outflows; and
    
    a net decrease of $30 related to accounts payable and accrued liabilities and other operating assets and liabilities. The net decrease of $30 related to accounts payable and accrued liabilities and other operating
assets and liabilities was mainly a result of:  
    
    contributions to our defined benefit pension plans of approximately $300;
    
    the settlement of the liability associated with the put option related to the sale of
our interest in EADS Telecom in conjunction with the changes in ownership of our French and
German operations;
    
    payments of certain contract manufacturer and supplier accruals;
    
    settlement of certain obligations related to our internal information systems infrastructure;
    
    activities associated with our outsourcing contracts; partially offset by
    
    cash collections of outstanding customer financing amounts associated with certain customers;
    
    reduction of certain customer contract settlement costs; and
    
    the proportionate decrease in these assets and liabilities as a result of the decline in
sales volumes and the associated size of our business. As a result of previously incurred tax losses and tax credits, we do not expect that we will have
to make significant cash income tax payments in the foreseeable future. Cash flows used in investing activities were $85 and were primarily due to $172 in plant and
equipment expenditures and $58 associated with acquisitions of certain investments and businesses
including the ownership adjustment in our French and German operations. These amounts were
partially offset by proceeds of $107 from the sale of certain investments and businesses which we
no longer considered strategic and proceeds of $38 primarily from the sale of plant and equipment
in the U.S. Cash flows used in financing activities were $362 and were primarily due to $270 used to reduce our
long-term debt, a reduction of our notes payable by a net amount of $45 and $35 used in connection
with the payment of dividends to NNLs preferred shareholders. In 2003, our cash increased $176 due to favorable effects of changes in foreign exchange rates.
Approximately $150 of the favorable impact was the result of favorable changes in the euro and the
British pound. Also in 2003, our discontinued operations generated net cash of $379 related to certain investing
and operating activities. We generated $241 of cash from investing activities primarily related to
proceeds from the sale of the common shares of Arris and the settlement of certain customer
financing receivables. The remaining cash of $138 was generated from operating activities related
to the continued wind down of our discontinued operations. 77




---



##### Table of Contents



Uses of liquidity Our cash requirements for the next 12 months are primarily to fund:  
    
    operations;
    
    research and development;
    
    costs relating to workforce reduction and other restructuring activities;
    
    capital expenditures;
    
    debt service;
    
    pension and post-retirement benefits; and
    
    costs in relation to the restatement activities, matters related to the Independent
Review and other related matters, including regulatory and other legal proceedings. In particular, we are subject to significant pending civil litigation actions and regulatory and
criminal investigations which could materially adversely affect our financial condition and
liquidity by requiring us to pay substantial judgments, settlements, fines or other penalties. See
Risk factors/forward looking statements. Considerable effort and resources have been expended on
our restatement activities in 2004, including the dedicated effort of hundreds of employees and
numerous external consultants and advisors. The estimated costs of our restatement activities in
2004 are approximately $115, which amount will be included in SG&A expense in our consolidated
statements of operations in the periods in which the costs are incurred. Also, from time to time, we may purchase our outstanding debt securities and/or convertible notes
in privately negotiated or open market transactions, by tender offer or otherwise, in compliance
with applicable laws. As well, we expect to be required to fund some portion of our aggregate
undrawn customer financing commitments. 
  Contractual cash obligations Payments due
    
    
    TotalContractual cash obligations(a)
    
    2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    Thereafter
    
    
    obligationsLong-term debt (b)
    
    $
    119
    
    
    $
    16
    
    
    $
    1,492
    
    
    $
    15
    
    
    $
    16
    
    
    $
    552
    
    
    $
    2,210Operating leases (c)
    
    
    161
    
    
    
    157
    
    
    
    144
    
    
    
    129
    
    
    
    111
    
    
    
    650
    
    
    
    1,352Purchase obligations
    
    
    1,209
    
    
    
    1,123
    
    
    
    102
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,434Outsourcing contracts
    
    
    161
    
    
    
    104
    
    
    
    104
    
    
    
    104
    
    
    
    104
    
    
    
    104
    
    
    
    681Obligations under special charges
    
    
    145
    
    
    
    95
    
    
    
    72
    
    
    
    59
    
    
    
    49
    
    
    
    248
    
    
    
    668Pension, post-retirement and
post-employment obligations
    
    
    170
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    170Other long-term liabilities reflected
on the balance sheet
    
    
    13
    
    
    
    6
    
    
    
    4
    
    
    
    3
    
    
    
    3
    
    
    
    47
    
    
    
    76Total contractual cash obligations
    
    $
    1,978
    
    
    $
    1,501
    
    
    $
    1,918
    
    
    $
    310
    
    
    $
    283
    
    
    $
    1,601
    
    
    $
    7,591
 (a)
    
    Amounts represented our known, undiscounted, minimum contractual payment obligations under
our long-term obligations and include amounts identified as contractual obligations in current
liabilities of the accompanying consolidated financial statements.(b)
    
    Included principal payments due on long term debt and $178 of capital lease obligations. As
described in note 12 to the accompanying consolidated financial statements, we have entered
into certain interest rate swap contracts which swap fixed rate payments for floating rate
payments. For additional information, also see note 11 Long-term debt, credit and support
facilities to the accompanying consolidated financial statements.(c)
    
    For additional information, see note 14 Commitments to the accompanying consolidated
financial statements.  Purchase obligations Purchase obligation amounts in the above table represent the minimum obligation under our supply
arrangements related to product and/or services entered into in the normal course of our business.
Where the arrangement specifies quantity, pricing and timing information, we have included that
arrangement in the amounts presented above. In certain cases, these arrangements define an end
date of the contract, but do not specify timing of payments between December 31, 2003 and the end
date of the agreement. In those cases, we have estimated the timing of the payments based on
forecasted usage rates. 78




---



##### Table of Contents



During the third quarter of 2003, we renegotiated a key supply arrangement that was initially put
into place prior to the
industry and economic downturn that commenced in 2001. The renegotiated
agreement is reflective of the current market environment, and the terms include a reduction in our
minimum spending levels plus an extension in the time period, from 2004 to 2009, within which these
minimum levels must be met. As well, we are no longer obligated to compensate the supplier for
direct costs if the minimum spending levels are not met. The renegotiated agreement includes a
graduated liquidated damages remedy for the benefit of the supplier if the minimum spending levels
are not met by the end of the agreement in 2009. However, based upon the renegotiated terms, we
expect to meet the minimum spending levels. The remaining minimum purchase obligation has been
reflected in the contractual cash obligations table above.  Outsourcing contracts Outsourcing contract amounts in the table above represent our minimum contractual obligation for
services provided to us primarily related to a portion of information services, payroll, capital
services, accounts payable and training and human resource functions. The amount payable under our
outsourcing contracts is variable to the extent that our workforce fluctuates from the baseline
levels contained in the contracts and our contractual obligation could increase above such baseline
amount. If our workforce were to fall below the baseline levels in the contracts, we would be
required to make the minimum payments included above.  Obligations under special charges Balance sheet provisions of $64 for workforce reduction costs, included in restructuring in current
liabilities in the accompanying consolidated financial statements, have not been reflected in the
contractual cash obligations table above. The remaining balance sheet provision of $455, net of
approximately $317 in estimated sublease revenues, related to contract settlement and lease costs
and is expected to be substantially drawn down by the end of 2013.  Pension, post-retirement and post-employment obligations During 2003, we made cash contributions to our defined benefit pension plans of approximately $300.
In 2004, we made cash contributions of approximately $140 to our defined benefit pension plans,
which excludes $78 of deferred contributions for 2004 which were made in 2003, and approximately
$30 to our post-retirement benefit plans.  Other long-term liabilities reflected on the balance sheets The contractual cash obligations table above primarily included long-term balance sheet reserves
related to asset retirement costs and deferred compensation accruals. Payment information related
to our asset retirement costs has been presented based on the termination date of the associated
lease contracts. Payment information related to our deferred compensation accruals has been
presented based on the anticipated retirement dates of the employees participating in the programs. 
  Customer financing Generally, customer financing arrangements may include financing with deferred payment terms
in connection with the sale of our products and services, as well as funding for non-product costs
associated with network installation and integration of our products and services. We may also
provide funding for working capital purposes and equity financing. The following table provides
information related to our customer financing commitments, excluding our discontinued operations as
of: December 31,2003
    
    
    2002Drawn and outstanding  gross
    
    $
    401
    
    
    $
    1,120Provisions for doubtful accounts
    
    
    (281
    )
    
    
    (824
    )Drawn and outstanding  net
    
    
    120
    
    
    
    296Undrawn commitments(a)
    
    
    180
    
    
    
    831Total customer financing
    
    $
    300
    
    
    $
    1,127
 (a)
    
    Included short-term and long-term amounts. Short-term and long-term amounts were included in
accounts receivable  net and other assets, respectively, in the consolidated balance sheets.(b)
    
    On January 8, 2004, we renegotiated an agreement with a certain customer which reduced our
aggregate undrawn customer financing commitments from $177 to $69. In 2003, we entered into certain agreements to restructure and/or settle various customer
financing and related receivables. 79




---



##### Table of Contents



As a result of these transactions, we received cash
consideration of approximately $230 to settle outstanding receivables of approximately $610 (with a
net carrying value of approximately $120). Also, we recorded net customer financing bad debt
recoveries of $113 as a result of these favorable settlements and adjustments to other existing
provisions. During 2003, we reduced undrawn commitments by $651 primarily as a result of the expiration or
cancellation of commitments and changing customer business plans. As of December 31, 2003,
approximately $108 of the $177 in undrawn commitments was not available for funding under the terms
of our financing agreements. We continue to regularly assess the levels of our customer financing provisions based on a
loan-by-loan review to evaluate whether the terms of each loan reflect current market conditions.
We review the ability of our customers to meet their repayment obligations and determine our
provisions accordingly. Commitments to extend future financing generally have conditions for
funding, fixed expiration or termination dates and specific interest rates and purposes. We cannot
predict with certainty the extent to which our customers will satisfy the applicable conditions for
funding, and subsequently request funding, prior to the termination date of the commitments. We
are currently directly supporting most outstanding balances and expect to initially fund any future
commitments in the normal course of business from our working capital. We expect to fund
substantially all of our current remaining undrawn commitments of $69 in 2004 or 2005. However, we
also expect that we will be able to arrange for third party lenders to assume these obligations in
the same timeframe. 
 Joint ventures/minority interests As discussed in
Developments in 2003 and 2004  Other business developments  Ownership
adjustment in our French and German operations, on October 19, 2002, we entered into a number of
put option and call option agreements as well as a share exchange agreement with EADS, our partner
at that time in three European joint ventures. During 2003, the options and share exchange were
exercised which resulted in us acquiring all of the equity interest of EADS in Nortel Networks
Germany and Nortel Networks France. For additional information, see Nortel Networks Germany and
Nortel Networks France in note 10 of the accompanying consolidated financial statements. 
 Discontinued operations As of December 31, 2003, accruals related to our discontinued access solutions operations
totaled $6 and were related to future contractual obligations and estimated liabilities during the
planned period of disposition. The remaining accruals are expected to be substantially drawn down
by cash payments by the end of 2005. For additional information related to our discontinued operations, see Discontinued operations in
note 19 of the accompanying consolidated financial statements. 
 Sources of liquidity 
  Credit facilities As of December 31, 2003, we had $750 in undrawn credit under the Five Year Facilities
scheduled to expire in April 2005. These credit facilities were entered into on April 12, 2000 by
us and NNI and permitted borrowings for general corporate purposes. The Five Year Facilities
contained a financial covenant requiring that our consolidated tangible net worth be not less than
$1,888 at any time. As of December 31, 2003, we were in compliance with this covenant and there
were no amounts drawn under the Five Year Facilities. On April 28, 2004, we notified the lenders
under the Five Year Facilities that we were terminating these facilities. Due to our failure to
file our 2003 Annual Report on Form 10-K by April 29, 2004, the banks under the Five Year
Facilities would have otherwise been permitted to, upon 30 days notice, terminate their
commitments under the Five Year Facilities. Upon termination, we were in compliance with that
financial covenant and the Five Year Facilities were undrawn. For additional information relating
to the Five Year Facilities and the impact of the termination of these facilities under the related
security agreements, see Developments in 2003 and 2004  Nortel Networks Audit Committee
Independent Review; restatements; related matters  Credit facilities and security agreements and
Risk factors/forward looking statements. 80




---



##### Table of Contents



Available support facility On February 14, 2003, we entered into the EDC Support Facility. As of December 31, 2003, the
facility provided for up to $750 in support including:  
    
    $300 of committed revolving support for performance bonds or similar instruments, of which $151 was utilized;
    
    $150 of uncommitted support for receivables sales and/or securitizations, of which none was utilized; and
    
    $300 of uncommitted support for performance bonds and/or receivables sales and/or
securitizations, of which $183 was utilized. For additional information related to the EDC Support Facility subsequent to December 31, 2003 and
waivers obtained in connection with the defaults arising under the EDC Support Facility from the
delay in filing the Reports, see Developments in 2003 and 2004  Nortel Networks Audit Committee
Independent Review; restatements; related matters  EDC Support Facility and Risk factors/forward
looking statements. On March 29, 2004, we and EDC amended the EDC Support Facility to provide that EDC may suspend its
obligation to issue us any additional support if events occur that would have a material adverse
effect on our business, financial position or results of operation. As a result of an amendment on
December 10, 2004, the EDC Support Facility will expire on December 31, 2006. The EDC Support Facility does not materially restrict our ability to sell any of its assets
(subject to certain maximum amounts) or to purchase or pre-pay any of its currently outstanding
debt. The EDC Support Facility can be suspended or terminated if our senior long-term debt rating
by Moodys, has been downgraded to less than B3 or if its debt rating by S&P has been downgraded to
less than B. As of December 31, 2003, our obligations under the EDC Support Facility were secured on an equal
and ratable basis under the security agreements entered into by us and various of our subsidiaries
that pledged substantially all of our and our subsidiaries assets in favor of the holders of our
public debt securities and the holders of NNCs 4.25% Convertible Senior Notes. As of December 31,
2003, the security provided under the security agreements was comprised of:  
    
    pledges of substantially all of our assets and those of most of our U.S. and Canadian subsidiaries;
    
    share pledges in certain of NNLs other subsidiaries; and
    
    guarantees by certain of our wholly owned subsidiaries organized in Canada, England, Ireland and Hong Kong. If our senior long-term debt rating by Moodys returns to Baa2 (with a stable outlook) and its
rating by S&P returns to BBB (with a stable outlook), the security and guarantees will be released
in full. If the EDC Support Facility is terminated, or expires, the security and guarantees will
also be released in full. We may provide EDC with cash collateral in an amount equal to the total
amount of its outstanding obligations and undrawn commitments and expenses under this facility (or
any other alternative collateral or arrangements acceptable to EDC) in lieu of the security
provided under the security agreements. Accordingly, if the EDC Support Facility is secured by
cash or other alternate collateral or arrangements acceptable to EDC, the security and guarantees
will also be released in full. For information related to our outstanding public debt, see Long-term debt, credit and support
facilities in note 11 of the accompanying consolidated financial statements. For additional
financial information related to those subsidiaries providing guarantees as of December 31, 2003,
see Supplemental consolidating financial information in note 23 of the accompanying consolidated
financial statements. For information related to the security pledged, those subsidiaries
providing guarantees and the impact of the termination of the Five Year Facilities on the related
security agreements, subsequent to December 31, 2003, see Developments in 2003 and 2004  Nortel
Networks Audit Committee Independent Review; restatements; related matters  Credit facilities and
security agreements. For information related to our debt ratings, see Credit ratings below.
See Risk factors/forward looking statements for factors that may affect our ability to comply
with covenants and conditions in our EDC Support Facility in the future. 
  Shelf registration statement and base shelf prospectus In 2002, we and NNC filed a shelf registration statement with the SEC and a base shelf
prospectus with the applicable securities regulatory authorities in Canada, to qualify for the
potential sale of up to $2,500 of various types of securities in the
U.S. and/or Canada. The qualifying securities include guaranteed debt securities of Nortel
Networks Limited. As of December 31, 2003, approximately $1,700 under the shelf registration
statement and base shelf prospectus has been utilized. As of June 6, 2004, the Canadian shelf
registration expired. Owing to matters described above in Developments in 2003 and 2004  Nortel
Networks Audit Committee Independent Review; restatements; related matters with respect to the
delayed filing of the Reports, we are currently unable to utilize the remaining capacity under the
SEC shelf registration statement in its current form. For the same reasons, we are also unable to
permit holders of our prepaid forward purchase contracts to exercise certain early settlement
rights and receive Nortel Networks Corporation common shares in advance of the 81




---



##### Table of Contents



otherwise applicable
August 15, 2005 settlement date. These rights will again become exercisable upon the effectiveness
of a registration statement (or a post-effective amendment to the shelf registration statement)
filed with the SEC (with respect to the common shares to be delivered) that contains a related
current prospectus. Under the terms of the Purchase Contract and Unit Agreement which governs the
purchase contracts, we have agreed to use commercially reasonable efforts to have, in effect, a
registration statement covering the common shares to be delivered and to provide a prospectus in
connection therewith. 
 Credit ratings Rating on long-term debt
    
    
    Rating onissued or guaranteed by
    
    
    preferred sharesNortel Networks
    
    
    issued byLimited/Nortel Networks
    
    
    Nortel NetworksRating agency
    
    Corporation
    
    
    Limited
    
    
    Last changeStandard & Poors Ratings Service
    
    
    B
    
    
    CCC
    
    
    April 28, 2004Moodys Investors Service, Inc.
    
    
    B3
    
    
    Caa3
    
    
    November 1, 2002
 On April 28, 2004, S&P downgraded its ratings on us, including its long-term corporate credit
rating from B to B and its preferred shares rating from CCC to CCC. At the same time, it
revised its outlook to developing from negative. Moodys outlook changed to review for potential
downgrade from uncertain on April 28, 2004. There can be no assurance that our credit ratings will
not be lowered or that these ratings agencies will not issue adverse commentaries, potentially
resulting in higher financing costs and reduced access to capital markets or alternative financing
arrangements. A reduction in our credit ratings may also affect our ability, and the cost, to
securitize receivables, obtain bid, performance related and other bonds, access the EDC Support
Facility and/or enter into normal course derivative or hedging transactions. Preferred Shares NNC, as the sole holder of the common shares of Nortel Networks Limited, approved reductions
in the legal stated capital of the common shares of Nortel Networks Limited in the amount of nil in
2003, $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 Cumulative Redeemable Class A Preferred Shares Series 6, or Series 6 preferred
shares, provided that a minimum number of Series 5 preferred shares were tendered for conversion.
This condition was not satisfied and, as a result, no Series 6 preferred shares were issued.
Holders of Series 6 preferred shares would have been entitled to an annual fixed cumulative
preferential cash dividend of Canadian $0.821 per share (3.284%), payable (if declared) on a
quarterly basis. The Series 5 preferred shares are redeemable at our option any time after
December 1, 2001, at Canadian $25.50 per share, plus any declared and unpaid dividends. The next
opportunity for conversion of Series 5 preferred shares into Series 6 preferred shares will be as
of December 1, 2006. Beginning December 1, 2002, the holders of our Non-cumulative Redeemable Class A Preferred Shares
Series 7, or Series 7 preferred shares, are entitled (if declared) to a monthly floating
non-cumulative preferential cash dividend based on the
average prime rate of two Canadian banks. Prior to that time, the holders were entitled to an
annual fixed non-cumulative preferential cash dividend of Canadian $1.225 per share (4.9%), which
was payable on a quarterly basis up to November 30, 2002. Also, as of December 1, 2002, the
holders of Series 7 preferred shares had the right to convert their shares into Non-cumulative
Redeemable Class A Preferred Shares Series 8, or Series 8 preferred shares, provided that a minimum
number of Series 7 preferred shares were tendered for conversion. This condition was not satisfied
and, as a result, no Series 8 preferred shares were issued. Holders of Series 8 preferred shares
would have been entitled to an annual fixed non-cumulative preferential cash dividend of Canadian
$0.84725 per share (3.389%), payable (if declared) on a quarterly basis. The Series 7 Shares are
redeemable at our option any time after December 1, 2002, at Canadian $25.50 per share, plus any
declared and unpaid dividends. The next opportunity for conversion of Series 7 preferred shares
into Series 8 preferred shares will be as of 82




---



##### Table of Contents



December 1, 2007. For additional information about our preferred shares, see Capital stock in note 16 of the
accompanying consolidated financial statements. 
 Off-balance sheet arrangements 
 Bid, performance related and other bonds We have entered into bid, performance related and other bonds in connection with various
contracts. Bid bonds generally have a term of less than twelve months, depending on the length of
the bid period for the applicable contract. Performance related and other bonds generally have a
term of twelve months and are typically renewed, as required, over the term of the applicable
contract. The various contracts to which these bonds apply generally have terms ranging from two
to five years. Any potential payments which might become due under these bonds would be related to
our non-performance under the applicable contract. Historically, we have not had to make material
payments and we do not anticipate that we will be required to make material payments under these
types of bonds. The following table provides information related to these types of bonds as of: December 31,2003
    
    
    2002Bid and performance related bonds (a)
    
    $
    427
    
    
    $
    299Other bonds (b)
    
    
    53
    
    
    
    136Total bid, performance related and other bonds
    
    $
    480
    
    
    $
    435
 (a)
    
    Net of restricted cash and cash equivalents of $14 as of December 31, 2003 and $188 as of
December 31, 2002.(b)
    
    Net of restricted cash and cash equivalents of $31 as of December 31, 2003 and $26 as of
December 31, 2002. The criteria under which bid, performance related and other bonds can be obtained changed due
to the industry environment primarily in 2002 and 2001. During that timeframe, in addition to the
payment of higher fees, we experienced significant cash collateral requirements in connection with
obtaining new bid, performance related and other bonds. Given that the EDC Support Facility is
used to support bid and performance bonds with varying terms, including those with at least 365 day
terms, we will likely need to increase our use of cash collateral to support these obligations
beginning on January 1, 2006 absent a further extension of the facility. The EDC Support Facility provides support for certain obligations under bid and performance related
bonds and has reduced the requirement to provide cash collateral to support these obligations. As
of December 31, 2003, the EDC Support Facility provided for up to $750 in support, of which $300
was committed revolving support for performance bonds of which $151 was utilized. The remainder
was uncommitted support, subject to certain limitations, for performance bonds, receivables sales
and/or securitizations of which $183 was utilized as of December 31, 2003. Any bid or performance
related bonds with terms that extend beyond December 31, 2006 are currently not eligible for the
support provided by this facility. In addition to the support facility with EDC, our existing
security agreements permit us to secure additional obligations under bid and performance related
bonds with the assets pledged under the security agreements and to provide cash collateral as
security for these types of bonds. See Available support facility for additional information on
the EDC Support Facility and the security agreements and see Developments in 2003 and 2004 
Nortel Networks Audit Committee Independent Review; restatements; related matters  EDC Support
Facility for additional information in connection with amendments to the EDC Support Facility and
developments in connection with the EDC Support Facility and related security agreements subsequent
to December 31, 2003. 
 Receivables securitization and certain lease financing transactions In January 2003, the Financial Accounting Standards Board, or FASB, issued FASB
Interpretation, or FIN, No. 46, Consolidation of Variable Interest Entities  an Interpretation of
Accounting Research Bulletin No. 51, Consolidated Financial Statements, or FIN 46, and in
December 2003, the FASB issued a revision of FIN 46  FIN 46 (Revised 2003), or FIN 46R. FIN 46R
provides guidance with respect to the consolidation of variable interest entities, or VIEs. VIEs
are characterized as entities in which equity investors do not have a controlling financial
interest or there is not sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support. Reporting entities which have a variable
interest in such an entity and are deemed to be the primary beneficiary must consolidate the
variable 83




---



##### Table of Contents



interest entity. As of December 31, 2003, our participation in a lease financing transaction was structured through
a single transaction variable interest entity which did not have sufficient equity at risk as
defined in FIN 46R and is no longer considered an off-balance sheet arrangement effective July 1,
2003. We retained certain risks associated with guaranteeing recovery of the unamortized principal
balance of the special purpose entitys debt which represented the majority of the risks associated
with the variable interest entitys activities. For additional information, see Consolidation of
variable interest entities in note 4(d) of the accompanying consolidated financial statements. We have also conducted certain receivable sales transactions either directly with financial
institutions or with multi-seller conduits. Under some of these agreements, we have continued as
servicing agent and/or have provided limited recourse. The fair value of these retained interests
is based on the market value of servicing the receivables, historical payment patterns, expected
future cash flows and appropriate discount rates as applicable. Where we have acted as the
servicing agent, we generally have not recorded an asset or liability related to servicing as the
annual servicing fees were equivalent to those that would have been paid to a third party servicing
agent. Also, we have not historically experienced significant credit losses with respect to
receivables sold with limited recourse. As of December 31, 2003, we were not required to, and did
not, consolidate or provide any of the additional disclosures set out in FIN 46R with respect to
the variable interest entities involving receivable sales because we were not considered the
primary beneficiary. Additionally, we have agreed to indemnify our counterparties in receivables securitization
transactions. The indemnifications provided to counterparties in these types of transactions may
require us to compensate counterparties for costs incurred as a result of changes in laws and
regulations (including tax legislation) or in the interpretations of such laws and regulations, or
as a result of regulatory penalties that may be suffered by the counterparty as a consequence of
the transaction. Certain receivables securitization transactions include indemnifications
requiring the repurchase of the receivables if the particular transaction becomes invalid. As of
December 31, 2003, we had approximately $327 of securitized receivables which were subject to
repurchase under this provision, in which case we would assume all rights to collect such
receivables. The indemnification provisions generally expire upon expiration of the securitization
agreements, which extend through 2005, or collection of the receivable amount by the counterparty.
We are generally unable to estimate the maximum potential liability for all of these types of
indemnification guarantees as certain agreements do not specify a maximum amount and the amounts
are dependent upon the outcome of future contingent events, the nature and likelihood of which
cannot be determined at this time. Historically, we have not made any significant indemnification
payments or receivable repurchases under these agreements and no significant liability has been
accrued in the accompanying consolidated financial statements with respect to the obligation
associated with these guarantees. 
 Other indemnifications or guarantees Through our normal course of business, we have also entered into other indemnifications or
guarantees that arise in various types of arrangements including:  
    
    business sale and business combination agreements;
    
    intellectual property indemnification obligations;
    
    lease agreements;
    
    third party debt agreements;
    
    indemnification of banks and agents under our credit and support facilities and security agreements; and
    
    other indemnification agreements. In 2003, we did not make any significant payments under any of these indemnifications or
guarantees. In certain cases, due to the nature of the agreement, we have not been able to
estimate our maximum potential loss or the maximum potential loss has not been specified. For
additional information, see Guarantees in note 13 of the accompanying consolidated financial
statements. 
 Application of critical accounting estimates Our accompanying consolidated financial statements are based on the selection and application
of accounting policies, generally accepted in the U.S., which require us to make significant
estimates and assumptions. We believe that the following accounting estimates may involve a higher
degree of judgment and complexity in their application and represent our critical accounting
estimates. The application of these estimates requires us to make subjective and objective
judgments. 84




---



##### Table of Contents



In general, any changes in estimates or assumptions relating to revenue recognition, provisions for
doubtful accounts, provisions for inventory and other contingencies (excluding legal contingencies)
are directly reflected in the results of our reportable operating segments. Changes in estimates or
assumptions pertaining to our tax asset valuations, our pension and post-retirement benefits and
our legal contingencies are generally not reflected in our reportable operating segments, but are
reflected on a consolidated basis. We have discussed the application of these critical accounting estimates with the Audit Committee
of our Board of Directors. 
 Revenue recognition Our material revenue streams are the result of a wide range of activities, from custom design
and installation over a period of time to a single delivery of equipment to a customer. Our
networking solutions also cover a broad range of technologies and are offered on a global basis. As
a result, our revenue recognition policies can differ depending on the level of customization
within the solution and the contractual terms with the customer. Newer technologies within one of
our reporting segments may also have different revenue recognition policies, depending on, among
other factors, the specific performance and acceptance criteria within the applicable contract.
Therefore, management must use judgment in determining how to apply the current accounting
standards and interpretations, not only based on the networking solution, but also within
networking solutions based on reviewing the level of customization and contractual terms with the
customer. As a result, our revenues may fluctuate from period to period based on the mix of
solutions sold and the geographic region in which they are sold. When a sale involves multiple deliverables where the deliverables are governed by more than one
authoritative standard, we evaluate all deliverables to determine whether they represent separate
units of accounting based on the following criteria:  
    
    whether the delivered item has value to the customer on a stand-alone basis;
    
    whether there is objective and reliable evidence of the fair value of the undelivered item(s); and
    
    if the contract includes a general right of return relative to the delivered
item, delivery or performance of the undelivered item(s) is considered probable and is
substantially in our control. Our determination of whether deliverables within a multiple element arrangement can be treated
separately for revenue recognition purposes involves significant estimates and judgment, such as
whether fair value can be established on undelivered obligations and/or whether delivered elements
have standalone value to the customer. Changes to our assessment of the accounting units in an
arrangement and/or our ability to establish fair values could significantly change the timing of
revenue recognition. If objective and reliable evidence of fair value exists for all units of accounting in the
contract, revenue is allocated to each unit of accounting or element based on relative fair values.
In situations where there is objective and reliable evidence of fair value for all undelivered
elements, but not for delivered elements, the residual method is used to allocate the contract
consideration. Under the residual method, the amount of revenue allocated to delivered elements
equals the total arrangement consideration less the aggregate fair value of any undelivered
elements. Each unit of accounting is then accounted for under the applicable revenue recognition
guidance. If fair value does not exist for any undelivered element, revenue is not recognized
until the earlier of (i) the undelivered element is delivered or (ii) fair value of the undelivered
element exists, unless the undelivered element is a service, in which case revenue is recognized as
the service is performed once the service is the only undelivered element. Our assessment of which revenue recognition guidance is appropriate to account for a deliverable
also can involve significant judgment. For instance, the determination of whether software is more
than incidental to hardware can impact whether the hardware is accounted for under software revenue
recognition or general revenue recognition guidance. This assessment could impact the amount and
timing of revenue recognition. For accounting units related to customized network solutions and certain network build outs,
revenues are recognized under SOP 81-1 using the percentage-of-completion method. In using the
percentage-of-completion method, revenues are generally recorded based on a measure of the
percentage of costs incurred to date on a contract relative to the estimated total expected
contract costs. Significant judgment is often required when estimating total contract costs and
progress to completion on these arrangements, as well as whether a loss is expected to be incurred
on the contract. Management uses historical experience, project plans and an assessment of the
risks and uncertainties inherent in the arrangement to establish 85




---



##### Table of Contents



these estimates. Uncertainties
include implementation delays or performance issues that may or may not be within our control.
Changes in these estimates could result in a material impact on revenues and net earnings (loss). We make certain sales through multiple distribution channels, primarily resellers and distributors.
These customers are generally given certain rights of return. Accruals for estimated sales returns
and other allowances and deferrals are recorded as a reduction of revenue at the time of revenue
recognition. These provisions are based on contract terms and prior claims experience and involve
significant estimates. If these estimates are significantly different from actual results, our
revenue could be impacted. We provide extended payment terms on certain software contracts and may sell these receivables to
third parties. The fees on these contracts are considered fixed or determinable if the contracts
are similar to others for which we have a standard business practice of providing extended payment
terms and have a history of successfully collecting under the original payment terms without making
concessions. If fees are not considered fixed or determinable at the outset of the arrangement,
revenue for delivered products is deferred until the fees become legally due and payable and
therefore estimates and judgment in this area can impact the timing of revenue recognition. The collectibility of trade and notes receivables is also critical in determining whether revenue
should be recognized, 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. As a result, our estimates and judgment regarding customer credit quality could
significantly impact the timing and amount of revenue recognition. For further information on our revenue recognition policies relating to our material revenue
streams, you should also refer to note 2(d) of the accompanying consolidated financial statements. 
 Provisions for doubtful accounts In establishing the appropriate provisions for trade, notes and long-term receivables due from
customers, we make assumptions with respect to their future collectibility. Our assumptions are
based on an individual assessment of a customers credit quality as well as subjective factors and
trends, including the aging of receivable balances. Generally, these individual credit assessments
occur prior to the inception of the credit exposure and at regular reviews during the life of the
exposure and consider:  
    
    a customers ability to meet and sustain its financial commitments;
    
    a customers current and projected financial condition;
    
    the positive or negative effects of the current and projected industry outlook; and
    
    the economy in general. Once we consider all of these individual factors, we make a determination as to the probability of
default. An appropriate provision is then made, which takes into consideration the severity of the
likely loss on the outstanding receivable balance based on our experience in collecting these
amounts. In addition to these individual assessments, in general, outstanding trade accounts
receivable amounts that are greater than 365 days are fully provisioned for and amounts greater
than 180 days are 50% provisioned for. In subsequent periods, we may be required to make
adjustments once further information becomes available or actual events occur. As a result, we may
incur significant adjustments to our provisions for trade, notes and long-term receivables. We recorded net receivable recoveries, related to continuing operations, of $179 in 2003. In 2002
and 2001, we recorded receivable provisions, related to continuing operations, of $292 and $1,789,
respectively. The net receivable recoveries of $179 in 2003 primarily related to trade and
customer financing receivable recoveries as a result of favorable settlements related to our sale
or restructuring of various receivables as well as net recoveries on other trade and customer
financing receivables due to subsequent collections for amounts exceeding our original estimates of
net recovery. These recoveries were partially offset by receivable provisions recorded during 2003
that related to our normal business activity. The receivable provisions recorded in 2002 and 2001
primarily related to the financial difficulties of several of our service provider and enterprise
customers as a result of the significant industry adjustment. 86




---



##### Table of Contents



The following table summarizes our accounts receivable and long-term receivable balances and
related reserves of our
continuing operations as of: December 31,2003
    
    
    2002Gross accounts receivable
    
    $
    2,853
    
    
    $
    2,784Provision for doubtful accounts
    
    
    (194
    )
    
    
    (502
    )Accounts receivable  net
    
    $
    2,659
    
    
    $
    2,282Accounts receivable provision as a percentage of gross accounts receivables
    
    
    7%
    
    
    
    18%Gross long-term receivables
    
    $
    386
    
    
    $
    1,054Provision for doubtful accounts
    
    
    (297
    )
    
    
    (780
    )Net long-term receivables
    
    $
    89
    
    
    $
    274Long-term receivable provision as a percentage of gross long-term receivables
    
    
    77%
    
    
    
    74%
 Throughout 2002 and 2001, we recorded significant provisions related to receivables from our
continuing operations compared to 2003 when we recorded significant net recoveries. Given the
current market conditions and creditworthiness of some of our customers, it is difficult to
determine the extent to which this trend will continue in the future. 
 Provisions for inventory Management must make estimates about the future customer demand for our products when
establishing the appropriate provisions for inventory. When making these estimates, we consider
general economic conditions and growth prospects within our customers ultimate marketplace, and
the market acceptance of our current and pending products. These judgments must be made in the
context of our customers shifting technology needs and changes in the geographic mix of our
customers. With respect to our provisioning policy, in general, we fully reserve for surplus
inventory in excess of our 365 day demand forecast or that we deem to be obsolete. Generally, our
inventory provisions have an inverse relationship with the projected demand for our products. For
example, our provisions usually increase as projected demand decreases due to adverse changes in
the conditions mentioned above. We have experienced significant changes in required provisions in
recent periods due to changes in strategic direction, such as discontinuances of product lines, as
well as declining market conditions. A misinterpretation or misunderstanding of any of these
conditions could result in inventory losses in excess of the provisions determined to be
appropriate as of the balance sheet date. We recorded inventory provisions, related to continuing operations, of $1,226 as of December 31,
2003, $1,180 as of December 31, 2002 and $896 as of December 31, 2001. The increase in inventory
provisions was primarily due to our inventory levels being aligned to decreased customer demand in
2003 compared to 2002 and 2001. The following table summarizes our inventory balances and other
related reserves of our continuing operations as of: December 31,2003
    
    
    2002Gross inventory
    
    $
    2,416
    
    
    $
    2,686Inventory provisions
    
    
    (1,226
    )
    
    
    (1,180
    )Inventories  net
    
    $
    1,190
    
    
    $
    1,506Inventory provisions as a percentage of gross inventory
    
    
    51%
    
    
    
    44%Other reserves for claims related to our contract manufacturers and suppliers(a)
    
    
    (120
    )
    
    
    (171
    )
 (a)
    
    This amount was included in other accrued liabilities and related to cancellation charges,
contracted for inventory in excess of future demand and the settlement of certain other
claims. As of December 31, 2003, our inventory provisions as a percentage of gross inventory was 51%.
In the future, we may be required to make significant adjustments to these provisions for the sale
and/or disposition of inventory that was previously provided for. 87




---



##### Table of Contents



Customers continued to be cautious with their capital expenditures in 2004. As a result, we will
continue to closely monitor our inventory provisions to ensure that they appropriately reflect the
current market conditions. However, the inventory provisions we have recorded in the past may not
be reflective of those in future quarters. 
 Income taxes 
  Tax asset valuation Our net deferred tax asset balance was $3,576 at December 31, 2003 and $3,093 at December 31,
2002. The $483 increase was primarily due to the impact of foreign exchange effects related
primarily to the Canadian dollar and the British pound. We currently have deferred tax assets
resulting from net operating loss carryforwards, tax credit carryforwards and deductible temporary
differences, all of which are available to reduce future taxes payable in our significant tax
jurisdictions. Generally, our loss carryforward periods range from seven years to an indefinite
period. As a result, we do not expect that a significant portion of these carryforwards will
expire in the near future. We assess the realization of these deferred tax assets quarterly to determine whether an income tax
valuation allowance is required. Based on available evidence, both positive and negative, we
determine whether it is more likely than not that all or a portion of the remaining net deferred
tax assets will be realized. The main factors that we consider include:  
    
    cumulative losses in recent years;
    
    history of loss carryforwards and other tax assets expiring;
    
    the carryforward period associated with the deferred tax assets;
    
    the nature of the income that can be used to realize the deferred tax assets;
    
    our net earnings / loss; and
    
    future earnings potential determined through the use of internal forecasts. In evaluating the positive and negative evidence, the weight given to each type of evidence must be
proportionate to the extent to which it can be objectively verified. If it is our belief that it
is more likely than not that some portion of these assets will not be realized, an income tax
valuation allowance is recorded. In 2003, our gross income tax valuation allowances increased to $3,108 as of December 31, 2003 from
$2,840 as of December 31, 2002. The increase was primarily due to the impact of foreign exchange
effects and additional valuation allowances recorded against the deferred tax assets recognized in
connection with our minimum pension liability, partially offset by drawdowns related to our 2003
net earnings. We assessed positive evidence including forecasts of future taxable income to
support realization of the net deferred tax assets, and negative evidence including our cumulative
loss position, and concluded that the valuation allowances as of December 31, 2003 were
appropriate. 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 an additional tax valuation allowance for all or a portion of the net
deferred tax assets, which may have a material adverse effect on our business, results of
operations and financial condition. Alternatively, if our future results of operations are better
than expected, these assessments may result in the reduction of our valuation allowances. Given
the magnitude of our valuation allowance, future adjustments to this allowance based on actual
results could result in a significant adjustment to our net earnings. 
  Tax contingencies We are subject to ongoing examinations by certain taxation authorities of the jurisdictions in
which we operate. We regularly assess the status of these examinations and the potential for
adverse outcomes to determine the adequacy of the provision for income and other taxes. We believe
that we have adequately provided for tax adjustments that we believe are probable as a result of
any ongoing examination. We had previously entered into Advance Pricing Arrangements, or APAs, with the taxation authorities
of the U.S. and Canada in connection with our intercompany transfer pricing and cost sharing
arrangements between Canada and the U.S. These arrangements expired in 1999 and 2000. In 2002, we
filed APA requests with the taxation authorities of the U.S. Canada and the United Kingdom, or the
U.K., that are expected to apply to the taxation years beginning in 2000. The APA 88




---



##### Table of Contents



requests are
currently under consideration. We have applied the transfer pricing methodology proposed in the
APA requests since 2001. As part of the APA applications, we have requested that the methodology
adopted in 2001 be applied retroactively to the 2000 taxation year. If the retroactive application
is accepted by the taxation authorities, it would result in an increase in taxable income in
certain jurisdictions offset by an equal decrease in taxable income in the other jurisdictions. We
have provided for any taxes and interest that would be due as a result of retroactive application
of the APAs. Although the outcome of the APA applications are uncertain, we do not believe the ultimate
resolution of these negotiations will have a material adverse effect on our consolidated financial
position, results of operations or cash flows. However, if this matter is resolved unfavorably, it
could have a material adverse effect on our business, results of operations, financial condition
and liquidity. 
 Goodwill valuation Commencing January 1, 2002, we test goodwill for possible impairment on an annual basis on
October 1 of each year and at any other time if an event occurs or circumstances change that would
more likely than not reduce the fair value of a reporting unit below its carrying amount.
Circumstances that could trigger an impairment test include, but are not limited to:  
    
    a significant adverse change in the business climate or legal factors;
    
    an adverse action or assessment by a regulator;
    
    unanticipated competition;
    
    loss of key personnel;
    
    the likelihood that a reporting unit or a significant portion of a reporting unit will be sold or disposed of;
    
    results of testing for recoverability of a significant asset group within a reporting unit; and/or
    
    recognition of a goodwill impairment loss in the financial statements of a subsidiary
that is a component of a reporting unit. The 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. We have not yet finalized our assessment for potential triggering events for fiscal year 2004 and
further have not yet completed our annual impairment test for 2004, which is to be performed
effective October 1, 2004. The results of these assessments may or may not result in a triggering
event. We do not believe that our goodwill impairment test would result in an impairment charge. In 2003, we concluded that an impairment of our goodwill did not exist and no write down was
recorded. 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 then expected present value of discounted future cash flows of these
businesses. The discount rate used ranged from 12% to 16% and the terminal values were estimated
based on terminal growth rates ranging from 3% to 5%. 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. 89




---



##### Table of Contents



The carrying value of goodwill was $2,125 as of December 31, 2003 and $2,019 as of December 31,
2002. The increase in goodwill primarily related to our acquisition of the minority interests in
our French and German operations as discussed in Developments in 2003 and 2004. For additional
information on this transaction, including the allocation of the purchase price, see Nortel
Networks Germany and Nortel Networks France in note 10 of the accompanying consolidated financial
statements. 
 Pension and post-retirement benefits We maintain various pension and post-retirement benefit plans for our employees globally.
These plans include significant pension and post-retirement benefit obligations which are
calculated based on actuarial valuations. Key assumptions are made in determining these
obligations and related expenses, including expected rates of return on plan assets and discount
rates. For 2003, 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, 2002.
The expected long-term rate of return on plan assets remained unchanged from 2002. The discount
rates used to estimate the net pension obligations and expenses for 2003 were 5.8% and 6.3%,
respectively, on a weighted average basis, compared to 6.3% and 6.7%, respectively, in 2002. The key assumptions used to estimate the post-retirement costs for 2003 were an expected long-term
rate of return on plan assets of 8.0% and a discount rate of 6.0% and 6.8% 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 2002. The discount rates for the obligations and costs
decreased in 2003 to 6.0% and 6.8%, respectively, from 6.8% and 7.0%, respectively, in 2002 due to
the decline experienced in global interest rates during 2001 through 2002. The difference between the expected long-term rate of return on plan assets and the discount rate
reported for the net pension obligations and expenses and those rates reported for the net
post-retirement benefit obligations and costs is due to the weighted-average calculation as a
result of the number of countries in which we offer either pension or pension and post-retirement
benefits. In developing these assumptions, we evaluated, among other things, input from our
actuaries, expected long-term market returns and current high-quality bond rates. Changes in net periodic pension and post retirement benefit expense may occur in the future due to
changes in our expected rate of return on plan assets and discount rate resulting from economic
events. The following table highlights the sensitivity of our pension and post retirement benefit
expense to changes in these assumptions, assuming all other assumptions remain constant: Effect on 2003 pre-taxEffect on 2003 pre-tax
    
    post-retirementChange in Assumption
    
    pension expense *
    
    benefit expenseIncrease/(decrease)
    
    Increase/(decrease)1 percentage point increase in the expected return on assets
    
    
    ($50
    )
    
    $
    <11 percentage point decrease in the expected return on assets
    
    
    50
    
    
    
    <11 percentage point increase in the discount rate
    
    
    (73
    )
    
    
    (3
    )1 percentage point decrease in the discount rate
    
    
    67
    
    
    
    2
  Plan assets were primarily comprised of debt and equity securities. Included in the equity
securities of the defined benefit plan were common shares of Nortel Networks Corporation with an
aggregate market value of $13 (0.2% of total plan assets) as of December 31, 2003 and $3 (0.1% of
total plan assets) as of December 31, 2002. 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 2003, we had unrecognized net actuarial losses related to the
defined benefit plans of $1,664 which could result in an increase to pension expenses in future
years depending on several factors, including whether such losses exceed the corridor in accordance
with SFAS No. 87, Employers Accounting for Pensions. The post-retirement benefit plans had
unrecognized actuarial losses of $119 at the end of 2003. 90




---



##### Table of Contents



The estimated accumulated benefit obligations for the defined benefit plans exceeded the fair value
of the plan assets at September 30, 2003 as a result of reductions in discount rates and changes in
foreign exchange rates which more than offset the favorable impacts of strong pension asset returns
and the voluntary contributions made by us during 2003. Accordingly, we recorded a non-cash charge
of $219 ($188 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 2003, we made cash contributions to our defined benefit pension plans of approximately $300.
In 2004, we expect to make cash contributions of approximately $140 to our defined benefit pension
plans, which excludes $78 of deferred contributions for 2004 that were made in 2003, and
approximately $30 to our post-retirement benefit plans. For 2004, our expected rate of return on plan assets was lowered from 7.8% to 7.4% for defined
benefit pension plans and was lowered from 8.0% to 6.0% for 2004 for post-retirement benefit plans.
Also for 2004, we lowered our discount rate on a weighted-average basis for pension expenses from
6.3% to 5.8% for the defined benefit pension plans and from 6.8% to 6.0% for post-retirement
benefit plans given the declining trend in current global interest rates. We will continue to
evaluate our expected long-term rates of return on plan assets and discount rates at least annually
and make adjustments as necessary, which could change the pension and post-retirement obligations
and expenses in the future. If the actual operation of the plans differs from the assumptions,
additional contributions by us may be required. If we are required to make significant
contributions to fund the defined benefit plans, reported results could be materially and adversely
affected and our cash flow available for other uses may be significantly reduced. For additional information, see Employee benefit plans in note 9 of the accompanying consolidated
financial statements. 
 Special charges In 2001 we entered into an unprecedented period of business realignment in response to a
significant adjustment in the industry. We implemented a company-wide restructuring plan to
streamline our operations and activities around core markets and operations, which included
significant workforce reductions, global real estate closures and dispositions, substantial
write-downs of our plant and equipment, goodwill and other intangible assets and extensive contract
settlements with customers and suppliers around the world. As a result of these actions, our
workforce declined significantly from January 1, 2001 to December 31, 2003 and over the same time
period, we significantly reduced our facilities. At each reporting date, we evaluate our accruals related to workforce reduction charges, contract
settlement and lease costs and plant and equipment write downs to ensure that these accruals are
still appropriate. As of December 31, 2003, we had $64 in accruals related to workforce reduction
charges and $455 in accruals related to contract settlement and lease costs, which included
significant estimates, primarily related to sublease income over the lease terms and other costs
for vacated
properties. In certain instances, we may determine that these accruals are no longer required
because of efficiencies in carrying out our restructuring work plan. In these cases, we reverse
any related accrual to income when it is determined it is no longer required. Alternatively, in
certain circumstances, we may determine that certain accruals are insufficient as new events occur
or as additional information is obtained. In these cases, we would increase the applicable
existing accrual with the offset recorded against income. 
 Other contingencies We are subject to the possibility of various loss contingencies arising in the ordinary course
of business. As a result, we consider the likelihood of loss or impairment of an asset or the
incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in
determining loss contingencies. We recognize a reserve for an estimated loss contingency when it
is probable that an asset has been impaired or a liability has been incurred and the amount of loss
can be reasonably estimated. We regularly evaluate current information available to us to
determine whether such accruals should be adjusted. We are also subject to proceedings, lawsuits, investigations and other claims (some of which may
involve substantial dollar amounts), including proceedings under laws and government regulations
related to securities, income and other taxes, environmental, labor, product and other matters. In
particular, our two restatements of our consolidated financial statements and related events have
caused us to be subject to ongoing regulatory and criminal investigations and significant pending
civil litigation actions in the U.S. and Canada. We are required to assess the likelihood of any
adverse judgments or outcomes in any of these matters, as well as potential ranges of probable
losses. A determination of the amount of reserves required, if any, for these contingencies is
based on an analysis of each individual issue. The required reserves may change in the future due
to new developments in each matter or changes in approach such as a change in settlement strategy
in dealing 91




---



##### Table of Contents



with these matters. We cannot determine whether these matters will, individually or
collectively, have a material adverse effect on our business, results of operations and financial
condition. See Risk factors/forward looking statements. For more information related to our outstanding legal and other proceedings, see Contingencies in
note 21 of the accompanying consolidated financial statements. 
 Accounting changes and recent accounting pronouncements 
 Accounting changes Our consolidated financial statements are based on the selection and application of accounting
policies, generally accepted in the U.S. For more information related to the accounting policies
that we adopted as a result of new accounting standards, see Accounting changes in note 4 of the
accompanying consolidated financial statements. The following summarizes the accounting changes
that we have adopted:  
    
    Guarantees   the adoption of FASB Interpretation FIN No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others  an Interpretation of FASB Statement Nos. 5, 57 and 107 and
Rescission of FIN No. 34 did not have a material impact on our results of operations
and financial condition.
    
    Asset retirement obligations  the adoption of SFAS No. 143, Accounting for Asset
Retirement Obligations, or SFAS No. 143, resulted in a decrease to net earnings of $12
(net of tax of nil) which has been reported as a cumulative effect of accounting
changes  net of tax, an increase in plant and equipment  net of $4 and an asset
retirement obligation liability of $16 as of January 1, 2003. The adoption of SFAS No.
143 did not have a material impact on depreciation and accretion expense.
    
    Accounting for costs associated with exit or disposal activities  the adoption of
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities did
not have a material impact on our results of operations and financial condition.
    
    Consolidation of variable interest entities  the adoption of FIN 46 resulted in the
inclusion of $184 in long-term debt and $183 of plant and equipment  net. These
amounts represented both the collateral and maximum exposure to loss as a result of our
involvement with VIEs.
    
    Accounting for certain financial instruments with characteristics of both
liabilities and equity  the adoption of SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity did not have
a material impact on our results of operations and financial condition.
    
    Accounting for revenue arrangements with multiple deliverables  the adoption of
Emerging Issues Task Force 00-21, Revenue Arrangements with Multiple Deliverables and
EITF 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software
Deliverables in an Arrangement Containing More-Than-Incidental Software did not have a
material impact on our results of operations and financial condition.
    
    Amendment of SFAS No. 133 on derivative instruments and hedging activities  the
adoption of SFAS No. 149, Amendment of SFAS No. 133 on Derivative Instruments and
Hedging Activities did not have a material impact on our results of operations and
financial condition.
    
    Determining whether an arrangement contains a lease   the impact of the adoption of
the Emerging Issues Task Force 01-8, Determining Whether an Arrangement Contains a
Lease on our future results of operations and financial condition will depend on the
terms contained in contracts signed or contracts amended in the future.
    
    Pensions and other post-retirement benefits  the adoption of SFAS No. 132 (Revised
2003), Employers Disclosures about Pensions and Other Post-retirement Benefits
requires additional disclosures regarding defined benefit pension plan and other
post-retirement benefit plan assets, obligations, cash flows and net cost as well as
retaining a number of disclosures required by SFAS No. 132, Employers Disclosures
about Pensions and Other Postretirement Benefits. The applicable current year
requirements have been applied in the presentation of the consolidated financial
statements.
    
    Stock-based compensation  we adopted SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure  an Amendment of FASB Statement No. 123
which amended the transitional provisions of SFAS No. 123, Accounting for Stock-based
Compensation for companies electing to recognize employee stock-based compensation
using the fair value based method. Effective January 1, 2003 we elected to expense
employee stock-based compensation using the fair value based method prospectively for
all awards granted, modified, or settled on or after January 1, 2003. The impact of
the adoption of the fair value based method for expense recognition of employee awards
resulted in $26 (net of tax of nil) of stock option expense during 2003. 92




---



##### Table of Contents




    
    Accounting for goodwill and other intangible assets  the adoption of SFAS No. 142,
effective January 1, 2002, which changed the accounting for goodwill from an
amortization method to an impairment approach, had a material impact on our results of
operations and financial condition through the elimination of amortization expense.
    
    Impairment or disposal of long-lived assets (plant and equipment and acquired
technology)  the adoption of SFAS No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets resulted in write downs for plant and equipment of $290 related
to long-lived assets held and used, and $38 related to long-lived assets held for sale
for the year ended December 31, 2002. See Special charges in note 7 of the
accompanying consolidated financial statements for further information regarding these
write downs.
    
    Derivative financial instruments  the adoption of SFAS No. 133 and the
corresponding amendments under SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities  an Amendment of SFAS No. 133 resulted in
a cumulative decrease in net loss of $15 (net of tax of $9), which has been reported as
cumulative effect of accounting changes-net of tax and a charge to other comprehensive
income of $7 (net of tax of $4) in 2001. 
 Recent accounting pronouncements On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of
2003, or the MPDIM Act, was signed into law in the U.S. The MPDIM Act introduced a prescription
drug benefit under Medicare (specifically, Medicare Part D) as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially
equivalent to Medicare Part D. As permitted by FASB Staff Position, or FSP, Financial Accounting
Standard, or FAS, 106-1, Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003, we chose to make the one-time
deferral election which remained in effect for our plans in the U.S. until the earlier of the
issuance of specific authoritative guidance by the FASB on how to account for the federal subsidy
to be provided to plan sponsors under the MPDIM Act, or the remeasurement of plan assets and
obligations subsequent to January 31, 2004. Therefore, our post-retirement benefit obligation as
of December 31, 2003 and net post-retirement benefit cost for the year ended December 31, 2003 did
not reflect the effects of the MPDIM Act on the plans. On May 19, 2004, FSP FAS 106-2, Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003, or FSP FAS 106-2, was issued by the FASB to provide guidance relating
to the prescription drug subsidy provided by the MPDIM Act. We expect to have portions of our
post-retirement benefit plans qualify as actuarially equivalent to the benefit provided under the
MPDIM Act, for which it expects to receive federal subsidies. We expect that other portions of the
plans will not be actuarially equivalent. The financial impact of the federal
subsidies was determined by remeasuring our retiree life and medical obligation as of January 1,
2004, as provided under the retroactive application provision of FSP FAS 106-2. The effective date
of FSP FAS 106-2 is the first annual or interim period beginning after June 15, 2004, with earlier
adoption encouraged. We adopted FSP FAS 106-2 for the three-month period ended June 30, 2004. As
a result of adoption, the accrued post-retirement benefit obligation decreased by $31. Net
periodic post-retirement benefit costs are expected to decrease by $2 for 2004, as a result of the
subsidy. In March 2004, the Emerging Issues Task Force, or EITF, reached consensus on Issue No. 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, or EITF
03-1. EITF 03-1 provides guidance on determining when an investment is considered impaired, whether
that impairment is other than temporary and the measurement of an impairment loss. EITF 03-1 is
applicable to marketable debt and equity securities within the scope of SFAS No. 115, Accounting
for Certain Investments in Debt and Equity Securities, or SFAS 115, and SFAS No. 124, Accounting
for Certain Investments Held by Not-for-Profit Organizations, and equity securities that are not
subject to the scope of SFAS 115 and not accounted for under the equity method of accounting. In
September 2004, the FASB issued FSP EITF 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue
No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments, which delays the effective date for the measurement and recognition criteria
contained in EITF 03-1 until final application guidance is issued. The delay does not suspend the
requirement to recognize other-than-temporary impairments as required by existing authoritative
literature. The adoption of EITF 03-1 is not expected to have a material impact on our results of
operations and financial position. 
 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 93




---



##### Table of Contents



have authorized
under our policies and procedures. We maintain risk management control systems to monitor market
risks and counterparty risks. These systems rely on analytical techniques including both
sensitivity analysis and value-at-risk estimations. We do not hold or issue financial instruments
for trading purposes. For a discussion of our accounting policies for derivative financial instruments, see Significant
accounting policies in note 2(t) and Accounting changes in note 4(e), (g), and (m) 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 sale and purchase
commitments. Our most significant foreign exchange exposures are in the Canadian dollar, the
British pound and the euro. We enter into U.S. to Canadian dollar forward and option contracts
intended to hedge the U.S. to Canadian dollar exposure on future revenues and expenditure streams.
In accordance with SFAS No. 133, we recognize the gains and losses on the effective portion of
these contracts in income when the hedged transaction occurs. Any ineffective portion of these
contracts is recognized in income immediately. We expect to continue to expand our business globally and, as such, expect that an increasing
proportion of our business may be denominated in currencies other than U.S. dollars. As a result,
fluctuations in foreign currencies may have a material impact on our business, results of
operations and financial condition. We try to minimize the impact of such currency fluctuations
through our ongoing commercial practices and by attempting to hedge our major currency exposures.
In attempting to manage this foreign exchange risk, we identify operations and transactions that
may have exposure based upon the excess or deficiency of foreign currency receipts over foreign
currency expenditures. Our significant currency flows for the year ended December 31, 2003 were in
U.S. dollars, Canadian dollars, British pounds and euros. The net impact of foreign exchange
fluctuations resulted in a gain of $83 in 2003, a loss of $84 in 2002 and a loss of $161 in 2001.
Given our exposure to international markets, we regularly monitor all of our material foreign
currency exposures. We cannot predict whether we will incur foreign exchange gains or losses in
the future. However, if significant foreign exchange losses are experienced, they could have a
material adverse effect on our business, results of operations and financial condition. We use sensitivity analysis to measure our foreign currency risk by computing the potential
decrease in cash flows that may result from adverse changes in foreign exchange rates. The balances
are segregated by source currency, and a hypothetical unfavorable variance in foreign exchange
rates of 10% is applied to each net source currency position using year-end rates, to determine the
potential decrease in cash flows over the next year. The sensitivity analysis includes all foreign
currency-denominated cash, short-term and long-term debt, and derivative instruments that will
impact cash flows over the next year that are held at December 31, 2003 and 2002, respectively. The
underlying cash flows that relate to the hedged firm
commitments are not included in the analysis. The analysis is performed at the reporting date and
assumes no future changes in the balances or timing of cash flows from the year-end position.
Further, the model assumes no correlation in the movement of foreign exchange rates. Based on a
one-year time horizon, a 10% adverse change in exchange rates would result in a potential decrease
in after-tax cash flows of $195 as of December 31, 2003 and $132 as of December 31, 2002. This
potential decrease would result primarily from our exposure to the Canadian dollar, the British
pound and the euro. A portion of our long-term debt is subject to changes in fair value resulting from changes in
market interest rates. We have hedged a portion of this exposure to interest rate volatility using
fixed for floating interest rate swaps. The change in fair value of the swaps are recognized in
earnings with offsetting amounts related to the change in the fair value of the hedged debt
attributable to interest rate changes. Any ineffective portion of the swaps is recognized in
income immediately. We record net settlements on these swap instruments as adjustments to interest
expense. Historically, we have managed interest rate exposures, as they relate to interest expense, using a
diversified portfolio of fixed and floating rate instruments denominated in several major
currencies. We use sensitivity analysis to measure our interest rate risk. The sensitivity
analysis includes cash, our outstanding floating rate long-term debt and any outstanding
instruments that convert fixed rate long-term debt to floating rate. A 100 basis point adverse
change in interest rates would result in a potential decrease in cash flows of $51 as of December
31, 2003 and $39 as of December 31, 2002. 
 Equity price risk The values of our equity investments in several publicly traded companies are subject to
market price volatility. These investments are generally in companies in the technology industry
sector and are classified as available for sale. We typically do not attempt to reduce or
eliminate the market exposure on these investment securities. We also hold certain derivative
instruments or warrants that are subject to market price volatility because their value is based on
the common share price of a 94




---



##### Table of Contents



publicly traded company. These derivative instruments are generally
acquired through business acquisitions or divestitures. In addition, derivative instruments may
also be purchased to hedge exposure to certain compensation obligations that vary based on future
Nortel Networks Corporation common share prices. We do not hold equity securities or derivative
instruments for trading purposes. As of December 31, 2003, a hypothetical 20% adverse change in
the stock prices of our publicly traded equity securities and the related underlying stock prices
of publicly traded equity securities for certain of our derivative instruments would result in a
loss in their aggregate fair values of $52 and $12, respectively, which would be offset by a
corresponding reduction in future compensation expense. As of December 31, 2002, a hypothetical
20% adverse change in the stock prices of our publicly traded equity securities and the related
underlying stock prices of publicly traded equity securities for certain of our derivative
instruments would result in a loss in their aggregate fair values of $27. 
 Environmental matters We are subject to numerous environmental protection laws and regulations in various
jurisdictions around the world, primarily due to our manufacturing operations. As a result, we are
exposed to liabilities and compliance costs arising from our past and current generation,
management and disposition of hazardous substances and wastes. We have remedial activities under way at twelve of our facilities which are either currently
occupied or were previously owned or occupied. We have also been listed as a potentially
responsible party at six Superfund sites in the U.S. An estimate of our anticipated remediation
costs associated with all such facilities and sites, to the extent probable and reasonably
estimable, is included in our environmental accruals in an approximate amount of $33. For a discussion of Environmental matters, see Contingencies in note 21 of the accompanying
consolidated financial statements. 
 Legal proceedings Nortel Networks and/or certain of our directors and officers have been named as defendants in
various class action lawsuits. We are unable to determine the ultimate aggregate amount of
monetary liability or financial impact to us in these legal matters, which unless otherwise
specified, seek damages from the defendants of material or indeterminate amounts. We are also a
defendant in various other suits, claims, proceedings and investigations which are in the normal
course of business. We cannot determine whether these matters will, individually or collectively,
have a material adverse effect on our business, results of operations, financial condition and
liquidity. We, and any of our named directors or officers, intend to vigorously defend these
actions, suits, claims, proceedings and investigations. We are also subject to significant pending
civil litigation
and ongoing regulatory and criminal investigations in the U.S. and Canada which could require us to
pay substantial judgments, settlements, fines or other penalties. For additional information
related to our legal proceedings, see Contingencies in note 21 of the accompanying consolidated
financial statements and Risk factors/forward looking statements. 
 Risk factors/forward looking statements You should carefully consider the risks described below before investing in our securities.
The risks described below are not the only ones facing us. Additional risks not currently known to
us or that we currently believe are immaterial may also impair our business, results of operations,
financial condition and liquidity. Unless required by applicable securities laws, we do not have
any intention or obligation to publicly update or revise any forward looking statements, whether as
a result of new information, future events or otherwise. Certain statements in this Annual Report onForm 10-Kcontain words such as could, expects,
may, anticipates, believes, intends, estimates, plans, envisions, seeks and other
similar language and are considered forward looking statements. These statements are based on our
current expectations, estimates, forecasts and projections about the operating environment,
economies and markets in which we operate. In addition, other written or oral statements which are
considered forward looking may be made by us or others on our behalf. These statements are subject
to important risks, uncertainties and assumptions, which are difficult to predict and the actual
outcome may be materially different. In particular, the risks described below could cause actual
events to differ materially from those contemplated in forward looking statements. 95




---



##### Table of Contents



Risks relating to our restatements and related matters Our two restatements of our consolidated financial statements and related events have had, and
will continue to have, a material adverse effect on us. In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to the Comprehensive Review, which resulted in the First Restatement.
In late October 2003, the Audit Committee initiated the Independent Review and engaged WCPHD to
advise it in connection with the Independent Review. The Audit Committee sought to gain a full
understanding of the events that caused significant excess liabilities to be maintained on the
balance sheet that needed to be restated, and to recommend that our Board of Directors adopt, and
direct management to implement, necessary remedial measures to address personnel, controls,
compliance and discipline. As the Independent Review progressed, the Audit Committee directed new
corporate management to examine in depth the concerns identified by WCPHD regarding provisioning
activity and to review certain provision releases. That examination, and other errors identified by
management, led to the Second Restatement and our revision of previously announced unaudited
results for the year ended December 31, 2003. The need for the Second Restatement resulted in
delays in filing the Reports. Over the course of the Second Restatement process, management identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In particular,
management identified certain errors related to revenue recognition and undertook a process of
revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit
Committee has determined to review the facts and circumstances leading to the restatement of these
revenues for specific transactions identified in the Second Restatement. The review will have a
particular emphasis on the underlying conduct that led to the initial recognition of these
revenues. The Audit Committee will seek a full understanding of the historic events that required
the revenues for these specific transactions to be restated and will consider any appropriate
additional remedial measures, including those involving internal controls and processes. The Audit
Committee has engaged WCPHD to advise it in connection with this review. For more information on the Comprehensive Review, Independent Review, First Restatement, Second
Restatement and Revenue Independent Review, see the MD&A and Controls and Procedures sections
of this report. As a result of these events, we have become subject to the following key risks, each of which is
described in more detail below. Each of these risks could have a material adverse effect on our
business, results of operations, financial condition and liquidity.  
    
    We are subject to ongoing regulatory and criminal investigations in the
U.S. and Canada, which could require us to pay substantial fines or other penalties.
    
    We are subject to significant pending civil litigation, which if decided
against us, could require us to pay substantial judgments, settlements or other
penalties.
    
    Material adverse legal judgments, fines, penalties or settlements could
have a material adverse effect on our business, results of operations, financial
condition and liquidity, which could be very significant.
    
    We cannot predict the outcome of the Revenue Independent Review being
undertaken by our Audit Committee.
    
    We and our independent auditors have identified a number of material
weaknesses related to our internal control over financial reporting, which could
continue to impact our ability to report our results of operations and financial
condition accurately and in a timely manner.
    
    The governing principles of the Independent Review particularly as they
relate to remedial measures may take time to implement.
    
    The delayed filing of our Reports and related matters caused us to breach
our public debt indentures and seek waivers from EDC under the EDC Support Facility,
which may affect our liquidity. The continuing delays in filing certain of our Reports
and related matters has resulted in a continuing breach of our public debt indentures
and our obligations under the EDC Support Facility. It is possible that the holders of
our public debt will seek to accelerate the maturity of that debt and EDC will not
grant us additional waivers.
    
    Our credit ratings have been downgraded, we are currently unable to access
our shelf registration statement filed with the SEC and we terminated the Five Year
Facilities, each of which may affect our liquidity.
    
    The delay in filing certain of our Reports could cause the TSX and/or the
NYSE to commence suspension or delisting procedures in respect of Nortel Networks
Corporations common shares or other of our or NNCs 96




---



##### Table of Contents



listed securities.
    
    Continuing negative publicity may adversely affect our business.
    
    We may not be able to attract or retain the personnel necessary to achieve our business objectives.
    
    Ongoing SEC review may require us to amend our public disclosures further. We are subject to ongoing regulatory and criminal investigations in the U.S. and Canada, which
could require us to pay substantial fines or other penalties. We are under investigation by the SEC and the OSC. On April 5, 2004, we announced that the SEC had
issued a formal order of investigation in connection with our previous restatement of financial
results for certain periods and our announcements in March 2004 regarding the likely need to revise
certain previously announced results and restate previously filed financial results for one or more
earlier periods. On April 13, 2004, we announced that we had received a letter from the staff of the OSC advising us
of an OSC Enforcement Staff investigation into the same matters that are the subject of the SEC
investigation. We have also received a U.S. federal grand jury subpoena for the production of certain documents
sought in connection with an ongoing criminal investigation being conducted by the U.S. Attorneys
Office for the Northern District of Texas, Dallas Division. Further, the Integrated Market
Enforcement Team of the RCMP has advised NNC that it would be commencing a criminal investigation
into our financial accounting situation. Our senior management and Board of Directors have been required to devote significant time to these
investigations and related matters. We cannot predict when these investigations will be completed,
nor can we predict what the results of these investigations may be. Expenses incurred in connection
with these investigations (which include substantial fees of lawyers and other professional
advisors and potential obligations to indemnify officers and directors who may be parties to such
actions) could adversely affect our cash position. We may be required to pay material fines,
consent to injunctions on future conduct or suffer other penalties, each of which could have a
material adverse effect on our business, results of operations, financial condition and liquidity.
The investigations may adversely affect our ability to obtain, and/or increase the cost of
obtaining, directors and officers liability insurance and/or other types of insurance, which
could have a material adverse affect on our business, results of operations and financial
condition. In addition, the findings and outcomes of the Independent Review and the regulatory and
criminal investigations may affect the course of the civil litigation pending against us, which are
more fully described below. The effects and results of these or other investigations may have a material adverse effect on our
business, results of operations, financial condition and liquidity. We are subject to significant pending civil litigation, which if decided against us, could require
us to pay substantial judgments, settlements or other penalties. In addition to being subject to litigation in the ordinary course of business, we are currently,
and may in the future be, subject to class actions, other securities litigation and other actions
arising in relation to our accounting restatements. Subsequent to our March 10, 2004 announcement
of the likely need for the Second Restatement, numerous class action complaints, including ERISA
class action complaints and a derivative action complaint, have been filed against Nortel Networks
and certain current and former officers and directors. We expect that this litigation will be time consuming, expensive and distracting from the conduct
of our daily business. The adverse resolution of any specific lawsuit could have a material adverse
effect on our ability to favorably resolve other lawsuits and on our financial condition and
liquidity. We are unable at this time to estimate what our ultimate liability in these matters may
be, and it is possible that we will be required to pay substantial judgments, settlements or other
penalties and incur expenses that could have a material adverse effect on our business, results of
operations, financial condition and liquidity, and such effects could be very significant.
Expenses incurred in connection with these investigations (which include substantial fees of
lawyers and other professional advisors and potential obligations to indemnify officers and
directors who may be parties to such actions) could adversely affect our cash position. 97




---



##### Table of Contents



We cannot predict the outcome of the Revenue Independent Review being undertaken by our Audit
Committee. As discussed in greater detail in the Controls and Procedures section of this report, our Audit
Committee initiated the Revenue Independent Review to achieve a full understanding of the historic
events that required revenues for certain specific transactions to be restated. The Revenue
Independent Review will have a particular emphasis on the underlying conduct that led to the
initial recognition of these revenues. The review will also consider any appropriate additional
remedial measures, including those involving internal controls and processes. The Audit Committee
has engaged WCPHD to advise it in connection with this review. We cannot predict the outcome of
the Revenue Independent Review. Material adverse legal judgments, fines, penalties or settlements could have a material adverse
effect on our financial condition and liquidity, which could be very significant. We estimate that our available cash and our cash flow from operations will be adequate to fund our
operations and service our debt for at least the next 12 months. In making this estimate, we have
not assumed the need to make any payments in connection with our pending civil litigation or
investigations related to the First Restatement and Second Restatement, other than our anticipated
professional fees and expenses. Any material adverse legal judgments, fines, penalties or
settlements arising from the pending civil litigation and investigations could require additional
funding which may not be available on commercially reasonable terms, or at all. This could have a
material adverse effect on our business, results of operations, financial condition and liquidity,
including by:  
    
    requiring us to dedicate a substantial portion of our cash and/or cash flow from
operations to payments of such judgments, fines, penalties or settlements, thereby reducing
the availability of our cash and/or cash flow to fund working capital, capital
expenditures, R&D efforts and other general corporate purposes, including debt reduction;
    
    making it more difficult for us to satisfy our payment obligations with respect to our outstanding indebtedness;
    
    increasing the difficulty and/or cost to us of refinancing our indebtedness;
    
    increasing our vulnerability to general adverse economic and industry conditions;
    
    limiting our flexibility in planning for, or reacting to, changes in our businesses and
the industries in which we operate;
    
    making it more difficult for us to make acquisitions and investments;
    
    limiting our ability to obtain, and/or increase the cost of obtaining, directors and
officers liability insurance and/or other types of insurance; and
    
    restricting our ability to introduce new technologies and products and/or exploit
business opportunities. We and our independent auditors have identified a number of material weaknesses related to our
internal control over financial reporting, which could continue to impact our ability to report our
results of operations and financial condition accurately and in a timely manner. Two material weaknesses in our internal control over financial reporting were identified at the
time of the First Restatement. Over the course of Second Restatement, we and D&T identified a
number of additional material weaknesses in our internal control over financial reporting. D&T
confirmed to the Audit Committee these material weaknesses, listed below, on January 10, 2005:  
    
    lack of compliance with written Nortel Networks procedures for monitoring and adjusting
balances related to certain accruals and provisions, including restructuring charges and
contract and customer accruals;
    
    lack of compliance with Nortel Networks procedures for applying applicable GAAP to the
initial recording of certain liabilities, including those described in SFAS No. 5, and to
foreign currency translation as described in SFAS No. 52;
    
    lack of sufficient personnel with appropriate knowledge, experience and training in
U.S. GAAP and lack of sufficient analysis and documentation of the application of U.S.
GAAP to transactions, including but not limited to revenue transactions; 98




---



##### Table of Contents




    
    lack of a clear organization and accountability structure within the accounting
function, including insufficient review and supervision, combined with financial reporting
systems that are not integrated and which require extensive manual interventions;
    
    lack of sufficient awareness of, and timely and appropriate remediation of, internal
control issues by Nortel Networks personnel; and
    
    an inappropriate tone at the top, which contributed to the lack of a strong control
environment; as reported in the Independent Review Summary set forth in the Controls and
Procedures section of this report, there was a Management tone at the top that
conveyed the strong leadership message that earnings targets could be met through
application of accounting practices that finance managers knew or ought to have known were
not in compliance with U.S. GAAP and that questioning these practices was not acceptable. Upon completion of managements assessment of our internal control over financial reporting as at
December 31, 2004 pursuant to SOX 404, we currently expect to conclude that the first five of these
six material weaknesses continue to exist as at December 31, 2004, and we continue to identify,
develop and begin to implement remedial measures to address them. These material weaknesses, if not
fully addressed, could result in accounting errors such as those underlying the restatements of our
consolidated financial statements more fully discussed in
Developments in 2003 and 2004  Nortel
Networks Audit Committee Independent Review; restatements; related matters in the MD&A and
Controls and Procedures section of this report. While our Board of Directors has approved the
adoption of all of the recommendations for remedial measures contained in the Summary of Findings
and of Recommended Remedial Measures of the Independent Review in the Controls and Procedures
section of this report, and our management has adopted a number of measures to strengthen our
internal control over financial reporting and address the material weaknesses identified above, we
may be unable to address such material weaknesses in a timely manner, which could adversely impact
the accuracy and timeliness of future reports and filings we make with the SEC and OSC. In addition, starting with our fiscal year 2004 Annual Report on Form 10-K, we must comply with
Section 404(a) of the Sarbanes-Oxley Act of 2002, and the related SEC rules, which require
management to assess the effectiveness of our internal control over financial reporting annually
and to include in our Annual Report on Form 10-K a management report on that assessment, together
with an attestation by our independent registered public accounting firm. In light of the material
weaknesses identified in connection with the First Restatement and Second Restatement, our
management expects to conclude that our internal control over financial reporting as at December
31, 2004 is ineffective, and D&T has advised us that they expect their report on managements
assessment of internal control over financial reporting also to indicate that internal control over
financial reporting is ineffective. While we are implementing steps to ensure the effectiveness of
our internal control over financial reporting, failure to restore the effectiveness of our internal
control over financial reporting could continue to impact our ability to report our financial
condition and results of operations accurately and could have a material adverse effect on our
business, results of operations, financial condition and liquidity. The governing principles of the Independent Review for remedial measures may take time to
implement. As a result of the Independent Review, a number of significant remedial steps have been identified
as necessary to improve our process and procedures. These remedial steps may take time to
implement. In addition, the process of implementing the governing principles of the Independent
Review may be time consuming for our senior management and disrupt our business. The delayed filing of our Reports and related matters caused us to breach our public debt
indentures and seek waivers from EDC under the EDC Support Facility, which may affect our
liquidity. Continuing delays in filing certain of our Reports and related matters has resulted in
a breach of our public debt indentures and our obligations under the EDC Support Facility and it is
possible that the holders of our public debt will seek to accelerate the maturity of that debt and
EDC will not grant us additional waivers. As a result of the delayed filing of our Reports, we and NNC breached our obligations to deliver
the Reports to the trustees under our and NNCs public debt indentures. While continuing delays in
filing certain of our Reports will not result in an automatic event of default and acceleration of
the outstanding debt, if holders of 25% of the outstanding principal, amount of any relevant
series of debt securities provide notice of this non-compliance and we or NNC, as applicable, fail
to file and deliver the relevant Report within 90 days after the notice is provided, then the
trustee under the indenture or the holders will have the right to accelerate the maturity of the
relevant series of debt securities. While such notice could have been given any time after March
30, 2004, neither we nor NNC has received a notice as of the date of this report. If the required
percentage of holders under one series of debt securities were to give such a notice and, after the
90 day cure period expired, were to accelerate the maturity of such series of debt securities, then
the principal amount of each other series of debt securities 99




---



##### Table of Contents



could, upon 10 days notice, be
accelerated without the lapse of an additional 90 day cure period.If an acceleration of our debt
securities were to occur, we may be unable to meet our payment obligations. Based on publicly available information, we have reason to believe that more than 25% of the
outstanding principal amount of the $150 of 7.875% notes due June 2026 issued by one of our
subsidiaries and guaranteed by NNC are held by one holder, or a group of related holders. Other
than with respect to that series of debt securities, based on such publicly available information,
neither we nor NNC are aware of any holder, or group of related holders, that holds at least 25% of
the outstanding principal amount of any relevant series of debt securities. However, based on such
publicly available information, we have reason to believe that there is sufficient concentration
among holders of the $150 of 7.40% notes due June 2006 issued by us that the acquisition of a
relatively small additional amount of these notes by certain holders could result in a holder or a
group of related holders holding 25% or more of the outstanding principal amount of these notes.
See Liquidity and capital resources. As a result of the delayed filing of our Reports and the Related Breaches, we were also required to
seek waivers from EDC under the EDC Support Facility. Our continuing delays in filing certain of
our Reports will require us to seek an additional waiver from EDC. EDC may not grant an additional
waiver and the terms of such a waiver may be unfavorable. If we do not obtain an additional waiver
from EDC, EDC would have the right to terminate the EDC Support Facility, require cash collateral,
or exercise its rights against the collateral pledged under the related security agreements. In
addition, the Related Breaches will continue beyond the filing of the Reports. Accordingly, EDC
has the right absent a further waiver of the Related Breaches to terminate or suspend the EDC
Support Facility notwithstanding the filing of the Reports. While we are seeking a permanent
waiver from EDC in connection with the Related Breaches, there can be no assurance that we will
receive such waiver, or any waiver or as to the terms of any such waiver. Any future delay in the filing of our periodic reports with the SEC would similarly result in a
breach of our public debt indentures and require us to seek additional waivers from EDC under the
EDC Support Facility, which could reduce our access to the EDC Support Facility and may adversely
affect our liquidity. Our credit ratings have been downgraded, we are currently unable to access our shelf registration
statement filed with the SEC and we terminated the Five Year Facilities, each of which may
adversely affect our liquidity. On April 28, 2004, S&P downgraded its ratings of us, including its long-term corporate credit
rating from B to B- and its preferred share rating from CCC to CCC-. At the same time, it
revised its outlook to developing from negative. Moodys current long-term debt rating for us is
B3 and its preferred share rating is Caa3. On April 28, 2004, Moodys changed its outlook to
potential downgrade from uncertain. These ratings are below investment grade. Our credit ratings
could be lowered or rating agencies could issue adverse commentaries in the future, which could
have a material adverse effect on our business, results of operations, financial condition and
liquidity. These ratings and our current credit condition affect, among other things, our ability
to raise debt, access the commercial paper market (which is currently closed to us),
engage in alternative financing arrangements, and affect our ability, and the cost to securitize
receivables, obtain customer bid, performance-related and other bonds and contracts, access the EDC
Support Facility and/or enter into normal course derivative or hedging transactions and also affect
the price of our stock. As a result of a ratings downgrade in 2002, security agreements became effective under which
substantially all of our assets located in the U.S. and Canada and those of most of our U.S. and
Canadian subsidiaries, including the shares of certain of our U.S. and Canadian subsidiaries, were
pledged. In addition, certain of our wholly owned subsidiaries have guaranteed our obligations
under the EDC Support Facility and our and NNCs outstanding debt securities. These agreements
will continue to secure the EDC Support Facility and our and NNCs outstanding public debt until
the EDC Support Facility expires, alternative collateral is provided, alternative arrangements are
made, or our public debt ratings return to at least BBB (stable outlook) by S&P and Baa2 (stable
outlook) by Moodys. The continued existence of these security arrangements may adversely affect
our ability to incur additional debt or obtain alternative financing arrangements. In addition,
EDC is not obligated to make any support available under the EDC Support Facility if our senior
long-term rating by Moodys is downgraded to less than B3 or if its debt rating by S&P is
downgraded to less than B-. In addition, in April 2004, we terminated the Five Year Facilities. Absent this termination, the
banks would have been permitted, upon 30 days notice, to terminate their commitments under the
Five Year Facilities as a result of our failure to file our 2003 Annual Report on Form 10-K by
April 29, 2004. Although the Five Year Facilities were undrawn at termination, this termination
may adversely affect our liquidity. 100




---



##### Table of Contents



Further, the delayed filing of the Reports has resulted in our inability to use, in its current
form, the remaining approximately $800 of capacity under our shelf registration statement filed
with the SEC for various types of securities. As a result, our ability to access the capital
markets is constrained, which may adversely affect our liquidity. The delay in filing certain of our Reports could cause the Toronto Stock Exchange and/or the New
York Stock Exchange to commence suspension or delisting procedures in respect of Nortel Networks
Corporation common shares or other of our or NNCs listed securities. Although we have cured breaches of the TSXs and NYSEs continued listing requirements caused by
the delayed filing of our and NNCs 2003 Annual Reports, the delayed filing of certain of our
Reports causes us to continue to be in breach of these listing requirements. Although each of the
NYSE and TSX has verbally confirmed that it has not commenced, nor has any intention of commencing,
any suspension or delisting procedures in respect of our and NNCs listed securities at the date of
this report, the commencement of any suspension or delisting procedures by either exchange remains,
at all times, at the discretion of such exchange and would be publicly announced by the exchange.
Pending the filing of our and NNCs 2003 Annual Reports, the NYSE had permitted our and NNCs
listed securities to continue to be traded on the exchange for the three month period ended March
31, 2005. In exercising the discretion relating to the grant of that additional three month period
and the continued listing of our and NNCs securities in light of the delayed filing of certain of
our Reports, the NYSEs procedures provide that the NYSE would consider, among other things, the
likelihood of the relevant Reports being filed, our and NNCs general financial status and the
frequency and detail of our and NNCs ongoing disclosures to the market on the status of such
filings. If a suspension or delisting were to occur, there would be significantly less liquidity in the
suspended or delisted securities. In addition, our ability to raise additional necessary capital
through equity or debt financing, and attract and retain personnel by means of equity compensation,
would be greatly impaired. Furthermore, with respect to any suspended or delisted securities, we
would expect decreases in institutional and other investor demand, analyst coverage, market making
activity and information available concerning trading prices and volume, and fewer broker-dealers
would be willing to execute trades with respect to such securities. A suspension or delisting would
likely decrease the attractiveness of Nortel Networks Corporation common shares or other listed
securities of Nortel Networks Corporation and NNL to investors and cause the trading volume of
Nortel Network Corporation common shares or other listed securities of Nortel Networks Corporation
and NNL to decline, which could result in a decline in the market price of such securities. Continuing negative publicity may adversely affect our business. As a result of the First Restatement and Second Restatement, we have been the subject of continuing
negative publicity. This negative publicity has contributed to significant declines in the prices
of our publicly traded securities. This negative publicity may have an effect on the terms under
which some customers and suppliers are willing to continue to do business with us and could affect
our financial performance or financial condition. We also believe that many of our employees are
operating under stressful conditions, which reduce morale and could lead to increased employee
turnover. Continuing negative publicity could have a material adverse effect on our business. As a result of the delay in the filing of our 2003 Annual Report (containing our audited
consolidated financial statements for the year ended December 31, 2003), we were required to apply
to the Ontario Superior Court of Justice for an order permitting the postponement of our 2004
Annual Shareholders Meeting. The Ontario Superior Court of Justice granted that order, which
permitted us to extend the time for calling the meeting to a date not later than December 31, 2004,
or such later date as the Court may permit. As a result of the continued delay in the filing of
our 2003 Annual Report, in October 2004 we announced that we intended to seek a further order
extending the time for calling the meeting to a date no later than March 31, 2005, which order the
Court granted on December 10, 2004. A further extension to a date no later than May 31, 2005 was
obtained from the Court on December 21, 2004 to permit us to comply with a specific SEC rule which
would require us, in our circumstances, to provide to shareholders our 2004 audited financial
statements either prior to or concurrently with the mailing of proxy materials for the Meeting.
This postponement has, among other things, contributed to the continuing negative publicity related
to us, which may adversely affect our business. We may not be able to attract or retain the personnel necessary to achieve our business objectives. Competition for certain key positions and specialized technical personnel in the high-technology
industry remains strong. Our future success depends in part on our continued ability to hire,
assimilate in a timely manner and retain qualified personnel, particularly in key senior management
positions and in our key areas of potential growth. An important factor in attracting and
retaining qualified employees is our ability to provide employees with the opportunity to
participate in the potential growth of our business through programs such as stock option plans,
restricted stock unit plans and employee 101




---



##### Table of Contents



investment and share purchase plans. The scope and value
of these programs will be adversely affected by the volatility or negative performance of the
market price for our common shares. In connection with the delay in filing our 2003 Annual Reports, as of March 10, 2004, NNC suspended
the purchase of Nortel Networks Corporation common shares under the stock purchase plans for
eligible employees in eligible countries that facilitate the acquisition of Nortel Networks
Corporation common shares; the exercise of outstanding options granted under the 2000 Plan, or the
1986 Plan, or the grant of any additional options under those plans, or the exercise of outstanding
options granted under employee stock option plans previously assumed by us in connection with
mergers and acquisitions; and the purchase of units in Nortel Networks stock fund or purchase of
Nortel Networks Corporation common shares under our defined contribution and investments plans
until such time as, at the earliest, we are in compliance with U.S. and Canadian regulatory
securities filing requirements. On May 31, 2004, the OSC issued a final order prohibiting all
trading by our directors, officers and certain current and former employees in our securities and
those of Nortel Networks Corporation. This order will remain in effect until two full business
days following the receipt by the OSC of all filings required to be made by us and NNC pursuant to
Ontario securities law. Accordingly, our ability to provide employees with the opportunity to
participate in Nortel Networks stock option plans, restricted stock unit plans and employee
investment and share purchase plans has been adversely affected and certain employees have not been
able to trade in our securities. The current suspension of these programs and OSC trading order,
and any future suspension or OSC order, may have a material adverse effect on our ability to hire,
assimilate in a timely manner and retain qualified personnel. In addition, in 2004 we terminated for cause our former president and chief executive officer,
former chief financial officer, former controller and seven additional individuals with significant
responsibilities for financial reporting. In August and September 2004, as part of our new
strategic plan, we announced an anticipated workforce reduction of approximately 3,250 employees.
Approximately 64% of employee actions related to the focused workforce reduction were completed by
the end of 2004, including approximately 55% that were notified of termination or acceptance of
voluntary retirement, with the remainder comprised of voluntary attrition of employees that were
not replaced. The remainder of employee actions are expected to be completed by June 30, 2005. In
addition, in 2001, 2002 and 2003, we implemented a company-wide restructuring plan, which included
a reduction of approximately two-thirds of our workforce over the three-year period. We may find it more difficult to attract or retain qualified employees because of our recent
significant workforce reductions, business performance, management changes, restatement activities
and resulting negative publicity and the resulting impacts on our incentive programs and incentive
compensation plans. If we have not properly sized our workforce and retained those employees with
the appropriate skills, our ability to compete effectively may be adversely affected. We are also
more dependent on those employees we have retained, as many have taken on increased
responsibilities due to workforce reductions. If we are not successful in attracting, recruiting
or retaining qualified employees, including members of senior management, we may not have the
personnel necessary to achieve our business objectives, including the implementation of our
remedial measures. Ongoing SEC review may require us to amend our public disclosures further. We have received comments on our periodic filings from the staff of the SECs Division of
Corporation Finance. As part of this comment process, we may receive further comments from the
staff of the SEC relating to this Annual Report on Form 10-K and our other periodic filings. As a
result, we may be required by the SEC to amend this Form 10-K or other reports filed with the SEC
in order to make adjustments or additional disclosures. However, we do not believe that it will be
feasible to amend our 2002 Form 10-K/A or 2003 Form 10-Qs due to, among other factors, the
identified material weaknesses in our internal control over financial reporting, the significant
turnover in our finance personnel, changes in accounting systems, documentation weaknesses, a
likely inability to obtain third party corroboration in certain cases due to the substantial
industry adjustment in recent years and the passage of time generally. Amendments to our prior
filings would be required for us to be in full compliance with our Exchange Act reporting
obligations. 
 Risks relating to our business We continue to restructure our business to respond to industry and market conditions. The
assumptions underlying our restructuring efforts may prove to be inaccurate and we may have to
restructure our business again in the future. We continue to restructure our business to realign resources and achieve desired cost savings in an
increasingly competitive market. Our new strategic plan includes an anticipated further workforce
reduction of approximately 3,250 employees. We have based our restructuring efforts on certain
assumptions regarding the cost structure of our business. Our current 102




---



##### Table of Contents



assumptions may or may not
be correct and as a result, we may determine that further restructuring in the future will be
needed. Our restructuring efforts may not be sufficient for us to achieve improved results and
meet the changes in industry and market conditions, including increased competition. In
particular, we face increased competition from low cost competitors such as Huawei Technologies
Co., Ltd. and ZTE Corporation. We must manage the potentially higher growth areas of our business,
as well as the non-core areas, in order for us to achieve improved results. We have made, and will continue to make, judgments as to whether we should further reduce our
workforce or exit, or dispose of, certain businesses. These workforce reductions may impair our
ability to achieve our current or future business objectives. Costs incurred in connection with
restructuring efforts may be higher than estimated. Any decision by management to further limit
investment or exit, or dispose of, businesses may result in the recording of additional charges.
As a result, the costs actually incurred in connection with the restructuring efforts may be higher
than originally planned and may not lead to the anticipated cost savings and/or improved results. As part of our review of restructured businesses, we look at the recoverability of their tangible
and intangible assets. Future market conditions may trigger further write downs of these assets
due to uncertainties in:  
    
    the estimates and assumptions used in asset valuations, which are based on our
forecasts of future business performance; and
    
    accounting estimates related to the useful life and recoverability of the net
book value of these assets, including inventory, goodwill, net deferred taxes and other
intangible assets. We will continue to review our restructuring work plan based on our ongoing assessment of the
industry and the business environment. Our operating results have historically been subject to yearly and quarterly fluctuations and are
expected to continue to fluctuate. Our operating results have historically been, and are expected to continue to be, subject to
quarterly and yearly fluctuations as a result of a number of factors. These factors include:  
    
    our ability to execute our strategic plan, including the planned workforce
reductions, without negatively impacting our relationships with our customers, the delivery
of products based on new and developing technologies at competitive prices, the
effectiveness of our internal processes and organizations and the retention of qualified
personnel;
    
    our ability to focus on the day-to-day operation of our business while
implementing improvements in our internal controls and procedures, including our accounting
systems, and addressing the civil litigation actions and investigations related to our
restatements;
    
    our ability to successfully implement programs to stimulate customer spending
by anticipating and offering the kinds of products and services customers will require in
the future to increase the efficiency and profitability of their networks;
    
    our ability to successfully complete programs on a timely basis to reduce our
cost structure, including fixed costs, to streamline our operations and to reduce product
costs;
    
    our ability to successfully comply with increased and complex regulations;
    
    our ability to focus our business on what we believe to be potentially higher
growth, higher margin businesses and to dispose of or exit non-core businesses;
    
    increased price and product competition in the networking industry, including
from low cost competitors;
    
    the inherent uncertainties of using forecasts, estimates and assumptions for
asset valuations and in determining the amounts of accrued liabilities, provisions and
other items in our consolidated financial statements;
    
    the impact of changes in global capital markets and interest rates on our pension plan assets and obligations;
    
    fluctuations in our gross margins;
    
    the development, introduction and market acceptance of new technologies, and
integrated networking solutions, as well as the adoption of new networking standards;
    
    the overall trend toward industry consolidation and rationalization among our
customers, competitors and suppliers;
    
    our ability to make investments, including acquisitions to strengthen our business;
    
    the ability of our customers and suppliers to obtain financing to fund capital expenditures; 103




---



##### Table of Contents




    
    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; and
    
    the impact of our product development schedules, product quality variances,
manufacturing capacity and lead times required to produce our products; and the impact of
higher insurance premiums and deductibles and greater limitations on insurance coverage. Our decision to adopt fair value accounting for employee stock options on a prospective basis as of
January 1, 2003 has caused us to record an expense over the stock option vesting period, based on
the fair value at the date the options are granted, and could have a significant negative effect on
our reported results. Additionally, we are required to perform goodwill impairment tests on an annual basis and between
annual tests in certain circumstances, to value our deferred tax assets and to accrue unfunded
pension liabilities, each of which may result in a negative effect on our reported results. We enter into agreements that may require us to make certain indemnification payments to third
parties in the event of certain changes in an underlying economic characteristic related to assets,
liabilities or equity securities of such third parties. The occurrence of events that may cause us
to become liable to make an indemnification payment is not within our control and an obligation to
make a significant indemnification payment under such agreements could have a significant negative
effect on our reported results. As a consequence, operating results for a particular future period are difficult to predict, and
therefore, prior results are not necessarily indicative of results to be expected in future
periods. Any of the foregoing factors, or any other factors described herein, could have a
material adverse effect on our business, results of operations and financial condition. Global economic conditions and other trends and factors affecting the telecommunications industry
are beyond our control and may result in reduced demand and pricing pressure on our products. There are trends and factors affecting the industry that are beyond our control and may affect our
operations. These trends and factors include:  
    
    adverse changes in the public and private equity and debt markets and our
ability, as well as the ability of our customers and suppliers, to obtain financing or to
fund working capital and capital expenditures;
    
    adverse changes in the credit quality of our customers and suppliers;
    
    adverse changes in the market conditions in our industry and the specific markets for our products;
    
    the trend towards the sale of converged networking solutions, which could lead
to reduced capital spending on multiple networks by our customers;
    
    visibility to, and the actual size and timing of, capital expenditures by our customers;
    
    inventory practices, including the timing of product and service deployment, of our customers;
    
    the amount of network capacity and the network capacity utilization rates of
our customers, and the amount of sharing and/or acquisition of new and/or existing network
capacity by our customers;
    
    policies of our customers regarding utilization of single or multiple vendors
for the products they purchase;
    
    the overall trend toward industry consolidation and rationalization among our
customers, competitors and suppliers;
    
    conditions in the broader market for communications products, including data
networking products and computerized information access equipment and services;
    
    increased price competition, particularly from low cost competitors;
    
    changes in legislation or accounting rules and governmental and environmental
regulation or intervention affecting communications or data networking;
    
    computer viruses, break-ins and similar disruptions from unauthorized
tampering with our computer systems; and
    
    acts of war or terrorism that could lead to disruptions in general global
economic activity, changes in logistics and security arrangements and reduced customer
demand for our products and services. Cautious capital spending in our industry has affected, and could affect, demand for, or pricing
pressures on, our products. 104




---



##### Table of Contents



Our gross margins may decline, which would reduce our operating results. Our gross margins may be negatively affected as a result of a number of factors, including:  
    
    increased price competition, particularly from low cost competitors;
    
    changes in product and geographic mix;
    
    customer and contract settlement costs;
    
    higher product, material or labor costs;
    
    increased inventory provisions or contract and customer settlement costs;
    
    warranty costs;
    
    obsolescence charges;
    
    loss of cost savings on future inventory purchases as a result of high inventory levels;
    
    introduction of new products and costs of entering new markets;
    
    increased levels of customer services;
    
    changes in distribution channels;
    
    excess capacity or excess fixed assets;
    
    accruals for employee incentive bonuses;
    
    further restructuring costs; and
    
    costs related to our restatements, including the possibility of substantial
fines, settlements and/or damages or other penalties, and/or remedial actions. Lower than expected gross margins would negatively affect our operating results. Cash flow fluctuations may affect our ability to fund our working capital requirements or achieve
our business objectives in a timely manner. Additional sources of funds may not be available or
may not be available on acceptable terms. Our working capital requirements and cash flows historically have been, and are expected to
continue to be, subject to quarterly and yearly fluctuations, depending on such factors as timing
and size of capital expenditures, levels of sales, timing of deliveries and collection of
receivables, inventory levels, customer payment terms, customer financing obligations and supplier
terms and conditions. In addition, if the industry or our current condition deteriorates,
notwithstanding the EDC Support Facility, an increased portion of our cash and cash equivalents may
be restricted as cash collateral for customer performance bonds and contracts. We believe our cash
on hand will be sufficient to fund our current business model, manage our investments and meet our
customer commitments for at least the next 12 months. In making this estimate, we have not made
provision for any material payments in connection with our pending civil litigation actions and
investigations related to
the First Restatement and Second Restatement, other than our anticipated professional fees and
expenses. Any material adverse legal judgments, fines, penalties or settlements arising from these
pending civil litigation actions and investigations could require additional funding which may not
be available on commercially reasonable terms, or at all. This could have a material adverse
effect on our liquidity, which could be very significant. In addition, a greater than expected slow down in capital spending by service providers and other
customers may require us to adjust our current business model. As a result, our revenues and cash
flows may be materially lower than we expect and we may be required to further reduce our capital
expenditures and investments or take other measures in order to meet our cash requirements. We may seek additional funds from liquidity-generating transactions and other sources of external
financing (which may include a variety of debt, convertible debt and/or equity financings). We
cannot provide any assurance that our net cash requirements will be as we currently expect, that we
will continue to have access to the EDC Support Facility when and as needed, or that
liquidity-generating transactions or financings will be available to us on acceptable terms or at
all. Our inability to manage cash flow fluctuations resulting from the above factors and the
potential reduction, expiry or termination of the EDC Support Facility could have a material
adverse effect on our ability to fund our working capital requirements from operating cash flows
and other sources of liquidity or to achieve our business objectives in a timely manner. 105




---



##### Table of Contents



We may be materially and adversely affected by cautious capital spending by our customers. The
loss of customers in certain markets could have a material adverse effect on our business, results
of operations and financial condition. We expect that our consolidated revenues in 2004 will be slightly lower compared to 2003. The 2003
consolidated revenues included revenues that were deferred from prior periods. Continued
cautiousness in capital spending by service providers and other customers may affect our revenues
more than we currently expect. Our revenues and operating results have been and may continue to be
materially and adversely affected by the continued cautiousness in capital spending by our
customers. We have focused on the larger customers in certain markets, which provide a substantial
portion of our revenues. A reduction or delay in business from one or more of these customers, or
a failure to achieve a significant market share with these customers, could have a material adverse
effect on our business, results of operations and financial condition. Our business may be materially and adversely affected by our high level of debt. In order to finance our business, we have incurred significant levels of debt compared to
historical levels, and we may need to 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 covenants in
the EDC Support Facility and any significant reduction in, or access to, such facility, poor
business performance or lower than expected cash inflows could materially and adversely affect our
ability to fund the operation of our business. Other effects of a high level of debt include the following:  
    
    we may have difficulty borrowing money in the future or accessing other sources of funding;
    
    we may need to use a large portion of our cash flow from operations to pay
principal and interest on our indebtedness, which would reduce the amount of cash available
to finance our operations and other business activities;
    
    a high debt level, arduous or restrictive terms and conditions, or lower than
expected cash flows would make us more vulnerable to economic downturns and adverse
developments in our business; and
    
    if operating cash flows are not sufficient to meet our operating expenses,
capital expenditures and debt service requirements as they become due, we may be required,
in order to meet our debt service obligations, to delay or reduce capital expenditures or
the introduction of new products, sell assets and/or forego business opportunities
including acquisitions, research and development projects or product design enhancements. An increased portion of our cash and cash equivalents may be restricted as cash collateral if we
are unable to secure alternative support for certain obligations arising out of our normal course
business activities. The EDC Support Facility may not provide all the support we require for certain of our obligations
arising out of our normal course of business activities. In particular, although this facility
provides for up to $750 in support, the $300 revolving small bond sub-facility will not become
committed support until all of the Reports are filed and we obtain a permanent waiver of the
Related Breaches. As of December 31, 2004, there was approximately $296 of outstanding support
utilized under the
EDC Support Facility, approximately $212 of which was outstanding under the small bond
sub-facility. In addition, bid and performance related bonds with terms that extend beyond
December 31, 2006, which, absent any early termination of the EDC Support Facility, is the expiry
date of this facility, are currently not eligible for the support provided by the EDC Support
Facility. Given that the EDC Support Facility is used to support bid and performance bonds with
varying terms, including those with at least 365 days, we may need to increase our use of cash
collateral to support these obligations beginning on January 1, 2006 absent a further extension of
the facility. Unless EDC agrees to extend the facility or agrees to provide support outside the
scope of the facility, we may be required to provide cash collateral to support these obligations.
We cannot provide any assurance that we will reach an agreement with EDC on these matters. Under
the terms of the waiver letter with EDC dated March 29, 2004, EDC may also suspend its obligation
to issue us any additional support if events occur that have a material adverse effect on our
business, financial position or results of operations. If we do not have access to sufficient
support under the EDC Support Facility, and if we are unable to secure alternative support, an
increased portion of our cash and cash equivalents may be restricted as cash collateral, which
could adversely affect our ability to fund some of our normal course business activities, capital
expenditures, R&D and our ability to borrow in the future. An inability of our subsidiaries to provide us with funding in sufficient amounts could adversely
affect our ability to meet our obligations. We may at times depend primarily on loans, dividends or other forms of financing from our
subsidiaries to meet our obligations to pay interest and principal on outstanding public debt and
to pay corporate expenses. If our subsidiaries are unable to pay dividends or provide us with
loans or other forms of financing in sufficient amounts, it could adversely affect our ability to
meet our obligations. 106




---



##### Table of Contents



We may need to make larger contributions to our defined benefit plans in the future. We currently maintain various defined benefit plans in North America and the U.K. which cover
various categories of employees and retirees, which represent our major retirement plans. In
addition, we have smaller retirement plans in other countries. Our obligations to make
contributions to fund benefit obligations under these plans are based on actuarial valuations,
which themselves are based on certain assumptions about the long-term operation of the plans,
including employee turnover and retirement rates, the performance of the financial markets and
interest rates. If experience differs from the assumptions, the amounts we are obligated to
contribute to the plans may increase. In particular, the performance of the financial markets is
difficult to predict, particularly in periods of high volatility in the equity markets. If the
financial markets perform lower than the assumptions, we may have to make larger contributions in
the future than we would otherwise have to make and expenses related to defined benefit plans could
increase. Similarly, changes in interest rates can impact our contribution requirements. In a low
interest rate environment, the likelihood of required contributions in the future increases. If
interest rates are lower in the future than we assume they will be, then we would probably be
required to make larger contributions than we would otherwise have to make. In addition, the 2004 decision of the Supreme Court of Canada in Monsanto Canada Inc. v.
Superintendent of Financial Services has caused companies in Canada that sponsor defined benefit
plans, including us, to review certain of our past activities that may have triggered partial
wind-ups of such plans to determine whether a distribution of plan surplus, if any, should have
occurred at the time of any triggering event. Although the full impact of the decision remains
unclear and we have not yet made any determination regarding our plans, if it is determined that a
distribution of plan surplus should have occurred at the time of any triggering event, we may be
required to make a distribution out of our plan assets, which may lead to an increase in the amount
of future contributions that we are required to make. If market conditions deteriorate or future results of operations are less than expected, an
additional valuation allowance may be required for all or a portion of our deferred tax assets. We currently have deferred tax assets, which may be used to reduce taxable income in the future.
We assess the realization of these deferred tax assets quarterly, and if we determine that it is
more likely than not that some portion of these assets will not be realized, an income tax
valuation allowance is recorded. Our valuation allowance is primarily attributable to continued
uncertainty in the industry. If market conditions deteriorate or future results of operations are
less than expected, future assessments may result in a determination that it is more likely than
not that some or all of our net deferred tax assets are not realizable. As a result, we may need
to establish an additional valuation allowance for all or a portion of our net deferred tax assets,
which may have a material adverse effect on our business, results of operations and financial
condition. Our performance may be materially and adversely affected if our expectations regarding market
demand for particular products prove to be wrong. We expect that data communications traffic will grow at a faster rate than the growth expected for
voice traffic and that the use of the Internet will continue to increase. We expect the growth of
data traffic and the use of the Internet will significantly impact traditional voice networks, both
wireline and wireless. We believe that this will create market discontinuities, which will make
traditional voice network products and services less effective as they were not designed for data
traffic. We believe that these market discontinuities in turn will lead to the convergence of data
and voice through upgrades of traditional voice networks to transport large volumes of data traffic
or through the construction of new networks designed to transport both voice and data traffic.
Either approach would require significant capital expenditures by service providers. We also
believe that such developments will give rise to the demand for IP optimized networking solutions,
and third generation, or 3G, wireless networks. We cannot be sure what the rate of this convergence of voice and data networks will be, due to the
dynamic and rapidly evolving nature of the communications business, the technology involved and the
availability of capital. Consequently, market discontinuities and the resulting demand for
IP-optimized networking solutions or 3G wireless networks may not continue. Alternatively, the
pace of that development may be slower than currently anticipated. The market may also develop in
an unforeseen direction. Certain events, including the commercial availability and actual
implementation of new technologies, including 3G networks, or the evolution of other technologies,
may occur, which would affect the extent or timing of anticipated market demand, or increase demand
for products based on other technologies, or reduce the demand for IP-optimized networking
solutions or 3G wireless networks. Any such change in demand may reduce purchases of our
networking solutions by our customers, require increased expenditures to develop and market
different technologies, or provide market opportunities for our competitors. Our performance may
also be materially and adversely affected by a lack 107




---



##### Table of Contents



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. If we are not successful in
operating or integrating these acquisitions, our business, results of operations and financial
condition may be materially and adversely affected. In the past, we acquired companies that we believed would enhance the expansion of our business and
products. We may make selective opportunistic acquisitions of companies or businesses with
resources and product or service offerings capable of providing us with additional product and/or
market strengths. Acquisitions involve significant risks and uncertainties, including:  
    
    the industry may develop in a different direction than anticipated and the
technologies we acquire may not prove to be those we need;
    
    the future valuations of acquired businesses may decrease from the market
price we paid for these acquisitions;
    
    the revenues of acquired businesses may not offset increased operating
expenses associated with these acquisitions;
    
    potential difficulties in completing in-process research and development
projects and delivering high quality products to our customers;
    
    potential difficulties in integrating new products, software, businesses and
operations in an efficient and effective manner;
    
    our customers or customers of the acquired businesses may defer purchase
decisions as they evaluate the impact of the acquisitions on our future product strategy;
    
    potential loss of key employees of the acquired businesses;
    
    diversion of the attention of our senior management from the operation of our daily business;
    
    entering new markets in which we have limited experience and where competitors
may have a stronger market presence; and
    
    potential assumption of liabilities. Our inability to successfully operate and integrate newly acquired businesses appropriately,
effectively and in a timely manner could have a material adverse effect on our ability to take
advantage of further growth in demand for IP-optimized network solutions and other advances in
technology, as well as on our revenues, gross margins and expenses. Acquisitions are inherently risky, and no assurance can be given that our previous or future
acquisitions will be successful and will not materially adversely affect our business, operating
results, or financial condition. Failure to manage and successfully integrate acquisitions could
materially harm our business and operating results. We operate in highly dynamic and volatile industries characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions and short product
life cycles. The markets for our products are characterized by rapidly changing technologies, evolving industry
standards, frequent new product introductions and short product life cycles. Our success depends,
in substantial part, on the timely and successful introduction of high quality new products and
upgrades, as well as cost reductions on current products to address the operational speed,
bandwidth, efficiency and cost requirements of our customers. Our success will also depend on our
ability to comply with emerging industry standards, to operate with products of other suppliers, to
integrate, simplify and reduce the number of software programs used in our portfolio of products,
to address emerging market trends, to provide our customers with new revenue-generating
opportunities and to compete with technological and product developments carried out by others.
The development of new, technologically advanced products, including IP-optimized networking
solutions, software products and 3G wireless networks, is a complex and uncertain process requiring
high levels of innovation, as well as the accurate anticipation of technological and market trends.
Investments in this development may result in our expenses growing at a faster rate than our
revenues, particularly since the initial investment to bring a product to market may be high. We
may not be successful in targeting new market opportunities, in developing and commercializing new
products in a timely manner or in achieving market acceptance for our new products. The success of new or enhanced products, including IP-optimized networking solutions and 3G
wireless networks, depends on a number of other factors, including the timely introduction of those
products, market acceptance of new technologies and industry standards, the quality and robustness
of new or enhanced products, competing product offerings, the pricing and 108




---



##### Table of Contents



marketing of those
products and the availability of funding for those networks. Products and technologies developed
by our competitors may render our products obsolete. Hackers may attempt to disrupt or exploit our
customers use of our technologies. If we fail to respond in a timely and effective manner to
unanticipated changes in one or more of the technologies affecting telecommunications and data
networking or our new products or product enhancements fail to achieve market acceptance, our
ability to compete effectively in our industry, and our sales, market share and customer
relationships could be materially and adversely affected. In addition, unanticipated changes in market demand for products based on a specific technology,
particularly lower than anticipated, or delays in, demand for IP-optimized networking solutions,
particularly long-haul and metro optical networking solutions, or 3G wireless networks, could have
a material adverse effect on our business, results of operations and financial condition if we fail
to respond to those changes in a timely and effective manner. We face significant competition and may not be able to maintain our market share and may suffer
from competitive pricing practices. We operate in a highly volatile industry that is characterized by industry rationalization and
consolidation, vigorous competition for market share and rapid technological development.
Competition is heightened in periods of slow overall market growth. These factors could result in
aggressive pricing practices and growing competition from smaller niche companies, established
competitors, as well as well-capitalized computer systems and communications companies, which, in
turn, could have a material adverse effect on our gross margins. Since some of the markets in which we compete are characterized by the potential for rapid growth
and, in certain cases, low barriers to entry and rapid technological changes, smaller, specialized
companies and start-up ventures are now, or may in the future become, principal competitors. We
may also face competition from the resale of used telecommunications equipment, including our own
on occasion, by failed, downsized or consolidated high technology enterprises and
telecommunications service providers. In addition, we face the risk that certain of our
competitors may enter into additional business combinations, accelerate product development, or
engage in aggressive price reductions or other competitive practices, which make them more powerful
or aggressive competitors. We expect that we will face additional competition from existing competitors and from a number of
companies that have entered or may enter our existing and future markets. In particular, we
currently, and may in the future, face increased competition from low cost competitors such as
Huawei Technologies Co., Ltd. and ZTE Corporation. Some of our current and potential competitors
have greater marketing, technical and financial resources, including access to capital markets
and/or the ability to provide customer financing in connection with the sale of products. Many of
our current and potential competitors have also established, or may in the future establish,
relationships with our current and potential customers. Other competitive factors include the
ability to provide new technologies and products, end-to-end networking solutions, and new product
features, such as security, as well as conformance to industry standards. Increased competition
could result in
price reductions, negatively affecting our operating results, reducing profit margins and could
potentially lead to a loss of market share. For a list of our principal competitors, see Competition in each of the business segment
descriptions in the Business section of this report. We face certain barriers in our efforts to expand internationally. We intend to continue to pursue international and emerging market growth opportunities. In many
international markets, long-standing relationships between potential customers and their local
suppliers and protective regulations, including local content requirements and type approvals,
create barriers to entry. In addition, pursuing international opportunities may require
significant investments for an extended period before returns on such investments, if any, are
realized and such investments may result in expenses growing at a faster rate than revenues.
Furthermore, those projects and investments could be adversely affected by:  
    
    reversals or delays in the opening of foreign markets to new competitors;
    
    trade protection measures;
    
    exchange controls;
    
    currency fluctuations;
    
    investment policies; 109




---



##### Table of Contents




    
    restrictions on repatriation of cash;
    
    nationalization of local industry;
    
    economic, social and political risks;
    
    taxation;
    
    interest rates;
    
    challenges in staffing and managing international opportunities;
    
    other factors, depending on the country involved; and
    
    acts of war or terrorism. Difficulties in foreign financial markets and economies and of foreign financial institutions,
particularly in emerging markets, could adversely affect demand from customers in the affected
countries. An inability to maintain or expand our business in international and emerging markets
could have a material adverse effect on our business, results of operations and financial
condition. Fluctuations in foreign currency exchange rates could negatively impact our business, results of
operations and financial condition. As an increasing proportion of our business may be denominated in currencies other than U.S.
dollars, fluctuations in foreign currency exchange rates may have an adverse impact on our
business, results of operations and financial condition. Our primary currency exposures are to
Canadian dollars, British pounds and the euro. These exposures may change over time as we change
the geographic mix of our global business and as our business practices evolve. For instance, if
we increase our presence in emerging markets, we may see an increase in our exposure to emerging
market currencies, such as, for example, the Indian rupee. These currencies may be affected by
internal factors and external developments in other countries. Also, our ability to enter into
normal course derivative or hedging transactions in the future may be impacted by our current
credit condition. We cannot predict whether foreign exchange losses will be incurred in the
future, and significant foreign exchange rate fluctuations may have a material adverse effect on
our business, results of operations and financial condition. If we fail to protect our intellectual property rights, or if we are subject to adverse judgments
or settlements arising out of disputes regarding intellectual property rights, our business,
results of operations and financial condition could be materially and adversely affected. Our industry is subject to uncertainty over adoption of industry standards and protection of
intellectual property rights. Our success is dependent on our proprietary technology, for the
protection of which we rely on patent, copyright, trademark and trade secret laws. Our business is
global and the level of protection of our proprietary technology provided by those laws varies by
jurisdiction. Our issued patents may be challenged, invalidated or circumvented, and our rights
under issued patents may not provide us with competitive advantages. Patents may not be issued
from pending applications, and claims in
patents issued in the future may not be sufficiently broad to protect our proprietary technology.
In addition, claims of intellectual property infringement or trade secret misappropriation may be
asserted against us or our customers in connection with their use of our products and the outcome
of any of those claims may be uncertain. An unfavorable outcome in such a claim could require us
to cease offering for sale the products that are the subject of such a claim, pay substantial
monetary damages to a third party and/or make ongoing royalty payments to a third party. In
addition, any defense of claims of intellectual property infringement or trade secret
misappropriation may require extensive participation by senior management and/or other key
employees and may reduce their time and ability to focus on other aspects of our business. A
failure by us to react to changing industry standards, the lack of broadly-accepted industry
standards, successful claims of intellectual property infringement or other intellectual property
claims against us or our customers, or a failure by us to protect our proprietary technology could
have a material adverse effect on our business, results of operations and financial condition. In
addition, if others infringe on our intellectual property rights, we may not be able to
successfully contest such challenges. Rationalization and consolidation in the industry may lead to increased competition and harm our
business. The industry has experienced consolidation and rationalization and we expect this trend to
continue. There have been adverse changes in the public and private equity and debt markets for
industry participants which have affected their ability to obtain financing or to fund capital
expenditures. Some operators have experienced financial difficulty and have, or may, file for
bankruptcy protection or be acquired by other operators. Other operators may merge and we and one
or more of our competitors may each supply products to the companies that have merged or will
merge. This rationalization and/or consolidation could result in our dependence on a smaller
number of customers, purchasing decision delays by the merged companies and/or our playing a lesser
role, or no longer playing a role, in the supply of communications products to the 110




---



##### Table of Contents



merged
companies. This rationalization and/or consolidation, including the acquisition by Cingular
Wireless of AT&T Wireless, could also cause increased competition among our customers and pressure
on the pricing of their products and services, which could cause further financial difficulties for
our customers. A rationalization of industry participants could also increase the supply of used
communications products for resale, resulting in increased competition and pressure on the pricing
for our new products. In addition, telecommunications equipment suppliers may enter into business
combinations, or may be acquired by or sell a substantial portion of their assets to other
competitors, resulting in accelerated product development, increased financial strength, or a
broader base of customers, creating even more powerful or aggressive competitors. We may also see
rationalization among equipment/component suppliers. The business failures of operators,
competitors or suppliers may cause uncertainty among investors and in the industry generally and
harm our business. Changes in regulation of the Internet and/or other aspects of the industry may affect the manner in
which we conduct our business and may materially and adversely affect our business, results of
operations and financial condition. Investment decisions of our customers could be affected by regulation of the Internet or other
aspects of the industry in any country where we operate. We could also be materially and adversely
affected by an increase in competition among equipment suppliers or by reduced capital spending by
our customers, as a result of a change in the regulation of the industry. If a jurisdiction in
which we operate adopts measures which affect the regulation of the Internet and/or other aspects
of the industry, we could experience both decreased demand for our products and increased costs of
selling such products. Changes in laws or regulations governing the Internet, Internet commerce
and/or other aspects of the industry could have a material adverse effect on our business, results
of operations and financial condition. In the U.S., on February 20, 2003, the FCC announced a decision in its triennial review proceeding
of the agencys rules regarding UNEs. The text of the FCCs order and reasons for the decision
were released on August 21, 2003. The uncertainty surrounding the impact of the FCC decision and
subsequent adoption on December 15, 2004 of new unbundling rules in response to the remand by the
U.S. Court of Appeals for the D.C. Circuit is affecting, and may continue to affect, the decisions
of certain of our U.S.-based service provider customers regarding investment in their
telecommunications infrastructure. These UNE rules and/or material changes in other
country-specific telecommunications or other regulations may affect capital spending by certain of
our service provider customers, which could have a material adverse effect on our business, results
of operations and financial condition. In Europe, we expect to become subject to new product content laws and product takeback and
recycling requirements that will require full compliance by 2006. We expect that these laws will
require us to incur additional compliance costs. Although compliance costs relating to
environmental matters have not resulted in a material adverse effect on our business, results of
operations and financial condition in the past, they may result in a material adverse effect in the
future. Industry concerns could continue and increase our exposure to our customers credit risk and the
risk that our customers will not be able to fulfill their payment obligations to us under customer
financing arrangements. The competitive environment in which we operate has required us in the past to provide significant
amounts of medium-term and long-term customer financing. Customer financing arrangements may
include financing in connection with the sale of our products and services, funding for certain
non-product and service costs associated with network installation and integration of our products
and services, financing for working capital and equity financing. While we have significantly
reduced our customer financing exposure, we expect we may continue in the future to provide
customer financing to customers in areas that are strategic to our core business activity. 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 111




---



##### Table of Contents



obligations do not reflect actual future financial conditions and customer payment
levels, we could incur losses in excess of our provisions, which could have a material adverse
effect on our cash flow and operating results. Negative developments associated with our supply contracts and contract manufacturing agreements
may materially and adversely affect our business, results of operations, financial condition and
supply relationships. We have entered into supply contracts with customers to provide products and services, which in
some cases involve new technologies currently being developed, or which we have not yet
commercially deployed, or which require us to build networks. Some of these supply contracts
contain delivery and installation timetables, performance criteria and other contractual
obligations which, if not met, could result in our having to pay substantial penalties or
liquidated damages and/or the termination of the supply contract. Unexpected developments in these
supply contracts could have a material adverse effect on our revenues, cash flows and relationships
with our customers. 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 substantially all of our
manufacturing capacity to contract manufacturers, including an agreement with Flextronics announced
on June 29, 2004 regarding the divestiture of certain of our manufacturing operations and related
activities. The transfer to Flextronics of our optical design operations and related assets in
Ottawa, Canada and Monkstown, Northern Ireland was completed in the fourth quarter of 2004. The
transfer of our manufacturing activities in Montreal, Canada is expected to be completed in the
first quarter of 2005. The balance of the divestiture is anticipated to close in the first half of
2005, subject to completion of the required information and consultation processes with the
relevant employee representatives. Upon the completion of the divestiture, a significant portion
of our supply chain will be concentrated with Flextronics. We work closely with our suppliers and
contract manufacturers to address quality issues and to meet increases in customer demand, when
needed, and we also manage our internal manufacturing capacity, quality, and inventory levels as
required. However, we may encounter shortages of quality components and/or products in the future.
In addition, our component suppliers and contract manufacturers have experienced, and may continue
to experience, a consolidation in the industry and financial difficulties, both of which may result
in fewer 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. Many of our current and planned products are highly complex and may contain defects or errors that
are detected only after deployment in telecommunications networks, which could harm our reputation. Our products are highly complex, and some of them can be fully tested only when deployed in
telecommunications networks or with other equipment. From time to time, our products have
contained undetected defects, errors or failures. The occurrence of any defects, errors or
failures could result in cancellation of orders, product returns, diversion of our resources,
legal actions by our customers or our customers end users and other losses to us or to our
customers or end users. Any of these occurrences could also result in the loss of or delay in
market acceptance of our products and loss of sales, which would harm our business and adversely
affect our business, results of operations and financial condition. Our business may suffer if our strategic alliances are not successful. We have entered into a number of strategic alliances with suppliers, developers and members in our
industry to facilitate product compatibility, encourage adoption of industry standards or to offer
complementary product or service offerings to meet customer needs. In some cases, the companies
with which we have strategic alliances also compete against us in some of our business areas. If a
member of a strategic alliance fails to perform its obligations, if the relationship fails to
develop as expected or if the relationship is terminated, we could experience delays in product
availability or impairment of our relationships with our customers. In addition to the investigations and litigation arising out of our restatements, we are also
subject to numerous class actions and other lawsuits as well as lawsuits in the ordinary course of
business. In addition to the investigations and litigation arising out of our restatements, we are currently
a defendant in numerous class actions and other lawsuits, including lawsuits initiated on behalf of
holders of Nortel Networks Corporation common shares, which seek damages of material and
indeterminate amounts, as well as lawsuits in the ordinary course of our business. In the future,
we may be subject to similar litigation. The defense of these lawsuits may divert our managements
attention, and we 112




---



##### Table of Contents



may incur significant expenses in defending these lawsuits (including substantial
fees of lawyers and other professional advisors and potential obligations to indemnify officers and
directors who may be parties to such actions). In addition, we may be required to pay judgments or
settlements that could have a material adverse effect on our results of operations, financial
condition and liquidity. 
 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. 113




---



##### Table of Contents



ITEM 8.
    
    Consolidated Financial Statements and Supplementary Data
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageReport of Independent Registered Chartered Accountants
    
    
    F-1Consolidated Statements of Operations
    
    
    F-2Consolidated Balance Sheets
    
    
    F-3Consolidated Statements of Changes in Equity and Comprehensive Income (Loss)
    
    
    F-4Consolidated Statements of Cash Flows
    
    
    F-5Notes to Consolidated Financial Statements
    
    
    F-6Quarterly Financial Data (Unaudited)
    
    
    F-91
 114




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS To the Shareholders and Board of Directors of Nortel Networks Limited We have audited the accompanying consolidated balance sheets of Nortel Networks Limited and its
subsidiaries (Nortel Networks) as of December 31, 2003 and 2002 and the related consolidated
statements of operations, changes in equity and comprehensive income (loss) and cash flows for each
of the three years in the period ended December 31, 2003. 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 the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether 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, 2003 and 2002 and the results of their
operations and their cash flows for each of the three years in the period ended December 31, 2003
in conformity with accounting principles generally accepted in the United States of America. As described in note 3 to the consolidated financial statements, the accompanying consolidated
financial statements of Nortel Networks as of December 31, 2002, and for the years ended December
31, 2002 and 2001 have been restated. As described in note 4 to the consolidated financial statements, effective January 1, 2003, Nortel
Networks changed its method of accounting for stock-based compensation and asset retirement
obligations, in accordance with Statement of Financial Accounting Standards (SFAS) SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure, and SFAS No. 143,
Accounting for Asset Retirement Obligations, respectively. Also, as described in note 4,
effective January 1, 2002, Nortel Networks changed its method of accounting for goodwill in
accordance with SFAS No. 142, Goodwill and Other Intangible Assets. On January 10, 2005, 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 Independent Registered Chartered Accountants Toronto, Canada
January 10, 2005 F-1




---



##### Table of Contents



NORTEL NETWORKS LIMITED
Consolidated Statements of Operations for the years ended December 31 (millions of U.S. dollars)
    
    2003
    
    
    2002
    
    
    2001As restated
    *
    
    As restated
    *Revenues
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763Cost of revenues
    
    
    5,861
    
    
    
    7,139
    
    
    
    14,511Gross profit
    
    
    4,332
    
    
    
    3,855
    
    
    
    4,252Selling, general and administrative expense
    
    
    1,931
    
    
    
    2,532
    
    
    
    6,010Research and development expense
    
    
    1,965
    
    
    
    2,084
    
    
    
    3,128In-process research and development expense
    
    
    
    
    
    
    
    
    
    
    Amortization of intangiblesAcquired technology and other
    
    
    3
    
    
    
    19
    
    
    
    574Goodwill
    
    
    
    
    
    
    
    
    
    
    2,081Deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    Special chargesGoodwill impairment
    
    
    
    
    
    
    264
    
    
    
    2,239Other special charges
    
    
    285
    
    
    
    1,358
    
    
    
    2,939(Gain) loss on sale of businesses and assets
    
    
    (4
    )
    
    
    (4
    )
    
    
    (100
    )Operating earnings (loss)
    
    
    152
    
    
    
    (2,398
    )
    
    
    (12,619
    )Other income (expense)  net
    
    
    433
    
    
    
    (28
    )
    
    
    (519
    )Interest expenseLong-term debt
    
    
    (98
    )
    
    
    (135
    )
    
    
    (176
    )Other
    
    
    (26
    )
    
    
    (55
    )
    
    
    (108
    )Earnings
(loss) from continuing operations before income taxes, minority interests and equity in net loss of associated companies
    
    
    461
    
    
    
    (2,616
    )
    
    
    (13,422
    )Income tax benefit (expense)
    
    
    33
    
    
    
    438
    
    
    
    2,573494
    
    
    
    (2,178
    )
    
    
    (10,849
    )Minority interests  net of tax
    
    
    (28
    )
    
    
    32
    
    
    
    (7
    )Equity in
net loss of associated companies  net of tax
    
    
    (36
    )
    
    
    (17
    )
    
    
    (150
    )Net earnings (loss) from continuing operations
    
    
    430
    
    
    
    (2,163
    )
    
    
    (11,006
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    184
    
    
    
    (101
    )
    
    
    (2,031
    )Net earnings (loss) before cumulative effect of accounting changes
    
    
    614
    
    
    
    (2,264
    )
    
    
    (13,037
    )Cumulative effect of accounting changes  net of tax
    
    
    (12
    )
    
    
    
    
    
    
    15Net earnings (loss)
    
    
    602
    
    
    
    (2,264
    )
    
    
    (13,022
    )Dividends on preferred shares
    
    
    35
    
    
    
    26
    
    
    
    27Net earnings (loss) applicable to common shares
    
    $
    567
    
    
    $
    (2,290
    )
    
    $
    (13,049
    )
 * See note 3 The accompanying notes are an integral part of these consolidated financial statements F-2




---



##### Table of Contents



NORTEL NETWORKS LIMITED
Consolidated Balance Sheets as of December 31 (millions of U.S. dollars)
    
    2003
    
    
    2002As restated
    *ASSETSCurrent assetsCash and cash equivalents
    
    $
    3,928
    
    
    $
    3,742Restricted cash and cash equivalents
    
    
    63
    
    
    
    249Accounts receivable  net
    
    
    2,659
    
    
    
    2,282Inventories  net
    
    
    1,190
    
    
    
    1,506Income taxes recoverable
    
    
    90
    
    
    
    113Deferred income taxes  net
    
    
    369
    
    
    
    793Other current assets
    
    
    314
    
    
    
    636Total current assets
    
    
    8,613
    
    
    
    9,321Investments
    
    
    244
    
    
    
    237Plant and equipment  net
    
    
    1,654
    
    
    
    1,689Goodwill
    
    
    2,125
    
    
    
    2,019Intangible assets  net
    
    
    86
    
    
    
    41Deferred income taxes  net
    
    
    3,397
    
    
    
    2,657Other assets
    
    
    337
    
    
    
    750Total assets
    
    $
    16,456
    
    
    $
    16,714LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    17
    
    
    $
    30Trade and other accounts payable
    
    
    860
    
    
    
    802Payroll and benefit-related liabilities
    
    
    764
    
    
    
    484Contractual liabilities
    
    
    529
    
    
    
    893Restructuring
    
    
    205
    
    
    
    499Other accrued liabilities
    
    
    2,467
    
    
    
    3,215Long-term debt due within one year
    
    
    119
    
    
    
    243Total current liabilities
    
    
    4,961
    
    
    
    6,166Long-term debt
    
    
    2,091
    
    
    
    2,160Deferred income taxes  net
    
    
    190
    
    
    
    357Other liabilities
    
    
    2,944
    
    
    
    2,757Total liabilities
    
    
    10,186
    
    
    
    11,440Minority interests in subsidiary companies
    
    
    80
    
    
    
    94Commitments and contingencies (notes 14 and 21)SHAREHOLDERS EQUITYPreferred shares, without par value  Authorized shares: unlimited;Issued and outstanding shares: 30,000,000 for 2003 and 30,000,000 for 2002
    
    
    536
    
    
    
    536Common shares, without par value  Authorized shares: unlimited;Issued and outstanding shares: 1,460,978,638 for 2003 and 1,460,978,638 for 2002
    
    
    1,211
    
    
    
    1,211Additional paid-in capital
    
    
    22,031
    
    
    
    22,007Accumulated deficit
    
    
    (17,066
    )
    
    
    (17,633
    )Accumulated other comprehensive loss
    
    
    (522
    )
    
    
    (941
    )Total shareholders equity
    
    
    6,190
    
    
    
    5,180Total liabilities and shareholders equity
    
    $
    16,456
    
    
    $
    16,714
 * See note 3 The accompanying notes are an integral part of these consolidated financial statements F-3




---



##### Table of Contents



NORTEL NETWORKS LIMITED
Consolidated Statements of Changes in Equity and Comprehensive Income (Loss) (millions of U.S. dollars)
    
    2003
    
    
    2002
    
    
    2001As restated
    *
    
    As restated
    *Preferred sharesBalance at the beginning of the year
    
    $
    536
    
    
    $
    536
    
    
    $
    609Conversion of Series 4 preferred shares
    
    
    
    
    
    
    
    
    
    
    (73
    )Balance at the end of the year
    
    
    536
    
    
    
    536
    
    
    
    536Common sharesBalance at the beginning of the year
    
    
    1,211
    
    
    
    2,111
    
    
    
    17,024Common shares issued
    
    
    
    
    
    
    2,287
    
    
    
    1,800Common shares issued related to acquisitions  net
    
    
    
    
    
    
    
    
    
    
    26Conversion of Series 4 preferred shares
    
    
    
    
    
    
    
    
    
    
    61Reduction of legal stated capital
    
    
    
    
    
    
    (3,187
    )
    
    
    (16,800
    )Balance at the end of the year
    
    
    1,211
    
    
    
    1,211
    
    
    
    2,111Additional paid-in capitalBalance at the beginning of the year
    
    
    22,007
    
    
    
    18,806
    
    
    
    1,878Adjustments
as of January 1, 2001 due to restatement *
    
    
    
    
    
    
    
    
    
    
    1Additions resulting from acquisitions
    
    
    
    
    
    
    
    
    
    
    8Conversion
of Series 4 preferred shares
    
    
    
    
    
    
    
    
    
    
    12Reduction of legal stated capital
    
    
    
    
    
    
    3,187
    
    
    
    16,800Stock option compensation
    
    
    26
    
    
    
    
    
    
    
    Tax benefit associated with stock options
    
    
    
    
    
    
    13
    
    
    
    105Other
    
    
    (2
    )
    
    
    1
    
    
    
    2Balance at the end of the year
    
    
    22,031
    
    
    
    22,007
    
    
    
    18,806Accumulated deficitBalance at the beginning of the year
    
    
    (17,633
    )
    
    
    (14,818
    )
    
    
    (370
    )Adjustments
as of January 1, 2001 due to restatement *
    
    
    
    
    
    
    
    
    
    
    (1,399
    )Net earnings (loss)
    
    
    602
    
    
    
    (2,264
    )
    
    
    (13,022
    )Dividends on preferred shares
    
    
    (35
    )
    
    
    (26
    )
    
    
    (27
    )Stock option fair value increment
    
    
    
    
    
    
    (525
    )
    
    
    Balance at the end of the year
    
    
    (17,066
    )
    
    
    (17,633
    )
    
    
    (14,818
    )Accumulated other comprehensive lossBalance at the beginning of the year
    
    
    (941
    )
    
    
    (587
    )
    
    
    (511
    )Adjustments as of January 1, 2001 due to restatement *
    
    
    
    
    
    
    
    
    
    
    187Foreign currency translation adjustment
    
    
    535
    
    
    
    173
    
    
    
    (125
    )Unrealized gain (loss) on investments  net
    
    
    57
    
    
    
    19
    
    
    
    (40
    )Unrealized
derivative gain (loss) on cash flow hedges  net
    
    
    15
    
    
    
    11
    
    
    
    (7
    )Minimum pension liability adjustment  net
    
    
    (188
    )
    
    
    (557
    )
    
    
    (84
    )Cumulative effect of accounting change  net
    
    
    
    
    
    
    
    
    
    
    (7
    )Other comprehensive income (loss)
    
    
    419
    
    
    
    (354
    )
    
    
    (263
    )Balance at the end of the year
    
    
    (522
    )
    
    
    (941
    )
    
    
    (587
    )Total shareholders equity
    
    $
    6,190
    
    
    $
    5,180
    
    
    $
    6,048Total comprehensive income (loss) for the yearNet earnings (loss)
    
    $
    602
    
    
    $
    (2,264
    )
    
    $
    (13,022
    )Other comprehensive income (loss)
    
    
    419
    
    
    
    (354
    )
    
    
    (263
    )Total comprehensive income (loss) for the year
    
    $
    1,021
    
    
    $
    (2,618
    )
    
    $
    (13,285
    )
 * See note 3 The accompanying notes are an integral part of these consolidated financial statements F-4




---



##### Table of Contents



NORTEL NETWORKS LIMITED
Consolidated Statements of Cash Flows for the years ended December 31 (millions of U.S. dollars)
    
    2003
    
    
    2002
    
    
    2001As restated
    *
    
    As restated
    *Cash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    430
    
    
    $
    (2,163
    )
    
    $
    (11,006
    )Adjustments to reconcile net earnings (loss) from continuing operations to
net cash from (used in) operating activities, net of effects from acquisitions
and divestitures of businesses:Amortization and depreciation
    
    
    434
    
    
    
    553
    
    
    
    3,374Non-cash portion of special charges and related asset write downs
    
    
    87
    
    
    
    692
    
    
    
    3,135Equity in net loss of associated companies
    
    
    36
    
    
    
    17
    
    
    
    150Stock option compensation
    
    
    26
    
    
    
    
    
    
    
    Deferred income taxes
    
    
    (8
    )
    
    
    (405
    )
    
    
    (1,339
    )Other liabilities
    
    
    161
    
    
    
    1
    
    
    
    (9
    )(Gain) loss on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    (60
    )
    
    
    (Gain) loss on sale or write down of investments and businesses
    
    
    (51
    )
    
    
    35
    
    
    
    268Other  net
    
    
    (812
    )
    
    
    (283
    )
    
    
    (1,458
    )Change in operating assets and liabilities
    
    
    (221
    )
    
    
    619
    
    
    
    7,043Net cash from (used in) operating activities of continuing operations
    
    
    78
    
    
    
    (994
    )
    
    
    158Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (172
    )
    
    
    (352
    )
    
    
    (1,269
    )Proceeds on disposals of plant and equipment
    
    
    38
    
    
    
    406
    
    
    
    208Acquisitions of investments and businesses  net of cash acquired
    
    
    (58
    )
    
    
    (29
    )
    
    
    (89
    )Proceeds on sale of investments and businesses
    
    
    107
    
    
    
    61
    
    
    
    604Net cash from (used in) investing activities of continuing operations
    
    
    (85
    )
    
    
    86
    
    
    
    (546
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (35
    )
    
    
    (26
    )
    
    
    (27
    )Increase (decrease) in notes payable  net
    
    
    (45
    )
    
    
    (333
    )
    
    
    (230
    )Proceeds from long-term debt
    
    
    
    
    
    
    33
    
    
    
    1,530Repayments of long-term debt
    
    
    (270
    )
    
    
    (611
    )
    
    
    (469
    )Repayments of capital leases payable
    
    
    (12
    )
    
    
    (16
    )
    
    
    (26
    )Issuance of common shares
    
    
    
    
    
    
    2,287
    
    
    
    1,800Payment of stock option fair value increment
    
    
    
    
    
    
    (525
    )
    
    
    Net cash from (used in) financing activities of continuing operations
    
    
    (362
    )
    
    
    809
    
    
    
    2,578Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    176
    
    
    
    74
    
    
    
    (10
    )Net cash from (used in) continuing operations
    
    
    (193
    )
    
    
    (25
    )
    
    
    2,180Net cash from (used in) discontinued operations
    
    
    379
    
    
    
    350
    
    
    
    (308
    )Net increase (decrease) in cash and cash equivalents
    
    
    186
    
    
    
    325
    
    
    
    1,872Cash and cash equivalents at beginning of year
    
    
    3,742
    
    
    
    3,417
    
    
    
    1,545Cash and cash equivalents at end of year
    
    $
    3,928
    
    
    $
    3,742
    
    
    $
    3,417
 * See note 3 The accompanying notes are an integral part of these consolidated financial statements F-5




---



##### Table of Contents



NORTEL NETWORKS LIMITED
Notes to Consolidated Financial Statements
(millions of U.S. dollars, unless otherwise stated)  1.
    
    Nortel Networks Limited  Nortel Networks Limited (Nortel Networks) is a recognized leader in delivering
communications capabilities, serving both service provider and enterprise customers. Nortel
Networks delivers innovative technology solutions encompassing end-to-end broadband, Voice over
IP, multimedia services and applications, and wireless broadband solutions. Nortel Networks
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 business has a technology focus and is dedicated to research and development.For 2003, Nortel Networks operations were organized into four reportable segments consisting of
Wireless Networks, Enterprise Networks, Wireline Networks and Optical Networks. See note 6 for
information concerning a change in Nortel Networks organizational structure in 2004.Nortel Networks is the principal direct operating subsidiary of Nortel Networks Corporation
(NNC). NNC holds all of Nortel Networks Limiteds outstanding common shares but none of
Nortel Networks Limiteds outstanding preferred shares. NNCs common shares are publicly traded
on the New York Stock Exchange (NYSE) and Toronto Stock Exchange (TSX) under the symbol
NT. Nortel Networks Limiteds Cumulative Redeemable Class A Preferred Shares Series 5 and
Non-cumulative Redeemable Class A Preferred Shares Series 7 are traded on the TSX under the
symbols NTL.PR.F and NTL.PR.G, respectively. Acquisitions involving any share consideration
are completed by NNC, while acquisitions involving only cash consideration are generally
completed by Nortel Networks.  2.
    
    Significant accounting policies  Basis of presentation  The consolidated financial statements of Nortel Networks have been prepared in accordance
with accounting principles generally accepted in the United States (U.S.) (GAAP) and the
rules and regulations of the U.S. Securities and Exchange Commission (the SEC) for the
preparation of financial statements. Although Nortel Networks is headquartered in Canada, the
consolidated financial statements are expressed in U.S. dollars as the greater part of the
financial results and net assets of Nortel Networks are denominated in U.S. dollars.As described in note 3, the consolidated statements of operations, changes in equity and
comprehensive income (loss) and cash flows for the years ended December 31, 2002 and 2001 and
the consolidated balance sheet as of December 31, 2002, including the applicable notes, were
restated.  (a)
    
    Principles of consolidationThe financial statements of entities which are controlled by Nortel Networks through voting
equity interests, referred to as subsidiaries, are consolidated. Entities which are jointly
controlled, referred to as joint ventures, and entities which are not controlled but over
which Nortel Networks has the ability to exercise significant influence, referred to as
associated companies, are accounted for using the equity method. Variable Interest Entities
(VIEs) (which include, but are not limited to, special purpose entities, trusts,
partnerships, certain joint ventures and other legal structures), as defined by the
Financial Accounting Standards Board (FASB) in FASB Interpretation (FIN) No. 46 (Revised
2003), Consolidation of Variable Interest Entities  an Interpretation of Accounting
Research Bulletin No. 51 (FIN 46R), are entities in which equity investors do not have
the characteristics of a controlling financial interest or there is not sufficient equity
at risk for the entity to finance its activities without additional subordinated financial
support. VIEs are consolidated by Nortel Networks when it is determined that it will, as
the primary beneficiary, absorb the majority of the VIEs expected losses and/or expected
residual returns. Intercompany accounts and transactions are eliminated upon consolidation
and unrealized intercompany gains and losses are eliminated when accounting under the equity
method. F-6




---



##### Table of Contents



(b)
    
    Use of estimatesNortel Networks makes estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities as of the date of the
consolidated financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results may differ from those estimates. Estimates are used
when accounting for items and matters such as revenue recognition, allowances for
uncollectible accounts receivable and customer financing, receivables sales, inventory
obsolescence, product warranty, amortization, asset valuations, impairment assessments,
employee benefits including pensions, taxes, restructuring and other provisions, in-process
research and development (IPR&D), stock-based compensation and contingencies.(c)
    
    Translation of foreign currenciesThe consolidated financial statements of Nortel Networks are presented in U.S. dollars. The
financial statements of Nortel Networks operations whose functional currency is not the U.S.
dollar (except for highly inflationary economies as described below) are translated into
U.S. dollars at the exchange rates in effect at the balance sheet dates for assets and
liabilities, and at average rates for the period for revenues and expenses. The unrealized
translation gains and losses on Nortel 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 U.S. dollar
are translated into U.S. dollars at the exchange rates in effect at the balance sheet dates
for monetary assets and liabilities, and at historical exchange rates for non-monetary
assets and liabilities. Revenue and expenses are translated at average rates for the
period, except for amortization and depreciation which are translated on the same basis as
the related assets. Resulting translation gains or losses are reflected in net earnings
(loss).When appropriate, Nortel 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 the
effective portion of the hedging instruments that qualify for hedge accounting are recorded
in OCI; other translation gains and losses are recorded in net earnings (loss).(d)
    
    Revenue recognitionNortel 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 methods.Depending upon the terms of the contract and types of products and services sold, Nortel
Networks recognizes revenue under American Institute of Certified Public Accountants
Statement of Position (SOP) 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts (SOP 81-1), SOP 97-2, Software Revenue Recognition
(SOP 97-2), and SEC Staff Accounting Bulletin (SAB) 104, Revenue Recognition (SAB
104), which was preceded by SAB 101, Revenue Recognition in Financial Statements (SAB
101). Revenue is recognized net of cash discounts and allowances.Effective July 1, 2003, for contracts involving multiple deliverables, where the
deliverables are governed by more than one authoritative accounting standard, Nortel
Networks generally applies the FASB Emerging Issues Task Force (EITF) Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables (EITF 00-21), and evaluates each
deliverable to determine whether it represents a separate unit of accounting based on the
following criteria: (a) whether the delivered item has value to the customer on a standalone
basis, (b) whether there is objective and reliable evidence of the fair value of the
undelivered item(s), and (c) if the contract includes a general right of return relative to
the delivered item, delivery or performance of the undelivered item(s) is considered
probable and
substantially in the control of Nortel Networks. If objective and reliable evidence of fair
value exists for all units of accounting in the contract, revenue is allocated to each unit
of accounting or element based on relative fair values. F-7




---



##### Table of Contents



In situations where there is
objective and reliable evidence of fair value for all undelivered elements, but not for
delivered elements, the residual method is used to allocate the contract consideration.
Under the residual method, the amount of revenue allocated to delivered elements equals the
total arrangement consideration less the aggregate fair value of any undelivered elements.
Each unit of accounting is then accounted for under the applicable revenue recognition
guidance.For arrangements that include hardware and software where software is considered more than
incidental to the hardware, provided that the software is not essential to the functionality
of the hardware and the hardware and software represent separate units of accounting,
revenue related to the software element is recognized under SOP 97-2 and revenue related to
the hardware element is recognized under SOP 81-1 or SAB 104. For arrangements where the
software is considered more than incidental and essential to the functionality of the
hardware, or where the hardware is not considered a separate unit of accounting from the
software deliverables, revenue is recognized for the software and the hardware as a single
unit of accounting pursuant to SOP 97-2 for off-the-shelf products and pursuant to SOP 81-1
for customized products.Prior to July 1, 2003, for contracts involving multiple elements, Nortel Networks allocated
revenue to each element based on the relative fair value or the residual method, as
applicable. 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.For accounting units related to customized network solutions and certain network build outs,
revenues are recognized under SOP 81-1 using the percentage-of-completion method. In using
the percentage-of-completion method, revenues are generally recorded based on a measure of
the percentage of costs incurred to date on a contract relative to the estimated total
expected contract costs. Profit estimates on long-term contracts are revised periodically
based on changes in circumstances and any losses on contracts are recognized in the period
that such losses become known. Generally, the terms of long-term contracts provide for
progress billing based on completion of certain phases of work. Contract revenues
recognized, based on costs incurred towards the completion of the project, that are unbilled
are accumulated in the contracts in progress account included in accounts receivable  net.
Billings in excess of revenues recognized to date on long-term contracts are recorded as
advance billings in excess of revenues within other accrued liabilities.Revenue for hardware that does not require significant customization, and where any software
is considered incidental, is recognized under SAB 104. Under SAB 104, revenue is recognized
provided that persuasive evidence of an arrangement exists, delivery has occurred or
services have been rendered, the fee is fixed or determinable and collectibility is
reasonably assured. For hardware, delivery is considered to have occurred upon shipment
provided that risk of loss, and title in certain jurisdictions, have been transferred to the
customer.Engineering, installation and other service revenues are recognized as the services are
performed.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 when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable and collection
is reasonably assured. Accruals for estimated sales returns and other allowances are
recorded at the time of revenue recognition and are based on contract terms and prior claims
experience.Software revenue is generally recognized under SOP 97-2. For software arrangements
involving multiple elements, Nortel Networks allocates revenue to each element based on the
relative fair value or the residual method, as applicable, and using vendor specific
objective evidence of fair values, which is based on prices charged when the element is sold
separately. Software revenue accounted for under SOP 97-2 is recognized when: persuasive
evidence of an arrangement exists; the software is delivered in accordance with all terms
and conditions of the customer contracts; the fee is fixed or determinable; and collection
is reasonably assured. Revenue related to post-contract support, including technical
support and unspecified when-and-if available software upgrades (PCS), is
recognized ratably over the PCS term. 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 F-8




---



##### Table of Contents



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.Under SAB 104 or SOP 97-2, if fair value does not exist for any undelivered element, revenue
is not recognized until the earlier of (i) the undelivered element is delivered or (ii) fair
value of the undelivered element exists, unless the undelivered element is a service, in
which case revenue is recognized as the service is performed once the service is the only
undelivered element.(e)
    
    Research and developmentResearch and development (R&D) costs are charged to net earnings (loss) in the periods in
which they are incurred. However, costs incurred pursuant to specific contracts with third
parties for which Nortel Networks is obligated to deliver a product are charged to cost of
revenues in the same period as the related revenue is recognized. Related global investment
tax credits are deducted from the income tax provision.(f)
    
    Income taxesNortel 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 consolidated financial statements and tax returns. Deferred income taxes are
adjusted to reflect the effects of changes in tax laws or enacted tax rates.In establishing the appropriate income tax valuation allowances, Nortel 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
remaining net deferred tax assets or a portion thereof will be realized.(g)
    
    Earnings (loss) per common shareBasic earnings (loss) per common share is calculated by dividing the net earnings (loss) applicable to common shares by
the weighted-average number of Nortel Networks Corporation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 warrants, options and similar instruments. The
if-converted method is used to compute the dilutive effect of convertible debt. A
comparison of the conditions required for issuance of shares compared to those existing at
the end of the period is used to compute the dilutive effect of contingently issuable
 shares.As all of Nortel Networks Limiteds common shares are held by NNC and are not publicly
traded, information concerning Nortel Networks Limiteds net earnings (loss) per common
share and weighted-average number of common shares outstanding has not been presented in the
consolidated financial statements. For information regarding NNCs earnings (loss) per
common share and weighted-average number of common shares outstanding, see NNCs
consolidated financial statements and notes thereto for the year ended December 31, 2003
contained in the 2003 Annual Report on Form 10-K filed with the SEC.(h)
    
    Cash and cash equivalentsCash and cash equivalents consist of cash on hand, balances with banks and short-term
investments. All highly liquid investments with original maturities of three months or less
are classified as cash and cash equivalents. The fair value of cash and cash equivalents
approximates the amounts shown in the consolidated financial statements.(i)
    
    Restricted cash and cash equivalentsCash and cash equivalents are considered restricted when they are subject to contingent
rights of a third party customer under bid, performance related and other bonds associated
with contracts that Nortel Networks is not able to unilaterally revoke. F-9




---



##### Table of Contents



(j)
    
    Provision for doubtful accountsThe provision for doubtful accounts for trade, notes and long-term receivables due from
customers is established based on an assessment of a customers credit quality, as well as
subjective factors and trends, including the aging of receivable balances. Generally, these
credit assessments occur prior to the inception of the credit exposure and at regular
reviews during the life of the exposure.Customer financing receivables include receivables from customers with deferred payment
terms. Customer financing receivables are considered impaired when they are classified as
non-performing, payment arrears exceed 90 days or a major credit event such as a material
default has occurred, and management determines that collection of amounts due according to
the contractual terms is doubtful. Provisions for impaired customer financing receivables
are recorded based on the expected recovery of defaulted customer obligations, being the
present value of expected cash flows, or the realizable value of the collateral if recovery
of the receivables is dependent upon a liquidation of the assets. Interest income on
impaired customer finance receivables is recognized as the cash payments are collected.(k)
    
    InventoriesInventories are valued at the lower of cost (calculated generally on a first-in, first-out
basis) or market. The cost of finished goods and work in process is comprised of material,
labor and manufacturing overhead. Provisions for inventory are based on estimates of future
customer demand for products, including general economic conditions, growth prospects within
the customers ultimate marketplaces and market acceptance of current and pending products.
In addition, full provisions are generally recorded for surplus inventory in excess of one
years forecast demand or inventory deemed obsolete.(l)
    
    Receivables salesTransfers of accounts receivable that meet the criteria for surrender of control under FASB
Statement of Financial Accounting Standard (SFAS) No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, are accounted for as
sales. Generally, Nortel Networks retains servicing rights and, in some cases, provides
limited recourse when it sells receivables. A gain or loss is recorded in other income
(expense)  net at the date of the receivables sale and is based upon, in part, the previous
carrying amount of the receivables involved in the transfer allocated between the assets
sold and the retained interests based on their relative fair 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. Retained interests are classified as available-for-sale
securities.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 sometimes paid at the discretion of the transferee. Nortel Networks
initially records the non-discretionary servicing bonus at fair value which is the
discounted value of the estimated future cash flows taking into consideration future
estimated interest rates and credit losses. Generally, the discretionary servicing bonus is
initially recorded at a fair value of nil due to the fact that it is paid at the discretion
of the transferee and based on the determination that future credit losses will offset any
such servicing bonus.Nortel Networks reviews the fair value assigned to retained interests, including the
servicing bonus, at each reporting date subsequent to the date of the transfer to determine
if there is an other than temporary impairment. Fair value is reviewed using similar
valuation techniques as those used to initially measure the retained interest and,
if a change in events or circumstances warrants, the fair value is adjusted and any other
than temporary impairments are recorded in other income (expense)  net. F-10




---



##### Table of Contents



(m)
    
    InvestmentsInvestments 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.Investments in equity securities of private companies over which Nortel Networks does not
exert significant influence are accounted for using the cost method. Investments in
associated companies and joint ventures are accounted for using the equity method. An
impairment loss is recorded when there has been a loss in value of the investment that is
other than temporary.Nortel Networks monitors its investments for factors indicating other than temporary
impairment and records a charge to net earnings (loss) when appropriate.(n)
    
    Plant and equipmentPlant 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.(o)
    
    Impairment or disposal of long-lived assets (plant and equipment and acquired
technology)Long-lived assets held and usedNortel Networks tests long-lived assets or asset groups held and used for recoverability
when events or changes in circumstances indicate that their carrying amount may not be
recoverable. Circumstances which could trigger a review include, but are not limited to:
significant decreases in the market price of the asset; significant adverse changes in the
business climate or legal factors; the accumulation of costs significantly in excess of the
amount originally expected for the acquisition or construction of the asset; current period
cash flow or operating losses combined with a history of losses or a forecast of continuing
losses associated with the use of the asset; and a current expectation that the asset will
more likely than not be sold or disposed of significantly before the end of its estimated
useful life.Recoverability is assessed based on the carrying amount of the asset and the sum of the
undiscounted cash flows expected to result from the use and the eventual disposal of the
asset or asset group. An impairment loss is recognized when the carrying amount is not
recoverable and exceeds the fair value of the asset or asset group. The impairment loss is
measured as the amount by which the carrying amount exceeds fair value.Long-lived assets held for saleLong-lived assets are classified as held for sale when certain criteria are met, which
include: managements commitment to a plan to sell the assets; the 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 have 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 or fair value less cost to sell. These assets are not depreciated. Fair
value is determined using quoted market prices or the anticipated cash flows discounted at a
rate commensurate with the risk involved. F-11




---



##### Table of Contents



Long-lived assets to be disposed of other than by saleNortel Networks classifies assets that will be disposed of other than by sale as held and
used until the disposal transaction occurs. The assets continue to be depreciated based on
revisions to their estimated useful lives until the date of disposal or abandonment.Recoverability is assessed based on the carrying amount of the asset and the sum of the
undiscounted cash flows expected to result from the remaining period of use and the eventual
disposal of the asset or asset group. An impairment loss is recognized when the carrying
amount is not recoverable and exceeds the fair value of the asset or asset group. The
impairment loss is measured as the amount by which the carrying amount exceeds fair value.(p)
    
    GoodwillGoodwill represents the excess of the purchase price of an acquired enterprise over the fair
value of the identifiable assets acquired and liabilities assumed. Nortel Networks tests
for impairment of goodwill on an annual basis as of October 1 and at any other time if
events occur or circumstances change that would indicate that it is more likely than not
that the fair value of the reporting unit has been reduced below its carrying amount (see
note 4(k)).Circumstances that could trigger an impairment test include: a significant adverse change in
the business climate or legal factors; an adverse action or assessment by a regulator;
unanticipated competition; the loss of key personnel; the likelihood that a reporting unit
or significant portion of a reporting unit will be sold or otherwise disposed of; the
results of testing for recoverability of a significant asset group within a reporting unit;
and the recognition of a goodwill impairment loss in the financial statements of a
subsidiary that is a component of a reporting unit.The impairment test for goodwill is a two-step process. Step one consists of a comparison
of the fair value of a reporting unit with its carrying amount, including the goodwill
allocated to the reporting unit. Measurement of the fair value of a reporting unit is based
on one or more fair value measures including present value techniques of estimated future
cash flows and estimated amounts at which the unit as a whole could be bought or sold in a
current transaction between willing parties. Nortel Networks also considers its market
capitalization as of the date of the impairment test. If the carrying amount of the
reporting unit exceeds the fair value, step two requires the fair value of the reporting
unit to be allocated to the underlying assets and liabilities of that reporting unit,
resulting in an implied fair value of goodwill. If the carrying amount of the reporting
unit goodwill exceeds the implied fair value of that goodwill, an impairment loss equal to
the excess is recorded in net earnings (loss).(q)
    
    Intangible assetsAcquired technology represents the value of the proprietary know-how which was
technologically feasible as of the acquisition date, and is charged to net earnings (loss)
on a straight-line basis over its estimated useful life of two to three years. Other
intangible assets are amortized into net earnings (loss) based on their expected pattern of
benefit to future periods using estimates of undiscounted cash flows.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 of the date of acquisition.(r)
    
    Warranty costsAs part of the normal sale of product, Nortel Networks provides its customers with product
warranties that extend for periods generally ranging from one to six years from the date of
sale. A liability for the expected cost of warranty-related claims is established when
products are sold. In estimating warranty liability, historical material replacement costs
and the associated labor to correct the product defect are considered. Revisions are made
when F-12




---



##### Table of Contents



actual experience differs materially from historical experience. Known product defects
are specifically accrued for as Nortel Networks becomes aware of such defects.(s)
    
    Pension, post-retirement and post-employment benefitsPension 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, for active employees are accrued in the consolidated financial statements during
the years employees provide service to Nortel Networks. These costs are recorded based on
actuarial methods and assumptions. Other post-employment benefits are recognized when the
event triggering the obligation occurs.(t)
    
    Derivative financial instrumentsNortel 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.
Nortel Networks does not hold or issue derivative instruments for trading purposes. Nortel
Networks policy is to formally document all relationships between hedging instruments and
hedged items, as well as its risk management objectives and strategy for undertaking various
hedge transactions. Where hedge accounting will be applied, this process includes linking
all derivatives to specific assets and liabilities on the consolidated balance sheet or to
specific firm commitments or forecasted transactions. Nortel Networks also formally
assesses, both at the hedges inception and on an ongoing basis, as applicable, whether the
derivatives that are used in hedging transactions are highly effective in offsetting changes
in fair values or cash flows of hedged items.For a derivative designated as a fair value hedge, changes in the fair value of the
derivative and of the hedged item attributable to the hedged risk are recognized in net
earnings (loss). For a derivative designated as a cash flow hedge, the effective portions of
changes in the fair value of the derivative are recorded in OCI and are recognized in net
earnings (loss) when the hedged item affects net earnings (loss). Ineffective portions of
changes in the fair value of cash flow hedges are recognized in other
income (expense) 
net. If the derivative used in an economic hedging relationship is not designated in an
accounting hedging relationship or if it has become ineffective, changes in the fair value
of the derivative are recognized in net earnings (loss).When a cash flow or fair value hedging relationship is terminated because the derivative is
sold, terminated or de-designated as a hedge, the accumulated OCI balance to the termination
date or the fair value basis adjustment recorded on the hedged item is amortized into other
income (expense)  net or interest expense on an effective yield basis over the original
term of the hedging relationship. If a cash flow or fair value hedging relationship is
terminated because the underlying hedged item is repaid or is sold, or it is no longer
probable that the hedged forecasted transaction will occur, the accumulated balance in OCI
or the fair value basis adjustment recorded on the hedged item is recorded immediately in
net earnings (loss).Nortel Networks generally classifies cash flows resulting from its derivative financial
instruments in the same manner as the cash flows from the item that the derivative is
hedging. Typically, this is within cash flows from (used in) operating activities in the
consolidated statements of cash flows, or, for derivatives designated as hedges relating to
the cash flows associated with settlement of the principal component of long-term debt,
within cash flows from (used in) financing activities. F-13




---



##### Table of Contents



Nortel Networks may also invest in warrants to purchase securities of other companies as a
strategic investment or receive warrants in various transactions. Warrants that relate to
publicly traded companies or that can be net share settled are deemed to be derivative
financial instruments. Such warrants, however, are generally not eligible to be designated
as hedging instruments as there is no corresponding underlying exposure. In addition, Nortel
Networks may enter into certain commercial contracts containing embedded derivative
financial instruments. Generally, for these embedded derivatives, for which the economic
characteristics and risks are not clearly and closely related to the economic
characteristics and risks of the host contract, the changes in fair value are recorded in
net earnings (loss).(u)
    
    Stock-based compensationIn December 2002, the FASB issued Statement of Financial Accounting Standards (SFAS) No.
148, Accounting for Stock-Based Compensation  Transition and Disclosure  an Amendment of
FASB Statement No. 123 (SFAS 148), which amended the transitional provisions of SFAS No.
123, Accounting for Stock-based Compensation (SFAS 123), for companies electing to
recognize employee stock-based compensation using the fair value based method.Prior to January 1, 2003, Nortel Networks, as permitted under SFAS 123, applied the
intrinsic value method under Accounting Principles Board Opinion (APB) No. 25, Accounting
for Stock Issued to Employees (APB 25), and related interpretations in accounting for its
employee stock-based compensation plans.Effective January 1, 2003, Nortel Networks elected to expense employee stock-based
compensation using the fair value based method prospectively for all awards granted,
modified, or settled on or after January 1, 2003. The fair value at grant date of stock
options is estimated using the Black-Scholes option-pricing model. Compensation expense is
recognized on a straight line basis over the stock option vesting period. The impact of the
adoption of the fair value based method for expense recognition of employee awards resulted
in $26 (net of tax of nil) of stock option expense during 2003.Stock-based awards that are settled or may be settled in cash or shares purchased on the
open market at the option of employees or directors are recorded as liabilities. The
measurement of the liability and compensation cost for these awards is based on the
intrinsic value of the award and is recorded in net earnings (loss) over the vesting period
of the award. Changes in Nortel Networks payment obligation subsequent to vesting of the
award and prior to the settlement date are recorded in net earnings (loss) in the period
incurred. The payment amount is established for Stock Appreciation Rights (SARs) on the
date of exercise of the award by the employee, for Restricted Stock Units (RSUs) on the
vesting date of the award and for Deferred Stock Units (DSUs) on the later of the date of
termination of employment and/or directorship. Stock-based awards which are substantively
discretionary in nature are recorded in the period that the issuance and settlement of the
award is approved.Nortel Networks parent, NNC, has stock purchase plans for eligible Nortel Networks employees
in eligible countries, and a stock purchase plan for eligible Nortel Networks unionized
employees in Canada (collectively, the ESPPs), to facilitate the acquisition of the common
 shares of Nortel Networks Corporation at a discount. Nortel Networks contribution to the
ESPPs is recorded as compensation expense on a quarterly basis as the obligation to
contribute is incurred.Under various stock option programs of NNC, options may be granted to various eligible
employees of Nortel Networks to purchase common shares of Nortel Networks Corporation. Had
Nortel Networks applied the fair value based method to all stock-based awards in all
periods, reported net earnings (loss) applicable to common shares would have been adjusted
to the pro forma amounts indicated below for the following years ended December 31: 2003
    
    
    2002
    
    
    2001Net earnings (loss) applicable to common shares  as reported
    
    $
    567
    
    
    $
    (2,290
    )
    
    $
    (13,049
    )Stock-based compensation  reported(a)
    
    
    54
    
    
    
    17
    
    
    
    15Stock-based compensation  pro forma (b)
    
    
    (308
    )
    
    
    (873
    )
    
    
    (1,347
    )Net earnings (loss) applicable to common shares  pro forma
    
    $
    313
    
    
    $
    (3,146
    )
    
    $
    (14,381
    )
 (a)
    
    Stock-based compensation  reported, included, for the years ended December 31,
2003, 2002 and 2001: F-14




---



##### Table of Contents



i.
    
    Stock option expense of $26, nil and nil, respectively, which was net of tax of nil in
each period;ii.
    
    Employer portion of ESPPs contributions expense of $6, $6 and $12, respectively,
which was net of tax of nil, $2 and $6, respectively;iii.
    
    RSUs expense of $19, $5 and $4, respectively, which was net of tax of
nil, $1 and $2, respectively; andiv.
    
    DSUs expense of $3, $6 and $(1), respectively, which was net of tax of
nil, $3 and nil, respectively.  (b)
    
    Stock-based compensation  pro forma expense for the years ended December 31,
2003, 2002 and 2001 was net of tax of nil, $136 and $379, respectively.  The following weighted-average assumptions were used in computing the fair value of
stock options for purposes of expense recognition and pro forma disclosures, as applicable,
for the following periods: 2003
    
    
    2002
    
    
    2001Black-Scholes weighted-average assumptionsExpected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    92.49
    %
    
    
    71.33
    %
    
    
    70.64
    %Risk-free interest rate
    
    
    2.81
    %
    
    
    4.49
    %
    
    
    4.74
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4Weighted-average stock option fair value
per option granted
    
    $
    1.57
    
    
    $
    3.50
    
    
    $
    8.38
  (v)
    
    Recent accounting pronouncements  (i)
    
    On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the MPDIM Act) was signed into law in the U.S. The MPDIM
Act introduced a prescription drug benefit under Medicare (specifically, Medicare Part
D) as well as a federal subsidy to sponsors of retiree health care benefit plans that
provide a benefit that is at least actuarially equivalent to Medicare Part D. As
permitted by FASB Staff Position (FSP) Financial Accounting Standard (FAS) 106-1,
Accounting and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003, Nortel Networks chose to make the one-time
deferral election which remained in effect for its plans in the U.S. until the earlier
of the issuance of specific authoritative guidance by the FASB on how to account for
the federal subsidy to be provided to plan sponsors under the MPDIM Act, or the
remeasurement of plan assets and obligations subsequent to January 31, 2004.
Therefore, Nortel Networks post-retirement benefit obligation as of December 31, 2003
and net post-retirement benefit cost for the year ended December 31, 2003 did not
reflect the effects of the MPDIM Act on the plans. On May 19, 2004, FSP FAS 106-2,
Accounting and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (FSP FAS 106-2) was issued by the FASB to
provide guidance relating to the prescription drug subsidy provided by the MPDIM Act.
Nortel Networks expects to have portions of its post-retirement benefit plans qualify
as actuarially equivalent to the benefit provided under the MPDIM Act, for which it
expects to receive federal subsidies. Nortel Networks expects that other portions of
the plans will not be actuarially equivalent. The financial impact of the federal
subsidies was determined by remeasuring Nortel Networks retiree life and medical
obligation as of January 1, 2004, as provided under the retroactive application
provision of FSP FAS 106-2. The effective date of FSP FAS 106-2 is the first annual or
interim period beginning after June 15, 2004, with earlier adoption encouraged. Nortel
Networks adopted FSP FAS 106-2 for the three-month period ended June 30, 2004. As a
result of adoption, the accrued post-retirement benefit obligation decreased by $31.
Net periodic post-retirement benefit costs are expected to decrease by $2 for 2004, as
a result of the subsidy.(ii)
    
    In March 2004, the EITF reached consensus on Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides guidance on determining when an investment is considered
impaired, whether that impairment is other than temporary and the measurement of an
impairment loss. EITF 03-1 is applicable to marketable debt and equity securities
within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities (SFAS 115), and SFAS No. 124, Accounting for Certain Investments
Held by Not-for-Profit Organizations, and equity securities that are not subject to
the scope of SFAS 115 and not accounted for under the equity method of accounting. In
September 2004, the FASB issued FSP EITF 03-1-1, Effective Date of Paragraphs 10-20 of
EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments, which delays the effective date for the
measurement and recognition criteria contained in EITF 03-1 until final application
guidance is issued. The delay does not suspend the requirement to recognize F-15




---



##### Table of Contents



other-than-temporary impairments as required by existing authoritative literature. The
adoption of EITF 03-1 is not expected to have a material impact on Nortel Networks
results of operations and financial position.  Comparative figuresCertain 2002 and 2001 figures in the consolidated financial statements have been
reclassified to conform to the 2003 presentation and have been restated as set out in note 3.  3.
    
    RestatementFirst Restatement  In May 2003, Nortel Networks commenced certain balance sheet reviews at the direction of
certain members of former management that led to a comprehensive review and analysis of its
assets and liabilities (the Comprehensive Review), which resulted in the restatement (effected
in December 2003) of its consolidated financial statements for the years ended December 31,
2002, 2001 and 2000 and for the quarters ended March 31, 2003 and June 30, 2003 (the First
Restatement).The Comprehensive Review purported to (i) identify balance sheet accounts that, as of June 30,
2003, were not supportable and required adjustment; (ii) determine whether such adjustments
related to the third quarter of 2003 or prior periods; and (iii) document certain account
balances in accordance with Nortel Networks accounting policies and procedures. The
Comprehensive Review was supplemented by additional procedures carried out between July 2003 and
November 2003 to quantify the effects of potential adjustments in the relevant periods and
review the appropriateness of releases of certain contractual liability and other related
provisions (also called accruals, reserves or accrued liabilities) in the six fiscal quarters
ending with the fiscal quarter ended June 30, 2003 and formed the basis for the adjustments made
to the financial statements in the First Restatement.On December 23, 2003, Nortel Networks filed with the SEC an amended Annual Report on Form 10-K/A
for the year ended December 31, 2002 (the 2002 Form 10-K/A) and amended Quarterly Reports on
Form 10-Q/A for the first and second quarters of 2003 (the 2003 Form 10-Q/As) reflecting the
First Restatement. As disclosed in those reports, the net effect of the First Restatement
adjustments was a reduction in accumulated deficit of $486, $171 and $32 as of December 31,
2002, 2001 and 2000, respectively.  Second Restatement  In late October 2003, the Audit Committee of Nortel Networks and NNCs Boards of
Directors (the Audit Committee) initiated an independent review of the facts and circumstances
leading to the First Restatement (the Independent Review) and engaged the law firm now known
as Wilmer Cutler Pickering Hale & Dorr LLP (WCPHD) to advise it in connection with the
Independent Review. The Audit Committee sought to gain a full understanding of the events that
caused significant excess liabilities to be maintained on the balance sheet that needed to be
restated, and to recommend that the Board adopt, and direct management to implement, necessary
remedial measures to address personnel, controls, compliance and discipline. The Independent
Review focused initially on events relating to the establishment and release of contractual
liability and other related provisions in the second half of 2002 and the first half of 2003,
including the involvement of senior corporate leadership. As the Independent Review evolved,
its
focus broadened to include specific provisioning activities in each of the business units and
geographic regions. In light of concerns raised in the initial phase of the Independent Review,
the Audit Committee expanded the review to include provisioning activities in the third and
fourth quarters of 2003.As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in depth the concerns identified by WCPHD regarding provisioning activity and to review
provision releases in each of the four quarters of 2003, down to a low threshold. That
examination, and other errors identified by management, led to the restatement of Nortel
Networks consolidated financial statements for the years ended December 31, 2002 and 2001 and
the quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003 and
2002 (the Second Restatement). F-16




---



##### Table of Contents



Over the course of the Second Restatement process, management also identified certain accounting
practices that it determined should be adjusted as part of the Second Restatement. In
particular, management identified certain errors related to revenue recognition and undertook a
process of revenue reviews. In light of the resulting adjustments to revenues previously
reported, the Audit Committee has determined to review the facts and circumstances leading to
the restatement of these revenues for specific transactions identified in the Second
Restatement. This review will have a particular emphasis on the underlying conduct that led to
the initial recognition of these revenues.Other accounting practices that management examined
and adjusted as part of the Second Restatement included, among other things, the following:  
    
    Nortel Networks foreign exchange accounting as part of managements plan to
address an identified material weakness related to foreign currency translation;
    
    intercompany balances that did not eliminate upon consolidation and related
provisions;
    
    special charges relating to inventory impairment, contract settlement
costs and other charges; and
    
    the accounting treatment of certain elements of discontinued operations.  Due to, among other factors, significant turnover in Nortel Networks finance personnel, changes
in accounting systems, documentation weaknesses and identified material weaknesses in internal
control over financial reporting, the Second Restatement involved hundreds of Nortel Networks
finance personnel and a number of outside consultants and advisors. The process required the
review and verification of a substantial number of documents and communications and related
accounting entries over multiple fiscal periods. In addition, the review of accruals and
provisions and the application of accounting literature to certain matters in the Second
Restatement, including revenue recognition, foreign exchange, special charges and discontinued
operations, was complicated by the passage of time, lack of availability of supporting records
and the turnover of finance personnel. As a result of this complexity, estimates and
assumptions that impact both the quantum of the various recorded adjustments and the fiscal
period to which they were attributed were required in the determination of certain of the Second
Restatement adjustments. Nortel Networks believes the procedures followed in determining such
estimates were appropriate and reasonable using the best available information.The following tables present the impact of the Second Restatement adjustments on Nortel Networks
previously reported consolidated statements of operations and a summary of the adjustments from
the Second Restatement for the years ended December 31, 2002 and 2001. The Second Restatement
adjustments related primarily to the following items, each of which reflect a number of related
adjustments that have been aggregated for disclosure purposes, and are described in the
paragraphs following the tables below:  
    
    Revenues and cost of revenues;
    
    Foreign exchange;
    
    Intercompany balances;
    
    Special charges;
    
    Other;
    
    Reclassifications; and
    
    Discontinued operations. F-17




---



##### Table of Contents



Consolidated Statement of Operations for the year ended December 31, 2002 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    10,554
    
    
    $
    440
    
    
    $
    10,994Cost of revenues
    
    
    6,990
    
    
    
    149
    
    
    
    7,139Gross profit
    
    
    3,564
    
    
    
    291
    
    
    
    3,855Selling, general and administrative expense
    
    
    2,621
    
    
    
    (89
    )
    
    
    2,532Research and development expense
    
    
    2,205
    
    
    
    (121
    )
    
    
    2,084Amortization of acquired technology and other
    
    
    19
    
    
    
    
    
    
    
    19Special chargesGoodwill impairment
    
    
    264
    
    
    
    
    
    
    
    264Other special charges
    
    
    1,435
    
    
    
    (77
    )
    
    
    1,358(Gain) loss on sale of businesses and assets
    
    
    (39
    )
    
    
    35
    
    
    
    (4
    )Operating earnings (loss)
    
    
    (2,941
    )
    
    
    543
    
    
    
    (2,398
    )Other income (expense)  net
    
    
    (34
    )
    
    
    6
    
    
    
    (28
    )Interest expenseLong-term debt
    
    
    (130
    )
    
    
    (5
    )
    
    
    (135
    )Other
    
    
    (44
    )
    
    
    (11
    )
    
    
    (55
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    (3,149
    )
    
    
    533
    
    
    
    (2,616
    )Income tax benefit (expense)
    
    
    422
    
    
    
    16
    
    
    
    438(2,727
    )
    
    
    549
    
    
    
    (2,178
    )Minority interests  net of tax
    
    
    
    
    
    
    32
    
    
    
    32Equity in net loss of associated companies  net of tax
    
    
    (18
    )
    
    
    1
    
    
    
    (17
    )Net earnings (loss) from continuing operations
    
    
    (2,745
    )
    
    
    582
    
    
    
    (2,163
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    21
    
    
    
    (122
    )
    
    
    (101
    )Net earnings (loss)
    
    
    (2,724
    )
    
    
    460
    
    
    
    (2,264
    )Dividends on preferred shares
    
    
    22
    
    
    
    4
    
    
    
    26Net earnings (loss) applicable to common shares
    
    $
    (2,746
    )
    
    $
    456
    
    
    $
    (2,290
    )
 F-18




---



##### Table of Contents



Summary of Restatement Adjustments for the year ended December 31, 2002: Revenues
    
    
    
    
    
    
    Inter-
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dis-and cost of
    
    
    Foreign
    
    
    company
    
    
    Special
    
    
    
    
    
    
    Reclassifi-
    
    
    continued
    
    
    Totalrevenues
    
    
    exchange
    
    
    balances
    
    
    charges
    
    
    Other
    
    
    cations
    
    
    operations
    
    
    adjustmentsRevenues
    
    $
    443
    
    
    $
    (3
    )
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    440Cost of revenues
    
    
    153
    
    
    
    (51
    )
    
    
    (16
    )
    
    
    88
    
    
    
    (71
    )
    
    
    46
    
    
    
    
    
    
    
    149Gross profit
    
    
    290
    
    
    
    48
    
    
    
    16
    
    
    
    (88
    )
    
    
    71
    
    
    
    (46
    )
    
    
    
    
    
    
    291Selling, general and administrative expense
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    (115
    )
    
    
    32
    
    
    
    
    
    
    
    (89
    )Research and development expense
    
    
    
    
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    (85
    )
    
    
    (22
    )
    
    
    
    
    
    
    (121
    )Special charges  other special charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (77
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (77
    )(Gain) loss on sale of businesses and assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    38
    
    
    
    
    
    
    
    35Other income (expense)  net
    
    
    
    
    
    
    (111
    )
    
    
    3
    
    
    
    
    
    
    
    21
    
    
    
    93
    
    
    
    
    
    
    
    6Interest expense  long term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )Interest expense  other
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    
    
    
    
    (11
    )Income tax benefit (expense)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    16Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31
    
    
    
    1
    
    
    
    
    
    
    
    32Equity in net loss of associated
companies  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Net earnings (loss) from
discontinued operations  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (122
    )
    
    
    (122
    )Total restatement adjustments
    
    $
    290
    
    
    $
    (57
    )
    
    $
    36
    
    
    $
    (11
    )
    
    $
    324
    
    
    $
    
    
    
    $
    (122
    )
    
    $
    460
 F-19




---



##### Table of Contents



Consolidated Statement of Operations for the year ended December 31, 2001 As previouslyreported
    
    
    Adjustments
    
    
    As restatedRevenues
    
    $
    17,272
    
    
    $
    1,491
    
    
    $
    18,763Cost of revenues
    
    
    14,089
    
    
    
    422
    
    
    
    14,511Gross profit
    
    
    3,183
    
    
    
    1,069
    
    
    
    4,252Selling, general and administrative expense
    
    
    5,712
    
    
    
    298
    
    
    
    6,010Research and development expense
    
    
    3,208
    
    
    
    (80
    )
    
    
    3,128In-process research and development expense
    
    
    
    
    
    
    
    
    
    
    Amortization of intangiblesAcquired technology and other
    
    
    574
    
    
    
    
    
    
    
    574Goodwill
    
    
    2,080
    
    
    
    1
    
    
    
    2,081Special chargesGoodwill impairment
    
    
    2,239
    
    
    
    
    
    
    
    2,239Other special charges
    
    
    3,089
    
    
    
    (150
    )
    
    
    2,939(Gain) loss on sale of businesses and assets
    
    
    (126
    )
    
    
    26
    
    
    
    (100
    )Operating earnings (loss)
    
    
    (13,593
    )
    
    
    974
    
    
    
    (12,619
    )Other income (expense)  net
    
    
    (367
    )
    
    
    (152
    )
    
    
    (519
    )Interest expenseLong-term debt
    
    
    (173
    )
    
    
    (3
    )
    
    
    (176
    )Other
    
    
    (120
    )
    
    
    12
    
    
    
    (108
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    (14,253
    )
    
    
    831
    
    
    
    (13,422
    )Income tax benefit (expense)
    
    
    2,973
    
    
    
    (400
    )
    
    
    2,573(11,280
    )
    
    
    431
    
    
    
    (10,849
    )Minority interests  net of tax
    
    
    
    
    
    
    (7
    )
    
    
    (7
    )Equity in net loss of associated companies  net of tax
    
    
    (150
    )
    
    
    
    
    
    
    (150
    )Net earnings (loss) from continuing operations
    
    
    (11,430
    )
    
    
    424
    
    
    
    (11,006
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (2,524
    )
    
    
    493
    
    
    
    (2,031
    )Net earnings (loss) before cumulative effect of accounting changes
    
    
    (13,954
    )
    
    
    917
    
    
    
    (13,037
    )Cumulative effect of accounting changes  net of tax
    
    
    15
    
    
    
    
    
    
    
    15Net earnings (loss)
    
    
    (13,939
    )
    
    
    917
    
    
    
    (13,022
    )Dividends on preferred shares
    
    
    27
    
    
    
    
    
    
    
    27Net earnings (loss) applicable to common shares
    
    $
    (13,966
    )
    
    $
    917
    
    
    $
    (13,049
    )
 F-20




---



##### Table of Contents



Summary of Restatement Adjustments for the year ended December 31, 2001: Revenues
    
    
    
    
    
    
    Inter-
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dis-and cost of
    
    
    Foreign
    
    
    company
    
    
    Special
    
    
    
    
    
    
    Reclassifi-
    
    
    continued
    
    
    Totalrevenues
    
    
    exchange
    
    
    balances
    
    
    charges
    
    
    Other
    
    
    cations
    
    
    operations
    
    
    adjustmentsRevenues
    
    $
    1,534
    
    
    $
    (43
    )
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,491Cost of revenues
    
    
    522
    
    
    
    (78
    )
    
    
    45
    
    
    
    
    
    
    
    (107
    )
    
    
    40
    
    
    
    
    
    
    
    422Gross profit
    
    
    1,012
    
    
    
    35
    
    
    
    (45
    )
    
    
    
    
    
    
    107
    
    
    
    (40
    )
    
    
    
    
    
    
    1,069Selling, general and administrative expense
    
    
    
    
    
    
    (53
    )
    
    
    42
    
    
    
    
    
    
    
    (231
    )
    
    
    4
    
    
    
    536
    
    
    
    298Research and development expense
    
    
    
    
    
    
    
    
    
    
    (27
    )
    
    
    
    
    
    
    (48
    )
    
    
    (5
    )
    
    
    
    
    
    
    (80
    )Amortization of intangibles  goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Special charges  other special charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (150
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (150
    )(Gain) loss on sale of businesses and assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    29
    
    
    
    
    
    
    
    26Other income (expense)  net
    
    
    
    
    
    
    (201
    )
    
    
    8
    
    
    
    
    
    
    
    (22
    )
    
    
    63
    
    
    
    
    
    
    
    (152
    )Interest expense  long term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    (3
    )Interest expense  other
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    12Income tax benefit (expense)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (400
    )
    
    
    
    
    
    
    
    
    
    
    (400
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    5
    
    
    
    
    
    
    
    (7
    )Net earnings (loss) from
discontinued operations  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    493
    
    
    
    493Total restatement adjustments
    
    $
    1,012
    
    
    $
    (113
    )
    
    $
    (42
    )
    
    $
    150
    
    
    $
    (47
    )
    
    $
    
    
    
    $
    (43
    )
    
    $
    917
 Additionally, the cumulative effect of the Second Restatement adjustments was a (decrease)
increase to additional paid-in capital, accumulated deficit and accumulated other comprehensive
loss as of January 1, 2001, as previously reported, of $1, $1,399 and $(187), respectively. The
effect of the Second Restatement adjustments on the consolidated balance sheet as of December
31, 2002 is shown following the discussion below. Revenues and cost of revenues Revenues and cost of revenues were impacted by various errors related to revenue recognition,
corrections to foreign exchange accounting, intercompany related items, special charges and
other adjustments, including financial statement reclassifications. These items are further
described below. The net impact to revenues of the adjustments was an increase of $440 and
$1,491 for the years ended December 31, 2002 and 2001, respectively. The net impact to cost of
revenues related to these revenue adjustments, and the other corrections was an increase of $149
and $422 for the years ended December 31, 2002 and 2001, respectively. The following table
summarizes the revenue recognition adjustments and other adjustments to revenues and cost of
revenues, which increased gross profit by $291 and increased gross profit by $1,069 for the
years ended December 31, 2002 and 2001, respectively: F-21




---



##### Table of Contents



Revenues
    
    
    Cost of revenues2002
    
    
    2001
    
    
    2002
    
    
    2001Revenue recognition adjustments:Application
of SAB 101 or SOP 97-2Title and delivery
    
    $
    211
    
    
    $
    1,624
    
    
    $
    107
    
    
    $
    727Undelivered elements and liquidated damages
    
    
    45
    
    
    
    (190
    )
    
    
    117
    
    
    
    (231
    )Fixed or determinable fees
    
    
    133
    
    
    
    
    
    
    
    
    
    
    
    Reseller transactions
    
    
    
    
    
    
    151
    
    
    
    
    
    
    
    83Other revenue recognition adjustments
    
    
    54
    
    
    
    (51
    )
    
    
    (71
    )
    
    
    (57
    )Increase associated with revenue recognition adjustments
    
    
    443
    
    
    
    1,534
    
    
    
    153
    
    
    
    522Other adjustments:Foreign exchange
    
    
    (3
    )
    
    
    (43
    )
    
    
    (51
    )
    
    
    (78
    )Intercompany
    
    
    
    
    
    
    
    
    
    
    (16
    )
    
    
    45Special charges
    
    
    
    
    
    
    
    
    
    
    88
    
    
    
    Other
    
    
    
    
    
    
    
    
    
    
    (71
    )
    
    
    (107
    )Reclassifications
    
    
    
    
    
    
    
    
    
    
    46
    
    
    
    40Total increase to revenues and cost of revenues
    
    $
    440
    
    
    $
    1,491
    
    
    $
    149
    
    
    $
    422
 Application of SAB 101 or SOP 97-2 Title and delivery Revenues were recognized on certain sales (primarily prior to 2001) for which it was
subsequently determined that the criteria for revenue recognition under SAB 101 or SOP 97-2, as
applicable, had not been met, including arrangements in which legal title or risk of loss on
products did not transfer to the buyer until full payment was received, and arrangements where
delivery had not occurred. Revenues and related cost of revenues for these agreements should
have been deferred until title or risk of loss had passed and all criteria for revenue
recognition had been met. Therefore, adjustments were made to defer revenues and related cost
of revenues from the periods in which they were originally recorded and to recognize them in the
periods in which all revenue recognition criteria were met. Undelivered elements and liquidated damages In certain multiple element arrangements, total arrangement fees were recognized as revenue at
the time of delivery of software or hardware, but prior to the delivery of future contractual or
implicit PCS or other services. Revenues should have been allocated to these future deliverables
based on their fair value and recognized ratably over the PCS period or as the future
obligations were performed. As well, in certain circumstances where the criteria to treat
delivered software and hardware elements and undelivered PCS services as separate accounting
units were not met, the entire arrangement fee should have been recognized over the PCS period.
Adjustments were made to appropriately allocate revenue among the accounting units and recognize
the allocated revenue in accordance with the applicable revenue recognition guidance. Revenues were also recognized for certain contracts that involved undelivered elements as a
result of product development delays. The lack of relative fair value for the undelivered
element meant that revenues and cost of revenues for all products delivered should have been
deferred until the undelivered element was delivered. As originally recorded, revenues were
recognized upon delivery of an alternative product and costs were accrued for the undelivered
element. To correct for these items, related cost provisions were reversed and revenues and
associated cost of revenues were recognized in the appropriate periods when all elements had
been delivered. Revenues were recognized on certain contracts with potential liquidated damages arising
primarily from network outages, shipment delays or product development delays on undelivered
elements. Generally, revenues and related cost of revenues should have been deferred up to the
maximum potential liquidated damages until the damages had been incurred or there was no longer
a possibility of incurring such damages. Specific contracts, primarily in the Asia region, had
the potential for liquidated damages plus right of return privileges if such damages exceeded
contractually defined thresholds due to a product development delay (undelivered element).
Revenues for all products delivered should have been deferred until the undelivered element was
delivered. After delivery of the undelivered element, and in light of a F-22




---



##### Table of Contents



lack of a reasonable
and reliable history of comparable product returns on which to base a returns allowance,
revenues should have been deferred until the right of return had lapsed or until expected
returns could be reasonably estimated. After the right of return had lapsed or reasonable
estimates of expected returns could be made, revenues should have continued to be deferred up to
the amount of the maximum potential liquidated damages until either the earlier of when the
damages were incurred, or there was no longer the possibility of incurring any damages. As
originally recorded, cost provisions were recorded for the amount of the estimated damages
and/or cost of product replacement. To correct these items, related cost provisions were
reversed and revenues and associated cost of revenues were recognized in the appropriate
periods. Fixed or determinable fees Revenues were recognized on certain sales for which it was subsequently determined that the
criteria for revenue recognition under SOP 97-2 had not been met, including arrangements in
which the criteria for fixed or determinable fees was not met. Revenues and related cost of
revenues for these agreements were deferred to later periods when payments became due and all
criteria for revenue recognition had been met. Reseller transactions Prior to 2001, revenues were recognized upon product delivery to a certain reseller who lacked
economic substance apart from Nortel Networks. Revenue should have been deferred and only
recognized by Nortel Networks upon sale by the reseller to an end customer. Correction of this
resulted in revenues and cost of revenues being deferred with ultimate recognition in 2001. Other revenue recognition adjustments Other adjustments included corrections related to an overstatement of revenues and cost of
revenues related to a specific contract in the Caribbean and Latin American (CALA) region, two
specific transactions recorded in the first quarter of 2003 which should have been recorded in
2002, a specific contract with a reciprocal arrangement that should have been treated as a
reduction of revenues and therefore the revenues recorded in 2001 have been reversed, errors in
the application of percentage-of-completion accounting for certain contracts, other errors
related to non-cash incentives and concessions provided to customers and other calculation
errors. Foreign exchange As part of the plan to address a material weakness reported in Nortel Networks Quarterly Report
on Form 10-Q for the period ended September 30, 2003, a review of foreign exchange accounting
was undertaken. The net impact was an increase to pre-tax loss of $57 and $113 for the years
ended December 31, 2002 and 2001, respectively. The following presents the impact of these
restatement adjustments on the consolidated statements of operations for the years ended
December 31, which are described below: F-23




---



##### Table of Contents



2002
    
    
    2001Gross profitPresentation errors
    
    $
    42
    
    
    $
    34Other errors
    
    
    6
    
    
    
    1Total increase to gross profit
    
    $
    48
    
    
    $
    35Operating expensesPresentation errors
    
    $
    (6
    )
    
    $
    (53
    )Total
decrease to operating expenses
    
    $
    (6
    )
    
    $
    (53
    )Other expenseFunctional currency designation
    
    $
    81
    
    
    $
    113Intercompany transaction designation
    
    
    (43
    )
    
    
    14Presentation errors
    
    
    48
    
    
    
    87Other errors
    
    
    25
    
    
    
    (13
    )Total increase to other expense
    
    $
    111
    
    
    $
    201Total increase to pre-tax loss
    
    $
    57
    
    
    $
    113
 Presentation errors For a period of six consecutive quarters ended June 30, 2002, foreign exchange gains or losses
were recorded to various components of the consolidated statements of operations rather than as
part of other income (expense)  net. This presentation has been adjusted with no effect on net
earnings (loss) in any period. Functional currency designation The determination of the functional currency for certain entities was re-examined, based on the
guidance under SFAS No. 52, Foreign Currency Translation (SFAS 52). As a result, Nortel
Networks identified four instances in which the functional currency designation of an entity was
incorrect. These revisions resulted in increases or decreases to other income (expense)  net. Intercompany transaction designation Nortel Networks identified two instances of incorrect treatment of significant foreign currency
translation gains and losses arising from intercompany positions. Under SFAS 52, intercompany
foreign currency transactions that were long-term in nature should have been recorded in
accumulated other comprehensive loss on the balance sheet when translated rather than recorded
as a transactional gain or loss in the statement of operations. The net impact of the
adjustments was an increase or decrease to other income (expense)  net, with an offset to
accumulated other comprehensive loss. Other errors Other errors identified were related to translation of foreign denominated intercompany
transactions, revaluation of certain foreign denominated intercompany transactions and
accounting for mark-to-market adjustments for foreign exchange contracts as required under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). Intercompany balances Historically, Nortel Networks had certain intercompany balances that did not eliminate upon
consolidation (out-of-balance positions), and provisions had been recorded accordingly. As
part of the Second Restatement, Nortel Networks reviewed these provisions and determined that
they should not have been recorded. Adjustments were recorded in the appropriate periods to
reverse these provisions and to correct the significant out-of-balance positions. The
adjustments to reverse the provisions affected the second quarter of 2003 and periods prior to
2000. The net impact of the adjustments to correct the significant out-of-balance positions was
a decrease of $36 and an increase of $42 to the previously reported pre-tax loss for the years
ended December 31, 2002 and 2001, respectively. F-24




---



##### Table of Contents



Special charges As part of the Second Restatement, the components of special charges were re-examined and
decreases to special charges of $77 and $150 for the years ended December 31, 2002 and 2001,
respectively, were recorded. Inventory impairments previously incorrectly classified as special
charges in the year ended December 31, 2002 were reclassified to cost of revenues. Also
impacting special charges were adjustments for restructuring related to contract settlement
costs, including real estate related items, severance and fringe benefit related costs and plant
and equipment impairment costs. Nortel Networks determined that these items were either
recorded in special charges in error or, although correctly recorded when originally recognized,
were not adjusted in the appropriate subsequent periods for changes in estimates and/or
assumptions. The following presents the impact of these adjustments on special charges
for the years ended December 31: 2002
    
    
    2001Inventory impairment reclassification
    
    $
    88
    
    
    $
    Contract settlement costs
    
    
    (36
    )
    
    
    85Severance and fringe benefit related costs
    
    
    21
    
    
    
    35Plant and equipment impairment costs
    
    
    4
    
    
    
    30Total decrease to special charges
    
    $
    77
    
    
    $
    150
 Other Other adjustments were primarily to correct certain accruals, provisions or other transactions
which were either initially recorded incorrectly in prior periods, or not properly released or
adjusted for changes in estimates and/or assumptions in the appropriate subsequent periods. The
components of these adjustments are described below. 2002
    
    
    2001Other adjustmentsCost of revenues
    
    $
    71
    
    
    $
    107Selling, general and administrative expense
    
    
    115
    
    
    
    231Research and development expense
    
    
    85
    
    
    
    48Amortization of intangibles  goodwill
    
    
    
    
    
    
    (1
    )(Gain) loss on sale of businesses and assets
    
    
    3
    
    
    
    3Other income (expense)  net
    
    
    21
    
    
    
    (22
    )Interest expense
    
    
    (19
    )
    
    
    (1
    )Income tax benefit (expense)
    
    
    16
    
    
    
    (400
    )Minority interests  net of tax
    
    
    31
    
    
    
    (12
    )Equity in net loss of associated companies  net of tax
    
    
    1
    
    
    
    Net decrease (increase) to net loss
    
    $
    324
    
    
    $
    (47
    )
 Cost of revenues For the year ended December 31, 2002, the decrease to cost of revenues of $71 was comprised
primarily of reductions of approximately $42 to inventory provisions and related accruals (such
as accounts payable and contract manufacturer related accruals including approximately $39 for a
correction to the accounting for a spares inventory management program which should have been
treated as warranty costs), approximately $18 decrease related to customer and contract related
accruals and other accruals for such items as vacation and fringe benefits, partially offset by
an increase of approximately $11 for warranty costs. For the year ended December 31, 2001, the decrease to cost of revenues of $107 was comprised
primarily of reductions of approximately $84 to contract and customer related accruals and
approximately $72 for inventory provisions and related accruals (such as accounts payable and
contract manufacturer related accruals including approximately $16 for correction to the
accounting for a spares inventory management program which should have been treated as warranty
costs), partially offset by increases of approximately $48 for warranty costs. F-25




---



##### Table of Contents



Selling, general and administrative expense For the year ended December 31, 2002, the decrease of $115 to selling, general and
administrative expense was comprised primarily of reductions of approximately $45 related to
contract amendments and settlements with certain service providers, approximately $30 for salary
and fringe benefit related accruals, approximately $29 from the reversal of rent expense
associated with certain facilities for corrections to accounting for sale-leaseback
transactions, approximately $13 related to the capitalization of certain software development
costs under SOP 98-1, Accounting for Software Development Costs, and decreases to other
accruals, partially offset by a net increase of $19 in bad debt expense. For the year ended December 31, 2001, the decrease of $231 to selling, general and
administrative expense was comprised primarily of reductions of approximately $88 from the
reversal of bad debt expense related to revenue and receivables that had been reversed as part
of the Second Restatement, approximately $52 from adjustments to customer and contractual
accruals, approximately $41 for the reversal of items previously expensed related to reciprocal
agreements with customers (the offset was a reduction to revenues primarily in prior periods),
approximately $30 related to contract amendments and settlements with certain service providers
and decreases to other accruals. Research and development expense For the year ended December 31, 2002, the decrease of $85 in research and development expense
was primarily the result of a decrease of approximately $64 to correctly treat certain software
repair costs as warranty costs, reductions to accruals related to various research and
development projects and to other accruals for such items as vacation and fringe benefits. For the year ended December 31, 2001, the decrease of $48 in research and development expense
was primarily the result of a decrease of approximately $31 to correctly treat certain software
repair costs as warranty costs, reductions to accruals related to various research and
development projects and to other accruals for such items as vacation and fringe benefits. Other income (expense)  net For the year ended December 31, 2002, the decrease of $21 in other expense was primarily the
result of a $10 reversal of an item previously expensed related to a reciprocal agreement
(offset by a reduction to revenues in a prior period), a $9 decrease from corrections to
interest rate swaps relating to debt buybacks and the reduction to other accruals totaling $38,
partially offset by a $20 increase from adjustments to the recognition of income and expense
associated with sales of receivables and an $18 increase from corrections to the timing of the
recognition of impairment of investments. For the year ended December 31, 2001, the $22 increase to other expense was primarily the result
of adjustments of approximately $40 for the recognition of the income and expense associated
with the sale of receivables, partially offset by decreases to other accruals. Interest expense For the year ended December 31, 2002, the increase to interest expense of $19 was primarily the
result of a $32 increase related to long-term debt for corrections to accounting for certain
sale-leaseback transactions, partially offset by a $13 decrease from adjustments to the timing
of the recognition of costs associated with sales of receivables and customer financing. For the year ended December 31, 2001, the increase to interest expense of $1 was primarily the
result of a $10 increase related to long-term debt recognized on certain sale-leaseback
transactions, partially offset by a $4 decrease from adjustments to the timing of the
recognition of costs associated with sales of receivables and customer financing. Income taxes and minority interests Income tax benefit and minority interests were also adjusted as part of the Second Restatement.
The adjustment to income tax benefit, substantially all as a result of the Second Restatement
adjustments, was an increase of $16 and a F-26




---



##### Table of Contents



decrease of $400 for the years ended December 31, 2002
and 2001, respectively. In addition to the reclassifications noted below, the adjustment to
minority interests as a result of the Second Restatement adjustments was an increase of $31 and
a decrease of $12 for the years ended December 31, 2002 and 2001, respectively. Reclassifications As a result of the restatement process, various presentation inconsistencies were identified.
Adjustments were made to appropriately reflect certain items in the consolidated statements of
operations. The reclassifications were made for royalty expense, (gain) loss on sale of
businesses and assets, minority interest  net of tax (now reported separately), and other items
including certain functional spending and specific expenses. The amounts that were reclassified
for the years ended December 31 are detailed below: Royalty
    
    
    Disposal
    
    
    Minorityexpense
    
    
    of assets
    
    
    interests
    
    
    Other
    
    
    Total2002 ReclassificationsCost of
revenues
    
    $
    49
    
    
    $
    7
    
    
    $
    
    
    
    $
    (10
    )
    
    $
    46Selling, general and administrative expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32
    
    
    
    32Research and development expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (22
    )
    
    
    (22
    )(Gain) loss on sale of businesses and assets
    
    
    
    
    
    
    38
    
    
    
    
    
    
    
    
    
    
    
    38Other expense
    
    
    (49
    )
    
    
    (45
    )
    
    
    1
    
    
    
    
    
    
    
    (93
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Net impact of reclassifications
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2001 ReclassificationsCost of
revenues
    
    $
    59
    
    
    $
    (20
    )
    
    $
    
    
    
    $
    1
    
    
    $
    40Selling, general and administrative expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    4Research and development expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    (5
    )(Gain) loss on sale of businesses and assets
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    29Other expense
    
    
    (59
    )
    
    
    (9
    )
    
    
    5
    
    
    
    
    
    
    
    (63
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Net impact of reclassifications
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
 Discontinued operations As a result of the restatement process, the initial provision for loss on disposal of the access
solutions discontinued operations recorded in June 2001, and the subsequent activity during 2001
through 2004 were re-examined. Nortel Networks concluded that the net loss on disposal of
operations recognized in the second quarter of 2001 was overstated. In addition, other
adjustments were necessary to correct certain items that were either initially recorded
incorrectly, or not properly released or adjusted for changes in estimates in the appropriate
periods subsequent to the second quarter of 2001. The net impact of all of these changes was an
increase of $122 and a decrease of $493 to net loss from discontinued operations  net of tax
for the years ended December 31, 2002 and 2001, respectively, as follows: 2002
    
    
    2001Decrease to net loss on disposal of operationsItems that should have been charged to continuing operations
    
    $
    
    
    
    $
    520Overstatement of accruals
    
    
    
    
    
    
    438Investment impairments
    
    
    
    
    
    
    41Tax effect on the above
    
    
    
    
    
    
    (261
    )Decrease to net loss on disposal of operations  net of tax
    
    
    
    
    
    
    738Other adjustments
    
    
    (122
    )
    
    
    (245
    )Decrease (increase) to the net loss from discontinued operations  net of tax
    
    $
    (122
    )
    
    $
    493
 F-27




---



##### Table of Contents



Decrease to net loss on disposal of operations  net of tax The components of the decrease to the initial loss on disposal of operations recorded in the
second quarter of 2001 were as follows:  
    
    a $520 decrease for contingent liabilities and customer financing provisions that should
have been charged to continuing operations rather than discontinued operations;
    
    a $438 decrease to accruals for contingent liabilities and for other contingencies that
did not meet the definition of a liability under SFAS No. 5, Accounting for
Contingencies, when initially recorded;
    
    a $41 decrease for investment impairments that should have been charged to the net loss
from discontinued operations rather than the net loss on disposal of operations; and
    
    the tax effect on the above of $261. Other adjustments In periods subsequent to the second quarter of 2001, adjustments were necessary to record gains
and losses from the reassessment of the remaining discontinued operations provisions in net
earnings (loss) from discontinued operations, in accordance with APB No. 30, Reporting the
Results of Operations  Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB 30). These
adjustments, which included gains and losses arising from divestitures of the access solutions
assets were previously recorded as an increase or decrease to the estimated remaining provisions
for discontinued operations on the consolidated balance sheets. In the Second Restatement,
these adjustments were appropriately recorded in net earnings (loss) from discontinued
operations  net of tax in the period they occurred. For the year ended December 31, 2002, these adjustments increased the net loss from discontinued
operations by approximately $122. This consisted primarily of $206 for additional customer
financing provisions, partially offset by the release of $51 due to changes in estimates for
other provisions, and an increase to the income tax recovery of $16. For the balance of the year ended December 31, 2001, the adjustments increased the net loss from
discontinued operations by approximately $245. This consisted
primarily of $260 for additional
provisions related to the discontinued operations, and $126 for equity losses and impairment
charges on investments, partially offset by $104 due to the reversal of a provision originally
recorded in error related to an investment interest, $16 for contingent liabilities that should
have been charged to continuing operations, and $15 for gross margin impacts resulting from
revenue recognition adjustments as detailed above. Balance sheet The following table presents the impact of the Second Restatement adjustments on Nortel Networks
previously reported consolidated balance sheet as of December 31, 2002. The impact on
inventories  net and various liabilities, including deferred revenue, was primarily due to the
adjustments to revenues and cost of revenues described above. The adjustments to plant and
equipment  net and long-term debt primarily related to corrections to the accounting for
certain sale-leaseback transactions. In addition, there were reclassifications resulting from
the restatement adjustments and to conform to the 2003 presentation in the consolidated balance
sheet. F-28




---



##### Table of Contents



Consolidated Balance Sheet as of December 31, 2002 As previouslyreported
    
    
    Adjustments
    
    
    As restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    3,743
    
    
    $
    (1
    )
    
    $
    3,742Restricted cash and cash equivalents
    
    
    249
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    2,247
    
    
    
    35
    
    
    
    2,282Inventories  net
    
    
    986
    
    
    
    520
    
    
    
    1,506Income taxes recoverable
    
    
    58
    
    
    
    55
    
    
    
    113Deferred income taxes  net
    
    
    793
    
    
    
    
    
    
    
    793Other current assets
    
    
    668
    
    
    
    (32
    )
    
    
    636Total current assets
    
    
    8,744
    
    
    
    577
    
    
    
    9,321Investments
    
    
    248
    
    
    
    (11
    )
    
    
    237Plant and equipment  net
    
    
    1,464
    
    
    
    225
    
    
    
    1,689Goodwill
    
    
    2,021
    
    
    
    (2
    )
    
    
    2,019Intangible assets  net
    
    
    41
    
    
    
    
    
    
    
    41Deferred income taxes  net
    
    
    2,653
    
    
    
    4
    
    
    
    2,657Other assets
    
    
    725
    
    
    
    25
    
    
    
    750Total assets
    
    $
    15,896
    
    
    $
    818
    
    
    $
    16,714LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    30
    
    
    $
    
    
    
    $
    30Trade and other accounts payable
    
    
    899
    
    
    
    (97
    )
    
    
    802Payroll and benefit-related liabilities
    
    
    499
    
    
    
    (15
    )
    
    
    484Contractual liabilities
    
    
    1,213
    
    
    
    (320
    )
    
    
    893Restructuring
    
    
    537
    
    
    
    (38
    )
    
    
    499Other accrued liabilities
    
    
    2,894
    
    
    
    321
    
    
    
    3,215Long-term debt due within one year
    
    
    233
    
    
    
    10
    
    
    
    243Total current liabilities
    
    
    6,305
    
    
    
    (139
    )
    
    
    6,166Long-term debt
    
    
    1,949
    
    
    
    211
    
    
    
    2,160Deferred income taxes  net
    
    
    366
    
    
    
    (9
    )
    
    
    357Other liabilities
    
    
    2,321
    
    
    
    436
    
    
    
    2,757Total liabilities
    
    
    10,941
    
    
    
    499
    
    
    
    11,440Minority interests in subsidiary companies
    
    
    129
    
    
    
    (35
    )
    
    
    94SHAREHOLDERS EQUITYPreferred shares, without par value
    
    
    536
    
    
    
    
    
    
    
    536Common shares, without par value
    
    
    1,211
    
    
    
    
    
    
    
    1,211Additional paid-in capital
    
    
    22,004
    
    
    
    3
    
    
    
    22,007Accumulated deficit
    
    
    (17,607
    )
    
    
    (26
    )
    
    
    (17,633
    )Accumulated other comprehensive loss
    
    
    (1,318
    )
    
    
    377
    
    
    
    (941
    )Total shareholders equity
    
    
    4,826
    
    
    
    354
    
    
    
    5,180Total liabilities and shareholders equity
    
    $
    15,896
    
    
    $
    818
    
    
    $
    16,714
 F-29




---



##### Table of Contents



4.
    
    Accounting changes  (a)
    
    Guarantees  In November 2002, the FASB issued FIN 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others  an
interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB interpretation
No. 34 (FIN 45). FIN 45 defines a guarantee as a contract that contingently requires a
guarantor to pay a guaranteed party as a result of changes in an underlying economic
characteristic (such as interest rates or market value) that is related to an asset, a
liability or an equity security of the guaranteed party or a third partys failure to
perform under a specified agreement. FIN 45 requires that a liability be recognized for the
estimated fair value of the guarantee at its inception. Guarantees issued prior to January
1, 2003 are not subject to the recognition and measurement provisions, but are subject to
expanded disclosure requirements. Nortel Networks has entered into agreements that contain
features which meet the definition of a guarantee under FIN 45. Effective December 31,
2002, Nortel Networks adopted the disclosure requirements of FIN 45. In addition, effective
January 1, 2003, Nortel Networks adopted the initial recognition and measurement provisions
of FIN 45 which apply on a prospective basis to certain guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 did not have a material impact on the results of
operations and financial condition of Nortel Networks (see note 13).  (b)
    
    Asset retirement obligations  In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations (SFAS 143), which applies to certain obligations associated with the
retirement of tangible long-lived assets. SFAS 143 requires that a liability be initially
recognized for the estimated fair value of the obligation when it is incurred. The
associated asset retirement cost is capitalized as part of the carrying amount of the
long-lived asset and depreciated over the remaining life of the underlying asset and the
associated liability is accreted to the estimated fair value of the obligation at the
settlement date through periodic accretion charges to net earnings (loss). When the
obligation is settled, any difference between the final cost and the recorded amount is
recognized as income or loss on settlement. Effective January 1, 2003, Nortel Networks
adopted the initial recognition and measurement provisions of SFAS 143 and identified
certain asset retirement obligations to remediate leased premises and buildings and
equipment situated on leased land. The adoption of SFAS 143 resulted in a decrease to net
earnings (loss) of $12 (net of tax of nil) which has been reported as a cumulative effect of
accounting changes  net of tax, an increase in plant and equipment  net of $4 and an asset
retirement obligation liability of $16 as of January 1, 2003. The adoption of SFAS 143 did
not have a material impact on depreciation and accretion expense.  (c)
    
    Accounting for costs associated with exit or disposal activities  In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit
or Disposal Activities (SFAS 146), which is effective for exit or disposal activities
initiated after December 31, 2002. SFAS 146 supercedes EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) (EITF 94-3). SFAS 146 requires
recognition of costs associated with an exit or disposal activity when the liability is
incurred, whereas under EITF 94-3, a liability for an exit cost was recognized when an
entity committed to an exit plan. In addition, SFAS 146 establishes that fair value is the
objective for initial measurement of the liability. The effect of SFAS 146 was to change
the timing of recognition and the basis for measuring certain liabilities and therefore
created valuation differences between SFAS 146 and EITF 94-3. Exit and disposal activities
initiated before December 31, 2002 continue to be accounted for under EITF 94-3. Nortel
Networks adopted the requirements of SFAS 146 effective January 1, 2003. The adoption of
SFAS 146 did not have a material impact on Nortel Networks results of operations and
financial condition. F-30




---



##### Table of Contents



(d)
    
    Consolidation of variable interest entities  In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities 
an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial
Statements (FIN 46). FIN 46 clarifies the application of consolidation guidance to
those entities defined as VIEs (which includes, but is not limited to special purpose
entities, trusts, partnerships, certain joint ventures and other legal structures) in which
equity investors do not have the characteristics of a controlling financial interest or
there is not sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support. FIN 46 applied immediately to all VIEs created
after January 31, 2003 and by the beginning of the first interim or annual reporting period
commencing after June 15, 2003 for VIEs created prior to February 1, 2003. In October 2003,
the FASB issued FSP FIN 46-6, Effective Date of FASB Interpretation No. 46, deferring the
effective date for applying the provisions of FIN 46 for VIEs created prior to February 1,
2003 to the end of the first interim or annual period ending after December 15, 2003. While
the criteria for deferral were met, Nortel Networks elected early application of FIN 46.Effective July 1, 2003, Nortel Networks prospectively began consolidating two VIEs for which
Nortel Networks was considered the primary beneficiary following the guidance of FIN 46, on
the basis that Nortel Networks retained certain risks associated with guaranteeing recovery
of the unamortized principal balance of the VIEs debt, in two lease financing transactions,
which represented the majority of the risks associated with the respective VIEs activities.
The amount of the guarantees will be adjusted over time as the underlying debt matures. As
of December 31, 2003, Nortel Networks consolidated balance sheet included $184 of long-term
debt (see note 11) and $183 of plant and equipment  net (see note 5) related to these VIEs.
These amounts represented both the collateral and maximum exposure to loss as a result of
Nortel Networks involvement with these VIEs.In December 2003, the FASB issued FIN 46R which amends and supercedes the original FIN 46.
Effective December 2003, Nortel Networks adopted FIN 46R. Any impacts of applying FIN 46R
to an entity to which FIN 46 had previously been applied are considered immaterial to Nortel
Networks results of operations and financial condition and Nortel Networks accounting
treatment of VIEs.Nortel Networks has conducted certain receivable sales with multi-seller conduits. As well,
Nortel Networks has other financial interests and contractual arrangements which would meet
the definition of a variable interest under FIN 46R, including investments in associated
companies and joint ventures, customer financing arrangements, guarantees and
indemnification arrangements, certain leasing arrangements and certain compensation
arrangements. As of December 31, 2003, none of these interests or arrangements met the
requirements for consolidation under FIN 46R.  (e)
    
    Accounting for certain financial instruments with characteristics of both liabilities
and equity  In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150
clarifies the accounting for certain financial instruments with characteristics of both
liabilities and equity, including mandatorily redeemable non-controlling interests, and
requires that those instruments be classified as liabilities on the balance sheets.
Previously, many of those financial instruments were classified as equity. SFAS 150 is
effective for financial instruments entered into or modified after May 31, 2003 and
otherwise is effective at the beginning of the first interim period beginning after June 15,
2003. In November 2003, the FASB issued FSP FAS 150-3, Effective Date, Disclosures, and
Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities
and Certain Mandatorily Redeemable Non-controlling Interests under FASB Statement No. 150,
Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity (FSP FAS 150-3), which deferred indefinitely the effective date for applying the
specific provisions within SFAS 150 related to the classification and measurement of
mandatorily redeemable non-controlling interests.As of December 31, 2003, Nortel Networks continued to consolidate two enterprises with
limited lives. Upon liquidation in 2024, the net assets of these entities will be
distributed to the owners based on their relative interests at that time. The minority
interest included in the consolidated balance sheet related to these entities as of December
31, 2003 was $45. Nortel Networks has not yet determined the fair value of this minority
interest as of December 31, 2003. The adoption of SFAS 150, as amended by FSP FAS 150-3, did not have a
material impact on Nortel Networks results of operations and financial condition. F-31




---



##### Table of Contents



(f)
    
    Accounting for revenue arrangements with multiple deliverables  In November 2002, the EITF reached a consensus on EITF 00-21. In the absence of higher
level accounting literature, EITF 00-21 governs how to separate and allocate revenue to
goods or services or both that are to be delivered in a bundled sales arrangement. EITF
00-21 applies to revenue arrangements entered into after June 30, 2003 and allows for either
prospective application or cumulative adjustment upon adoption. Nortel Networks adopted the
requirements of EITF 00-21 on a prospective basis effective July 1, 2003. On October 1,
2003, Nortel Networks has also adopted related interpretive guidance contained in EITF 03-5,
Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an
Arrangement Containing More-Than-Incidental Software (EITF 03-5), which addresses whether
non-software deliverables included in an arrangement that contains software that is more
than incidental to the products or services as a whole are included within the scope of SOP
97-2. The adoption of EITF 00-21 and EITF 03-5 did not have a material impact on Nortel
Networks results of operations and financial condition.  (g)
    
    Amendment of SFAS 133 on derivative instruments and hedging activities  In April 2003, the FASB issued SFAS No. 149, Amendment of SFAS No. 133 on Derivative
Instruments and Hedging Activities (SFAS 149). SFAS 149 amends and clarifies the
accounting for derivative instruments, including certain derivative instruments embedded in
other contracts and hedging activities under SFAS 133. In particular, SFAS 149: clarifies
under what circumstances a contract with an initial net investment meets the characteristic
of a derivative as discussed in SFAS 133; clarifies when a derivative contains a financing
component; amends the definition of an underlying to conform it to the language used in
FIN 45; and amends certain other existing pronouncements. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003, except as stated below, and for
hedging relationships designated after June 30, 2003.The provisions of SFAS 149 that relate to guidance in SFAS 133 that have been effective for
fiscal quarters which began prior to June 15, 2003 continue to be applied in accordance with
their respective effective dates. In addition, certain provisions relating to forward
purchases or sales of when-issued securities or other securities that do not yet exist are
applied to both existing contracts as well as new contracts entered into after June 30,
2003.Effective July 1, 2003, Nortel Networks applied the requirements of SFAS 149 on a
prospective basis to contracts entered into or modified after June 30, 2003. The adoption
of SFAS 149 did not have a material impact on Nortel Networks results of operations and
financial condition.  (h)
    
    Determining whether an arrangement contains a lease  In May 2003, the EITF reached a consensus on Issue No. 01-8, Determining Whether an
Arrangement Contains a Lease (EITF 01-8). EITF 01-8 provides guidance on how to
determine whether an arrangement contains a lease that is within the scope of FASB Statement
No. 13, Accounting for Leases. The guidance in EITF 01-8 is based on whether the
arrangement conveys to the purchaser (or the lessee) the right to use or control the use of
a specific asset, and is effective for Nortel Networks for arrangements entered into or
modified after June 30, 2003. As of December 31, 2003, Nortel Networks recorded embedded
lease assets and liabilities of $2 included in each of plant and equipment  net (see note
5) and long-term debt (see note 11), respectively. The impact of EITF 01-8 on Nortel
Networks future results of operations and financial condition will depend on the terms
contained in contracts signed or contracts amended in the future.  (i)
    
    Pensions and other post-retirement benefits  On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003), Employers
Disclosures about Pensions and Other Postretirement Benefits (SFAS 132R). SFAS 132R is a
replacement of SFAS No. 132, Employers Disclosures about Pensions and Other Postretirement
Benefits (SFAS 132). It is effective for fiscal years ended after December 15, 2003 and
the applicable current year requirements have been applied in the presentation of the
consolidated financial statements. SFAS 132R requires additional disclosures regarding
defined benefit pension plan and other post-retirement benefit plan assets, obligations,
cash flows and net cost as well as retaining a number of disclosures required by SFAS 132. F-32




---



##### Table of Contents



(j)
    
    Stock-based compensation  In December 2002, the FASB issued SFAS 148, which amended the transitional provisions
of SFAS 123 for companies electing to recognize employee stock-based compensation using the
fair value based method. Effective January 1, 2003, Nortel Networks elected to expense
employee stock-based compensation using the fair value based method prospectively for all
awards granted, modified, or settled on or after January 1, 2003 (see note 2(u)).  (k)
    
    Accounting for goodwill and other intangible assets  In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets
(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.The following table presents the impact on net earnings (loss) for the year ended December
31, 2001 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, 2001: 2001Reported results:Net earnings (loss) from continuing operations
    
    $
    (11,006
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (2,031
    )Cumulative effect of accounting change  net of tax
    
    
    15Net earnings (loss)  reported
    
    $
    (13,022
    )Adjustments:Amortization
of goodwill from continuing operations  net of tax (a)
    
    $
    2,090Amortization of goodwill from discontinued operations
    
    
    127Total net adjustments
    
    $
    2,217Adjusted results:Net earnings (loss) from continuing operations
    
    $
    (8,916
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (1,904
    )Cumulative effect of accounting change  net of tax
    
    
    15Net earnings (loss)  adjusted
    
    $
    (10,805
    )
 (a)
    
    Included goodwill amortization of equity accounted investments of $9 (net of tax of $5).
  (l)
    
    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 addressed financial accounting and
reporting for the impairment or disposal of long-lived assets. SFAS 144 is applicable 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 superseded
SFAS No. 121, Accounting for the Impairment of Long-lived Assets and for Long-lived Assets
to be Disposed Of, and 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 broadened 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 F-33




---



##### Table of Contents



equipment of $290 related to long-lived assets held and used, and $38 related to long-lived
assets held for sale. See note 7 for further information regarding these write downs.  (m)
    
    Derivative financial instruments  Effective January 1, 2001, Nortel Networks adopted 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). See note 2(t) for further
information regarding the accounting for derivatives under SFAS 133.For the year ended December 31, 2001, the adoption of SFAS 133 resulted in a cumulative
decrease in net loss of $15 (net of tax of $9), which has been reported as cumulative effect
of accounting changes  net of tax, and a charge to OCI of $7 (net of tax of $4). 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.  5.
    
    Consolidated financial statement details  The following consolidated financial statement details are presented as of December 31 for
the consolidated balance sheets and for each of the years ended December 31 for the consolidated
statements of operations and consolidated statements of cash flows.Consolidated statements of operationsSelling, general and administrative expense:Selling, general and administrative (SG&A) expense included bad debt recoveries of $179 and
expense of $292 and $1,789 in the years ended December 31, 2003, 2002 and 2001, respectively.Research and development expense: 2003
    
    
    2002
    
    
    2001R&D expense
    
    $
    1,965
    
    
    $
    2,084
    
    
    $
    3,128R&D costs incurred on behalf of others (a)
    
    
    72
    
    
    
    49
    
    
    
    68Total
    
    $
    2,037
    
    
    $
    2,133
    
    
    $
    3,196
 (a)
    
    These costs included R&D charged to customers of Nortel Networks pursuant to contracts
that provided for full recovery of the estimated cost of development, material,
engineering, installation and other applicable costs, which were accounted for as contract
costs.
  Other income (expense)  net: 2003
    
    
    2002
    
    
    2001Interest income
    
    $
    75
    
    
    $
    88
    
    
    $
    133Gain(loss)on sale or write down of investments
    
    
    143
    
    
    
    (39
    )
    
    
    (368
    )Currency exchange gains (losses)
    
    
    83
    
    
    
    (84
    )
    
    
    (161
    )Other-net
    
    
    132
    
    
    
    7
    
    
    
    (123
    )Other income (expense)-net
    
    $
    433
    
    
    $
    (28
    )
    
    $
    (519
    )
  During the year ended December 31, 2003, reversals of
provisions of $87 relating to a customer bankruptcy settlement
reduced cost of revenues and SG&A expense by $53 and $4,
respectively, and increased other income (expense)  net by $30. F-34




---



##### Table of Contents



Consolidated balance sheetsAccounts receivable  net: 2003
    
    
    2002Trade receivables
    
    $
    2,271
    
    
    $
    1,917Contracts in process
    
    
    582
    
    
    
    8672,853
    
    
    
    2,784Less: provision for doubtful accounts
    
    
    (194
    )
    
    
    (502
    )Accounts receivable  net
    
    $
    2,659
    
    
    $
    2,282
  Inventories  net: 2003
    
    
    2002Raw materials
    
    $
    249
    
    
    $
    339Work in process
    
    
    172
    
    
    
    256Finished goods
    
    
    769
    
    
    
    911Inventories  net(a)
    
    $
    1,190
    
    
    $
    1,506
 (a)
    
    Net of inventory provisions of $1,226 and $1,180 as of December 31, 2003 and 2002,
respectively. Other reserves for claims related to contract manufacturers and suppliers of
$120 and $171 as of December 31, 2003 and 2002, respectively, were included in other
accrued liabilities. These accruals were related to cancellation charges, contracted-for
inventory in excess of future demand and the settlement of certain other claims.
  Other current assets: 2003
    
    
    2002Prepaid expenses
    
    $
    176
    
    
    $
    161Current assets of discontinued operations(a)
    
    
    28
    
    
    
    198Other
    
    
    110
    
    
    
    277Other current assets
    
    $
    314
    
    
    $
    636
 (a)
    
    See note 19 for additional information.
  Plant and equipment  net: 2003
    
    
    2002Cost:Land
    
    $
    63
    
    
    $
    63Buildings
    
    
    1,483
    
    
    
    1,427Machinery and equipment
    
    
    2,705
    
    
    
    3,4014,251
    
    
    
    4,891Less accumulated depreciation:Buildings
    
    
    (457
    )
    
    
    (526
    )Machinery and equipment
    
    
    (2,140
    )
    
    
    (2,676
    )(2,597
    )
    
    
    (3,202
    )Plant and equipment  net(a) (b) (c)
    
    $
    1,654
    
    
    $
    1,689
 (a)
    
    Included assets held for sale with a carrying value of $30 and $73 as of December 31,
2003 and 2002, respectively, related to owned facilities that were being actively marketed.
These assets were written down in previous periods to their estimated fair values less
costs to sell. The write downs were included in special charges. Nortel Networks expects
to dispose of all of these facilities by mid-2005.(b)
    
    Included VIE assets consolidated prospectively, as required by FIN 46R, of $183 as of
December 31, 2003 (see note 4(d)).(c)
    
    Included embedded leases recorded prospectively, as required by EITF 01-8, of $2 as of
December 31, 2003 (see note 4(h)).
   F-35




---



##### Table of Contents



Goodwill:  The following table outlines goodwill by reportable segment: Wireless
    
    
    Enterprise
    
    
    Wireline
    
    
    OpticalNetworks
    
    
    Networks
    
    
    Networks
    
    
    Networks
    
    
    Other
    
    
    TotalBalance  net as of December 31, 2001
    
    $
    21
    
    
    $
    1,521
    
    
    $
    481
    
    
    $
    258
    
    
    $
    
    
    
    $
    2,281Change:Impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (264
    )
    
    
    
    
    
    
    (264
    )Foreign exchange
    
    
    
    
    
    
    (2
    )
    
    
    (2
    )
    
    
    6
    
    
    
    
    
    
    
    2Balance  net as of December 31, 2002
    
    
    21
    
    
    
    1,519
    
    
    
    479
    
    
    
    
    
    
    
    
    
    
    
    2,019Change:Additions(a)
    
    
    13
    
    
    
    31
    
    
    
    43
    
    
    
    9
    
    
    
    
    
    
    
    96Foreign exchange
    
    
    1
    
    
    
    5
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    10Balance  net as of December 31, 2003
    
    $
    35
    
    
    $
    1,555
    
    
    $
    526
    
    
    $
    9
    
    
    $
    
    
    
    $
    2,125
 (a)
    
    See note 10 for additional information.
  During the year ended December 31, 2003, Nortel Networks performed its annual goodwill
impairment test and concluded that there was no impairment. During the three months ended
September 30, 2002, an impairment test was performed on goodwill in accordance with SFAS 142 for
all reporting units due to a significant adverse change in the business climate and taking into
consideration Nortel Networks market capitalization at the end of the third quarter of 2002.
All of Nortel Networks reporting units had fair values in excess of their carrying values with
the exception of Optical Networks. As a result of the impairment test, Nortel Networks recorded
a write down of goodwill of $264 within the Optical Networks segment during the year ended
December 31, 2002.  Intangible assets  net: 2003
    
    
    2002Other intangible assets(a)
    
    $
    45
    
    
    $
    Pension intangible assets(b)
    
    
    41
    
    
    
    41Intangible assets  net(a)
    
    $
    86
    
    
    $
    41
 (a)
    
    Other intangible assets are being amortized over a ten year period ending in 2013.
Amortization expense for the next five years commencing in 2004 is expected to be $9, $6,
$5, $5 and $4, respectively. The amortization expense is denominated in a foreign currency
and may fluctuate due to changes in foreign exchange rates.(b)
    
    Pension intangible assets were recorded as required by SFAS No. 87, Employers
Accounting for Pensions. Amounts are not amortized but are adjusted as part of the annual
minimum pension liability assessment.
 F-36




---



##### Table of Contents



Other accrued liabilities: 2003
    
    
    2002Outsourcing and selling, general and administrative related
    
    $
    298
    
    
    $
    481Customer deposits
    
    
    73
    
    
    
    68Product related
    
    
    120
    
    
    
    171Warranty
    
    
    382
    
    
    
    404Deferred income
    
    
    761
    
    
    
    1,108Miscellaneous taxes
    
    
    75
    
    
    
    70Income taxes payable
    
    
    110
    
    
    
    150Current liabilities of discontinued operations
    
    
    6
    
    
    
    63Interest payable
    
    
    37
    
    
    
    42Advance billings in excess of revenues recognized to date on long-term contracts
    
    
    509
    
    
    
    394Other
    
    
    96
    
    
    
    264Other accrued liabilities
    
    $
    2,467
    
    
    $
    3,215
  Other liabilities: 2003
    
    
    2002Pension,
post-employment and post-retirement benefits liabilities
    
    $
    1,973
    
    
    $
    1,645Long-term provisions
    
    
    971
    
    
    
    1,112Other liabilities
    
    $
    2,944
    
    
    $
    2,757
  Consolidated statements of cash flowsChange in operating assets and liabilities: 2003
    
    
    2002
    
    
    2001Restricted cash and cash equivalents
    
    $
    200
    
    
    $
    (231
    )
    
    $
    Accounts receivable
    
    
    (302
    )
    
    
    937
    
    
    
    5,513Inventories
    
    
    437
    
    
    
    845
    
    
    
    2,747Income taxes
    
    
    25
    
    
    
    1,249
    
    
    
    (953
    )Restructuring
    
    
    (551
    )
    
    
    (1,084
    )
    
    
    (1,110
    )Accounts payable and accrued liabilities
    
    
    (479
    )
    
    
    (1,591
    )
    
    
    (613
    )Other operating assets and liabilities
    
    
    449
    
    
    
    494
    
    
    
    1,459Change in operating assets and liabilities
    
    $
    (221
    )
    
    $
    619
    
    
    $
    7,043
  Cash and cash equivalents at end of year: 2003
    
    
    2002
    
    
    2001Cash on hand and balances with banks
    
    $
    729
    
    
    $
    902
    
    
    $
    1,264Short-term investments
    
    
    3,199
    
    
    
    2,840
    
    
    
    2,153Cash and cash equivalents at end of year
    
    $
    3,928
    
    
    $
    3,742
    
    
    $
    3,417
 F-37




---



##### Table of Contents



Acquisitions of investments and businesses  net of cash acquired: 2003
    
    
    2002
    
    
    2001Cash acquired
    
    $
    (12
    )
    
    $
    
    
    
    $
    Total net assets acquired other than cash
    
    
    (163
    )
    
    
    (29
    )
    
    
    (89
    )Total purchase price
    
    
    (175
    )
    
    
    (29
    )
    
    
    (89
    )Less:Cash acquired
    
    
    12
    
    
    
    
    
    
    
    Non-cash consideration paid other than common share options
and contingent consideration
    
    
    105
    
    
    
    
    
    
    
    Acquisitions of investments and businesses  net of cash acquired
    
    $
    (58
    )
    
    $
    (29
    )
    
    $
    (89
    )
  Interest and taxes paid (recovered): 2003
    
    
    2002
    
    
    2001Cash interest paid
    
    $
    110
    
    
    $
    201
    
    
    $
    252Cash taxes paid (recovered)  net(a)
    
    $
    2
    
    
    $
    (1,218
    )
    
    $
    18
 (a)
    
    During the year ended December 31, 2003, Nortel Networks paid Canadian tax on preferred
dividends of $11. This amount is included in the $35 of dividends on preferred shares in
the consolidated statement of cash flows.
  Receivables sales: 2003
    
    
    2002
    
    
    2001Proceeds from new securitizations
    
    $
    651
    
    
    $
    562
    
    
    $
    789Proceeds from collections reinvested in revolving period securitizations
    
    $
    52
    
    
    $
    276
    
    
    $
    688
  6.
    
    Segment informationGeneral description  During 2003 and up to September 30, 2004, Nortel Networks operations were organized around
four reportable segments consisting of Wireless Networks, Enterprise Networks, Wireline Networks
and Optical Networks. Wireless Networks included network access and core networking products
for voice and data communications that span second and third generation wireless technologies
and most major global standards for mobile networks and related professional services.
Enterprise Networks included circuit and packet voice solutions, data networking and security
solutions and the related professional services used by enterprise customers. Wireline Networks
included circuit and packet voice solutions, data networking and security solutions and the
related professional services used by service provider customers. Optical Networks included
metropolitan, regional and long-haul optical transport and switching solutions and managed
broadband services and related professional services for both service provider and enterprise
customers.Other represented miscellaneous business activities and corporate functions. None of these
activities meet the quantitative criteria to be disclosed as reportable segments. As described
in note 19, Nortel Networks access solutions operations were discontinued during the year ended
December 31, 2001. These operations were previously included as a separate business activity
within other. The data below excludes amounts related to the access solutions operations.Effective October 1, 2004, a new streamlined organizational structure was established that
involved, among other things, combining the businesses of Nortel Networks four segments into two
business organizations: (i) Carrier Networks and Global Operations, and (ii) Enterprise
Networks. Nortel Networks is reviewing the impact of these changes on its reportable segments.Nortel Networks president and chief executive officer (the 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 F-38




---



##### Table of Contents



information derived directly from
the Nortel Networks management reporting system. In 2003, Nortel Networks reported that the
primary financial measure used by the former chief operating decision maker in assessing
performance and allocating resources to the segments was contribution margin, a measure that was
comprised of gross profit less SG&A expense. In April 2004, Nortel Networks and NNCs board of
directors appointed a new CEO. Commencing in the second quarter of 2004, the primary financial
measure used by the CEO in assessing performance and allocating resources to the segments is
management earnings (loss) before income taxes (Management EBT), a measure that includes
contribution margin, R&D expense, interest expense, other income (expense)  net, minority
interests  net of tax and equity in net loss of associated companies  net of tax. As a result of the change in
Nortel Networks primary financial measure used to assess the performance of the segments during
the period in which Nortel Networks financial reports as described in note 22 have been delayed,
and because both contribution margin and Management EBT were available to the former chief
operating decision maker during 2003, Nortel Networks has determined that it is appropriate to
disclose both contribution margin and Management EBT for the periods presented.Costs associated with shared services and other corporate costs are allocated to the segments
based on usage determined generally by headcount. Costs not allocated to the segments are
primarily related to Nortel Networks corporate compliance and other non-operational activities
and are included in other. In addition, the CEO does not review asset information on a
segmented basis in order to assess performance and allocate resources. The accounting policies
of the reportable segments are the same as those applied to the consolidated financial
statements.SegmentsThe following tables set forth information by segment for the years ended December 31: 2003
    
    
    2002
    
    
    2001RevenuesWireless Networks
    
    $
    4,389
    
    
    $
    4,161
    
    
    $
    5,699Enterprise Networks
    
    
    2,589
    
    
    
    2,415
    
    
    
    3,143Wireline Networks
    
    
    2,005
    
    
    
    2,572
    
    
    
    4,327Optical Networks
    
    
    1,179
    
    
    
    1,815
    
    
    
    5,014Other
    
    
    31
    
    
    
    31
    
    
    
    580Total
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763Contribution marginWireless Networks
    
    $
    1,573
    
    
    $
    1,104
    
    
    $
    515Enterprise Networks
    
    
    574
    
    
    
    314
    
    
    
    284Wireline Networks
    
    
    612
    
    
    
    740
    
    
    
    614Optical Networks
    
    
    
    
    
    
    (743
    )
    
    
    (1,458
    )Other
    
    
    (358
    )
    
    
    (92
    )
    
    
    (1,713
    )Total
    
    $
    2,401
    
    
    $
    1,323
    
    
    $
    (1,758
    )Management EBTWireless Networks
    
    $
    695
    
    
    $
    256
    
    
    $
    (456
    )Enterprise Networks
    
    
    317
    
    
    
    54
    
    
    
    (79
    )Wireline Networks
    
    
    170
    
    
    
    185
    
    
    
    (199
    )Optical Networks
    
    
    (258
    )
    
    
    (1,227
    )
    
    
    (2,352
    )Other
    
    
    (243
    )
    
    
    (232
    )
    
    
    (2,760
    )Total
    
    
    681
    
    
    
    (964
    )
    
    
    (5,846
    )In-process research and development expense
    
    
    
    
    
    
    
    
    
    
    Amortization of acquired technology and other
    
    
    (3
    )
    
    
    (19
    )
    
    
    (574
    )Amortization of goodwill
    
    
    
    
    
    
    
    
    
    
    (2,081
    )Deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    Special charges
    
    
    (285
    )
    
    
    (1,622
    )
    
    
    (5,178
    )Gain (loss) on sale of businesses and assets
    
    
    4
    
    
    
    4
    
    
    
    100Income tax benefit (expense)
    
    
    33
    
    
    
    438
    
    
    
    2,573Net earnings (loss) from continuing operations
    
    $
    430
    
    
    $
    (2,163
    )
    
    $
    (11,006
    )
 F-39




---



##### Table of Contents



Product revenues  The following table sets forth external revenues by product for the years ended December
31: 2003
    
    
    2002
    
    
    2001Wireless solutions
    
    $
    4,389
    
    
    $
    4,161
    
    
    $
    5,699Circuit and packet voice solutions
    
    
    3,044
    
    
    
    3,193
    
    
    
    5,224Optical solutions
    
    
    1,413
    
    
    
    1,992
    
    
    
    5,373Data networking and security solutions
    
    
    1,316
    
    
    
    1,617
    
    
    
    1,887Other
    
    
    31
    
    
    
    31
    
    
    
    580Total
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763
  During the years ended December 31, 2003, 2002 and 2001, no customers had revenues greater
than 10 percent of consolidated revenues.Geographic informationThe following table sets forth external revenues by geographic region based on the location
of the customer for the years ended December 31: 2003
    
    
    2002
    
    
    2001U.S.
    
    $
    5,424
    
    
    $
    5,809
    
    
    $
    10,059Europe,
Middle East and Africa (EMEA)
    
    
    2,366
    
    
    
    2,500
    
    
    
    4,352Canada
    
    
    587
    
    
    
    648
    
    
    
    1,078Other regions(a)
    
    
    1,816
    
    
    
    2,037
    
    
    
    3,274Total
    
    $
    10,193
    
    
    $
    10,994
    
    
    $
    18,763
 (a)
    
    The Asia Pacific and CALA regions.
  Long-lived assets  The following table sets forth long-lived assets representing plant and equipment  net,
goodwill and other intangible assets  net by geographic region as of December 31: 2003
    
    
    2002U.S.
    
    $
    2,466
    
    
    $
    2,453EMEA
    
    
    616
    
    
    
    506Canada
    
    
    683
    
    
    
    646Other regions
    
    
    100
    
    
    
    144Total
    
    $
    3,865
    
    
    $
    3,749
 F-40




---



##### Table of Contents



7.
    
    Special charges  During 2003, Nortel Networks continued to implement its restructuring work plan initiated
in 2001. In addition, as described below, certain exit activities were initiated in 2003.Special charges recorded from January 1, 2001 to December 31, 2003 were as follows: Contract
    
    
    
    
    
    
    
    
    
    
    Intangiblesettlement
    
    
    Plant and
    
    
    
    
    
    
    assetWorkforce
    
    
    and lease
    
    
    equipment
    
    
    
    
    
    
    impair-reduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    ments
    
    
    TotalProvision balance as of January 1, 2001
    
    $
    45
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    45Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,239
    
    
    
    2,239Other special charges
    
    
    1,156
    
    
    
    897
    
    
    
    969
    
    
    
    39
    
    
    
    
    
    
    
    3,061Revisions to prior accruals
    
    
    45
    
    
    
    (106
    )
    
    
    (59
    )
    
    
    (2
    )
    
    
    
    
    
    
    (122
    )Cash drawdowns
    
    
    (992
    )
    
    
    (110
    )
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    (1,110
    )Non-cash drawdowns
    
    
    14
    
    
    
    
    
    
    
    (910
    )
    
    
    
    
    
    
    (2,239
    )
    
    
    (3,135
    )Foreign exchange and other adjustments
    
    
    11
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7Provision balance as of December 31, 2001
    
    $
    279
    
    
    $
    677
    
    
    $
    
    
    
    $
    29
    
    
    $
    
    
    
    $
    985Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    264
    
    
    
    264Other special charges
    
    
    928
    
    
    
    210
    
    
    
    383
    
    
    
    
    
    
    
    
    
    
    
    1,521Revisions to prior accruals
    
    
    (126
    )
    
    
    18
    
    
    
    (55
    )
    
    
    
    
    
    
    
    
    
    
    (163
    )Cash drawdowns
    
    
    (778
    )
    
    
    (286
    )
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    (1,084
    )Non-cash drawdowns
    
    
    (100
    )
    
    
    
    
    
    
    (328
    )
    
    
    
    
    
    
    (264
    )
    
    
    (692
    )Foreign exchange and other adjustments
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Provision balance as of December 31, 2002(a)
    
    $
    204
    
    
    $
    620
    
    
    $
    
    
    
    $
    9
    
    
    $
    
    
    
    $
    833Other special charges
    
    
    198
    
    
    
    63
    
    
    
    74
    
    
    
    
    
    
    
    
    
    
    
    335Revisions to prior accruals
    
    
    (42
    )
    
    
    20
    
    
    
    (28
    )
    
    
    
    
    
    
    
    
    
    
    (50
    )Cash drawdowns
    
    
    (267
    )
    
    
    (275
    )
    
    
    
    
    
    
    (9
    )
    
    
    
    
    
    
    (551
    )Non-cash drawdowns
    
    
    (41
    )
    
    
    
    
    
    
    (46
    )
    
    
    
    
    
    
    
    
    
    
    (87
    )Foreign exchange and other adjustments
    
    
    12
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39Provision balance as of December 31, 2003(a)
    
    $
    64
    
    
    $
    455
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    519
 (a)
    
    As of December 31, 2003 and 2002, the short-term provision balance was $205 and $499,
respectively, and the long-term provision balance was $314 and $334, respectively, which
was included in long-term provisions, as a component of 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 2001
    
    
    13,800
    
    
    
    21,700
    
    
    
    35,500During 2002
    
    
    3,300
    
    
    
    8,800
    
    
    
    12,100During 2003
    
    
    400
    
    
    
    1,300
    
    
    
    1,700RFT employee notifications for the year ended December 31, 2003
    
    
    17,500
    
    
    
    31,800
    
    
    
    49,300
 (a)
    
    Direct employees included employees performing manufacturing, assembly, test and
inspection activities associated with the production of Nortel Networks products.(b)
    
    Indirect employees included employees performing manufacturing management, sales,
marketing, research and development and administrative activities.
  Year ended December 31, 2003  For the year ended December 31, 2003, Nortel Networks recorded total special charges of
$285, which was net of revisions of $50 related to prior accruals. F-41




---



##### Table of Contents



Workforce reduction charges of $198 were related to severance and benefit costs associated with
approximately 1,700 employees notified of termination. The workforce reduction was primarily in
the U.S., Canada and EMEA and extended across all segments. Offsetting these charges were
revisions to prior accruals of $42 which were primarily related to termination benefits where
actual costs were lower than the estimated amounts across all segments. During 2003, the
workforce reduction provision balance was drawn down by cash payments of $267 and by a non-cash
pension settlement loss of $41. The remaining provision is expected to be substantially drawn
down by the end of 2004.Contract settlement and lease costs of $63 consisted of negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities (comprised of office,
warehouse and manufacturing space) and leased furniture that were identified as no longer
required across all segments. These lease costs, net of anticipated sublease income, included
non-cancelable lease terms from the date leased facilities ceased to be used and termination
penalties. In addition to these charges were revisions to prior accruals of $20 resulting
primarily from changes in estimates for sublease income and costs to vacate certain properties,
across all segments. During 2003, the provision balance for contract settlement and lease costs
was drawn down by cash payments of $275. The remaining provision, net of approximately $317 in
estimated sublease income, is expected to be substantially drawn down by the end of 2013.Included in the above contract settlement and lease costs and net revisions to prior accruals
were charges related to activities initiated by Nortel Networks in 2003 to exit certain leased
facilities and leases for assets no longer used, across all segments. The table below
summarizes the total costs estimated to be incurred as a result of these activities which have
met the criteria described in SFAS 146, the balance of these accrued expenses as of December 31,
2003 and the movement in these accruals. These costs have been valued using the estimated fair
value method prescribed under SFAS 146. Nortel Networks expects to have completed these
activities by mid-2022, based on existing lease terms. Accrued
    
    
    Costs
    
    
    Payments
    
    
    Adjustments
    
    
    Accruedbalance as
    
    
    incurred
    
    
    made
    
    
    made
    
    
    balance asof January
    
    
    during
    
    
    during
    
    
    during
    
    
    of December1, 2003
    
    
    2003
    
    
    2003
    
    
    2003
    
    
    31, 2003Lease costs(a)
    
    $
    
    
    
    $
    50
    
    
    $
    (8
    )
    
    $
    (6
    )
    
    $
    36
 (a)
    
    Total estimated costs, net of estimated sublease income, associated with these accruals
are $62.
  Plant and equipment charges of $74 were largely related to current period write downs to
fair value less costs to sell for various leasehold improvements and excess Optical Networks
equipment held for sale. Offsetting these charges were revisions of $28 to prior write downs of
assets held for sale related primarily to adjustments to original plans or estimated amounts for
certain facility closures.  Year ended December 31, 2002  For the year ended December 31, 2002, Nortel Networks recorded total special charges of
$1,622, which were net of revisions of $163 related to prior accruals.Workforce reduction charges of $928 were related to severance and benefit costs associated with
approximately 12,100 employees notified of termination. The workforce reduction was primarily
in the U.S., Canada and EMEA and extended across all segments. Offsetting these charges were
revisions to prior accruals of $126 which were primarily related to termination benefits where
actual costs were lower than the estimated amounts across all segments. Workforce reduction
charges included $124 for pension and post-retirement benefits other than pension, settlement
and curtailment costs. During 2002, the workforce reduction provision balance was drawn down by
cash payments of $778 and by $100 of non-cash pension and post-retirement benefits other than
pension, settlement and curtailment costs attributable to the notified employee group charged
against the provision.Contract settlement and lease costs of $210 consisted of negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities (comprised of office,
warehouse and manufacturing space) and leased manufacturing equipment that were no longer
required, across all segments. In addition to these charges were revisions to prior accruals of
$18 resulting primarily from changes in estimates for sublease income and costs to vacate
certain properties, across all segments. During the year ended December 31, 2002, the provision
balance for contract settlement F-42




---



##### Table of Contents



and lease costs was drawn down by cash payments of $286. The
remaining provision balance was net of approximately $402 in estimated sublease income.Plant and equipment charges of $383 were related to current period write downs to fair value
less costs to sell for various owned facilities and plant and manufacturing related equipment.
These charges for facilities and equipment included $266 related to specialized plant
infrastructure and equipment within Optical Networks with the remaining charges for facilities
and equipment arising across all segments. Fair value was determined using quoted market prices
or the anticipated cash flows discounted at a rate commensurate with the risks involved.
Offsetting these charges were revisions of $55 to prior write downs of assets held for sale
related primarily to additional proceeds from disposals of equipment from Optical Networks and
other segments in excess of amounts previously expected and adjustments to original plans or
estimated amounts for certain facility closures across all segments.Within Optical Networks, Nortel Networks performed assessments of certain plant and equipment
due to the then current market conditions and the delay in the anticipated recovery of that
segment and concluded that the assets carrying values were not fully recoverable from estimated
future cash flows. As a result, Nortel Networks recorded a charge to income of $266 to write
down the value of this equipment to its fair value less costs to sell. Included in the $266
write down was $34 related to equipment held for sale, which was part of the Bookham Technology
plc (Bookham) transaction (see note 10).Goodwill impairment charges were $264. As a result of the continued decline during 2002, 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 then expected present value of
discounted future cash flows of the businesses within Optical Networks. The discount rate used
ranged from 12 to 16 percent and the terminal values were estimated based on terminal growth
rates ranging from 3 to 5 percent. The assumptions supporting the estimated future cash flows,
including the discount rate and estimated terminal values, reflected managements best
estimates.Year ended December 31, 2001For the year ended December 31, 2001, Nortel Networks recorded total special charges of
$5,178, which were net of revisions of $122 related to prior accruals.Workforce reduction charges of $1,156 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 U.S., Canada and EMEA and extended across all segments. In addition to
these charges were revisions to prior accruals of $45 which were primarily related to
termination benefits where actual costs were higher than the estimated amounts across all
segments. During the year ended December 31, 2001, the workforce reduction provision balance was drawn
down by cash payments of $992 and 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 $897 related to negotiated settlements to cancel or
renegotiate contracts and net lease charges related to a number of leased facilities (comprised
of office, warehouse and manufacturing space) and leased manufacturing equipment that were no
longer required, across all segments. Offsetting these charges were revisions to prior accruals
of $106 primarily related to contract settlement costs which were lower than the estimated
amounts across all segments. During the year ended December 31, 2001, the provision balance for
contract settlement and lease costs was drawn down by cash payments of $110. The remaining
provision balance was net of approximately $496 in estimated sublease revenues.Plant and equipment charges of $969 included write downs of $167 for owned facilities, $435 for
leasehold improvements and certain information technology equipment associated with the exiting
of leased and owned facilities and $367 for certain plant and manufacturing related equipment.
Owned facility write downs of $167 included $76 for specific owned facilities across all
segments primarily within the U.S., Canada and EMEA and $91 for a specialized manufacturing
facility in the U.S. within Optical Networks. The carrying values of the above owned facilities
have been F-43




---



##### Table of Contents



reflected at their net realizable value based on market assessments for general
purpose facilities. Offsetting these charges were revisions of $59 to prior write downs resulting primarily from adjustments to original
plans or estimated amounts for certain facility closures. These revisions related primarily to
global operations and Optical Networks.Plant and manufacturing related equipment write downs of $367 included $103 for equipment within
global operations, and $264 for specialized plant infrastructure and equipment within Optical
Networks.Goodwill and other intangible assets impairment charges totaled $2,239 during the year ended
December 31, 2001. In addition to the charge of $2,133 described below, this amount included 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
then 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, 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.  8.
    
    Income taxes  As of December 31, 2003, Nortel Networks net deferred tax assets, excluding discontinued
operations, were $3,576, reflecting temporary differences between the financial reporting and
tax treatment of certain current assets and liabilities and non-current assets and liabilities,
in addition to the tax benefit of net operating and capital loss carryforwards and tax credit
carryforwards.In accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109), Nortel Networks
reviews all available positive and negative evidence to evaluate the recoverability of the
deferred tax assets. This includes a review of such evidence as the carryforward periods of the
significant tax assets, Nortel Networks history of generating taxable income in its material tax
jurisdictions and Nortel Networks cumulative consolidated loss position.Based on this review, Nortel Networks concluded that the valuation allowance as of December 31,
2003 was appropriate. Further, Nortel Networks determined that it was more likely than not that
the remaining deferred tax assets would be realized. If market conditions deteriorate or future
results of operations are less than expected, an additional tax valuation allowance may be
required for all or a portion of Nortel Networks deferred tax assets.Nortel Networks is subject to ongoing examinations by certain taxation authorities of the
jurisdictions in which it operates. Nortel Networks regularly assesses the status of these
examinations and the potential for adverse outcomes to determine the adequacy of the provision
for income and other taxes. Nortel Networks believes that it has adequately provided for tax
adjustments that are probable as a result of any ongoing examination. F-44




---



##### Table of Contents



Nortel Networks had previously entered into Advance Pricing Arrangements (APAs) with the
taxation authorities of the U.S. and Canada in connection with its intercompany transfer pricing
and cost sharing arrangements between Canada and the U.S. These arrangements expired in 1999
and 2000. In 2002, Nortel Networks filed APA requests with the taxation authorities of the
U.S., Canada and the United Kingdom (U.K.) that are expected to apply to the taxation years
beginning in 2000. The APA requests are currently under consideration. Nortel Networks has
applied the transfer pricing methodology proposed in the APA requests since 2001. As part of
the APA applications, Nortel Networks has requested that the methodology adopted in 2001 be
applied retroactively to the 2000 taxation year. If the retroactive application is accepted by
the taxation authorities, it would result in an increase in taxable income in certain
jurisdictions offset by an equal decrease in taxable income in the other jurisdictions. Nortel
Networks has provided for any taxes and interest that would be due as a result of retroactive
application of the APAs.Although the outcome of the APA applications are uncertain, Nortel Networks does not believe the
ultimate resolution of these negotiations will have a material adverse effect on its
consolidated financial position, results of operations or cash flows. However, if this matter
is resolved unfavorably, it could have a material adverse effect on Nortel Networks consolidated
financial position, results of operations or cash flows.The following is a reconciliation of income taxes, calculated at the Canadian combined federal
and provincial income tax rate, to the income tax benefit (expense) included in the consolidated
statements of operations for each of the years ended December 31: 2003
    
    
    2002
    
    
    2001Income taxes at Canadian rates
(2003  35.8%, 2002  39.4%, 2001  40.8%)
    
    $
    (165
    )
    
    $
    1,031
    
    
    $
    5,476Reduction of Canadian taxes applicable to manufacturing profits
    
    
    
    
    
    
    (55
    )
    
    
    (64
    )Difference between Canadian rate and rates applicable to subsidiaries in
the U.S. and other jurisdictions
    
    
    (25
    )
    
    
    (30
    )
    
    
    (689
    )Difference between basic Canadian rate and rates applicable to gain (loss)
on sale of businesses
    
    
    
    
    
    
    2
    
    
    
    (31
    )Non-deductible amortization of acquired intangibles and IPR&D expense
    
    
    
    
    
    
    (90
    )
    
    
    (1,749
    )Foreign operation tax credit
    
    
    
    
    
    
    
    
    
    
    979Valuation allowances on tax benefits
    
    
    19
    
    
    
    (724
    )
    
    
    (1,322
    )Utilization of losses
    
    
    86
    
    
    
    65
    
    
    
    22Other
    
    
    118
    
    
    
    239
    
    
    
    (49
    )Income tax benefit (expense)
    
    $
    33
    
    
    $
    438
    
    
    $
    2,573Details of Nortel Networks income (loss):Earnings (loss) from continuing operations before income taxes, minority
interests and equity in net loss of associated companies:Canadian, excluding gain (loss) on sale of businesses and assets
    
    $
    (82
    )
    
    $
    (1,050
    )
    
    $
    (3,150
    )U.S. and other, excluding gain (loss) on sale of businesses and assets
    
    
    539
    
    
    
    (1,570
    )
    
    
    (10,372
    )Gain (loss) on sale of businesses and assets
    
    
    4
    
    
    
    4
    
    
    
    100$
    461
    
    
    $
    (2,616
    )
    
    $
    (13,422
    )Income tax benefit (expense):Canadian, excluding gain (loss) on sale of businesses and assets
    
    $
    184
    
    
    $
    121
    
    
    $
    323U.S. and
other, excluding gain (loss) on sale of businesses and assets
    
    
    (151
    )
    
    
    318
    
    
    
    2,326Gain (loss) on sale of businesses and assets
    
    
    
    
    
    
    (1
    )
    
    
    (76
    )$
    33
    
    
    $
    438
    
    
    $
    2,573Income tax benefit (expense):Current
    
    $
    25
    
    
    $
    33
    
    
    $
    1,234Deferred
    
    
    8
    
    
    
    405
    
    
    
    1,339Income tax benefit (expense)
    
    $
    33
    
    
    $
    438
    
    
    $
    2,573
 F-45




---



##### Table of Contents



The following table shows the significant components included in deferred income taxes as
of December 31:Deferred income taxes 2003
    
    
    2002Assets:Tax benefit of loss carryforwards and tax credits
    
    $
    5,428
    
    
    $
    4,451Provisions and reserves
    
    
    711
    
    
    
    1,718Post-retirement benefits other than pensions
    
    
    234
    
    
    
    104Plant and equipment
    
    
    122
    
    
    
    72Pension plan liabilities
    
    
    433
    
    
    
    285Deferred compensation
    
    
    277
    
    
    
    32Unrealized losses on investments
    
    
    
    
    
    
    3Other
    
    
    
    
    
    
    27,205
    
    
    
    6,667Valuation allowance
    
    
    (3,108
    )
    
    
    (2,840
    )4,097
    
    
    
    3,827Liabilities:Acquired technology
    
    
    
    
    
    
    Provisions and reserves
    
    
    341
    
    
    
    679Plant and equipment
    
    
    48
    
    
    
    6Other
    
    
    132
    
    
    
    49521
    
    
    
    734Net deferred income tax assets
    
    $
    3,576
    
    
    $
    3,093
  Subsequent to 2003, Nortel Networks determined that it expects to settle certain income tax
matters which will result in a reduction of its provisions and reserves liability along with an
offsetting reduction in its tax benefit of loss carryforwards and tax credits of approximately
$140. The balance of the provisions and reserves liability relates to certain tax credit and
transfer pricing matters, including the retroactive application of the APA.Nortel Networks has not provided for foreign withholding taxes or deferred income tax
liabilities for temporary differences related to the undistributed earnings of foreign
subsidiaries since Nortel Networks does not currently expect to repatriate these earnings. It
is not practical to reasonably estimate the amount of additional deferred income tax liabilities
or foreign withholding taxes that may be payable should these earnings be distributed in the
future.As of December 31, 2003, 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)
    
    
    Total2004 - 2006
    
    $
    102
    
    
    $
    
    
    
    $
    268
    
    
    $
    3702007 - 2009
    
    
    629
    
    
    
    
    
    
    
    319
    
    
    
    9482010 - 2016
    
    
    1,697
    
    
    
    68
    
    
    
    550
    
    
    
    2,3152017 - 2023
    
    
    2,950
    
    
    
    
    
    
    
    243
    
    
    
    3,193Indefinitely
    
    
    1,783
    
    
    
    4,426
    
    
    
    23
    
    
    
    6,232$
    7,161
    
    
    $
    4,494
    
    
    $
    1,403
    
    
    $
    13,058
 (a)
    
    The capital losses related primarily to the U.K. and may only be used to offset future
capital gains. Nortel Networks has recorded a full valuation allowance against this future
tax benefit.(b)
    
    Global investment tax credits of $41, $76 and $154 have been applied against the income
tax provision in 2003, 2002 and 2001, respectively. Unused tax credits can be utilized to
offset future income taxes payable primarily in Canada.
 F-46




---



##### Table of Contents



9.
    
    Employee benefit plans  Nortel Networks maintains various retirement programs covering substantially all of its
employees, consisting of defined benefit, defined contribution and investment plans.Nortel Networks has four kinds of capital accumulation and retirement programs: balanced capital
accumulation and retirement programs (the Balanced Program) and investor capital accumulation
and retirement programs (the Investor Program) available to substantially all of its North
American employees; flexible benefits plan, which includes a group personal pension plan (the
Flexible Benefits Plan), available to substantially all of its employees in the U.K.; and
traditional capital accumulation and retirement programs that include defined benefit pension
plans (the Traditional Program) which are closed to new entrants in the U.K. and portions of
which are closed to new entrants in the U.S. and Canada. Although these four kinds of programs
represent Nortel Networks major retirement programs and may be available to employees in
combination and/or as options within a program, Nortel Networks also has smaller pension plan
arrangements in other countries. Certain of the prior year amounts for 2002 and 2001 have been
adjusted to include pension plans not previously presented.Nortel Networks also provides other benefits, including post-retirement benefits and
post-employment benefits. Employees in the Traditional Program are eligible for their existing
company sponsored post-retirement benefits or a modified version of these benefits, depending on
age or years of service. Employees in the Balanced Program are eligible for post-retirement
benefits at reduced company contribution levels, while employees in the Investor Program have
access to post-retirement benefits by purchasing a Nortel 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. Pension and other benefit
costs reflected in the consolidated statements of operations are based on the projected benefit
method of valuation. A measurement date of September 30 is used annually to determine pension
and other post-retirement benefit measurements for the pension plans and other post-retirement
benefit plans that make up the majority of plan assets and obligations.In 2003, the impact of reductions in discount rates and changes in foreign exchange rates more
than offset the favorable impacts of strong pension asset returns and the voluntary
contributions made by Nortel Networks. 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 recorded
liability. The effect of this adjustment was to increase accumulated other comprehensive loss
(before tax) by $219, increase intangible assets by $1 and increase pension liabilities by $220. F-47




---



##### Table of Contents



The following details the unfunded status of the defined benefit plans and post-retirement
benefits other than pensions, and the associated amounts recognized in the consolidated balance
sheets as of December 31: Defined benefit plans
    
    
    Post-retirement benefits2003
    
    
    2002
    
    
    2003
    
    
    2002Change in benefit obligation:Benefit obligation  beginning
    
    $
    6,187
    
    
    $
    6,053
    
    
    $
    568
    
    
    $
    529Service cost
    
    
    118
    
    
    
    158
    
    
    
    9
    
    
    
    10Interest cost
    
    
    401
    
    
    
    402
    
    
    
    40
    
    
    
    37Plan participants contributions
    
    
    7
    
    
    
    12
    
    
    
    3
    
    
    
    2Plan amendments
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    Actuarial loss (gain)
    
    
    362
    
    
    
    (19
    )
    
    
    106
    
    
    
    20Divestitures/settlements
    
    
    (116
    )
    
    
    (386
    )
    
    
    
    
    
    
    (3
    )Benefits paid
    
    
    (459
    )
    
    
    (320
    )
    
    
    (37
    )
    
    
    (31
    )Foreign exchange
    
    
    850
    
    
    
    287
    
    
    
    65
    
    
    
    4Benefit obligation  ending
    
    $
    7,355
    
    
    $
    6,187
    
    
    $
    754
    
    
    $
    568Change in plan assets:Fair value of plan assets  beginning
    
    $
    4,386
    
    
    $
    5,009
    
    
    $
    41
    
    
    $
    41Actual return on plan assets
    
    
    626
    
    
    
    (270
    )
    
    
    3
    
    
    
    Employer contributions
    
    
    399
    
    
    
    153
    
    
    
    31
    
    
    
    28Plan participants contributions
    
    
    7
    
    
    
    12
    
    
    
    3
    
    
    
    2Divestitures/settlements
    
    
    (170
    )
    
    
    (424
    )
    
    
    
    
    
    
    Benefits paid
    
    
    (459
    )
    
    
    (320
    )
    
    
    (37
    )
    
    
    (31
    )Foreign exchange
    
    
    626
    
    
    
    226
    
    
    
    9
    
    
    
    1Fair value of plan assets  ending
    
    $
    5,415
    
    
    $
    4,386
    
    
    $
    50
    
    
    $
    41Unfunded status of the plans
    
    $
    (1,940
    )
    
    $
    (1,801
    )
    
    $
    (704
    )
    
    $
    (527
    )Unrecognized net plan benefits existing at
January 1, 1987
    
    
    (1
    )
    
    
    (4
    )
    
    
    
    
    
    
    Unrecognized prior service cost (credit)
    
    
    20
    
    
    
    20
    
    
    
    (29
    )
    
    
    (31
    )Unrecognized net actuarial losses (gains)
    
    
    1,664
    
    
    
    1,403
    
    
    
    119
    
    
    
    13Contributions after measurement date
    
    
    108
    
    
    
    113
    
    
    
    3
    
    
    
    Net amount recognized
    
    $
    (149
    )
    
    $
    (269
    )
    
    $
    (611
    )
    
    $
    (545
    )Amount recognized in the accompanying
consolidated balance sheets consist of:Other liabilities  long-term
    
    $
    (1,290
    )
    
    $
    (1,040
    )
    
    $
    (581
    )
    
    $
    (516
    )Other liabilities  current
    
    
    (72
    )
    
    
    (93
    )
    
    
    (30
    )
    
    
    (29
    )Intangible assets  net
    
    
    42
    
    
    
    41
    
    
    
    
    
    
    
    Foreign currency translation adjustment
    
    
    151
    
    
    
    22
    
    
    
    
    
    
    
    Accumulated other comprehensive loss
    
    
    1,020
    
    
    
    801
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    (149
    )
    
    $
    (269
    )
    
    $
    (611
    )
    
    $
    (545
    )
  The following details selected information for defined benefit plans, all of which have
accumulated benefit obligations in excess of the fair value of plan assets as of December 31: 2003
    
    
    2002Projected benefit obligation
    
    $
    7,355
    
    
    $
    6,187Accumulated benefit obligation
    
    $
    6,797
    
    
    $
    5,562Fair value of plan assets
    
    $
    5,415
    
    
    $
    4,386
 F-48




---



##### Table of Contents



The following details the net pension expense and the underlying assumptions for the
defined benefit plans for the years ended December 31: 2003
    
    
    2002
    
    
    2001Pension expense:Service cost
    
    $
    118
    
    
    $
    158
    
    
    $
    200Interest cost
    
    
    401
    
    
    
    402
    
    
    
    413Expected return on plan assets
    
    
    (395
    )
    
    
    (417
    )
    
    
    (470
    )Amortization of prior service cost
    
    
    9
    
    
    
    7
    
    
    
    8Amortization of net losses (gains)
    
    
    50
    
    
    
    17
    
    
    
    (26
    )Settlement losses (gains)
    
    
    48
    
    
    
    94
    
    
    
    1Curtailment losses (gains)
    
    
    
    
    
    
    40
    
    
    
    17Net pension expense
    
    $
    231
    
    
    $
    301
    
    
    $
    143Allocation of net pension expense:Continuing operations
    
    $
    231
    
    
    $
    301
    
    
    $
    141Discontinued operations
    
    
    
    
    
    
    
    
    
    
    2Net pension expense
    
    $
    231
    
    
    $
    301
    
    
    $
    143Weighted-average assumptions used to determine
benefit obligations as at December 31:Discount rate
    
    
    5.8
    %
    
    
    6.3
    %
    
    
    6.7
    %Rate of compensation increase
    
    
    3.7
    %
    
    
    3.7
    %
    
    
    3.7
    %Weighted-average assumptions used to determine
net pension expense for years ended December 31: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
    %
    
    
    3.7
    %
    
    
    4.6
    %
  The following details the amounts included within other comprehensive income (loss) for the
year ended December 31: Defined benefit plans2003
    
    
    2002Increase in minimum pension liability included in
other comprehensive income (loss)
    
    $
    219
    
    
    $
    690
 F-49




---



##### Table of Contents



The following details the net cost components, all related to continuing operations, and
underlying assumptions of post-retirement benefits other than pensions for the years ended
December 31: 2003
    
    
    2002
    
    
    2001Post-retirement benefit cost:Service cost
    
    $
    9
    
    
    $
    10
    
    
    $
    13Interest cost
    
    
    40
    
    
    
    37
    
    
    
    36Expected return on plan assets
    
    
    (3
    )
    
    
    (3
    )
    
    
    (3
    )Amortization
    
    
    (3
    )
    
    
    (3
    )
    
    
    (5
    )Settlements and curtailments
    
    
    
    
    
    
    (9
    )
    
    
    (21
    )Net post-retirement benefit cost
    
    $
    43
    
    
    $
    32
    
    
    $
    20Weighted-average assumptions used to determine
benefit obligations as at December 31:Discount rate
    
    
    6.0
    %
    
    
    6.8
    %
    
    
    7.0
    %Weighted-average assumptions used to determine
net post-retirement benefit cost for years ended December 31: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
    
    
    8.5
    %
    
    
    8.0
    %
    
    
    7.3
    %Weighted-average ultimate health care cost trend rate
    
    
    4.8
    %
    
    
    4.7
    %
    
    
    5.1
    %Year in which ultimate health care cost trend rate will be achieved
    
    
    2010
    
    
    2009
    
    
    2005
  Assumed health care cost trend rates have a significant effect on the amounts reported for
health care plans. A one percentage-point change in assumed health care cost trend rates would
have the following effects for the years ended December 31: 2003
    
    
    2002
    
    
    2001Effect on aggregate of service and interest costs1% increase
    
    $
    5
    
    
    $
    5
    
    
    $
    51% decrease
    
    $
    (4
    )
    
    $
    (4
    )
    
    $
    (4
    )Effect on accumulated post-retirement benefit obligations1% increase
    
    $
    66
    
    
    $
    57
    
    
    $
    561% decrease
    
    $
    (55
    )
    
    $
    (46
    )
    
    $
    (46
    )
  The target allocation percentages and the year-end percentages based on actual asset
balances of the defined benefit plans as of December 31 are as follows: 2003
    
    
    2002Target
    
    
    Actual
    
    
    Target
    
    
    ActualDebt instruments
    
    
    39
    %
    
    
    39
    %
    
    
    39
    %
    
    
    44
    %Equity securities
    
    
    61
    %
    
    
    61
    %
    
    
    61
    %
    
    
    56
    %
  The primary investment objective of the defined benefit plans is to invest in a cost
effective manner which will provide sufficient funding for the liabilities of these plans. The
defined benefit plans maintain a long-term perspective in regard to investment philosophy and
return expectations which are reflective of the fact that the liabilities of the defined benefit
plans mature over an extended period of time. The investments have risk characteristics
consistent with underlying defined benefit plan demographics and liquidity requirements, and are
consistent and compliant with all regulatory standards.The primary investment performance objective is to obtain competitive rates of return on
investments at or above their assigned benchmarks while minimizing risk and volatility by
maintaining an appropriately diversified portfolio. The benchmarks selected are
industry-standard and widely-accepted indices. F-50




---



##### Table of Contents



The primary method of managing risk within the portfolio is through diversification among and
within asset categories, and through the utilization of a wide array of active and passive
investment managers. Broadly, the assets are allocated between debt and equity instruments.
Included within the debt instruments are government and corporate fixed income securities, money
market securities, mortgage-backed securities and inflation indexed securities. Generally,
these debt instruments are considered investment grade. Included in equity securities are
developed and emerging market stocks of companies at a variety of capitalization levels. The
securities are predominantly publicly traded. The amount of employer and related-party
securities that the defined benefit plans may hold is governed by the statutory limitations of
the jurisdictions of the applicable plans. Included in equity securities of the defined benefit
plans are common shares of Nortel Networks Corporation with an aggregate market value of $13
(0.2 percent of total plan assets) and $3 (0.1 percent of total plan assets) as of December 31,
2003 and 2002, respectively.As a policy, assets within the defined benefit plans are reviewed to the target allocations at
least on a quarterly basis and adjustments made as appropriate. The plans commission periodic
asset and liability studies to determine the optimal allocation of the portfolios assets.
These studies consider a variety of the plan characteristics, including membership,
benefits, and liquidity needs, and utilize mean-variance analysis of historic and projected
investment returns to develop a range of acceptable asset mixes among a variety of asset
classes.To develop the expected long-term rate of return on assets assumption, Nortel Networks
considered the weighted-average historical returns and the future expectations for returns for
each asset class.Nortel Networks made cash contributions of approximately $140 in 2004 to the defined benefit
plans, which excluded $78 of deferred contributions for 2004 which were made in 2003, and
approximately $30 in 2004 to the post-retirement benefit plans.Under the terms of the Balanced Program, Investor Program and Traditional Program, eligible
employees may contribute a portion of their compensation to an investment plan. Based on the
specific program that the employee is enrolled in, Nortel Networks matches a percentage of the
employees contributions up to a certain limit. The cost of these investment plans was $73, $89
and $139 for the years ended December 31, 2003, 2002 and 2001, respectively.Under the terms of the Balanced Program and Flexible Benefits Plan, Nortel Networks contributes
a fixed percentage of employees eligible earnings to a defined contribution plan arrangement.
The cost of these plan arrangements was $17, $20 and $28 for the years ended December 31, 2003,
2002 and 2001, respectively.  10.
    
    Acquisitions, divestitures and closuresAcquisitionsNortel Networks Germany and Nortel Networks France  On October 19, 2002, Nortel Networks, through various subsidiaries, entered into a number of put
option and call option agreements as well as a share exchange agreement with European Aeronautic
Defence and Space Company EADS N.V. (EADS), its partner at that time in three European joint
ventures. The written options were marked to fair value through the consolidated statements of
operations at each period end until they were exercised. At December 31, 2002, Nortel Networks
estimated the fair value of the written options to be approximately $81, which was included
within other accrued liabilities, and the corresponding loss was recorded in other income
(expense)  net during the year ended December 31, 2002. A further mark to fair value
adjustment and loss of $18 was recorded during the year ended December 31, 2003. The purchased
options and the share exchange were initially recorded at fair value and were assessed for
impairment throughout their term until they were exercised or expired. The estimated fair
values of the options were based on an estimate of the current fair values of the respective
joint ventures using an option-pricing model that is dependent on the assumptions used
concerning the amount of volatility and the discount rates that reflect varying degrees of risk.On July 1, 2003, EADS exercised its put option to sell its minority interest of 45 percent in
Nortel Networks France S.A.S. (NNF) to Nortel Networks. On July 18, 2003, Nortel Networks
exercised its call option and share exchange rights to acquire the minority interest held by
EADS of 42 percent in Nortel Networks Germany GmbH & Co. KG (NNG) and to sell Nortel Networks
equity interest of 41 percent in EADS Telecom S.A.S., formerly EADS Defence and Security
Networks S.A.S (EADS Telecom) to EADS. The transactions were completed on September 18, 2003. F-51




---



##### Table of Contents



During the three months ended September 30, 2003, Nortel Networks recorded the acquisitions of
the minority interests of NNF and NNG based on preliminary valuation estimates totaling $241.
The purchase price of $241 included $58 of cash, an in-kind component of approximately $82
representing the return of a loan note that was owed to Nortel Networks by EADS Telecom and the
remaining shares of EADS Telecom held by Nortel Networks. The allocation of the purchase price
resulted in the elimination of $23 of minority interest, settlement of a net liability of $94
related to the put and call options and an increase of $45 in intangible assets and $79 in
goodwill. The intangible assets of $45 related primarily to customer contracts and customer
relationships and are being amortized based on their expected pattern of benefit to future
periods using estimates of undiscounted cash flows, and were included in intangible assets on
the consolidated balance sheet as of December 31, 2003. The sale of Nortel Networks 41 percent
interest in EADS Telecom has resulted in the receipt of cash of $12 and a reduction in equity
investments of $23. As a result of this transaction, Nortel Networks recognized a gain of $79
which is included in other income (expense)  net for the year ended
December 31, 2003. Except as noted below, there was no additional impact on the results of
operations and financial condition, as NNF and NNG were already included in the consolidated
results.During the three months ended December 31, 2003, the valuation report for NNF and NNG was
completed by a third party appraiser. As a result of the finalization of this valuation, an
additional gain of $17 was recorded with a corresponding increase in goodwill on the transaction
(see note 5 for goodwill by reportable segment).  DivestituresSale of Arris Group, Inc. investment  On November 24, 2003, Nortel Networks sold 9 million shares of Arris Group, Inc. (Arris Group)
for cash consideration of $49, which resulted in a gain of $31. Following this transaction,
Nortel Networks owned 5 million Arris Group common shares or 6.6 percent of Arris Group
outstanding common shares (see note 19).  High speed module operations  On August 10, 2003, Nortel Networks sold certain assets related to its high speed module
operations to BreconRidge Manufacturing Solutions Corporation (BreconRidge). Nortel Networks
received proceeds of $6 in the form of cash and a note receivable. As a result of this
transaction, Nortel Networks recorded a loss of $1 during the year ended December 31, 2003. The
transaction included a minimum purchase commitment with BreconRidge requiring Nortel Networks to
purchase approximately $11 and $33 of products during 2003 and 2004, respectively (see note 14).  Optical components operations  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 1,200
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 $10. 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 (see note 14).During the three months ended September 30, 2002, Nortel Networks classified the assets sold to
Bookham as held for sale and assigned an estimated fair value of $47 to them resulting in a
charge of $123 ($89 to cost of revenues and $34 to special charges). A subsequent increase in
Bookhams common share price prior to the November 8, 2002 close date resulted in an increase in
the value assigned to the consideration received. As a result, Nortel Networks recorded a gain
on sale of businesses and assets of $29 during the year ended December 31, 2002.As a result of the transaction, Nortel 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. F-52




---



##### Table of Contents



During 2003, Nortel Networks sold 30 million shares of Bookham for cash proceeds of $32 and
recorded a gain of $6 which is included in other income (expense)  net for the year ended
December 31, 2003. As a result of this transaction, Nortel Networks reduced its ownership
interest in Bookham to approximately 14 percent.  Sale of Clarify  On November 28, 2001, Nortel Networks sold substantially all of the assets of its then wholly
owned subsidiary, Clarify, including patents, intellectual property and trademarks, to Amdocs
Limited for approximately $200 in cash, resulting in a gain of $16.  Closures  As part of its restructuring work plan initiated in 2001, Nortel Networks closed the
operations of Photonic and Dimension (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 and $2,239 during the years ended
December 31, 2002 and 2001, respectively.  11.
    
    Long-term debt, credit and support facilitiesLong-term debt  The following table shows the components of long-term debt as of December 31: 2003
    
    
    20026.00% Notes due September 1, 2003
    
    $
    
    
    
    $
    1646.125% Notes due February 15, 2006
    
    
    1,275
    
    
    
    1,3147.40% 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 3.49% for 2003 and 4.60% for 2002
    
    
    20
    
    
    
    88Fair value adjustment attributable to hedged debt obligations
    
    
    53
    
    
    
    72Obligations associated with consolidated VIEs(b)
    
    
    184
    
    
    
    Obligations under capital leases and sale leasebacks(c)
    
    
    178
    
    
    
    2652,210
    
    
    
    2,403Less: Long-term debt due within one year
    
    
    119
    
    
    
    243Long-term debt
    
    $
    2,091
    
    
    $
    2,160
 (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.(b)
    
    Represents obligations of certain VIEs consolidated prospectively, as required by FIN
46R, of $184 as of December 31, 2003 (see note 4(d)).(c)
    
    Included lease obligations recorded prospectively, in accordance with EITF 01-8, of $2
as of December 31, 2003 (see note 4(h)). F-53




---



##### Table of Contents



As of December 31, 2003, the amounts of long-term debt payable for each of the years ending
December 31 consisted of: 2004
    
    $
    1192005
    
    
    162006
    
    
    1,4922007
    
    
    152008
    
    
    16Thereafter
    
    
    552Total long-term debt payable
    
    $
    2,210
  On February 8, 2001, Nortel Networks completed an offering of $1,500 of 6.125% Notes due on
February 15, 2006 (the 6.125% Notes). The 6.125% Notes pay interest on a semi-annual basis on
February 15 and August 15, which began on August 15, 2001. The 6.125% Notes are redeemable, at
any time at Nortel 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, 2003, Nortel Networks purchased a portion of its 6.125% Notes
with a face value of $39. The transaction resulted in a gain of $4 which was included in the
consolidated statement of operations within other income (expense)  net for the year ended
December 31, 2003.During the year ended December 31, 2002, Nortel Networks paid $162 to purchase a portion of its
6.00% Notes due on September 1, 2003 and its 6.125% Notes with carrying values of $36 and $186,
respectively. The early extinguishment of debt resulted in a gain of $60 which was included in
the consolidated statement of operations within other income (expense)  net for the year ended
December 31, 2002.During the year ended December 31, 2002, Nortel Networks sold an office building for $24 and
concurrent with the sale Nortel Networks leased the property back for a period of fifteen years
at an average annual rental of $3. The lease is renewable at Nortel Networks option for four
additional five year terms. The lease requires that a letter of credit for $1 be provided while
Nortel Networks bonds are rated below investment grade. As a result of the letter of credit
structure, the transaction has been recorded as a financing transaction rather than a sale, and
the building and related accounts will continue to be recognized in the consolidated financial
statements.During the year ended December 31, 2001, Nortel Networks sold an office building for $9 and,
concurrent with the sale, Nortel Networks leased the property back for a period of fifteen years
at an average annual rental of $1. The lease is renewable at Nortel Networks option for three
additional five year terms. The lease requires that Nortel Networks indemnify the landlord
against environmental contamination caused by unrelated third parties during the lease term. As
a result of the indemnification, the transaction has been recorded as a financing transaction
rather than a sale, and the building and related accounts will continue to be recognized in the
consolidated financial statements.During the year ended December 31, 2001, Nortel Networks sold an office building for $137 and,
concurrent with the sale, Nortel Networks leased the property back for a period of fifteen years
at an average annual rental of $18. The lease is renewable at Nortel Networks option for four
additional five year terms. The lease is classified as a capital lease. As such, the
transaction has been recorded as a financing transaction rather than a sale, and the building
and related accounts will continue to be recognized in the consolidated financial statements.See note 22 for additional information related to Nortel Networks and NNCs debt securities.  Credit facilities  As of December 31, 2003 and 2002, Nortel Networks had total unused committed credit
facilities of $750 under the Nortel Networks and Nortel Networks Inc. (NNI) $750 April 2000
five year credit facilities (the Five Year Facilities). See note 22 for additional
information. F-54




---



##### Table of Contents



Support facility  On February 14, 2003, Nortel Networks entered into an agreement with Export Development
Canada (EDC) regarding arrangements to provide for support, on a secured basis, of certain
performance related obligations arising out of normal course business activities for the benefit
of Nortel Networks (the EDC Support Facility). On July 10, 2003, Nortel Networks and EDC
amended the terms of the EDC Support Facility by extending the termination date of the facility
to December 31, 2005 from June 30, 2004 (see notes 22 and 23).As of December 31, 2003, the EDC Support Facility provided for up to $750 in support including
$300 of committed revolving support for performance bonds or similar instruments, of which $151
was utilized, $150 of uncommitted support for receivables sales and/or securitizations, of which
none was utilized, and $300 of uncommitted support for performance bonds and/or receivables
sales and/or securitizations, of which $183 was utilized (see note 22).On February 14, 2003, Nortel Networks obligations under the EDC Support Facility became secured
on an equal and ratable basis under the security agreements entered into by Nortel Networks and
various of its subsidiaries that pledged substantially all of the assets of Nortel Networks in
favor of the banks under the Five Year Facilities and the holders of Nortel Networks and NNCs
public debt securities. This security became effective in favor of the banks and the public
debt holders on April 4, 2002 (for additional information relating to the EDC Support Facility
and the related security agreements see notes 22 and 23).  12.
    
    Financial instruments and hedging activitiesRisk 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 expected to occur within the next twelve months, and
forward contracts, which are denominated in various currencies, to limit its exposure to
exchange fluctuations on existing assets and liabilities and on future revenue or expenditure
streams expected to occur within the next twelve months. Option and forward contracts used to
hedge future revenue or expenditure streams are designated as cash flow hedges and hedge
specific exposures. Option and forward contracts that do not meet the criteria for hedge
accounting are also used to economically hedge the impact of fluctuations in exchange rates on
existing assets and liabilities and on future revenue and expenditure streams.The following table provides a summary of the total notional amounts of option and forward
contracts as of December 31: Currency
    
    2003(a)
    
    
    2002(b)OptionsCanadian dollar
    
    $
    37
    
    
    $
    52ForwardsCanadian dollar
    
    
    375
    
    
    
    920British pound
    
    
    435
    
    
    
    8Euro
    
    
    74
    
    
    
    555Other
    
    
    206
    
    
    
    75$
    1,127
    
    
    $
    1,610
  (a)
    
    All notional amounts of option and forward contracts matured no later than the end of
2004.(b)
    
    All notional amounts of option and forward contracts matured no later than the end of
2003. F-55




---



##### Table of Contents



Interest rate risk  Nortel Networks enters into interest rate swap contracts to minimize the impact of interest
rate fluctuations on the fair value of its long-term debt. These contracts swap fixed interest
rate payments for floating rate payments and certain swaps are designated as fair value hedges.
The fair value adjustment related to the effective portion of interest rate swaps and the
corresponding fair value adjustment to the hedged debt obligation included within long-term debt
are recorded to interest expense within the consolidated statements of operations. These swap
contracts have remaining terms to maturity between 2 and 2.5 years.On January 27, 2003, various cross currency coupon swaps (notional amount of Canadian $350) were
terminated. There was no impact to net earnings (loss) on termination as these instruments were
not designated as hedges and changes in fair value were previously accounted for in the
consolidated statements of operations.Hedge ineffectiveness and the discontinuance of cash flow hedges and fair value hedges that were
accounted for in accordance with SFAS 133 had no material impact on the net earnings (loss) for
the years ended December 31, 2003 and 2002 and were reported within other income (expense)  net
in the consolidated statements of operations.The following table provides a summary of interest rate swap contracts and cross currency coupon
swap contracts and their aggregated weighted-average rates as of December 31: 2003
    
    
    2002Interest rate swap contracts:Received-fixed swaps  notional amount
    
    $
    875
    
    
    $
    975Average fixed rate received
    
    
    6.3
    %
    
    
    6.3
    %Average floating rate paid
    
    
    2.6
    %
    
    
    3.2
    %Cross currency coupon swap contracts:Received-cross currency coupon swaps  notional amount
    
    $
    
    
    
    $
    224Average floating rate received (Canadian $)
    
    
    
    
    
    
    2.9
    %Average
floating rate paid (U.S. $)
    
    
    
    
    
    
    1.5
    %
  Equity price risk  Nortel Networks enters into equity forward contracts with terms from eight to fourteen
months to hedge the variability in future cash flows associated with certain compensation
obligations that vary based on future Nortel Networks Corporation common share prices. These
contracts fix the price of Nortel Networks Corporation common shares and are cash settled on
maturity to offset changes in the compensation liability based on changes in the share price
from the inception of the forward contract. Certain equity forward contracts are designated as
cash flow hedges when all criteria for hedge accounting are met and the changes in fair value of
the forward contract are recorded in OCI and reclassified to SG&A when the underlying
compensation expense is recorded. Other equity forward contracts that are not designated in a
hedging relationship and are considered economic hedges of the compensation obligation are
carried at fair value with changes in fair value recorded in other income (expense)  net. The
total notional amount of these contracts as of December 31, 2003 and 2002 was $47 and $4,
respectively, and the average fixed Nortel Networks Corporation common share price was $3.45 and
$2.42, respectively. The fair value of these contracts as of December 31, 2003 and 2002 was $10
and $(2), respectively.  Fair value  The estimated fair values approximate amounts at which financial instruments could be
exchanged in a current transaction between willing parties. The fair values are based on
estimates using present value and other valuation techniques that are significantly affected by
the assumptions used concerning the amount and timing of estimated future cash flows and
discount rates that reflect varying degrees of risk. Specifically, the fair value of interest
rate swaps and forward contracts reflected: the present value of the expected future cash flows
if settlement had taken place on December 31, 2003 and 2002; the fair value of option contracts
reflected the cash flows due to or by Nortel Networks if settlement had taken place on December
31, 2003 and 2002; and the fair value of long-term debt instruments reflected a current yield
valuation based on observed market prices as of December 31, 2003 and 2002. Accordingly, the
fair value F-56




---



##### Table of Contents



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 financial assets and
liabilities for which fair value differed from the carrying amount and fair values recorded for
derivative financial instruments in accordance with SFAS 133 as of December 31: 2003
    
    
    2002Carrying
    
    
    Fair
    
    
    Carrying
    
    
    Fairamount
    
    
    value
    
    
    amount
    
    
    valueFinancial liabilities:Long-term debt due within one year
    
    $
    119
    
    
    $
    119
    
    
    $
    243
    
    
    $
    234Long-term debt
    
    $
    2,091
    
    
    $
    2,102
    
    
    $
    2,160
    
    
    $
    1,423Derivative financial instruments net asset
(liability) position:Interest rate swap contracts (a)
    
    $
    61
    
    
    $
    61
    
    
    $
    80
    
    
    $
    80Forward and option contracts (b)
    
    $
    19
    
    
    $
    19
    
    
    $
    (28
    )
    
    $
    (28
    )Cross currency coupon swap contracts (a)
    
    $
    
    
    
    $
    
    
    
    $
    1
    
    
    $
    1
  (a)
    
    Recorded in other assets.(b)
    
    Comprised of other assets of $34 and other liabilities of $15 as of December 31, 2003,
and other assets of $10 and other liabilities of $38 as of December 31, 2002.  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 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
of $95 as of December 31, 2003. 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 or receive warrants in various transactions. Warrants that relate to
publicly traded companies or that can be net share settled are deemed derivative financial
instruments under SFAS 133. Such warrants are generally not eligible to be designated as
hedging instruments as there is no corresponding underlying exposure. In addition, Nortel
Networks may enter into certain commercial contracts containing derivative financial
instruments.  Receivables sales  In 2003, 2002 and 2001, Nortel Networks entered into various agreements to sell certain of
its receivables. These receivables were sold at a discount of $20,
$25 and $36 from book value
for the years ended December 31, 2003, 2002 and 2001, respectively, at annualized discount rates
of approximately 2 percent to 6 percent, 3 percent to 5 percent and 5 percent to 8 percent for
the years ended December 31, 2003, 2002 and 2001, respectively. Certain receivables have been
sold with limited recourse, not exceeding 10 percent, of $7, $9 and $7 as of December 31, 2003,
2002 and 2001, 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. Nortel
Networks, when acting as the servicing agent, generally does not record an asset or liability
related to servicing as F-57




---



##### Table of Contents



the annual servicing fees are equivalent to those that would be paid to
a third party servicing agent. 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.As of December 31, 2003 and 2002, total accounts receivable securitized and under Nortel
Networks management were $359 and $423, respectively.There is a possibility that the actual performance of receivables or the cost of servicing the
receivables will differ from the assumptions used to determine fair values at the transfer date
and at each reporting date. Assuming hypothetical, simultaneous, unfavorable variations of up
to 20 percent in credit losses, discount rate used and cost of servicing the receivables, the
pre-tax impact on the value of the retained interests and servicing assets would not be
significant.  13.
    
    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 as 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 guaranteed
party or a third partys failure to perform under a specified agreement. A description of the
major types of Nortel Networks outstanding guarantees as of December 31, 2003 is provided below:  (a)
    
    Business sale and business combination agreements  In connection with agreements for the sale of portions of its business, including
certain discontinued operations, Nortel Networks has typically retained the liabilities of a
business which relate to events occurring prior to its sale, such as tax, environmental,
litigation and employment matters. Nortel Networks generally indemnifies the purchaser of a
Nortel Networks business in the event that a third party asserts a claim against the
purchaser that relates to a liability retained by Nortel Networks. Some of these types of
guarantees have indefinite terms while others have specific terms extending to June 2008.Nortel Networks also entered into guarantees related to the escrow of shares in business
combinations in prior periods. These types of agreements generally include indemnities that
require Nortel Networks to indemnify counterparties for loss incurred from litigation that
may be suffered by counterparties arising under such agreements. These types of indemnities
apply over a specified period of time from the date of the business combinations and do not
provide for any limit on the maximum potential amount.Nortel Networks is unable to estimate the maximum potential liability for these types of
indemnification guarantees as the business sale agreements generally do not specify a
maximum amount and the amounts are dependent upon the outcome of future contingent events,
the nature and likelihood of which cannot be determined.Historically, Nortel Networks has not made any significant indemnification payments under
such agreements and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these guarantees.In conjunction with the sale of a subsidiary to a third party, Nortel Networks guaranteed to
the purchaser that specified annual volume levels would be achieved by the business sold
over a ten year period ending December 31, 2007. The maximum amount that Nortel Networks
may be required to pay under the volume guarantee as of December 31, 2003 is $8. A
liability of $6 has been accrued in the consolidated financial statements with respect to
the obligation associated with this guarantee as of December 31, 2003. F-58




---



##### Table of Contents



(b)
    
    Intellectual property indemnification obligations  Nortel Networks has periodically entered into agreements with customers and suppliers
that include limited intellectual property indemnification obligations that are customary in
the industry. These types of guarantees typically have indefinite terms and generally
require Nortel Networks to compensate the other party for certain damages and costs incurred
as a result of third party intellectual property claims arising from these transactions.The nature of the intellectual property indemnification obligations generally prevents
Nortel Networks from making a reasonable estimate of the maximum potential amount it could
be required to pay to its customers and suppliers. Historically, Nortel Networks has not
made any significant indemnification payments under such agreements. A liability of $6 has
been accrued in the consolidated financial statements with respect to the obligations
associated with these guarantees as of December 31, 2003.  (c)
    
    Lease agreements  Nortel Networks has entered into agreements with its lessors that guarantee the lease
payments of certain assignees 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 assignee fails to make scheduled payments. Most of these lease agreements
also require Nortel Networks to pay for facility restoration costs at the end of the lease
term if the assignee fails to do so. These lease agreements have expiration dates through
June 2015. The maximum amount that Nortel Networks may be required to pay under these types
of agreements is $57 as of December 31, 2003. Nortel Networks generally has the ability to
attempt to recover such lease payments from the defaulting party through rights of
subrogation.Historically, Nortel Networks has not made any significant payments under these types of
guarantees and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these guarantees.  (d)
    
    Debt agreements  Nortel Networks has guaranteed the debt of certain customers. These third party debt
agreements require Nortel Networks to make debt payments throughout the term of the related
debt instrument if the customer fails to make scheduled debt payments. These third party
debt agreements have expiration dates extending to May 2012. The maximum amount that Nortel
Networks may be required to pay under these types of debt agreements is $8 as of December
31, 2003. Under most such arrangements, the Nortel Networks guarantee is secured, usually
by the assets being purchased or financed. A liability of $7 has been accrued in the
consolidated financial statements with respect to the obligations associated with these
financial guarantees, as of December 31, 2003.Nortel Networks is a full and unconditional guarantor of NNCs $1,800 4.25% convertible
Senior Notes (Senior Notes) due September 1, 2008, in the event that NNC does not make
payments for the principal, premium, if any, interest and other amounts, if any, as they are
due. The maximum amount that Nortel Networks may be required to pay under this guarantee is
$1,800 plus the premium, if any, and interest. No amount has been accrued in the
consolidated financial statements with respect to the obligation associated with this
guarantee.  (e)
    
    Indemnification of banks and agents under credit facilities, EDC Support Facility and security agreements  As of December 31, 2003, Nortel Networks had agreed to indemnify the banks and agents
under its credit facilities against costs or losses resulting from changes in laws and
regulations which would increase the banks costs or reduce their return and from any legal
action brought against the banks or agents related to the use of loan proceeds. Nortel
Networks has also agreed to indemnify EDC under the EDC Support Facility against any legal
action brought against EDC that relates to the provision of support under the EDC Support
Facility. Nortel Networks has also agreed to indemnify the collateral agent under the
security agreements against any legal action brought against the collateral agent in
connection with the collateral pledged under the security agreements. These
indemnifications generally apply to issues that arise during the term of the credit and
support facilities, or for as long as the security agreements remain in effect (see notes
11, 22 and 23). F-59




---



##### Table of Contents



Nortel Networks is unable to estimate the maximum potential liability for these types of
indemnification guarantees as the agreements typically do not specify a maximum amount and
the amounts are dependent upon the outcome of future contingent events, the nature and
likelihood of which cannot be determined at this time.Historically, Nortel Networks has not made any significant indemnification payments under
such agreements and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these indemnification guarantees.Nortel Networks has agreed to indemnify its counterparties in receivables securitization
transactions. The indemnifications provided to counterparties in these types of
transactions may require Nortel Networks to compensate counterparties for costs incurred as
a result of changes in laws and regulations (including tax legislation) or in the
interpretations of such laws and regulations, or as a result of regulatory penalties that
may be suffered by the counterparty as a consequence of the transaction. Certain
receivables securitization transactions include
indemnifications requiring the repurchase of the receivables if the particular transaction
becomes invalid. As of December 31, 2003, Nortel Networks had approximately $327 of
securitized receivables which were subject to repurchase under this provision, in which case
Nortel Networks would assume all rights to collect such receivables. The indemnification
provisions generally expire upon expiration of the securitization agreements, which extend
through 2005, or collection of the receivable amounts by the counterparty.Nortel Networks is generally unable to estimate the maximum potential liability for all of
these types of indemnification guarantees as certain agreements do not specify a maximum
amount and the amounts are dependent upon the outcome of future contingent events, the
nature and likelihood of which cannot be determined at this time.Historically, Nortel Networks has not made any significant indemnification payments or
receivable repurchases under such agreements and no significant liability has been accrued
in the consolidated financial statements with respect to the obligations associated with
these guarantees.  (f)
    
    Other indemnification agreements  Nortel Networks has also entered into other agreements that provide indemnifications to
counterparties in certain transactions including investment banking agreements, guarantees
related to the administration of capital trust accounts, guarantees related to the
administration of employee benefit plans, indentures for its outstanding public debt and
asset sale agreements (other than the business sale agreements noted above). These
indemnification agreements generally require Nortel Networks to indemnify the counterparties
for costs incurred as a result of changes in laws and regulations (including tax
legislation) or in the interpretations of such laws and regulations and/or as a result of
losses from litigation that may be suffered by the counterparties arising from the
transactions. These types of indemnification agreements normally extend over an unspecified
period of time from the date of the transaction and do not typically provide for any limit
on the maximum potential payment amount.The nature of such agreements prevents Nortel Networks from making a reasonable estimate of
the maximum potential amount it could be required to pay to its counterparties. The
difficulties in assessing the amount of liability result primarily from the unpredictability
of future changes in laws, the inability to determine how laws apply to counterparties and
the lack of limitations on the potential liability.Historically, Nortel Networks has not made any significant indemnification payments under
such agreements and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these guarantees. F-60




---



##### Table of Contents



Product warranties  The following summarizes the accrual for product warranties that was recorded as part of
other accrued liabilities in the consolidated balance sheets as of December 31: 2003
    
    
    2002Balance at the beginning of the year
    
    $
    404
    
    
    $
    461Payments
    
    
    (347
    )
    
    
    (368
    )Warranties issued
    
    
    337
    
    
    
    317Revisions
    
    
    (12
    )
    
    
    (6
    )Balance at the end of the year
    
    $
    382
    
    
    $
    404
  14.
    
    CommitmentsBid, performance related and other bonds  Nortel Networks has entered into bid, performance related and other bonds associated with
various contracts. Bid bonds generally have a term of less than twelve months, depending on the
length of the bid period for the applicable contract. Performance related and other bonds
generally have a term of twelve months and are typically renewed, as required, over the term of
the applicable contract. The various contracts to which these bonds apply generally have terms
ranging from two to five years. Any potential payments which might become due under these bonds
would be related to Nortel Networks non-performance under the applicable contract.
Historically, Nortel Networks has not had to make material payments under these types of bonds
and does not anticipate that any material payments will be required in the future. The
following table sets forth the maximum potential amount of future payments under bid,
performance related and other bonds, net of the corresponding restricted cash and cash
equivalents, as of December 31: 2003
    
    
    2002Bid and performance related bonds(a)
    
    $
    427
    
    
    $
    299Other bonds (b)
    
    
    53
    
    
    
    136Total bid, performance related and other bonds
    
    $
    480
    
    
    $
    435
  (a)
    
    Net of restricted cash and cash equivalent amounts of $14 and $188 as of December 31,
2003 and 2002, respectively.(b)
    
    Net of restricted cash and cash equivalent amounts of $31 and $26 as of December 31,
2003 and 2002, respectively.  Customer financing  Pursuant to certain financing agreements, Nortel Networks is committed to provide future
financing in connection with purchases of Nortel Networks products and services. Commitments to
extend future financing generally have conditions for funding, fixed expiration or termination
dates and specific interest rates and purposes. Nortel Networks attempts to limit its financing
credit risk by utilizing an internal credit committee that monitors the credit exposure of
Nortel Networks. The following table sets forth customer financing related information and
commitments, excluding discontinued operations, as of December 31: 2003
    
    
    2002Drawn and outstanding  gross
    
    $
    401
    
    
    $
    1,120Provisions for doubtful accounts
    
    
    (281
    )
    
    
    (824
    )Drawn and outstanding  net(a)
    
    
    120
    
    
    
    296Undrawn commitments (b)
    
    
    180
    
    
    
    831Total customer financing
    
    $
    300
    
    
    $
    1,127
  (a)
    
    Included short-term and long-term amounts. Short-term and long-term amounts were
included in accounts receivable  net and other assets, respectively, in the consolidated
balance sheets.(b)
    
    See note 22. F-61




---



##### Table of Contents



During the year ended December 31, 2003, Nortel Networks recorded net customer financing
bad debt recoveries of $113 as a result of settlements and adjustments to other existing
provisions. During the year ended December 31, 2002, Nortel Networks recorded net customer
financing bad debt expense of $171. The recoveries and expense were included in the
consolidated statements of operations within SG&A.During the year ended December 31, 2003, Nortel Networks entered into certain agreements to
restructure and/or settle various customer financing and related receivables. As a result of
these transactions, Nortel Networks received cash consideration of approximately $230 to settle
outstanding receivables of approximately $610 (with a net carrying value of $120). Additional
non-cash consideration received under one such restructuring agreement included a five year
equipment and services supply agreement and the mutual release of all other claims between the
parties.During the year ended December 31, 2003, Nortel Networks reduced undrawn customer financing
commitments by $651 as a result of the expiration or cancellation of commitments and changing
customer business plans. As of December 31,
2003, approximately $108 of the $180 in undrawn commitments was not available for funding under
the terms of the financing agreements.  Venture capital financing  Nortel Networks has entered into agreements with selected venture capital firms where the
venture capital firms make and manage investments in start-ups and emerging enterprises. The
agreements require Nortel Networks to fund requests for additional capital up to its commitments
when and if requests for additional capital are solicited by the venture capital firm. Nortel
Networks had remaining commitments, if requested, of $24 and $30 as of December 31, 2003 and
2002, respectively. These commitments expire at various dates through 2012.  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.During the third quarter of 2003, Nortel Networks renegotiated a key supply arrangement with a
supplier. The renegotiated agreement requires that $2,800 in aggregate purchases with the
supplier be made between June 2003 and June 2009. As of December 31, 2003, the remaining
purchase commitment under the agreement was $2,300. The renegotiated agreement includes a
graduated liquidated damages remedy for the benefit of the supplier if the minimum purchase
commitment is not met by the end of the agreement in 2009, however, Nortel Networks expects to
meet the minimum purchase commitment.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 May 31, 2004. The purchase commitment was fully met by
December 31, 2004.Nortel Networks entered into an arrangement with BreconRidge with purchase commitments of
approximately $11 and $33 of products during 2003 and 2004, respectively. The 2003 and 2004
commitments have both been met.  Operating leases and other commitments  As of December 31, 2003, the future minimum payments under operating leases, outsourcing
contracts, special charges related to lease commitments accrued for as part of restructuring
contract settlement and lease costs and related sublease recoveries (see note 7), consisted of: F-62




---



##### Table of Contents



Operating
    
    
    Outsourcing
    
    
    Special
    
    
    Subleaseleases
    
    
    contracts
    
    
    charges
    
    
    income2004
    
    $
    161
    
    
    $
    161
    
    
    $
    145
    
    
    $
    (23
    )2005
    
    
    157
    
    
    
    104
    
    
    
    95
    
    
    
    (29
    )2006
    
    
    144
    
    
    
    104
    
    
    
    72
    
    
    
    (41
    )2007
    
    
    129
    
    
    
    104
    
    
    
    59
    
    
    
    (38
    )2008
    
    
    111
    
    
    
    104
    
    
    
    49
    
    
    
    (33
    )Thereafter
    
    
    650
    
    
    
    104
    
    
    
    248
    
    
    
    (153
    )Total future minimum payments
    
    $
    1,352
    
    
    $
    681
    
    
    $
    668
    
    
    $
    (317
    )
  Rental expense on operating leases for the years ended December 31, 2003, 2002 and 2001,
net of applicable sublease income, amounted to $257, $465 and $748, respectively.During the years ended December 31, 2003 and 2002, Nortel Networks entered into sale leaseback
transactions for certain of its properties with carrying values of approximately $17 and $250,
respectively, which resulted in a loss on disposal of $6 and $7, respectively.Expenses related to outsourcing contracts for the years ended December 31, 2003, 2002 and 2001
amounted to $308, $364 and $498, respectively, and were for services provided to Nortel Networks
primarily related to a portion of information services, payroll, capital services, accounts
payable and training and human resource functions. The 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. The table above shows the minimum commitment
contained in the outsourcing contracts.  15.
    
    Restricted cash and cash equivalents  As of December 31, 2003 and 2002, approximately $63 and $249, respectively, of cash and
cash equivalents was restricted as collateral for certain bid, performance related and other
bonds as well as for certain normal course of business transactions. The cash and cash
equivalents collateral was in addition to the payment of fees and was required as a result of
the general economic and industry environment and Nortel Networks credit ratings.  16.
    
    Capital stockPreferred shares  Nortel Networks Limited is authorized to issue an unlimited number of Class A preferred
 shares, which rank senior to the Class B preferred shares and the common shares upon a
distribution of capital or assets, and an unlimited number of Class B preferred shares, which
rank junior to the Class A preferred shares and senior to the common shares upon a distribution
of capital or assets, in each case without nominal or par value. Each of the Class A and Class
B preferred shares is issuable in one or more series, each series having such rights,
restrictions and provisions as determined by the Board of Directors of Nortel Networks at the
time of issue. Class A preferred shares have been issued for consideration denominated in
Canadian dollars and are presented in U.S. dollars after translation at the exchange rate in
effect at the date of original issue. Each series of Class A preferred shares ranks in parity
with every other series of Class A preferred shares. As of December 31, 2003 and 2002, the
following outstanding Class A preferred shares were included in shareholders equity: Numberof shares(thousands)
    
    
    $Series 5, issued November 26, 1996 for consideration of Canadian (C) $400
    
    
    16,000
    
    
    $
    294Series 7, issued November 28, 1997 for consideration of C$350
    
    
    14,000
    
    
    $
    242
  In addition, as of December 31, 2000, 200 shares of Cumulative Redeemable Class A Preferred
Shares Series 4 (Series 4 Shares) were outstanding and included in shareholders equity at a
value of $73. During the year ended December 31, F-63




---



##### Table of Contents



2001, the holders of all 200 Series 4 Shares
of Nortel Networks Limited exercised their right to exchange their Series 4 Shares for common
 shares of Nortel Networks Corporation. Nortel Networks Corporation issued in aggregate
approximately 9,035,000 common shares to the former holders of Series 4 Shares. As a result,
pursuant to an agreement in respect of the Series 4 Shares exchange rights, Nortel Networks
Limited issued approximately 4,090,000 common shares to NNC.The Cumulative Redeemable Class A Preferred Shares Series 5 (Series 5 Shares) are presented
net of tax effected issue costs of approximately $4. Until November 30, 2001, holders of Series
5 Shares were entitled to an annual fixed cumulative preferential cash dividend of Canadian
$1.275 per share (5.1 percent), payable, if declared, quarterly. As of December 1, 2001,
holders of Series 5 Shares are entitled to, if declared, a monthly floating cumulative
preferential cash dividend, which will float in relation to the average of the prime commercial
lending rates of two designated Canadian chartered banks during the relevant month, as adjusted by the weighted-average trading price of
Series 5 Shares during such month, up to a maximum of 100 percent of such prime rate. Holders
of Series 5 Shares will have the right to convert their shares into Cumulative Redeemable Class
A Preferred Shares Series 6 (Series 6 Shares), subject to certain conditions, on December 1,
2006, and on December 1 of every fifth year thereafter. No Series 6 Shares have been issued.
Holders of Series 6 Shares will have a similar right to convert back into Series 5 Shares every
5 years. In certain circumstances, conversions may be automatic and mandatory. Series 5 Shares
are redeemable at any time after December 1, 2001, at Nortel 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 and, in certain circumstances conversions may be automatic and
mandatory. 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
excluding, 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 Limited is authorized to issue an unlimited number of common shares without
nominal or par value. The outstanding number of common shares included in shareholders equity
consisted of the following as of December 31: 2003
    
    
    2002
    
    
    2001Number
    
    
    
    
    
    
    Number
    
    
    
    
    
    
    Number(number of shares in thousands)
    
    of shares
    
    
    $
    
    
    of shares
    
    
    $
    
    
    of shares
    
    
    $Balance at beginning of year
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    2,111
    
    
    
    1,453,438
    
    
    $
    17,024Share issuance to parent (a)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,287
    
    
    
    
    
    
    
    1,800Conversion of Series 4 preferred shares (b)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,090
    
    
    
    61Reduction of legal stated capital (c)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,187
    )
    
    
    
    
    
    
    (16,800
    )Acquisitions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,451
    
    
    
    26Balance at end of year
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    1,211
    
    
    
    1,460,979
    
    
    $
    2,111
  (a)
    
    During the year ended December 31, 2002, Nortel Networks
Limited issued four common shares
to NNC for cash consideration of $2,287. On August 15, 2001, NNC completed the private
offering of $1,800 Senior Notes and loaned the full proceeds to Nortel Networks for its
general F-64




---



##### Table of Contents



corporate purposes. On September 30, 2001, in accordance with the terms of the
loan agreement between NNC and Nortel Networks, NNC converted the
entire loan into one common
share of Nortel Networks Limited.(b)
    
    During the year ended December 31, 2001, the holders of all 200 Series 4 Shares of
Nortel Networks Limited exercised their right to exchange their Series 4 Shares for common
 shares of Nortel Networks Corporation. As a result, Nortel Networks Limited issued
approximately 4,090 common shares to NNC.(c)
    
    On December 19, 2002, September 27, 2002, August 29, 2002 and June 28, 2002, NNC, as
the holder of all Nortel Networks Limited issued and outstanding common shares, approved a
reduction in Nortel Networks Limited legal stated capital for its common shares in the
amount of $1,190, $672, $525 and $800, respectively. On September 30, 2001 and June 14,
2001, NNC approved a reduction in Nortel Networks Limited legal stated capital for its
common shares in the amount of $1,800 and $15,000, respectively.  17.
    
    Accumulated other comprehensive loss  The components of accumulated other comprehensive loss, net of tax, were as follows: 2003
    
    
    2002
    
    
    2001Accumulated foreign currency translation adjustmentBalance at the beginning of the year
    
    $
    (321
    )
    
    $
    (494
    )
    
    $
    (369
    )Change in foreign currency translation adjustment(a)
    
    
    535
    
    
    
    173
    
    
    
    (125
    )Balance at the end of the year
    
    
    214
    
    
    
    (321
    )
    
    
    (494
    )Unrealized gain (loss) on investments  netBalance at the beginning of the year
    
    
    24
    
    
    
    5
    
    
    
    45Change in unrealized gain (loss) on investments
    
    
    57
    
    
    
    19
    
    
    
    (40
    )Balance at the end of the year (b)
    
    
    81
    
    
    
    24
    
    
    
    5Unrealized derivative gain (loss) on cash flow hedges  netBalance at the beginning of the year
    
    
    (3
    )
    
    
    (14
    )
    
    
    Change in unrealized derivative gain (loss) on cash flow hedges (c)
    
    
    15
    
    
    
    11
    
    
    
    (14
    )Balance at the end of the year
    
    
    12
    
    
    
    (3
    )
    
    
    (14
    )Minimum pension liability(d)Balance at the beginning of the year
    
    
    (641
    )
    
    
    (84
    )
    
    
    Change in minimum pension liability
    
    
    (188
    )
    
    
    (557
    )
    
    
    (84
    )Balance at the end of the year
    
    
    (829
    )
    
    
    (641
    )
    
    
    (84
    )Accumulated other comprehensive loss
    
    $
    (522
    )
    
    $
    (941
    )
    
    $
    (587
    )
  (a)
    
    The change in the foreign currency translation adjustment was not adjusted for income
taxes since it related to indefinite term investments in non-U.S. subsidiaries.(b)
    
    Certain securities deemed available-for-sale by Nortel Networks were measured at fair
value. Unrealized holding gains (losses) related to these securities were excluded from
net earnings (loss) and were included in accumulated other comprehensive loss until
realized. Unrealized gain (loss) on investments was net of tax of nil, nil and $3 for the
years ended December 31, 2003, 2002 and 2001, respectively. During the years ended
December 31, 2003, 2002 and 2001, realized (gains) losses on investments of $(6), $(4) and
$(32), respectively, were reclassified to other income (expense)  net in the consolidated
statements of operations.(c)
    
    During the year ended December 31, 2003, net derivative gains of $32 were reclassified
to other income (expense)  net. Unrealized derivative gain (loss) on cash flow hedges is
net of tax of nil, $1 and $6 for the years ended December 31, 2003, 2002 and 2001,
respectively. During the year ended December 31, 2002, $18 of net derivative losses were
reclassified to other income (expense)  net. Nortel Networks estimates that $12 of net
derivative gains (losses) included in accumulated other comprehensive loss will be
reclassified into net earnings (loss) within the next 12 months. Also included $7 (pre-tax
$11) of net derivative losses related to the adoption of SFAS 133 during the year ended
December 31, 2001.(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 change in minimum pension liability amount is presented net of tax of $31,
$133 and $26 for the years ended December 31, 2003, 2002 and 2001, respectively.  18.
    
    Stock-based compensation plansStock options  Under the Nortel Networks Corporation 2000 Stock Option Plan (the 2000 Plan) and Nortel
Networks Corporation 1986 Stock Option Plan As Amended and Restated (the 1986 Plan) options to
purchase Nortel Networks Corporation common shares may be granted by NNC to Nortel Networks
employees, and under the 2000 Plan, options may be granted to directors of Nortel Networks that
entitle the holders to purchase one common share at a subscription price of F-65




---



##### Table of Contents



not less than 100
percent of market value on the effective date of the grant. Subscription prices are stated and
payable in U.S. dollars for U.S. options and in Canadian dollars for Canadian options. Generally
options granted prior to 2003 vest 331⁄3 percent on the anniversary date
of the grant for three years. Options granted in 2003 by NNC generally vest 25 percent each year
over a four year period on the anniversary date of the grant. The committee of the Board of
Directors
of Nortel Networks that administers both plans has the discretion to vary the period during
which the holder has the right to exercise options and, in certain circumstances, may accelerate
the right of the holder to exercise options, but in no case shall the exercise period exceed ten
years.Options granted under the 2000 Plan and 1986 Plan may be granted with or without a SAR. A SAR
entitles the holder to receive payment of an amount equivalent to the excess of the market value
of a common share at the time of exercise of the SAR over the subscription price of the common
share to which the option relates. Options with SARs may be granted on a cancellation basis, in
which case the exercise of one causes the cancellation of the other, or on a simultaneous basis,
in which case the exercise of one causes the exercise of the other.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. No Key Contributor Program options were
granted for the years ended December 31, 2003 and 2002, respectively, under both stock option
plans.NNC assumed stock options plans in connection with the acquisition of various companies and
granted options to purchase Nortel Networks Corporation common shares. 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.On June 20, 2001, NNC commenced a voluntary stock option exchange program (the Exchange
Program) for Nortel Networks employees allowing employees to exchange certain outstanding stock
options for new stock options, based on a prescribed formula. The terms of the Exchange Program
required that the new grants of options would be made at least six months and a day from the
cancellation date of the options tendered for exchange, which was July 27, 2001. Nortel Networks
then Board of Directors and its then board appointed officers were not eligible to participate
in the Exchange Program.  Restricted stock unit plan  The Nortel Networks Limited Restricted Stock Unit Plan is a long-term incentive plan that
generally provides executive officers and certain senior management with the opportunity to
receive RSUs over a specified period of time if assigned performance thresholds are achieved and
the joint leadership resources committee of the Boards of the Directors of Nortel Networks and
NNC (the Committee) determines, in its discretion, to issue and settle all or a portion of the
allocated RSUs. Each RSU issued entitles the holder to receive one common share of Nortel
Networks Corporation purchased on the open market, or at the discretion of the Committee, or at
the election of the holder in certain circumstances, cash in lieu of shares.The number of RSUs (in millions) allocated as of
December 31, 2003, 2002 and 2001 was
approximately 20, 2 and 2, respectively.The RSUs allocated in 2003 may be issued and settled in four tranches at the discretion of the
Committee. The Committees discretion is to be based, among other things, on the achievement of
four performance thresholds over a three year term ending December 31, 2005. The performance
criteria for each of the four performance thresholds are distinct and incremental Return on
Sales before Tax percentage targets, calculated on a rolling four-quarter basis. In order to
receive payout, the recipient must have continued employment until the date the allocated RSUs
are issued and settled. Once the Committee determines that a threshold has been achieved, the
Committee uses its discretion to determine whether additional factors should be considered in
determining the number of allocated RSUs to be issued and settled. Such additional factors may
include the performance of competitors and other relevant business, financial, competitive,
political and other criteria deemed appropriate by the Committee. In the third quarter of 2003,
Nortel Networks issued and settled approximately 7 million units of the RSUs allocated in 2003
(see note 22). F-66




---



##### Table of Contents



The RSUs allocated in 2001 were issued at the discretion of the Committee based, among
other things, on the achievement of five performance targets over a two year term ended March
31, 2003. Once the Committee determined whether the five performance targets had been achieved,
it used its discretion to determine the number of allocated RSUs to be issued and settled. On
May 29, 2003, Nortel Networks issued and settled approximately 1.5 million units in respect of
the RSUs allocated in 2001.  Directors deferred share compensation plans  Under the Nortel Networks Corporation Directors Deferred Share Compensation Plan and the
Nortel Networks Limited Directors Deferred Share Compensation Plan, non-employee directors can
elect to receive all or a portion of their compensation for services rendered as a director of
Nortel Networks or NNC, any committees thereof, and as board or committee chairperson, in the
form of share units, instead of cash. The share units are settled a specified number of trading
days following the release of NNCs financial results after the director ceases to be a member
of the applicable board, and each share unit entitles the holder to receive one common share of
Nortel Networks Corporation purchased on the open market. As of December 31, 2003 and 2002, the
number of share units issued (in millions) was 1 and 1, respectively.  Employee stock purchase plans  Nortel Networks has ESPPs to facilitate the acquisition of common shares of Nortel Networks
Corporation at a discount and the retention of such common shares by eligible employees (see
note 22). The ESPPs 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 Nortel Networks Corporation common shares. The Nortel Networks
Corporation common shares are purchased by an independent broker through the facilities of the
TSX and/or NYSE, and held by a custodian on behalf of the plan participants.For North American eligible employees, Nortel Networks Corporation common shares are purchased
at a purchase price of 85 percent of the market price of the Nortel Networks Corporation common
 shares on the last trading day of the offering period. 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; or(iii)
    
    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.  The purchases under the ESPPs for the years ended December 31 are shown below: (number of shares in thousands)
    
    2003
    
    
    2002
    
    
    2001Nortel
Networks Corporation common shares purchased (a)
    
    
    11,532
    
    
    
    38,824
    
    
    
    14,648Weighted-average price of shares purchased
    
    $
    3.10
    
    
    $
    1.31
    
    
    $
    8.50
 (a)
    
    Compensation expense was recognized for Nortel Networks portion of the contributions.
Nortel Networks contributed an amount equal to the difference between the market price and
the purchase price.  19.
    
    Discontinued operations  During the year ended December 31, 2003, Nortel Networks continued to wind down its access
solutions operations and there was no change to the initial disposal strategy or intent to exit
the business which was approved by the Nortel Networks Board of Directors on June 14, 2001.
However, the prolonged deterioration in industry and market conditions during 2002 and 2003
delayed certain disposal activities beyond the original planned timeframe of one year. In
particular, actions involving negotiations with customers, who were also affected by industry
conditions, took longer F-67




---



##### Table of Contents



than expected. Although disposal activities continued beyond the
one-year period generally contemplated under APB 30, Nortel Networks continues to present the
access solutions operations as discontinued operations in the consolidated financial statements.
As of December 31, 2003, Nortel Networks had substantially completed the wind down of its
discontinued operations.  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 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 of December 31 for the consolidated balance sheets and
for the years ended December 31 for the consolidated statements of operations and consolidated
statements of cash flows:  Consolidated statements of operations: 2003
    
    
    2002
    
    
    2001Revenues
    
    $
    14
    
    
    $
    158
    
    
    $
    1,069Net earnings (loss) from discontinued operations  net of tax (a)
    
    $
    
    
    
    $
    
    
    
    $
    (407
    )Net gain (loss) on disposal of operations  net of tax (b)
    
    
    184
    
    
    
    (101
    )
    
    
    (1,624
    )Net earnings (loss) from discontinued operations  net of tax
    
    $
    184
    
    
    $
    (101
    )
    
    $
    (2,031
    )
 (a)
    
    Net earnings (loss) from discontinued operations was net of applicable income tax
benefit of $99 for the year ended December 31, 2001.(b)
    
    Net gain (loss) on disposal of operations was net of an applicable income tax expense
(benefit) of $1, $(16) and $(358) for the years ended December 31, 2003, 2002 and 2001,
respectively.  Consolidated balance sheets: 2003
    
    
    2002Deferred income taxes
    
    $
    26
    
    
    $
    133Other current assets(a)
    
    
    2
    
    
    
    65Total current assets of discontinued operations(b)
    
    
    28
    
    
    
    198Other long-term assets (b) (c)
    
    
    4
    
    
    
    127Total assets of discontinued operations
    
    $
    32
    
    
    $
    325Current liabilities (b) (d)
    
    $
    6
    
    
    $
    63Long-term liabilities (b)
    
    
    1
    
    
    
    1Total liabilities of discontinued operations
    
    $
    7
    
    
    $
    64
 (a)
    
    Included accounts receivable of nil and $20, which was net of provisions of $5 and $53,
as of December 31, 2003 and 2002, respectively. Included inventories of nil, which was net
of provisions of $75 and $102, as of December 31, 2003 and 2002, respectively.(b)
    
    Current assets, other long-term assets, current liabilities and long-term liabilities
of discontinued operations were included in other current assets, other assets, other
accrued liabilities and other liabilities, respectively, on the consolidated balance
sheets.(c)
    
    Included customer financing receivables of $4 and $37, which was net of provisions of
$55 and $470, as of December 31, 2003 and 2002, respectively.(d)
    
    Included accruals of $6 and $63 as of December 31, 2003 and 2002, respectively. The
accruals consisted of future contractual obligations and estimated liabilities of nil and
$14 and accruals of $6 and $49 during the planned period of disposition as of December 31,
2003 and 2002, respectively.  Consolidated statements of cash flows: 2003
    
    
    2002
    
    
    2001Cash flows from (used in) discontinued operationsOperating activities
    
    $
    138
    
    
    $
    250
    
    
    $
    (338
    )Investing activities
    
    
    241
    
    
    
    100
    
    
    
    30Net cash from (used in) discontinued operations
    
    $
    379
    
    
    $
    350
    
    
    $
    (308
    )
 F-68




---



##### Table of Contents



2003 Activity  Nortel Networks recorded net earnings from discontinued operations  net of tax, of $184 in
2003. The significant items included in net earnings are summarized below.During the year ended December 31, 2003, Nortel Networks reassessed its remaining provisions for
discontinued operations and recorded a net gain of $68, consisting of changes in estimates of
$149 for liabilities, offset by additional provisions for both short-term and long-term
receivables of $81.On December 17, 2003, Nortel Networks entered into an agreement to settle an outstanding $21
note receivable from one of its customers, which was previously provisioned, for total cash
proceeds of approximately $17. A gain of $17 was recorded as a result of this transaction.On December 23, 2003, Nortel Networks sold certain plant and equipment, inventory, patent and
other intellectual property related to its fixed wireless access operations, to Airspan Networks
Inc. (Airspan). Nortel Networks received cash proceeds of $13. The majority of the assets
transferred to Airspan had previously been written off by Nortel Networks as part of its
discontinued operations. As a result of this transaction, Nortel Networks recorded a gain of
$14 during the year ended December 31, 2003.On March 24, 2003, Nortel Networks sold 8 million common shares of Arris Group back to Arris
Group for cash consideration of $28 pursuant to a March 11, 2003 agreement, which resulted in a
gain of $12. Following this transaction, Nortel Networks interest in Arris Group was reduced to
18.8 percent, and it ceased equity accounting for the investment. As a result, Nortel Networks
now classifies its remaining ownership interest in Arris Group as an available-for-sale
investment within continuing operations. Nortel Networks continues to dispose of its interest
in Arris Group and the gain or loss on the sale of shares subsequent to the first quarter of
2003 has been included in other income (expense)  net (see note 10).On March 18, 2003, Nortel Networks assigned its subordinated redeemable preferred interest
(membership interest) in Arris Interactive, L.L.C. (Arris Interactive) to ANTEC Corporation,
an Arris Group company, for cash consideration of $88. As a result of this transaction, Nortel
Networks recorded a loss of $2. Also in connection with the March 2003 transactions, Nortel
Networks received $11 upon settlement of a sales representation agreement with Arris Group and
recorded a gain of $11.On March 20, 2003, Nortel Networks entered into an agreement with a customer to restructure
approximately $465 of trade and customer financing receivables owed to Nortel Networks, the
majority of which was previously provisioned. As a result of the restructuring agreement,
Nortel Networks received consideration including cash of $125, notes receivable and an ownership
interest which have been fully provided for and the mutual release of all other claims between
the parties. A gain of $66 was recorded as a result of the transaction. In addition to the
restructuring agreement, a five year equipment and services supply agreement was entered into
requiring customer payment terms of either cash in advance or guarantee by letters of credit in
favor of Nortel Networks.  2002 Activity  Nortel Networks recorded a net loss from discontinued operations  net of tax, of $101 in
2002. The significant items included in this net loss are summarized below.During the year ended December 31, 2002, Nortel Networks reassessed its remaining provisions for
discontinued operations and recorded a net additional loss of $97. The loss consisted of
additional provisions for both short-term and long-term receivables of $157, offset by gains of
$60 due to other changes in estimates.On June 25, 2002, Arris Group completed a secondary public offering of 15 million common shares
held by Nortel Networks. Following the closing of the offering, 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 $17 was recorded as a result of this transaction. 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 Group, from approximately 49 percent to approximately 46
percent as a result of Arris Groups issuance of common shares in connection with its
acquisition of another company. F-69




---



##### Table of Contents



In addition, during the year, as a result of negotiation with Arris Group, Nortel Networks
reduced the carrying value of its membership interest in Arris Interactive and recorded a loss
of $14.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 Communications, Inc. (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 $44 on the transaction.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. The investment in Paradyne has been classified within
continuing operations.On February 6, 2002, Nortel Networks divested its 68.5 percent interest in Netgear, Inc. in
exchange for cash proceeds of $5, a subordinated, unsecured, convertible, promissory note
receivable of $20, and the assumption of certain liabilities. Nortel Networks recorded a gain
of approximately $7 on this transaction. Subsequent to 2002, Nortel Networks received cash of
$20 relating to the repayment of the subordinated, unsecured, convertible, promissory note
receivable.  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 access solutions, including copper, cable and fixed wireless solutions, as well as
Nortel Networks then consolidated membership interest in Arris Group and equity investment in
Elastic Networks. Also affected by the decision were Nortel Networks prior acquisitions of
Promatory Communications, Inc. (Promatory), 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 $1,881
in the three months ended June 30, 2001, which reflected the estimated costs directly associated
with Nortel Networks plan of disposition. The loss reflected: goodwill write-off of $417
associated with the acquisition of Promatory; provisions for both short-term and long-term
receivables of $477; a provision for inventories of $612; other asset write-offs totaling $98;
future contractual obligations and estimated liabilities of $130; estimated operating losses
during the planned period of disposition of $129; and estimated workforce reduction costs of
$18.In the three months ended June 30, 2001, Nortel Networks also reassessed the carrying value of
certain investments totaling $41. Based on this assessment, the fair value of these assets was
nil, and the write-off of $41 was included in net earnings (loss) from discontinued operations,
net of tax of nil.During the six months ended December 31, 2001, Nortel Networks reassessed its remaining
provisions for discontinued operations and recorded an additional pre-tax loss of $298. The loss
consisted mainly of additional provisions for customer financing receivables and equity losses
on investments.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 for cash proceeds of $8, which resulted in a loss of $9.On August 3, 2001, Nortel Networks announced the completion of the previously announced transfer
of its ownership interest in Arris Interactive to Arris Group, ANTEC Corporations new parent
company. As a result, as of 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 Interactive, including a subordinate redeemable preferred interest in Arris
Interactive. Nortel Networks recorded a pre-tax gain of $113 on the transaction. F-70




---



##### Table of Contents



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 for cash proceeds of $13, which resulted in a
gain of $13.  20.
    
    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, with joint ventures of NNC and with NNC and directly owned subsidiaries of NNC.
These transactions are sales and purchases of goods and services under usual trade terms and are
measured at their exchange amounts.Transactions with related parties for the years ended December 31 are summarized as follows: 2003
    
    
    2002
    
    
    2001Consolidated statements of operationsRevenues
    
    $
    3
    
    
    $
    15
    
    
    $
    7Purchases
    
    $
    15
    
    
    $
    52
    
    
    $
    76Research and development expense
    
    $
    30
    
    
    $
    19
    
    
    $
    141
  Balances with related parties as of December 31 were as follows: 2003
    
    
    2002Consolidated balance sheetsOwing from (to) NNC
    
    $
    67
    
    
    $
    (47
    )Owing from NNC subsidiaries
    
    
    87
    
    
    
    99Other related parties (a)
    
    
    
    
    
    
    2Related party receivables
    
    $
    154
    
    
    $
    54
 (a)
    
    Included accounts receivable from EADS Telecom of nil and $2 as of December 31, 2003
and 2002, respectively.  On August 29, 2002, a payment was made by a subsidiary of Nortel Networks to NNC equal to
$525 representing the difference between the market value of Nortel Networks Corporation common
 shares issued on option exercises and the exercise price of NNC stock options held and exercised
by employees of the subsidiary. This payment is referred to as stock option fair value
increment in the consolidated statements of shareholders equity and consolidated statement of
cash flows.In 2001, Nortel Networks completed the sale of substantially all of the assets in the Cogent
Defence Systems (CDS) business to EADS Telecom. At that time, Nortel Networks held a 41
percent ownership interest in EADS Telecom and 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
(but excluding cash on hand as at the closing date) for consideration of approximately $143,
comprised of a loan note due in 2002 and a call option to acquire an additional approximate 7
percent ownership interest in NNF beginning in 2004. Nortel Networks recorded a gain on the sale
of approximately $37 which was included in (gain) loss on sale of businesses and assets, and a
deferred gain of $26, which is amortized into (gain) loss on sale of businesses and assets over
the life of the assets sold to EADS Telecom. In 2002, in connection with negotiations with
EADS, the loan note and call option were cancelled and a new loan note was issued to satisfy the
remaining consideration owing in 2003. As a result, Nortel Networks recorded an additional gain
on the sale of approximately $30, which was included in (gain) loss on sale of businesses and
assets and a further deferred gain of $21, which is amortized into (gain) loss on sale of
businesses and assets over the remaining life of the assets sold to EADS Telecom in 2001.
During the years ended December 31, 2003 and 2002, $13 and $11, respectively, of the deferred
gains were amortized into (gain) loss on sale of businesses and assets. F-71




---



##### Table of Contents



On September 18, 2003 as a result of the sale of Nortel Networks 41 percent interest in EADS
Telecom (see note 10), the remaining unamortized deferred gain of $23 related to the sale of
substantially all of the assets in the CDS business during the year ended December 31, 2001, was
recognized and included in (gain) loss on sale of businesses and assets.On August 15, 2001, NNC completed a private offering of $1,800 of 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 NNC not make such
payments as they are due. The guarantee of the Senior Notes is a direct, unconditional and
unsubordinated obligation of Nortel Networks. NNC loaned the full proceeds from the offering to
Nortel Networks for its general corporate purposes. On September 30, 2001, NNC converted the
entire loan into one common share of Nortel Networks (see note 16).  21.
    
    Contingencies  Subsequent to the February 15, 2001 announcement in which NNC provided revised guidance for
financial performance for the 2001 fiscal year and the first quarter of 2001, NNC and certain of
its then current officers and directors were named as defendants in more than twenty-five
purported class action lawsuits. These lawsuits in the U.S. District Courts for the Eastern
District of New York, for the Southern District of New York and for the District of New Jersey
and the provinces of Ontario, Quebec and British Columbia in Canada, on behalf of shareholders
who acquired Nortel Networks Corporation securities as early as October 24, 2000 and as late as
February 15, 2001, allege, among other things, violations of U.S. federal and Canadian
provincial securities laws. These matters also have been the subject of review by Canadian and
U.S. securities regulatory authorities. On May 11, 2001, the defendants filed motions to
dismiss and/or stay in connection with the three proceedings in Quebec primarily based on the
factual allegations lacking substantial connection to Quebec and the inclusion of shareholders
resident in Quebec in the class claimed in the Ontario lawsuit. The plaintiffs in two of these
proceedings in Quebec obtained court approval for discontinuances of their proceedings on
January 17, 2002. The motion to dismiss and/or stay the third proceeding was heard on November
6, 2001 and the court deferred any determination on the motion to the judge who will hear the
application for authorization to commence a class proceeding. On December 6, 2001, the
defendants filed a motion seeking leave to appeal that decision. The motion for leave to appeal
was dismissed on March 11, 2002. On October 16, 2001, an order in the Southern District of New
York was filed consolidating twenty-five of the related U.S. class action lawsuits into a single
case, appointing class plaintiffs and counsel for such plaintiffs. The plaintiffs served a
consolidated amended complaint on January 18, 2002. On December 17, 2001, the defendants in the
British Columbia action served notice of a motion requesting the court to decline jurisdiction
and to stay all proceedings on the grounds that British Columbia is an inappropriate forum. The
motion has been adjourned at the plaintiffs request to a future date to be set by the parties.A class action lawsuit against NNC was also filed in the U.S. District Court for the Southern
District of New York on behalf of shareholders who acquired the securities of JDS Uniphase
Corporation (JDS) between January 18, 2001 and February 15, 2001, alleging violations of the
same U.S. federal securities laws as the above-noted lawsuits.On April 1, 2002, NNC filed a motion to dismiss both the above consolidated U.S. shareholder
class action and the above JDS shareholder class action complaints on the grounds that they
failed to state a cause of action under U.S. federal securities laws. With respect to the JDS
shareholder class action complaint, NNC also moved to dismiss on the separate basis that JDS
shareholders lacked standing to sue NNC. On January 3, 2003, the District Court granted the
motion to dismiss the JDS shareholder class action complaint and denied the motion to dismiss
the consolidated U.S. class action complaint. Plaintiffs appealed the dismissal of the JDS
shareholder class action complaint. On November 19, 2003, oral argument was held before the
Second Circuit on the JDS shareholders appeal of the dismissal of their complaint. On May 19,
2004, the Second Circuit issued an opinion affirming the dismissal of the JDS shareholder class
action complaint and on July 14, 2004 the Second Circuit denied plaintiffs motion for
rehearing. On October 12, 2004, the plaintiffs filed a petition for writ of certiorari in the
U.S. Supreme Court. On November 12, 2004, the defendants filed Brief for the Respondents in
Opposition, and on November 22, 2004, the plaintiffs filed Reply to Brief in Opposition. With
respect to the consolidated U.S. shareholder class action, the plaintiffs served a motion for
class certification on March 21, 2003. On May 30, 2003, the defendants served an opposition to
the motion for class certification. Plaintiffs reply was served on August 1, 2003. The
District Court held oral arguments on September 3, 2003 and issued an order granting class
certification on September 5, 2003. On September 23, 2003, the defendants filed a motion in the
Second Circuit for permission to appeal the class certification decision. The plaintiffs
opposition to the motion was filed on October 2, 2003. On November 24, 2003, the Second Circuit
denied the motion. On March 10, 2004, the District Court approved the form of notice to the
class which was published and mailed. F-72




---



##### Table of Contents



On July 17, 2002, a new purported class action lawsuit (the Ontario Claim) was filed in the
Ontario Superior Court of Justice, Commercial List, naming NNC, certain of its current and
former officers and directors and its auditors as defendants. The factual allegations in the
Ontario Claim are substantially similar to the allegations in the consolidated amended complaint
filed in the U.S. District Court described above. The Ontario Claim is on behalf of all
Canadian residents who purchased Nortel Networks Corporation securities (including options on
Nortel Networks Corporation securities) between October 24, 2000 and February 15, 2001. The
plaintiffs claim damages of Canadian $5,000, plus punitive damages in the amount of Canadian
$1,000, prejudgment and postjudgment interest and costs of the action. On September 23, 2003,
the Court issued an order allowing the plaintiffs to proceed to amend the Ontario Claim and
requiring that the plaintiffs serve class certification materials by December 15, 2003. On
September 24, 2003, the plaintiffs filed a notice of discontinuance of the original action filed
in Ontario. On December 12, 2003, plaintiffs counsel requested an extension of time to January 21,
2004 to deliver class certification materials. On January 21, 2004,
plaintiffs counsel advised the Court that the two representative plaintiffs in the action no
longer wished to proceed, but counsel was prepared to deliver draft certification materials
pending the replacement of the representative plaintiffs. On February 19, 2004, the plaintiffs
counsel advised the Court of a potential new representative plaintiff. On February 26, 2004,
the defendants requested the Court to direct the plaintiffs counsel to bring a motion to permit
the withdrawal of the current representative plaintiffs and to substitute the proposed
representative plaintiff. On June 8, 2004, the Court signed an order allowing a Second Fresh as
Amended Statement of Claim that substituted one new representative plaintiff, but did not change
the substance of the prior claim.A purported class action lawsuit was filed in the U.S. District Court for the Middle District of
Tennessee on December 21, 2001, on behalf of participants and beneficiaries of the Nortel
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 (ERISA) for
Plan-wide relief and alleging, among other things, material misrepresentations and omissions to
induce Plan participants to continue to invest in and maintain investments in Nortel Networks
Corporation common shares in the Plan. A second purported class action lawsuit, on behalf of
the Plan and Plan participants for whose individual accounts the Plan purchased Nortel Networks
Corporation common shares during the period from October 27, 2000 to February 15, 2001 and
making similar allegations was filed in the same court on March 12, 2002. A third purported
class action lawsuit, on behalf of persons who are or were Plan participants or beneficiaries at
any time since March 1, 1999 to the filing date and making similar allegations, was filed in the
same court on March 21, 2002. The first and second purported class action lawsuits were
consolidated by a new purported class action complaint, filed on May 15, 2002 in the same court
and making similar allegations, on behalf of Plan participants and beneficiaries who directed
the Plan to purchase or hold shares of certain funds, which held primarily Nortel Networks
Corporation common shares, during the period from March 7, 2000 through December 21, 2001. On
September 24, 2002, plaintiffs in the consolidated action filed a motion to consolidate all the
actions and to transfer them to the U.S. District Court for the Southern District of New York.
The plaintiffs then filed a motion to withdraw the pending motion to consolidate and transfer.
The withdrawal was granted by the District Court on December 30, 2002. A fourth purported class
action lawsuit, on behalf of the Plan and Plan participants for whose individual accounts the
Plan held Nortel Networks Corporation common shares during the period from March 7, 2000 through
March 31, 2001 and making similar allegations, was filed in the U.S. District Court for the
Southern District of New York on March 12, 2003. On March 18, 2003, plaintiffs in the fourth
purported class action filed a motion with the Judicial Panel on Multidistrict Litigation to
transfer all the actions to the Southern District of New York for coordinated or consolidated
proceedings pursuant to 28 U.S.C. section 1407. On June 24, 2003, the Judicial Panel on
Multidistrict Litigation issued a transfer order transferring the Southern District of New York
action to the Middle District of Tennessee (the Consolidated ERISA Action). On September 12,
2003, the plaintiffs in all the actions filed a consolidated class action complaint. On October
28, 2003, the defendants filed a motion to dismiss the complaint and a motion to stay discovery
pending disposition of the motion to dismiss. On March 30, 2004, the plaintiffs filed a motion
for certification of a class consisting of participants in, or beneficiaries of, the Plan who
held shares of the NNC Stock Fund during the period from March 7, 2000 through March 31, 2001.
On April 27, 2004, the Court granted the defendants motion to stay discovery pending resolution
of defendants motion to dismiss. On June 15, 2004, the plaintiffs filed a First Amended
Consolidated Class Action Complaint that added additional current and former officers and
employees as defendants and expanded the purported class period to extend from March 7, 2000
through to June 15, 2004.On March 4, 1997, Bay Networks, Inc. (Bay Networks), a company acquired on August 31, 1998,
announced that shareholders had filed two separate lawsuits in the U.S. District Court for the
Northern District of California (the F-73




---



##### Table of Contents



Federal Court) and the California Superior Court, County
of Santa Clara (the California Court), against Bay Networks and ten of Bay Networks then
current and former officers and directors purportedly on behalf of a class of shareholders who
purchased Bay Networks common shares during the period of May 1, 1995 through October 14, 1996.
On August 17, 2000, the Federal Court granted the defendants motion to dismiss the federal
complaint. On August 1, 2001, the U.S. Court of Appeals for the Ninth Circuit denied the
plaintiffs appeal of that decision. On April 18, 1997, a second lawsuit was filed in the
California Court, purportedly on behalf of a class of shareholders who acquired Bay Networks
common shares pursuant to the registration statement and prospectus that became effective on
November 15, 1995. The two actions in the California Court were consolidated in April 1998;
however, the California Court denied the plaintiffs motion for class certification. In January
2000, the California Court of Appeal rejected the plaintiffs appeal of the decision. A
petition for review was filed with the California Supreme Court by the plaintiffs and was
denied. In February 2000, new plaintiffs who allege to have been shareholders of Bay Networks
during the relevant periods, filed a
motion for intervention in the California Court seeking to become the representatives of a class
of shareholders. The motion was granted on June 8, 2001 and the new plaintiffs filed their
complaint-in-intervention on an individual and purported class representative basis alleging
misrepresentations made in connection with the purchase and sale of securities of Bay Networks
in violation of California statutory and common law. On March 11, 2002, the California Court
granted the defendants motion to strike the class allegations. The plaintiffs were permitted
to proceed on their individual claims. The intervenor-plaintiffs appealed the dismissal of
their class allegations. On July 25, 2003, the California Court of Appeal reversed the trial
courts dismissal of the intervenor-plaintiffs class allegations. On September 3, 2003, the
defendants filed a petition for review with the California Supreme Court seeking permission to
appeal the Court of Appeal decision. On October 22, 2003, the California Supreme Court denied,
without opinion, the defendants petition for review. On December 22, 2003, the plaintiffs
served their motion for certification of a class of purchasers of Bay Networks common shares
from July 25, 1995 through to October 14, 1996. Hearing of the plaintiffs motion for class
certification was held on May 4, 2004. On July 27, 2004, the Court entered an Amended Order
Denying Motion of Intervenor Plaintiffs for Class Certification and Setting Further Hearing. On
August 9, 2004, the intervenor-plaintiffs obtained Court approval to dismiss their claims and
this action and, on September 30, 2004, the Court entered dismissal with prejudice of the entire
action of all parties and all causes of action.Subsequent to the March 10, 2004 announcement in which NNC indicated it was likely that it and
Nortel Networks would need to revise their previously announced unaudited results for the year
ended December 31, 2003, and the results reported in certain of
their quarterly reports for 2003,
and to restate their previously filed financial results for one or more earlier periods, NNC and
certain of its then current and former officers and directors were named as defendants in 27
purported class action lawsuits. These lawsuits in the U.S. District Court for the Southern
District of New York on behalf of shareholders who acquired Nortel Networks Corporation
securities as early as February 16, 2001 and as late as May 15, 2004, allege, among other
things, violations of U.S. federal securities laws. These matters are also the subject of
investigations by Canadian and U.S. securities regulatory and criminal investigative authorities
(see note 22). On June 30, 2004, the Court signed Orders consolidating the 27 class actions and
appointing lead plaintiffs and lead counsel. The plaintiffs filed a consolidated class action
complaint on September 10, 2004, alleging a class period of April 24, 2003 through and including
April 27, 2004. On November 5, 2004, Nortel Networks Corporation and the Audit Committee
Defendants filed a motion to dismiss the consolidated class action complaint.On May 18, 2004, a purported class action lawsuit was filed in the U.S. District Court for the
Middle District of Tennessee on behalf of participants and beneficiaries of the Plan at any time
during the period of December 23, 2003 through the filing date and who made or maintained Plan
investments in Nortel Networks Corporation common shares, under the ERISA for Plan-wide relief
and alleging, among other things, breaches of fiduciary duty. On September 3, 2004, the Court
signed a stipulated order consolidating this action with the Consolidated ERISA Action described
above. On June 16, 2004, a second purported class action lawsuit, on behalf of the Plan and
Plan participants for whose individual accounts the Plan purchased Nortel Networks Corporation
common shares during the period from October 24, 2000 to June 16, 2004, and making similar
allegations, was filed in the U.S. District Court for the Southern District of New York. On
August 6, 2004, the Judicial Panel on Multidistrict Litigation issued a conditional transfer
order to transfer this action to the U.S. District Court for the Middle District of Tennessee
for coordinated or consolidated proceedings pursuant to 28 U.S.C. section 1407 with the
Consolidated ERISA Action described above. On August 20, 2004, plaintiffs filed a notice of
opposition to the conditional transfer order with the Judicial Panel. On December 6, 2004, the
Judicial Panel denied the opposition and ordered the action transferred to the U.S. District
Court for the Middle District of Tennessee for coordinated or consolidated proceedings with the
Consolidated ERISA Action described above. F-74




---



##### Table of Contents



On July 28, 2004, Nortel Networks and NNC, and certain directors and officers, and certain
former directors and officers, of Nortel Networks and NNC, were named as defendants in a
purported class proceeding in the Ontario Superior Court of Justice on behalf of shareholders
who acquired Nortel Networks Corporation securities as early as November 12, 2002 and as late as
July 28, 2004. This lawsuit alleges, among other things, breaches of trust and fiduciary duty,
oppressive conduct and misappropriation of corporate assets and trust property in respect of the
payment of cash bonuses to executives, officers and employees in 2003 and 2004 under the NNC
Return to Profitability bonus program and seeks damages of Canadian $250 and an order under the
Canada Business Corporations Act directing that an investigation be made respecting these bonus
payments.On July 30, 2004, a shareholders derivative complaint was filed in the U.S. District Court for
the Southern District of New York against certain directors and officers, and certain former
directors and officers, of NNC alleging, among other
things, breach of fiduciary duties owed to NNC during the period from 2000 to 2003 including by
causing NNC to engage in unlawful conduct or failing to prevent such conduct; causing NNC to
issue false statements; and violating the law.Except as otherwise described herein, in each of the matters described above, the plaintiffs are
seeking an unspecified amount of monetary damages.Nortel Networks is also a defendant in various other suits, claims, proceedings and
investigations which arise in the normal course of business.Nortel Networks is unable to ascertain the ultimate aggregate amount of monetary liability or
financial impact to Nortel Networks of the above matters which, unless otherwise specified, seek
damages from the defendants of material or indeterminate amounts or could result in fines and
penalties. 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, financial condition and liquidity of Nortel Networks. Nortel Networks or
NNC, as applicable, and any named directors and officers of Nortel Networks or NNC, as
applicable, intend to vigorously defend these actions, suits, claims and proceedings.  Environmental matters  Nortel Networks operations are subject to a wide range of environmental laws in various
jurisdictions around the world. Nortel Networks seeks to operate its business in compliance with
such laws. In 2004, Nortel Networks expects to become subject to new European product content
laws and product takeback and recycling requirements that will require full compliance by 2006.
It is expected that these laws will require Nortel Networks to incur additional compliance
costs. Although costs relating to environmental matters have not resulted in a material adverse
effect on the business, results of operations, financial condition and liquidity in the past,
there can be no assurance that Nortel Networks will not be required to incur such costs in the
future. Nortel Networks has a corporate environmental management system standard and an
environmental program 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. As of December 31, 2003,
the accruals on the consolidated balance sheet for environmental matters were $33. Based on
information available as of December 31, 2003, management believes that the existing accruals
are sufficient to satisfy probable and reasonably estimable environmental liabilities related to
known environmental matters. Any additional liability that may result from these matters, and
any additional liabilities that may result in connection with other locations currently under
investigation, are not expected to have a material adverse effect on the business, results of
operations, financial condition and liquidity of Nortel 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 F-75




---



##### Table of Contents



probable and reasonably estimable, is
included in the environmental accruals referred to above in an approximate amount of $33.Nortel Networks is also listed as a potentially responsible party (PRP) under the U.S.
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) at six Superfund
sites in the U.S. An estimate of Nortel 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 $33 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.  22.
    
    Subsequent eventsNortel Networks Audit Committee Independent Review; restatements; related matters  As previously announced by NNC in October 2003, in late October 2003 the Nortel
Networks and NNC Audit Committee initiated the Independent Review of the facts and circumstances leading
to the First Restatement and engaged WCPHD to advise it in connection with the Independent
Review.On March 10, 2004, NNC announced that as a result of the work done to date in connection with
the Independent Review, it was re-examining the establishment, timing of, support for and
release to income of certain accruals and provisions in prior periods. Further, it was likely
that NNC and Nortel Networks would need to revise their previously announced unaudited results
for the year ended December 31, 2003, and the results reported in certain of their quarterly
reports for 2003, and to restate their previously filed financial results for one or more earlier
periods. NNC announced on March 15, 2004 that the filing of the NNC and Nortel Networks annual
reports on Form 10-K for the year ended December 31, 2003 (the 2003 Annual Reports) would be
delayed beyond March 30, 2004.On April 5, 2004, NNC announced that the SEC had issued a formal order of investigation in
connection with NNCs previous restatement of its financial results for certain periods, as
announced in October 2003, and NNCs announcements in March 2004 regarding the likely need to
revise certain previously announced results and restate previously filed financial results for
one or more earlier periods. The matter had been the subject of an informal SEC inquiry. On
April 13, 2004, NNC announced that it had received a letter from the staff of the Ontario
Securities Commission (OSC) advising that there is an OSC Enforcement Staff investigation into
the same matters that are the subject of the SEC investigation.On April 28, 2004, NNC announced that the Independent Review was extended to include the second
half of 2003 and it was determined that the previously announced unaudited results for the year
ended December 31, 2003 needed to be revised and that the financial results reported in each of
NNCs and Nortel Networks quarterly periods of 2003 and for earlier periods including 2002 and
2001 needed to be restated. NNC announced that it and Nortel Networks were not expected to
timely file their first quarter 2004 financial statements and, in accordance with Canadian
securities regulations, their 2003 Canadian GAAP audited financial statements and Annual
Information Form.In April 2004, Nortel Networks terminated for cause its former president and chief executive
officer, former chief financial officer and former controller and, in August 2004, seven
additional senior finance employees with significant responsibilities for Nortel Networks
financial reporting as a whole or for their respective business units and geographic regions in
August 2004.On May 14, 2004, NNC announced that it had received a Federal Grand Jury Subpoena for the
production of certain documents, including financial statements and corporate, personnel and
accounting records, prepared during the period from January 1, 2000 to the date of the subpoena.
The materials sought are pertinent to an ongoing criminal investigation being conducted by the
U.S. Attorneys Office for the Northern District of Texas, Dallas Division.On May 17, 2004, NNC announced that the OSC had issued a temporary order that prohibits all
trading by directors, F-76




---



##### Table of Contents



officers and certain current and former employees in the securities of
Nortel Networks and NNC, which temporary order was replaced with a final order issued on May 31,
2004. The final order remains in effect until two full business days following the receipt by
the OSC of all filings required to be made by Nortel Networks and NNC pursuant to Ontario
securities laws.On June 29, 2004, NNC announced that Nortel Networks and
NNC did not expect to timely file financial statements for
the second quarter of 2004 and related periodic reports in accordance with U.S. and Canadian
securities laws.On August 16, 2004, NNC received a letter from the Integrated Market Enforcement Team of the
Royal Canadian Mounted Police (RCMP) advising NNC that the RCMP would be commencing a criminal
investigation into NNCs
financial accounting situation.On August 19, 2004, Nortel Networks announced a new streamlined organizational structure,
effective October 1, 2004, that involved, among other things, combining the businesses of Nortel
Networks four segments into two business organizations: (i) Carrier Networks and Global
Operations, and (ii) Enterprise Networks. Further, a focused workforce reduction of
approximately 3,250 employees was announced. In addition, the Audit Committee anticipated that
there would be work done, in addition to that portion of the inquiry which affects Nortel
Networks and NNCs ability to finalize their 2003 audited financial statements, in connection
with its Independent Review, on remedial measures, internal controls and improvements to
processes.On October 27, 2004, NNC announced that Nortel Networks and NNC did not expect to file their
third quarter 2004 financial statements, and the related periodic reports, by the required
deadlines in November 2004 in compliance with certain U.S. and Canadian securities regulations.Nortel Networks has terminated for cause 10 individuals, including its former president and
chief executive officer, its former chief financial officer and its former controller. Nortel
Networks has demanded repayment by the individuals terminated for cause of payments made under
Nortel Networks bonus plans in respect of 2003.Subsequent to the March 10, 2004 announcement, numerous class action complaints, including ERISA
class action complaints, have been filed against Nortel Networks and NNC in the U.S. and Canada.
In addition, a derivative action complaint has been filed against NNC. Nortel Networks and NNC
are subject to significant pending civil litigation which, if decided against Nortel Networks
and NNC, could result in substantial damages or other penalties which, in turn, could have a
material adverse effect on the business, results of operations, financial condition and
liquidity of Nortel Networks (see note 21).In January 2005, the Audit Committee reported the findings of the Independent Review, together
with its recommendations for governing principles for remedial measures that were developed for
the Audit Committee by WCPHD. Each of Nortel Networks and NNCs Boards of Directors has adopted
those recommendations in their entirety and directed management to develop a detailed plan and
timetable for their implementation, and will monitor their implementation.Also in January 2005, the Nortel Networks Audit Committee determined to review the facts and
circumstances leading to the restatement of certain revenues for specific transactions
identified in the Second Restatement. This review will have a particular emphasis on the
underlying conduct that led to the initial recognition of these revenues. The Audit Committee
will develop any appropriate additional remedial measures, and has engaged WCPHD to advise it in
connection with such review.  EDC Support Facility  On March 10, 2004, NNC announced that the filing of the 2003 Annual Reports with the SEC
would be delayed. On March 15, 2004, NNC announced that the filing of the 2003 Annual Reports
with the SEC would extend beyond March 30, 2004 and that would result in EDC having the right to
terminate its commitments under the EDC Support Facility and to exercise certain rights against
the collateral under the related security agreements (see note 23). Nortel Networks obtained a
waiver from EDC on March 29, 2004 of certain defaults under the EDC Support Facility related to
the delay in filing the 2003 Annual Reports with the SEC, the trustees under Nortel Networks and
NNCs public trust indentures and EDC and to permit continued access to the EDC Support Facility
in accordance with its terms while Nortel Networks and NNC completed
their filing obligations. The waiver also applied to certain related
breaches under the EDC F-77




---



##### Table of Contents



Support Facility relating to
the delayed filings and the planned restatements and revisions to Nortel Networks and NNCs
prior financial results (the Related Breaches). The waiver was to remain in effect until the
earliest of certain events or May 29, 2004. On March 29, 2004, Nortel Networks and EDC also
amended the EDC Support Facility to provide that EDC may also suspend its obligation to issue
Nortel Networks any additional support if events occur that have a material adverse effect on
Nortel Networks business, financial position or results of operations and that such amendment
would survive the waiver period.On May 28, 2004, Nortel Networks obtained a new waiver from EDC of certain defaults under the
EDC Support Facility related to the delay in filing the 2003 Annual Reports and Nortel Networks
and NNCs quarterly reports on Form 10-Q for the three months ended March 31, 2004 (the First
Quarter Reports) and the Related Breaches, which waiver was to remain in effect until the
earliest of certain events or August 30, 2004. This waiver reclassified the previously committed
$300 revolving small bond sub-facility of the EDC Support Facility as uncommitted support.A further waiver was obtained from EDC effective August 20, 2004 (the August Waiver) related
to the delay in filing the 2003 Annual Reports, the First Quarter Reports and Nortel Networks
and NNCs quarterly reports on Form 10-Q for the three months ended June 30, 2004 (the Second
Quarter Reports) and the Related Breaches, which waiver was to remain in effect until the
earliest of certain events or September 30, 2004.On September 29, 2004, Nortel Networks obtained a new waiver from EDC (the September Waiver)
which replaced the August Waiver on substantially the same terms as provided in the August
Waiver except that the September Waiver was to remain in effect until the earliest of certain
events or October 31, 2004.On October 29, 2004, Nortel Networks obtained a new waiver from EDC (the October Waiver) which
replaced the September Waiver on substantially the same terms as the September Waiver except
that the October Waiver remained in effect until the earliest of certain events or November 19,
2004.A further waiver was obtained from EDC effective November 19, 2004 (the November Waiver)
related to the delay in filing the 2003 Annual Reports, the First Quarter Reports, the Second
Quarter Reports and Nortel Networks and NNCs quarterly reports on Form 10-Q for the three
months ended September 30, 2004 (the Third Quarter Reports, and together with the 2003 Annual
Reports, the First Quarter Reports and the Second Quarter Reports, the Reports, and the Third
Quarter Reports together with the First Quarter Reports and Second Quarter Reports, the
Quarterly Reports) and the Related Breaches, which waiver was to remain in effect until the
earliest of certain events or December 10, 2004.On December 10, 2004, Nortel Networks obtained a new waiver from EDC (the December Waiver)
which replaced the November Waiver on substantially the same terms as the November Waiver except
that: (i) the December Waiver included an amendment to the EDC Support Facility to extend the
termination date of the EDC Support Facility to December 31, 2006 from December 31, 2005; and
(ii) the December Waiver remains in effect until the earliest of certain events including the
date on which Nortel Networks and NNC have filed all of the Reports or January 15, 2005.As Nortel Networks and NNC will not have filed all of the Reports by January 15, 2005, EDC will
have the right on such date (absent a further waiver in relation to the delayed filings and the
Related Breaches) to: (i) terminate the EDC Support Facility; (ii) exercise certain rights
against collateral; or (iii) require Nortel Networks to cash collateralize all existing support.In addition, the Related Breaches will continue beyond the filing of the Reports. Accordingly,
EDC will have the right beginning on January 15, 2005 (absent a further waiver of the Related
Breaches) to terminate or suspend the EDC Support Facility and exercise certain other rights
against collateral notwithstanding the filing of the Reports. While Nortel Networks is seeking
a permanent waiver from EDC in connection with the Related Breaches, there can be no assurance
that Nortel Networks will receive any waiver or as to the terms of any such waiver. The $300
revolving small bond sub-facility will not become committed support until all of the Reports
have been filed with the SEC, the trustees under Nortel Networks and NNCs public trust
indentures and EDC and Nortel Networks obtains a permanent waiver of the Related Breaches. F-78




---



##### Table of Contents



Credit facilities and security agreements  On April 28, 2004, Nortel Networks notified the banks under the Five Year Facilities that
it was terminating these facilities. Absent such termination, the banks would have been
permitted, upon 30 days notice, to terminate their commitments under the Five Year Facilities
as a result of Nortel Networks inability to file its annual report on Form 10-K for the year
ended December 31, 2003 by April 29, 2004. Upon termination, the Five Year Facilities were
undrawn.As a result of the termination of the Five Year Facilities, certain foreign security agreements
entered into by Nortel Networks and various of its subsidiaries under which shares of certain
subsidiaries of Nortel Networks incorporated outside of the U.S. and Canada were pledged in
favor of the banks under the Five Year Facilities, EDC and the holders of Nortel Networks and
NNCs outstanding public debt securities also terminated in accordance with their terms (see
note 23). In addition, guarantees by certain subsidiaries of Nortel Networks incorporated
outside of the U.S. and Canada terminated in accordance with their terms. Security agreements
remain in place under which substantially all of the assets of Nortel Networks located in the
U.S. and Canada and those of most of its U.S. and Canadian subsidiaries, including the shares of
certain of Nortel Networks U.S. and Canadian subsidiaries, are pledged in favor of EDC and the
holders of Nortel Networks and NNCs outstanding public debt securities. In addition, the
guarantees by certain of Nortel Networks wholly owned subsidiaries, including NNI, most of
Nortel Networks Canadian subsidiaries, Nortel Networks (Asia) Limited, Nortel Networks (Ireland)
Limited and Nortel Networks U.K. Limited, of Nortel Networks obligations under the EDC Support
Facility and Nortel Networks and NNCs outstanding public debt securities remain in place.  Debt securities  As a result of the delay in filing the Reports, Nortel Networks and NNC have not been in
compliance with their obligations to deliver their respective SEC filings to relevant parties
under Nortel Networks and NNCs public debt indentures. As of December 31, 2004, approximately
$1,800 of notes of Nortel Networks (or its subsidiaries) and $1,800 of convertible debt
securities of NNC were outstanding.These delays have not resulted in an automatic event of default and acceleration of the
outstanding long-term debt and such default and acceleration cannot occur unless notice of such
non-compliance from holders of 25% of the outstanding principal amount of any relevant debt
securities is provided to Nortel Networks or NNC, as applicable, and Nortel Networks or NNC, as
applicable, fail to file and deliver the relevant report within 90 days after such notice is
provided, all in accordance with the terms of the indentures. While such notice could have been
given at any time after March 30, 2004, neither Nortel Networks nor NNC has received a notice to
the date of this report.As a result of the delay in filing certain of the Reports, Nortel Networks and NNC continue not
to be in compliance with their obligations under Nortel Networks and NNCs public debt
indentures as described above. If notice were given and acceleration of Nortel Networks and
NNCs debt securities were to occur, Nortel Networks may be unable to meet its payment
obligations.  Stock-based compensation plans  As a result of NNCs March 10, 2004 announcement, as described above under Nortel Networks
Audit Committee Independent Review; restatements; related matters, NNC suspended as of March 10,
2004: the purchase of Nortel Networks Corporation common shares under the ESPPs; the
exercise of outstanding options granted under the 2000 Plan or 1986 Plan, or the grant of any
additional options under those plans, or the exercise of outstanding options granted under
employee stock option plans previously assumed by NNC in connection with mergers and
acquisitions; and the purchase of units in a NNC stock fund or purchase of Nortel Networks
Corporation common shares under Nortel Networks defined contribution and investments plans,
until such time, at the earliest, that Nortel Networks and NNC are in compliance with U.S. and
Canadian regulatory securities filing requirements.  Stock exchanges  As a result of the continued delay in filing the Quarterly Reports, Nortel Networks is in
breach of the continued listing requirements of the NYSE and the TSX. The NYSE has granted
Nortel Networks and NNC an extension up to F-79




---



##### Table of Contents



March 31, 2005 by which to file the 2003 Annual
Reports. To date, neither the NYSE nor the TSX has commenced any suspension or delisting
procedures in respect of Nortel Networks Corporation common shares and other of Nortel Networks
and NNCs listed securities. The commencement of any suspension or delisting procedures by
either exchange remains, at all times, at the discretion of such exchange.  Directory and operator services business


On August 2, 2004, Nortel Networks completed the contribution of certain assets and
liabilities of its directory and operator services (DOS) business to VoltDelta Resources LLC
(VoltDelta), a wholly owned subsidiary of Volt Information Sciences, Inc. (VIS), in return
for a 24 percent interest in VoltDelta. After a period of two years, Nortel Networks and VIS
each have an option to cause Nortel Networks to sell its VoltDelta shares to VIS for proceeds
ranging from $25 to $70. As a result of this transaction, approximately 160 Nortel Networks DOS
employees in North America and Mexico joined VoltDelta. Nortel Networks recorded a gain on sale
of businesses and assets of approximately $50 in the third quarter of 2004.  Evolution of Nortel Networks supply chain strategy  On June 29, 2004, Nortel Networks announced an agreement with Flextronics International
Ltd. (Flextronics), regarding the divestiture of substantially all of Nortel Networks
remaining manufacturing operations, including product integration, testing and repair operations
carried out in Nortel Networks Systems Houses in Calgary and Montreal, Canada and Campinas,
Brazil, as well as certain activities related to these locations, including the management of
the supply chain, related suppliers, and third-party logistics. In Europe, Flextronics has made
an offer to purchase similar operations at the Nortel Networks Monkstown, Northern Ireland and
Chateaudun, France Systems Houses, subject to the completion of the required information and
consultation process.Under the terms of the agreement and offer, Flextronics will also acquire Nortel Networks global
repair services, as well as certain design assets in Ottawa and Monkstown related to hardware
and embedded software design, and related product verification for certain established optical
products.Nortel Networks and Flextronics have entered into a four year supply agreement for manufacturing
services (whereby Flextronics will manage approximately $2,500 of Nortel Networks annual cost of
sales) and a three year supply agreement for design services. The portion of the transaction
related to the optical design activities in Ottawa and Monkstown was completed on November 1,
2004. The portions of the transaction related to the manufacturing activities in Montreal and
Calgary are expected to close in the first and second quarters of 2005, respectively. The
balance of the transaction is expected to close on separate dates occurring during the first
half of 2005. These transactions are subject to customary conditions and regulatory approvals.The successful completion of the agreement and offer with Flextronics will result in the
transfer of approximately 2,500 employees from Nortel Networks to Flextronics. Nortel Networks
expects to receive cash proceeds ranging from approximately $675 to $725, which will be
allocated to each separate closing and, with respect to each closing, will be paid on an
installment basis up to nine months thereafter. Such payments will be subject to a number of
adjustments, including potential post-closing date asset valuations and potential post-closing
indemnity payments. Flextronics also has the ability in certain cases to exercise rights to
sell back to Nortel Networks certain inventory and equipment after the expiration of a specified
period (of up to fifteen months) following each respective closing date. Nortel Networks does
not expect such rights to be exercised with respect to any material amount of inventory and/or
equipment. The cash proceeds estimate is comprised of approximately $475 to $525 for inventory
and equipment and $200 for intangible assets. The cash proceeds would be partially offset by
related estimated transaction costs (including transition, potential severance, and information
technology implementation and real estate costs) of approximately $200.  Other  On January 8, 2004, Nortel Networks renegotiated an agreement with a certain customer and
reduced Nortel Networks aggregate undrawn customer financing commitments from $177 to $69. F-80




---



##### Table of Contents



On February 3, 2004, Nortel Networks sold approximately 7 million common shares of Entrust Inc.
(Entrust) for cash consideration of $33, resulting in a gain of $18. As a result of this
transaction, Nortel Networks no longer holds any equity interest in Entrust.On March 1, 2004, Nortel Networks purchased land and two buildings for $87 that were previously
leased by Nortel Networks. As a result, Nortel Networks extinguished a debt of $87.On May 7, 2004, Nortel Networks received $80 in proceeds from the sale of certain assets in
connection with a customer contract settlement in Latin America. This resulted in a gain of
$78, which will be included in (gain) loss on sale of businesses and assets for the three months
ended June 30, 2004.In August 2004, Nortel Networks entered into a contract with Bharat Sanchar Nigram Limited to
establish a wireless network in India. Nortel Networks commitments to date for orders received
under this contract have resulted in an estimated project loss of approximately $130, which has
been recorded in the third quarter of 2004.On October 26, 2004, Nortel Networks entered into an agreement with Foundry Networks, Inc.
(Foundry) to settle outstanding patent infringement claims and counterclaims by the parties.
As part of the settlement, Nortel Networks granted Foundry a four year license under certain
patents, and Foundry paid $35 to Nortel Networks.On December 15 and 16, 2004, Nortel Networks sold certain notes receivable and convertible notes
receivable that had been received as a result of the restructuring of a customer financing
arrangement for cash proceeds of $116. The net carrying amount of the notes receivable and
convertible notes receivable was $56.On December 23, 2004, a customer financing arrangement was restructured. The notes receivable
that were restructured had a net carrying amount as of December 31, 2003 of $13, net of
provisions for doubtful accounts of $147 ($55 of the provision is included in discontinued
operations). Nortel Networks is currently assessing the value of the restructured notes
receivable and expects that an increase in value from the net carrying amount has occurred.  23.
    
    Supplemental consolidating financial information  As of December 31, 2003, and as a result of Nortel Networks credit ratings, various liens,
pledges and guarantees were effective under security agreements entered into by Nortel Networks
and various of its subsidiaries that pledged substantially all of the assets of Nortel Networks
in favor of the banks under the Five Year Facilities, EDC and the holders of Nortel Networks and
NNCs outstanding public debt securities, which debt securities represent substantially all of
NNCs consolidated long-term debt (see notes 11 and 22).The security agreements were originally entered into in connection with the $1,510 December 2001
364-day credit facilities (which expired on December 13, 2002). The security became effective
April 4, 2002, following Moodys Investors Service, Inc. (Moodys) downgrade of Nortel
Networks senior long-term debt rating to below investment grade, in respect of the then existing
credit facilities including the Five Year Facilities. Consequently, on April 4, 2002 and in
accordance with the negative pledge covenants in the indentures for all Nortel Networks and
NNCs outstanding public debt securities, all such public debt securities became, under the
terms of the security agreements, secured equally and ratably with the obligations under Nortel
Networks and NNIs then existing credit facilities.Nortel Networks obligations under the EDC Support Facility became secured on an equal and
ratable basis under the security agreements on February 14, 2003.As of December 31, 2003, the security provided under the security agreements was comprised of
pledges of substantially all of the assets of Nortel Networks and those of most of its U.S. and
Canadian subsidiaries and pledges of shares in certain of Nortel Networks other subsidiaries.
In addition, certain of Nortel Networks wholly owned subsidiaries guaranteed Nortel Networks
obligations under the credit and support facilities and outstanding public debt securities (the
Guarantor Subsidiaries). Non-guarantor subsidiaries (the Non-Guarantor Subsidiaries)
represented either wholly owned subsidiaries of Nortel Networks whose shares were pledged, or
were the remaining subsidiaries of Nortel Networks which did not provide liens, pledges or
guarantees (see note 22). F-81




---



##### Table of Contents



The liens, pledges and guarantees described above also applied equally and ratably to NNCs
$1,800 Senior Notes due September 1, 2008 as well as Nortel Networks guarantee of the Senior
Notes.If Nortel Networks senior long-term debt rating by Moodys returns to Baa2 (with a stable
outlook) and its rating by Standard & Poors returns to BBB (with a stable outlook), the
security and guarantees will be released in full. If both the Five Year Facilities and the EDC
Support Facility are terminated, or expire, the security and guarantees will also be released in
full. Nortel Networks may provide EDC with cash collateral in an amount equal to the total
amount of its outstanding obligations and undrawn commitments and expenses under the EDC Support Facility (or
any other alternative collateral or arrangements acceptable to EDC) in lieu of the security
provided under the security agreements (see note 11). Accordingly, if the EDC Support Facility
is secured by cash or other alternate collateral or arrangements acceptable to EDC and if the
Five Year Facilities are terminated or expire, the security and guarantees will also be released
in full (see note 22 for additional related information including the termination of the Five
Year Facilities).


The following supplemental consolidating financial data illustrates, in separate columns, the
composition of Nortel Networks Limited, the Guarantor Subsidiaries, the Non-Guarantor
Subsidiaries, eliminations and the consolidated total as of December 31, 2003 and 2002 and for
the years ended December 31, 2003, 2002 and 2001 (see note 22).Investments in subsidiaries are accounted for using the equity method for purposes of the
supplemental consolidating financial data. Net earnings (loss) of subsidiaries are therefore
reflected in the investment account and net earnings (loss). The principal elimination entries
eliminate investments in subsidiaries and intercompany balances and transactions. The financial
data may not necessarily be indicative of the results of operations or financial position had
the subsidiaries been operating as independent entities. F-82




---



##### Table of Contents



Supplemental Consolidating Statements of Operations for the year ended December 31, 2003: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalRevenues
    
    $
    3,182
    
    
    $
    7,566
    
    
    $
    2,789
    
    
    $
    (3,344
    )
    
    $
    10,193Cost of revenues
    
    
    1,995
    
    
    
    5,106
    
    
    
    2,104
    
    
    
    (3,344
    )
    
    
    5,861Gross profit
    
    
    1,187
    
    
    
    2,460
    
    
    
    685
    
    
    
    
    
    
    
    4,332Selling, general and administrative expense
    
    
    430
    
    
    
    1,327
    
    
    
    174
    
    
    
    
    
    
    
    1,931Research and development expense
    
    
    814
    
    
    
    878
    
    
    
    273
    
    
    
    
    
    
    
    1,965Amortization of intangibles
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    3Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other special charges
    
    
    66
    
    
    
    246
    
    
    
    (27
    )
    
    
    
    
    
    
    285(Gain) loss on sale of businesses and assets
    
    
    4
    
    
    
    (3
    )
    
    
    (5
    )
    
    
    
    
    
    
    (4
    )Operating earnings (loss)
    
    
    (127
    )
    
    
    12
    
    
    
    267
    
    
    
    
    
    
    
    152Other income (expense)  net
    
    
    86
    
    
    
    301
    
    
    
    46
    
    
    
    
    
    
    
    433Interest expenseLong-term debt
    
    
    (68
    )
    
    
    (4
    )
    
    
    (26
    )
    
    
    
    
    
    
    (98
    )Other
    
    
    (4
    )
    
    
    (69
    )
    
    
    47
    
    
    
    
    
    
    
    (26
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (113
    )
    
    
    240
    
    
    
    334
    
    
    
    
    
    
    
    461Income tax benefit (expense)
    
    
    184
    
    
    
    (50
    )
    
    
    (101
    )
    
    
    
    
    
    
    3371
    
    
    
    190
    
    
    
    233
    
    
    
    
    
    
    
    494Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (28
    )
    
    
    
    
    
    
    (28
    )Equity in net earnings (loss) of associated companies
 net of tax
    
    
    351
    
    
    
    404
    
    
    
    9
    
    
    
    (800
    )
    
    
    (36
    )Net earnings (loss) from continuing operations
    
    
    422
    
    
    
    594
    
    
    
    214
    
    
    
    (800
    )
    
    
    430Net earnings (loss) from discontinued operations
 net of tax
    
    
    184
    
    
    
    119
    
    
    
    
    
    
    
    (119
    )
    
    
    184Net earnings (loss) before cumulative effect of accounting
change
    
    
    606
    
    
    
    713
    
    
    
    214
    
    
    
    (919
    )
    
    
    614Cumulative effect of accounting change  net of tax
    
    
    (4
    )
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    (12
    )Net earnings (loss)
    
    
    602
    
    
    
    705
    
    
    
    214
    
    
    
    (919
    )
    
    
    602Dividends on preferred shares
    
    
    35
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35Net earnings (loss) applicable to common shares
    
    $
    567
    
    
    $
    705
    
    
    $
    214
    
    
    $
    (919
    )
    
    $
    567
 F-83




---



##### Table of Contents



Supplemental Consolidating Statements of Operations for the year ended December 31, 2002: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalRevenues
    
    $
    3,026
    
    
    $
    8,557
    
    
    $
    2,705
    
    
    $
    (3,294
    )
    
    $
    10,994Cost of revenues
    
    
    2,720
    
    
    
    5,433
    
    
    
    2,280
    
    
    
    (3,294
    )
    
    
    7,139Gross profit
    
    
    306
    
    
    
    3,124
    
    
    
    425
    
    
    
    
    
    
    
    3,855Selling, general and administrative expense
    
    
    593
    
    
    
    1,647
    
    
    
    292
    
    
    
    
    
    
    
    2,532Research and development expense
    
    
    870
    
    
    
    937
    
    
    
    277
    
    
    
    
    
    
    
    2,084Amortization of intangibles
    
    
    
    
    
    
    20
    
    
    
    (1
    )
    
    
    
    
    
    
    19Deferred Stock Option Compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special chargesGoodwill impairment
    
    
    
    
    
    
    203
    
    
    
    61
    
    
    
    
    
    
    
    264Other special charges
    
    
    346
    
    
    
    834
    
    
    
    178
    
    
    
    
    
    
    
    1,358(Gain) loss on sale of businesses and assets
    
    
    16
    
    
    
    (8
    )
    
    
    (12
    )
    
    
    
    
    
    
    (4
    )Operating earnings (loss)
    
    
    (1,519
    )
    
    
    (509
    )
    
    
    (370
    )
    
    
    
    
    
    
    (2,398
    )Other income (expense)  net
    
    
    (80
    )
    
    
    134
    
    
    
    (82
    )
    
    
    
    
    
    
    (28
    )Interest expenseLong-term debt
    
    
    (105
    )
    
    
    
    
    
    
    (30
    )
    
    
    
    
    
    
    (135
    )Other
    
    
    
    
    
    
    (53
    )
    
    
    (2
    )
    
    
    
    
    
    
    (55
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (1,704
    )
    
    
    (428
    )
    
    
    (484
    )
    
    
    
    
    
    
    (2,616
    )Income tax benefit (expense)
    
    
    330
    
    
    
    (49
    )
    
    
    157
    
    
    
    
    
    
    
    438(1,374
    )
    
    
    (477
    )
    
    
    (327
    )
    
    
    
    
    
    
    (2,178
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    32
    
    
    
    
    
    
    
    32Equity in net earnings (loss) of associated companies
 net of tax
    
    
    (789
    )
    
    
    (773
    )
    
    
    (9
    )
    
    
    1,554
    
    
    
    (17
    )Net earnings (loss) from continuing operations
    
    
    (2,163
    )
    
    
    (1,250
    )
    
    
    (304
    )
    
    
    1,554
    
    
    
    (2,163
    )Net earnings (loss) from discontinued
operations  net of tax
    
    
    (101
    )
    
    
    (66
    )
    
    
    
    
    
    
    66
    
    
    
    (101
    )Net earnings (loss)
    
    
    (2,264
    )
    
    
    (1,316
    )
    
    
    (304
    )
    
    
    1,620
    
    
    
    (2,264
    )Dividends on preferred shares
    
    
    26
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26Net earnings (loss) applicable to common shares
    
    $
    (2,290
    )
    
    $
    (1,316
    )
    
    $
    (304
    )
    
    $
    1,620
    
    
    $
    (2,290
    )
 F-84




---



##### Table of Contents



Supplemental Consolidating Statements of Operations for the year ended December 31, 2001: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalRevenues
    
    $
    5,196
    
    
    $
    14,124
    
    
    $
    4,837
    
    
    $
    (5,394
    )
    
    $
    18,763Cost of revenues
    
    
    4,639
    
    
    
    11,044
    
    
    
    4,222
    
    
    
    (5,394
    )
    
    
    14,511Gross profit
    
    
    557
    
    
    
    3,080
    
    
    
    615
    
    
    
    
    
    
    
    4,252Selling, general and administrative expense
    
    
    679
    
    
    
    4,499
    
    
    
    832
    
    
    
    
    
    
    
    6,010Research and development expense
    
    
    1,085
    
    
    
    1,654
    
    
    
    389
    
    
    
    
    
    
    
    3,128Amortization of intangiblesAcquired technology and other
    
    
    
    
    
    
    574
    
    
    
    
    
    
    
    
    
    
    
    574Goodwill
    
    
    22
    
    
    
    1,561
    
    
    
    498
    
    
    
    
    
    
    
    2,081Deferred Stock Option Compensation
    
    
    18
    
    
    
    (2
    )
    
    
    (16
    )
    
    
    
    
    
    
    Special chargesGoodwill impairment
    
    
    
    
    
    
    1,257
    
    
    
    982
    
    
    
    
    
    
    
    2,239Other special charges
    
    
    505
    
    
    
    1,654
    
    
    
    780
    
    
    
    
    
    
    
    2,939(Gain) loss on sale of businesses and assets
    
    
    (5
    )
    
    
    (90
    )
    
    
    (5
    )
    
    
    
    
    
    
    (100
    )Operating earnings (loss)
    
    
    (1,747
    )
    
    
    (8,027
    )
    
    
    (2,845
    )
    
    
    
    
    
    
    (12,619
    )Other income (expense)  net
    
    
    306
    
    
    
    (354
    )
    
    
    (91
    )
    
    
    (380
    )
    
    
    (519
    )Interest expenseLong-term debt
    
    
    (145
    )
    
    
    3
    
    
    
    (34
    )
    
    
    
    
    
    
    (176
    )Other
    
    
    (26
    )
    
    
    (72
    )
    
    
    (10
    )
    
    
    
    
    
    
    (108
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net earnings (loss) of associated companies
    
    
    (1,612
    )
    
    
    (8,450
    )
    
    
    (2,980
    )
    
    
    (380
    )
    
    
    (13,422
    )Income tax benefit (expense)
    
    
    1,777
    
    
    
    309
    
    
    
    487
    
    
    
    
    
    
    
    2,573165
    
    
    
    (8,141
    )
    
    
    (2,493
    )
    
    
    (380
    )
    
    
    (10,849
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    (7
    )
    
    
    
    
    
    
    (7
    )Equity in net earnings (loss) of associated companies
 net of tax
    
    
    (11,171
    )
    
    
    (4,744
    )
    
    
    2
    
    
    
    15,763
    
    
    
    (150
    )Net earnings (loss) from continuing operations
    
    
    (11,006
    )
    
    
    (12,885
    )
    
    
    (2,498
    )
    
    
    15,383
    
    
    
    (11,006
    )Net earnings (loss) from discontinued
operations  net of tax
    
    
    (2,031
    )
    
    
    (1,320
    )
    
    
    
    
    
    
    1,320
    
    
    
    (2,031
    )Net earnings (loss) before cumulative effect of
accounting change
    
    
    (13,037
    )
    
    
    (14,205
    )
    
    
    (2,498
    )
    
    
    16,703
    
    
    
    (13,037
    )Cumulative effect of accounting change  net of tax
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15Net earnings (loss)
    
    
    (13,022
    )
    
    
    (14,205
    )
    
    
    (2,498
    )
    
    
    16,703
    
    
    
    (13,022
    )Dividends on preferred shares
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Net earnings (loss) applicable to common shares
    
    $
    (13,049
    )
    
    $
    (14,205
    )
    
    $
    (2,498
    )
    
    $
    16,703
    
    
    $
    (13,049
    )
 F-85




---



##### Table of Contents



Supplemental Consolidating Balance Sheets as of December 31, 2003: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    (8
    )
    
    $
    3,164
    
    
    $
    772
    
    
    $
    
    
    
    $
    3,928Restricted cash and cash equivalents
    
    
    25
    
    
    
    37
    
    
    
    1
    
    
    
    
    
    
    
    63Accounts receivable  net
    
    
    314
    
    
    
    1,671
    
    
    
    520
    
    
    
    
    
    
    
    2,505Intercompany/related party accounts receivable
    
    
    345
    
    
    
    1,053
    
    
    
    808
    
    
    
    (2,052
    )
    
    
    154Inventories  net
    
    
    302
    
    
    
    565
    
    
    
    323
    
    
    
    
    
    
    
    1,190Income taxes recoverable
    
    
    13
    
    
    
    52
    
    
    
    25
    
    
    
    
    
    
    
    90Deferred income taxes  net
    
    
    67
    
    
    
    302
    
    
    
    
    
    
    
    
    
    
    
    369Other current assets
    
    
    31
    
    
    
    178
    
    
    
    105
    
    
    
    
    
    
    
    314Total current assets
    
    
    1,089
    
    
    
    7,022
    
    
    
    2,554
    
    
    
    (2,052
    )
    
    
    8,613Investments
    
    
    1,995
    
    
    
    (7,568
    )
    
    
    285
    
    
    
    5,532
    
    
    
    244Intercompany advances
    
    
    166
    
    
    
    537
    
    
    
    1,855
    
    
    
    (2,558
    )
    
    
    Plant and equipment  net
    
    
    475
    
    
    
    817
    
    
    
    362
    
    
    
    
    
    
    
    1,654Goodwill
    
    
    
    
    
    
    1,962
    
    
    
    163
    
    
    
    
    
    
    
    2,125Intangible assets  net
    
    
    40
    
    
    
    1
    
    
    
    45
    
    
    
    
    
    
    
    86Deferred income taxes  net
    
    
    1,673
    
    
    
    1,655
    
    
    
    69
    
    
    
    
    
    
    
    3,397Other assets
    
    
    102
    
    
    
    60
    
    
    
    175
    
    
    
    
    
    
    
    337Total assets
    
    $
    5,540
    
    
    $
    4,486
    
    
    $
    5,508
    
    
    $
    922
    
    
    $
    16,456LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    3
    
    
    $
    12
    
    
    $
    
    
    
    $
    17Trade and other accounts payable
    
    
    347
    
    
    
    406
    
    
    
    107
    
    
    
    
    
    
    
    860Intercompany/related party accounts payable
    
    
    (4,071
    )
    
    
    3,211
    
    
    
    2,912
    
    
    
    (2,052
    )
    
    
    Payroll and benefit-related liabilities
    
    
    137
    
    
    
    479
    
    
    
    148
    
    
    
    
    
    
    
    764Contractual liabilities
    
    
    26
    
    
    
    309
    
    
    
    194
    
    
    
    
    
    
    
    529Restructuring
    
    
    52
    
    
    
    138
    
    
    
    15
    
    
    
    
    
    
    
    205Other accrued liabilities
    
    
    356
    
    
    
    1,660
    
    
    
    451
    
    
    
    
    
    
    
    2,467Long-term debt due within one year
    
    
    11
    
    
    
    101
    
    
    
    7
    
    
    
    
    
    
    
    119Total current liabilities
    
    
    (3,140
    )
    
    
    6,307
    
    
    
    3,846
    
    
    
    (2,052
    )
    
    
    4,961Long-term debt
    
    
    1,549
    
    
    
    127
    
    
    
    415
    
    
    
    
    
    
    
    2,091Deferred income taxes  net
    
    
    
    
    
    
    173
    
    
    
    17
    
    
    
    
    
    
    
    190Other liabilities
    
    
    930
    
    
    
    1,811
    
    
    
    203
    
    
    
    
    
    
    
    2,944Intercompany advances
    
    
    11
    
    
    
    297
    
    
    
    2,250
    
    
    
    (2,558
    )
    
    
    (650
    )
    
    
    8,715
    
    
    
    6,731
    
    
    
    (4,610
    )
    
    
    10,186Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    80
    
    
    
    
    
    
    
    80SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    237
    
    
    
    
    
    
    
    (237
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    6,089
    
    
    
    799
    
    
    
    (6,888
    )
    
    
    1,211Additional paid-in capital
    
    
    22,031
    
    
    
    1,081
    
    
    
    3,891
    
    
    
    (4,972
    )
    
    
    22,031Accumulated deficit
    
    
    (17,066
    )
    
    
    (12,661
    )
    
    
    (5,972
    )
    
    
    18,633
    
    
    
    (17,066
    )Accumulated other comprehensive income (loss)
    
    
    (522
    )
    
    
    1,025
    
    
    
    (21
    )
    
    
    (1,004
    )
    
    
    (522
    )Total shareholders equity
    
    
    6,190
    
    
    
    (4,229
    )
    
    
    (1,303
    )
    
    
    5,532
    
    
    
    6,190Total liabilities and shareholders equity
    
    $
    5,540
    
    
    $
    4,486
    
    
    $
    5,508
    
    
    $
    922
    
    
    $
    16,456
 F-86




---



##### Table of Contents



Supplemental Consolidating Balance Sheets as of December 31, 2002: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    251
    
    
    $
    2,392
    
    
    $
    1,099
    
    
    $
    
    
    
    $
    3,742Restricted cash and cash equivalents
    
    
    6
    
    
    
    176
    
    
    
    67
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    288
    
    
    
    1,524
    
    
    
    416
    
    
    
    
    
    
    
    2,228Intercompany/related party accounts receivable
    
    
    4,147
    
    
    
    994
    
    
    
    448
    
    
    
    (5,535
    )
    
    
    54Inventories  net
    
    
    546
    
    
    
    712
    
    
    
    248
    
    
    
    
    
    
    
    1,506Income taxes recoverable
    
    
    1
    
    
    
    51
    
    
    
    61
    
    
    
    
    
    
    
    113Deferred income taxes  net
    
    
    178
    
    
    
    615
    
    
    
    
    
    
    
    
    
    
    
    793Other current assets
    
    
    146
    
    
    
    395
    
    
    
    95
    
    
    
    
    
    
    
    636Total current assets
    
    
    5,563
    
    
    
    6,859
    
    
    
    2,434
    
    
    
    (5,535
    )
    
    
    9,321Investments
    
    
    1,507
    
    
    
    (8,055
    )
    
    
    518
    
    
    
    6,267
    
    
    
    237Plant and equipment  net
    
    
    425
    
    
    
    865
    
    
    
    399
    
    
    
    
    
    
    
    1,689Goodwill
    
    
    
    
    
    
    1,954
    
    
    
    65
    
    
    
    
    
    
    
    2,019Intangible assets  net
    
    
    39
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    41Deferred income taxes  net
    
    
    1,077
    
    
    
    1,510
    
    
    
    70
    
    
    
    
    
    
    
    2,657Other assets
    
    
    605
    
    
    
    1,278
    
    
    
    761
    
    
    
    (1,894
    )
    
    
    750Total assets
    
    $
    9,216
    
    
    $
    4,413
    
    
    $
    4,247
    
    
    $
    (1,162
    )
    
    $
    16,714LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    2
    
    
    $
    3
    
    
    $
    25
    
    
    $
    
    
    
    $
    30Trade and other accounts payable
    
    
    342
    
    
    
    391
    
    
    
    69
    
    
    
    
    
    
    
    802Intercompany/related party accounts payable
    
    
    110
    
    
    
    3,052
    
    
    
    2,373
    
    
    
    (5,535
    )
    
    
    Payroll and benefit-related liabilities
    
    
    104
    
    
    
    298
    
    
    
    82
    
    
    
    
    
    
    
    484Contractual liabilities
    
    
    43
    
    
    
    536
    
    
    
    314
    
    
    
    
    
    
    
    893Restructuring
    
    
    78
    
    
    
    329
    
    
    
    92
    
    
    
    
    
    
    
    499Other accrued liabilities
    
    
    553
    
    
    
    2,267
    
    
    
    395
    
    
    
    
    
    
    
    3,215Long-term debt due within one year
    
    
    174
    
    
    
    14
    
    
    
    55
    
    
    
    
    
    
    
    243Total current liabilities
    
    
    1,406
    
    
    
    6,890
    
    
    
    3,405
    
    
    
    (5,535
    )
    
    
    6,166Long-term debt
    
    
    1,603
    
    
    
    166
    
    
    
    391
    
    
    
    
    
    
    
    2,160Deferred income taxes  net
    
    
    263
    
    
    
    84
    
    
    
    10
    
    
    
    
    
    
    
    357Other liabilities
    
    
    764
    
    
    
    2,071
    
    
    
    1,816
    
    
    
    (1,894
    )
    
    
    2,7574,036
    
    
    
    9,211
    
    
    
    5,622
    
    
    
    (7,429
    )
    
    
    11,440Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    94
    
    
    
    
    
    
    
    94SHAREHOLDERS EQUITYPreferred shares
    
    
    536
    
    
    
    342
    
    
    
    
    
    
    
    (342
    )
    
    
    536Common shares
    
    
    1,211
    
    
    
    6,129
    
    
    
    1,071
    
    
    
    (7,200
    )
    
    
    1,211Additional paid-in capital
    
    
    22,007
    
    
    
    1,432
    
    
    
    4,067
    
    
    
    (5,499
    )
    
    
    22,007Accumulated deficit
    
    
    (17,633
    )
    
    
    (13,447
    )
    
    
    (6,495
    )
    
    
    19,942
    
    
    
    (17,633
    )Accumulated other comprehensive income (loss)
    
    
    (941
    )
    
    
    746
    
    
    
    (112
    )
    
    
    (634
    )
    
    
    (941
    )Total shareholders equity
    
    
    5,180
    
    
    
    (4,798
    )
    
    
    (1,469
    )
    
    
    6,267
    
    
    
    5,180Total liabilities and shareholders equity
    
    $
    9,216
    
    
    $
    4,413
    
    
    $
    4,247
    
    
    $
    (1,162
    )
    
    $
    16,714
 F-87




---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2003: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    422
    
    
    $
    594
    
    
    $
    214
    
    
    $
    (800
    )
    
    $
    430Adjustments to reconcile net earnings (loss)
from continuing operations to net cash from
(used in) operating activities, net of effects
from acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    75
    
    
    
    249
    
    
    
    110
    
    
    
    
    
    
    
    434In-process research and development expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Non-cash portion of special charges and related asset write downs
    
    
    9
    
    
    
    76
    
    
    
    2
    
    
    
    
    
    
    
    87Equity in net loss of associated companies
    
    
    (351
    )
    
    
    (404
    )
    
    
    (9
    )
    
    
    800
    
    
    
    36Stock option compensation
    
    
    4
    
    
    
    19
    
    
    
    3
    
    
    
    
    
    
    
    26Deferred income taxes
    
    
    5
    
    
    
    (82
    )
    
    
    69
    
    
    
    
    
    
    
    (8
    )Other liabilities
    
    
    83
    
    
    
    74
    
    
    
    4
    
    
    
    
    
    
    
    161(Gain) loss on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )(Gain) loss on sale or write-down of investments and businesses
    
    
    (7
    )
    
    
    (4
    )
    
    
    (40
    )
    
    
    
    
    
    
    (51
    )Other  net
    
    
    291
    
    
    
    (904
    )
    
    
    (199
    )
    
    
    
    
    
    
    (812
    )Change in operating assets and liabilities
    
    
    190
    
    
    
    (741
    )
    
    
    330
    
    
    
    
    
    
    
    (221
    )Intercompany/related party activity
    
    
    (831
    )
    
    
    1,506
    
    
    
    (675
    )
    
    
    
    
    
    
    Net cash from (used in) operating activities
of continuing operations
    
    
    (114
    )
    
    
    383
    
    
    
    (191
    )
    
    
    
    
    
    
    78Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (41
    )
    
    
    (85
    )
    
    
    (46
    )
    
    
    
    
    
    
    (172
    )Proceeds on disposals of plant and equipment
    
    
    7
    
    
    
    28
    
    
    
    3
    
    
    
    
    
    
    
    38Acquisitions of investments and businesses  net of cash acquired
    
    
    (60
    )
    
    
    (6
    )
    
    
    8
    
    
    
    
    
    
    
    (58
    )Proceeds on sale of investments and businesses
    
    
    6
    
    
    
    101
    
    
    
    
    
    
    
    
    
    
    
    107Investments in subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net cash from (used in) investing activities
of continuing operations
    
    
    (88
    )
    
    
    38
    
    
    
    (35
    )
    
    
    
    
    
    
    (85
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (35
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35
    )Dividends paid by subsidiaries to minority interests
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Increase (decrease) in notes payable  net
    
    
    
    
    
    
    4
    
    
    
    (49
    )
    
    
    
    
    
    
    (45
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Repayments of long-term debt
    
    
    (199
    )
    
    
    (2
    )
    
    
    (69
    )
    
    
    
    
    
    
    (270
    )Repayments of capital leases payable
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    (12
    )Issuance of common shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net cash from (used in) financing activities
of continuing operations
    
    
    (234
    )
    
    
    (10
    )
    
    
    (118
    )
    
    
    
    
    
    
    (362
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    2
    
    
    
    137
    
    
    
    37
    
    
    
    
    
    
    
    176Net cash from (used in) continuing operations
    
    
    (434
    )
    
    
    548
    
    
    
    (307
    )
    
    
    
    
    
    
    (193
    )Net cash from (used in) discontinued operations
    
    
    175
    
    
    
    224
    
    
    
    (20
    )
    
    
    
    
    
    
    379Net increase (decrease) in cash and cash equivalents
    
    
    (259
    )
    
    
    772
    
    
    
    (327
    )
    
    
    
    
    
    
    186Cash and cash equivalents at beginning of year
    
    
    251
    
    
    
    2,392
    
    
    
    1,099
    
    
    
    
    
    
    
    3,742Cash and cash equivalents at end of year
    
    $
    (8
    )
    
    $
    3,164
    
    
    $
    772
    
    
    $
    
    
    
    $
    3,928
 F-88




---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2002: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    (2,163
    )
    
    $
    (1,250
    )
    
    $
    (304
    )
    
    $
    1,554
    
    
    $
    (2,163
    )Adjustments to reconcile net earnings (loss)
from continuing operations to net cash from
(used in) operating activities, net of effects
from acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    87
    
    
    
    402
    
    
    
    64
    
    
    
    
    
    
    
    553Non-cash portion of special charges and related asset write downs
    
    
    199
    
    
    
    464
    
    
    
    29
    
    
    
    
    
    
    
    692Equity in net loss of associated companies
    
    
    789
    
    
    
    773
    
    
    
    9
    
    
    
    (1,554
    )
    
    
    17Deferred income taxes
    
    
    (417
    )
    
    
    (137
    )
    
    
    149
    
    
    
    
    
    
    
    (405
    )Other liabilities
    
    
    (4
    )
    
    
    18
    
    
    
    (13
    )
    
    
    
    
    
    
    1(Gain) loss on repurchases of outstanding debt securities
    
    
    (60
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (60
    )(Gain) loss on sale or write-down of investments and businesses
    
    
    17
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    35Other  net
    
    
    447
    
    
    
    (553
    )
    
    
    (177
    )
    
    
    
    
    
    
    (283
    )Change in operating assets and liabilities
    
    
    (578
    )
    
    
    904
    
    
    
    293
    
    
    
    
    
    
    
    619Intercompany/related party activity
    
    
    91
    
    
    
    (152
    )
    
    
    61
    
    
    
    
    
    
    
    Net cash from (used in) operating activities
of continuing operations
    
    
    (1,592
    )
    
    
    487
    
    
    
    111
    
    
    
    
    
    
    
    (994
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (65
    )
    
    
    (242
    )
    
    
    (45
    )
    
    
    
    
    
    
    (352
    )Proceeds on disposals of plant and equipment
    
    
    16
    
    
    
    390
    
    
    
    
    
    
    
    
    
    
    
    406Acquisitions 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
of continuing operations
    
    
    (31
    )
    
    
    157
    
    
    
    (40
    )
    
    
    
    
    
    
    86Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (26
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26
    )Decrease in notes payable  net
    
    
    
    
    
    
    (174
    )
    
    
    (159
    )
    
    
    
    
    
    
    (333
    )Proceeds from long-term debt
    
    
    
    
    
    
    1
    
    
    
    32
    
    
    
    
    
    
    
    33Repayments of long-term debt
    
    
    (460
    )
    
    
    (138
    )
    
    
    (13
    )
    
    
    
    
    
    
    (611
    )Repayments of capital leases payable
    
    
    (3
    )
    
    
    (13
    )
    
    
    
    
    
    
    
    
    
    
    (16
    )Issuance of common shares
    
    
    2,287
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,287Stock option fair value increment
    
    
    
    
    
    
    (525
    )
    
    
    
    
    
    
    
    
    
    
    (525
    )Net cash from (used in) financing activities
of continuing operations
    
    
    1,798
    
    
    
    (849
    )
    
    
    (140
    )
    
    
    
    
    
    
    809Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    13
    
    
    
    45
    
    
    
    16
    
    
    
    
    
    
    
    74Net cash from (used in) continuing operations
    
    
    188
    
    
    
    (160
    )
    
    
    (53
    )
    
    
    
    
    
    
    (25
    )Net cash from (used in) discontinued operations
    
    
    104
    
    
    
    246
    
    
    
    
    
    
    
    
    
    
    
    350Net increase (decrease) in cash and cash equivalents
    
    
    292
    
    
    
    86
    
    
    
    (53
    )
    
    
    
    
    
    
    325Cash and cash equivalents at beginning of year
    
    
    (41
    )
    
    
    2,306
    
    
    
    1,152
    
    
    
    
    
    
    
    3,417Cash and cash equivalents at end of year
    
    $
    251
    
    
    $
    2,392
    
    
    $
    1,099
    
    
    $
    
    
    
    $
    3,742
 F-89




---



##### Table of Contents



Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2001: Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    (11,006
    )
    
    $
    (12,885
    )
    
    $
    (2,498
    )
    
    $
    15,383
    
    
    $
    (11,006
    )Adjustments to reconcile net earnings (loss)
from continuing operations to net cash from
(used in) operating activities, net of effects
from acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    191
    
    
    
    2,608
    
    
    
    575
    
    
    
    
    
    
    
    3,374Non-cash portion of special charges and related asset write downs
    
    
    88
    
    
    
    1,459
    
    
    
    1,588
    
    
    
    
    
    
    
    3,135Equity in net loss of associated companies
    
    
    11,171
    
    
    
    4,744
    
    
    
    (2
    )
    
    
    (15,763
    )
    
    
    150Deferred income taxes
    
    
    (537
    )
    
    
    (797
    )
    
    
    (5
    )
    
    
    
    
    
    
    (1,339
    )Other liabilities
    
    
    (73
    )
    
    
    85
    
    
    
    (21
    )
    
    
    
    
    
    
    (9
    )(Gain) loss on sale or write-down of investments and businesses
    
    
    69
    
    
    
    253
    
    
    
    (54
    )
    
    
    
    
    
    
    268Other  net
    
    
    (458
    )
    
    
    (371
    )
    
    
    (629
    )
    
    
    
    
    
    
    (1,458
    )Change in operating assets and liabilities
    
    
    522
    
    
    
    5,227
    
    
    
    1,294
    
    
    
    
    
    
    
    7,043Intercompany/related party activity
    
    
    (2,539
    )
    
    
    1,788
    
    
    
    371
    
    
    
    380
    
    
    
    Net cash from (used in) operating activities
of continuing operations
    
    
    (2,572
    )
    
    
    2,111
    
    
    
    619
    
    
    
    
    
    
    
    158Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (317
    )
    
    
    (833
    )
    
    
    (119
    )
    
    
    
    
    
    
    (1,269
    )Proceeds on disposals of plant and equipment
    
    
    23
    
    
    
    185
    
    
    
    
    
    
    
    
    
    
    
    208Acquisitions of investments and businesses  net of cash acquired
    
    
    (13
    )
    
    
    (76
    )
    
    
    
    
    
    
    
    
    
    
    (89
    )Proceeds on sale of investments and businesses
    
    
    6
    
    
    
    403
    
    
    
    195
    
    
    
    
    
    
    
    604Net cash from (used in) investing activities
of continuing operations
    
    
    (301
    )
    
    
    (321
    )
    
    
    76
    
    
    
    
    
    
    
    (546
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    (27
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (27
    )Increase in notes payable  net
    
    
    12
    
    
    
    (281
    )
    
    
    39
    
    
    
    
    
    
    
    (230
    )Proceeds from long-term debt
    
    
    1,500
    
    
    
    10
    
    
    
    20
    
    
    
    
    
    
    
    1,530Repayments of long-term debt
    
    
    (250
    )
    
    
    (12
    )
    
    
    (207
    )
    
    
    
    
    
    
    (469
    )Repayments of capital leases payable
    
    
    (3
    )
    
    
    (18
    )
    
    
    (5
    )
    
    
    
    
    
    
    (26
    )Issuance of common shares
    
    
    1,800
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,800Net cash from (used in) financing activities
of continuing operations
    
    
    3,032
    
    
    
    (301
    )
    
    
    (153
    )
    
    
    
    
    
    
    2,578Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    (7
    )
    
    
    (4
    )
    
    
    
    
    
    
    (10
    )Net cash from (used in) continuing operations
    
    
    160
    
    
    
    1,482
    
    
    
    538
    
    
    
    
    
    
    
    2,180Net cash from (used in) discontinued operations
    
    
    (108
    )
    
    
    (200
    )
    
    
    
    
    
    
    
    
    
    
    (308
    )Net increase (decrease) in cash and cash equivalents
    
    
    52
    
    
    
    1,282
    
    
    
    538
    
    
    
    
    
    
    
    1,872Cash and cash equivalents at beginning of year
    
    
    (93
    )
    
    
    1,024
    
    
    
    614
    
    
    
    
    
    
    
    1,545Cash and cash equivalents at end of year
    
    $
    (41
    )
    
    $
    2,306
    
    
    $
    1,152
    
    
    $
    
    
    
    $
    3,417
 F-90




---



##### Table of Contents



Quarterly Financial Data (Unaudited) 4th Quarter
    
    
    3rd Quarter
    
    
    2nd Quarter
    
    
    1st Quarter(millions of U.S. dollars)
    
    2003**
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002RevenuesAs previously reported
    
    
    
    
    
    $
    2,520
    
    
    $
    2,266
    
    
    $
    2,349
    
    
    $
    2,340
    
    
    $
    2,785
    
    
    $
    2,376
    
    
    $
    2,900As reported or restated*
    
    $
    3,266
    
    
    
    2,611
    
    
    
    2,344
    
    
    
    2,321
    
    
    
    2,288
    
    
    
    2,916
    
    
    
    2,295
    
    
    
    3,146Gross profitAs previously reported
    
    
    
    
    
    
    1,021
    
    
    
    1,177
    
    
    
    849
    
    
    
    1,023
    
    
    
    955
    
    
    
    1,052
    
    
    
    739As reported or restated*
    
    
    1,425
    
    
    
    1,119
    
    
    
    1,119
    
    
    
    714
    
    
    
    881
    
    
    
    1,015
    
    
    
    907
    
    
    
    1,007Special chargesAs previously reported
    
    
    
    
    
    
    184
    
    
    
    70
    
    
    
    827
    
    
    
    (1
    )
    
    
    266
    
    
    
    111
    
    
    
    422As reported or restated*
    
    
    86
    
    
    
    270
    
    
    
    81
    
    
    
    745
    
    
    
    (22
    )
    
    
    200
    
    
    
    140
    
    
    
    407Other income (expense)  netAs previously reported
    
    
    
    
    
    
    9
    
    
    
    100
    
    
    
    (18
    )
    
    
    25
    
    
    
    (20
    )
    
    
    5
    
    
    
    (5
    )As reported or restated*
    
    
    137
    
    
    
    (59
    )
    
    
    144
    
    
    
    35
    
    
    
    57
    
    
    
    96
    
    
    
    95
    
    
    
    (100
    )Net earnings (loss) from continuing operationsAs previously reported
    
    
    
    
    
    
    (172
    )
    
    
    186
    
    
    
    (1,371
    )
    
    
    109
    
    
    
    (500
    )
    
    
    (103
    )
    
    
    (702
    )As reported or restated*
    
    
    502
    
    
    
    (180
    )
    
    
    133
    
    
    
    (1,140
    )
    
    
    (32
    )
    
    
    (276
    )
    
    
    (173
    )
    
    
    (567
    )Net earnings
(loss) from discontinued operations  net of taxAs previously reported
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    2
    
    
    
    (2
    )
    
    
    3
    
    
    
    164
    
    
    
    16As reported or restated*
    
    
    27
    
    
    
    (99
    )
    
    
    32
    
    
    
    5
    
    
    
    (8
    )
    
    
    (62
    )
    
    
    133
    
    
    
    55Net earnings (loss) before cumulative
effect of accounting changeAs previously reported
    
    
    
    
    
    
    (172
    )
    
    
    230
    
    
    
    (1,369
    )
    
    
    107
    
    
    
    (497
    )
    
    
    61
    
    
    
    (686
    )As reported or restated*
    
    
    529
    
    
    
    (279
    )
    
    
    165
    
    
    
    (1,135
    )
    
    
    (40
    )
    
    
    (338
    )
    
    
    (40
    )
    
    
    (512
    )Cumulative effect of accounting changeAs previously reported
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    As reported or restated*
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    Net earnings (loss)As previously reported
    
    
    
    
    
    
    (172
    )
    
    
    230
    
    
    
    (1,369
    )
    
    
    107
    
    
    
    (497
    )
    
    
    53
    
    
    
    (686
    )As reported or restated*
    
    
    529
    
    
    
    (279
    )
    
    
    165
    
    
    
    (1,135
    )
    
    
    (40
    )
    
    
    (338
    )
    
    
    (52
    )
    
    
    (512
    )Dividends on preferred sharesAs previously reported
    
    
    
    
    
    
    (6
    )
    
    
    (6
    )
    
    
    (6
    )
    
    
    (7
    )
    
    
    (5
    )
    
    
    (5
    )
    
    
    (5
    )As reported or restated*
    
    
    (9
    )
    
    
    (8
    )
    
    
    (9
    )
    
    
    (8
    )
    
    
    (9
    )
    
    
    (5
    )
    
    
    (8
    )
    
    
    (5
    )Net earnings (loss) applicable to common sharesAs previously reported
    
    
    
    
    
    
    (178
    )
    
    
    224
    
    
    
    (1,375
    )
    
    
    100
    
    
    
    (502
    )
    
    
    48
    
    
    
    (691
    )As reported or restated*
    
    
    520
    
    
    
    (287
    )
    
    
    156
    
    
    
    (1,143
    )
    
    
    (49
    )
    
    
    (343
    )
    
    
    (60
    )
    
    
    (517
    )
 *
    
    As discussed in note 3 to the accompanying consolidated financial statements and
Managements Discussions and Analysis of Financial Condition and Results of Operations  Nortel Networks Audit Committee Independent Review; restatements;
related matters, the unaudited quarterly financial data for the first three quarters of 2003 and all of 2002 have been restated. A comparison of
previously reported and restated unaudited quarterly financial data is presented in the tables above.**
    
    The fourth quarter ended December 31, 2003 had not been previously reported.
 See notes 4, 7 and 10 to the accompanying consolidated financial statements for the impact of
accounting changes, special charges and acquisitions, divestitures and closures, respectively, that
affect the comparability of the above selected financial data. Additionally, the following
significant items were recorded in the fourth quarters of 2003 and 2002:  
    
    During the fourth quarter of 2003, revenue of $300 and gross
profit of $186 was recorded related to sales of Enterprise
Networks products that had been previously deferred until software
revenue recognition criteria were met. The gross profit impact was
partially offset by an incremental Optical Networks inventory
provision of $119. Also during the fourth quarter, bad debt
recoveries of $69 were recorded as a reduction to selling, general
and administrative expense.
    
    During the fourth quarter of 2002, bonus and fringe benefit
estimates were revised which reduced operating expenses by $33 and
$101, respectively. F-91




---



##### Table of Contents



ITEM 9.
    
    Changes in and Disagreements With Accountants on Accounting
and Financial DisclosureNONE 
 ITEM 9A.     Controls and Procedures In light of the relevance of the findings of the Independent Review to the matters addressed in
this Item 9A, this Item 9A first sets forth in full the Summary of Findings and of Recommended
Remedial Measures of the Independent Review, submitted to the Audit Committee by WCPHD and Huron
Consulting Services LLC, or the Independent Review Summary. The balance of this Item 9A addresses,
among other matters:  
    
    current managements conclusions concerning our disclosure controls and procedures as at
December 31, 2003 and January 10, 2005 and certain earlier dates (see Current Management
Conclusions Concerning Disclosure Controls and Procedures);
    
    information relating to the First Restatement, including a discussion of material
weaknesses in internal control over financial reporting identified at the time of the First
Restatement (see Additional Background  First Restatement);
    
    information relating to the Second Restatement, including a discussion of material
weaknesses in internal control over financial reporting identified over the course of the
Second Restatement (see Additional Background  Second Restatement);
    
    the determination of the Audit Committee to review the facts and circumstances leading
to the restatement of revenues, as part of the Second Restatement, for specific
transactions during the periods 1999 through 2002, with particular emphasis on the
underlying conduct that led to the initial recognition of these revenues, which we refer to
as the Revenue Independent Review (see Revenue Independent Review);
    
    the current status of our internal control over financial reporting and expectations as
to management conclusions and the independent auditor attestation required to be included
in our fiscal year 2004 Annual Report on Form 10-K, or the 2004 Form 10-K, pursuant to
Section 404 of the Sarbanes-Oxley Act (see Current Status of Material Weaknesses in
Internal Control Over Financial Reporting and Expectations as to Required Management
Conclusions and Independent Auditor Attestation Pursuant to Section 404 of the
Sarbanes-Oxley Act);
    
    remedial measures adopted by the Board of Directors pursuant to the recommendations of
WCPHD, and remedial measures identified, developed and begun to be implemented by our
current management, including pursuant to recommendations from D&T (see Remedial
Measures); and
    
    changes in internal control over financial reporting (see Remedial Measures). * * * * * * 115




---



##### Table of Contents



SUMMARY OF FINDINGS AND
OF RECOMMENDED REMEDIAL MEASURES
OF THE INDEPENDENT REVIEW SUBMITTED TO THE AUDIT COMMITTEE
OF THE BOARDS OF DIRECTORS
OF NORTEL NETWORKS CORPORATION
AND NORTEL NETWORKS LIMITED Wilmer Cutler Pickering Hale and Dorr LLP
2445 M Street, N.W.
Washington, D.C. 20037 
Huron Consulting Services LLC
99 High Street
Boston, Massachusetts 02110
 116




---



##### Table of Contents



In late October 2003, Nortel Networks Corporation (Nortel or the Company) announced that
it intended to restate approximately $900M of liabilities carried on its previously reported
balance sheet as of June 30, 2003, following a comprehensive internal review of these liabilities
(First Restatement). The Company stated that the principal effects of the restatement would be a
reduction in previously reported net losses for 2000, 2001, and 2002 and an increase in
shareholders equity and net assets previously reported on its balance sheet. Concurrent with this
announcement, the Audit Committees of the Boards of Directors of Nortel Networks Corporation and
Nortel Networks Limited (collectively, the Audit Committee and the Board of Directors or
Board, respectively) initiated an independent review of the facts and circumstances leading to
the First Restatement. The Audit Committee wanted to gain a full understanding of the events that
caused significant excess liabilities to be maintained on the balance sheet that needed to be
restated, and to recommend that the Board of Directors adopt, and direct management to implement,
necessary remedial measures to address personnel, controls, compliance, and discipline. The Audit
Committee engaged Wilmer Cutler Pickering Hale and Dorr LLP (WCPHD) to advise it in connection
with its independent review. Because of the significant accounting issues involved in the inquiry,
WCPHD retained Huron Consulting Services LLC (Huron) to provide expert accounting assistance.
Huron has been involved in all phases of WCPHDs work.  Scope of the Independent Review The independent review focused initially on events relating to the establishment and release of
contractual liability and other related provisions (also called accruals, reserves, or accrued
liabilities) in the second half of 2002 and the first half of 2003, including the involvement of
senior corporate leadership. (The review did not include provisioning activity in the first half
of 2002 because it was not expected that any such activity could have had a material impact on the
results of those quarters in light of the significant losses in those periods.) As the review
evolved, its focus broadened to include specific provisioning activities in each of the business
units and geographic regions. In light of concerns raised in the initial phase, the Audit
Committee expanded the review to include provisioning activities in the third and fourth quarters
of 2003. The Audit Committee expressly directed that requested documents be promptly provided and that
employees cooperate with requests for interviews; the Audit Committee instructed senior management
to implement these directions throughout the Company. Over the course of the inquiry, more than 50
current and former Nortel employees were interviewed, some more than once. While the independent
inquiry did not examine the work of Nortels external auditor, Deloitte & Touche LLP, several
current and former audit engagement partners were interviewed. Hundreds of thousands of hard copy
and electronic documents and emails were collected and reviewed from corporate headquarters in
Brampton, from company servers, and from key employees in the business units and in the regions. It was beyond the scope of the independent inquiry to audit or otherwise review the substantive
accuracy of Nortels restated financial statements. As the inquiry progressed, the Audit Committee
directed new corporate management to examine in depth the concerns identified by WCPHD regarding
provisioning activity and to review provision releases in each of the four quarters of 2003, down
to a low threshold. That examination, and other errors identified by management, led to a second
restatement of financial results, filed today (the Second Restatement). WCPHD and Huron played
no role in managements restatement efforts. It was also beyond the scope of the independent
inquiry to review other aspects of Nortels accounting practices. The Second Restatement addresses
a number of these practices. WCPHD and Huron reported regularly to the Audit Committee on the progress of the investigation.
Most, or all, of the independent and non-management Board members attended these Audit Committee 117




---



##### Table of Contents



briefings. The Chairs of the Audit Committee and of the Board of Directors were briefed between
Audit Committee meetings to provide them with a real time understanding of the progress of the
investigation. At the direction of the Audit Committee, WCPHD and Huron met regularly with new
management and the Companys external auditors to provide facts developed through the inquiry, so
both would have this information as they proceeded through the Second Restatement. WCPHD and Huron
also briefed Canadian and U.S. regulators on a regular basis. The Audit Committee has reviewed in
detail the findings of the independent review and the recommended remedial measures, and it has
adopted those findings and proposed remedial measures in their entirety. This synopsis summarizes
those findings and proposed remedial measures.  Summary of Findings of the Independent Review The investigation necessarily focused on the financial picture of the Company at the time that
decisions were made and actions were taken regarding provisioning activity. Because of significant
changes to financial results reflected in the Second Restatement, the restated financial results
differ from the historical results that formed the backdrop for this inquiry. In summary, former corporate management (now terminated for cause) and former finance management
(now terminated for cause) in the Companys finance organization endorsed, and employees carried
out, accounting practices relating to the recording and release of provisions that were not in
compliance with U.S. generally accepted accounting principles (U.S. GAAP) in at least four
quarters, including the third and fourth quarters of 2002 and the first and second quarters of
2003. In three of those four quarters  when Nortel was at, or close to, break even   these
practices were undertaken to meet internally imposed pro-forma earnings before taxes (EBT)
targets. While the dollar value of most of the individual provisions was relatively small, the
aggregate value of the provisions made the difference between a profit and a reported loss, on a
pro forma basis, in the fourth quarter of 2002 and the difference between a loss and a reported
profit, on a pro forma basis, in the first and second quarters of 2003. This conduct caused Nortel
to report a loss in the fourth quarter of 2002 and to pay no employee bonuses, and to achieve and
maintain profitability in the first and second quarters of 2003, which, in turn, caused it to pay
bonuses to all Nortel employees and significant bonuses to senior management under bonus plans tied
to a pro forma profitability metric. The failure to follow U.S. GAAP with respect to provisioning can be understood in light of the
management, organizational structure, and internal controls that characterized Nortels finance
organization. These characteristics, discussed below, include:  
    
    Management tone at the top that conveyed the strong leadership message that earnings
targets could be met through application of accounting practices that finance managers knew
or ought to have known were not in compliance with U.S. GAAP and that questioning these
practices was not acceptable;
    
    Lack of technical accounting expertise which fostered accounting practices not in
compliance with U.S. GAAP;
    
    Weak or ineffective internal controls which, in turn, provided little or no check on
inaccurate financial reporting;
    
    Operation of a complicated matrix structure which contributed to a lack of clear
responsibility and accountability by business units and by regions; and
    
    Lack of integration between the business units and corporate management that led to a
lack of transparency regarding provisioning activity to achieve internal EBT targets. 118




---



##### Table of Contents



Nortel posted significant losses in 2001 and 2002 and downsized its work force by nearly
two-thirds. The remaining employees were asked to undertake significant additional
responsibilities with no increase in pay and no bonuses. The Companys former senior corporate
management asserted, at the start of the inquiry, that the Companys downturn, and concomitant
downsizing of operations and workforce, led to a loss of documentation and a decline in financial
discipline. Those factors, in their view, were primarily responsible for the significant excess
provisions on the balance sheet as of June 30, 2003, which resulted in the First Restatement.
While that downturn surely played a part in the circumstances leading to the First Restatement, the
root causes ran far deeper. When Frank Dunn became CFO in 1999, and then CEO in 2001, he drove senior management in his finance
organization to achieve EBT targets that he set with his senior management team. The provisioning
practices adopted by Dunn and other finance employees to achieve internal EBT targets were not in
compliance with U.S. GAAP, particularly Statement of Financial Accounting Standards Number 5 (SFAS
5). SFAS 5, which governs accounting for contingencies, requires, among other things, a
probability analysis for each risk before a provision can be recorded. It also requires that a
triggering event  such as resolution of the exposure or a change in estimate  occur in the
quarter to warrant the release of a provision. Dunn and other finance employees recognized that
provisioning activity  how much to reserve for a particular exposure and when that reserve should
be released  inherently involved application of significant judgment under U.S. GAAP. Dunn and
others stretched the judgment inherent in the provisioning process to create a flexible tool to
achieve EBT targets. They viewed provisioning as a gray area. They became comfortable with the
concept that the value of a provision could be reasonably set at virtually any number within a wide
range and that a provision release could be justified in a number of quarters after the quarter in
which the exposure, which formed the basis for the provision, was resolved. Dunn and others
exercised their judgment strategically to achieve EBT targets. Third quarter, 2002.At the direction of then-CFO Doug Beatty, a company-wide analysis of
accrued liabilities on the balance sheet was launched in early August 2002. The CFO and the
Controller, Michael Gollogly, learned that this analysis showed approximately $303M in provisions
that were no longer required and were available for release. The CFO and the Controller, each a
corporate officer, knew, or ought to have known, that excess provisions, if retained on the balance
sheet, would cause the Companys financial statements to be inaccurate and that U.S. GAAP would
have required either that such provisions be released in that period and properly disclosed, or
that prior period financial statements be restated. Instead, they permitted finance employees in
the business units and in the regions to release excess accruals into income over the following
several quarters. They acted in contravention of U.S. GAAP by failing to correct the Companys
financial statements to account for the significant excess accrued liabilities. Neither the CFO
nor the Controller advised the Audit Committee and/or the Board of Directors that significant
excess provisions on the balance sheet had been identified and that the Companys financial
statements might be inaccurate, nor did either suggest such information should be disclosed in the
Companys financial statements. As a result of this company-wide review, senior finance employees recognized that their respective
business unit or region had excess provisions on Nortels balance sheet, and directed other finance
employees to track these excess provisions. Nortel finance employees had their own distinct term
for a provision on the balance sheet that was no longer needed  it was hard. Each business
unit developed, in varying levels of detail and over varying periods of time, internal hardness
schedules that identified provisions that were no longer required and were available for release.
Finance employees treated provisions identified on these schedules as a pool from which releases
could be made to close the gap between actual EBT and EBT targets in subsequent quarters. 119




---



##### Table of Contents



Fourth quarter, 2002.By mid-2002, employees throughout the Company were being recruited
by other companies and morale was low. Corporate management sought to retain these employees but
recognized that other public companies had come under criticism for awarding stay bonuses in the
face of enormous losses. At managements recommendation, the Board determined to reward employees
with bonuses under bonus plans tied to profitability. One plan, the Return to Profitability
(RTP) bonus, contemplated a one-time bonus payment to every employee, save 43 top executives, in
the first quarter in which the Company achieved pro forma profitability. The 43 executives were
eligible to receive 20% of their share of the RTP bonus in the first quarter in which the Company
attained profitability, 40% after the second consecutive quarter of cumulative profitability, and
the remaining 40% upon four quarters of cumulative profitability. In order for the RTP bonuses to
be paid, pro forma profits had to exceed, by at least one dollar, the total cost of the bonus for
that quarter. Another plan, the Restricted Stock Unit (RSU) plan, made a significant number of
share units available for award by the Board to the same 43 executives in four installments tied to
profitability milestones. Once a milestone was met, the Board had discretion whether to make the
award. Through the first three quarters of 2002, Nortel experienced significant losses, and management
reported to the Board that it expected losses would continue in the fourth quarter. After the
initial results for the business units and regions were consolidated, they showed that Nortel
unexpectedly would achieve pro forma profitability in the fourth quarter. Frank Dunn, who had been
promoted to CEO in 2001, understood that profitability had been attained from an operational
standpoint but determined that it was unwise to report profitability and pay bonuses in the fourth
quarter because performance for the rest of the year had been poor. He determined that provisions
should be taken to cause a loss for the quarter. Over a two day period late in the closing
process, the CFO and the Controller worked with employees in the finance organizations in the
business units, the regions, and in global operations, to identify and record additional provisions
totaling more than $175 million. All of these provisions were recorded top-side  that is, by
employees in the office of the Controller based on information provided by the business units,
regions and global operations  because of the late date in the closing process on which they were
made. Nortels results for the fourth quarter of 2002 turned from an unexpected profit into the
loss previously forecasted by management to the Board of Directors. Neither the CEO, the CFO, nor
the Controller advised the Audit Committee and/or the Board of Directors of this concerted
provisioning activity to improperly turn a profit into a loss. Nortel has since determined that
many of these provisions were not recorded in compliance with U.S. GAAP, and has reversed those
provisions in the Second Restatement. The loss then reported by Nortel in the fourth quarter meant
that no employee bonuses were paid for that quarter. First quarter, 2003.While Nortel had announced publicly that it expected to achieve pro
forma profitability in the second quarter of 2003, Dunn told a number of employees that he intended
to achieve profitability one quarter earlier, and he established internal EBT targets for each
business unit and for corporate to reach that goal. At Dunns direction, roadmaps were developed
to show how the targets could be achieved. These roadmaps made clear that the internal EBT targets
for the quarter could only be met through release from the balance sheet of excess provisions that
lacked an accounting trigger in the quarter. At the request of finance management in each business
unit, finance employees identified excess, or hard, provisions from the balance sheet, and,
together, they determined which provisions to release to close the gap and meet the internal EBT
targets. That release activity was supplemented by releases, directed by the CFO and by the
Controller, of excess corporate provisions that had been identified in the third quarter of 2002 as
available for release. Releases of provisions by corporate and by each business unit and region,
including excess provisions, totaling $361M, enabled Nortel to show a consolidated pro forma profit
in the first quarter, notwithstanding that its operations were running at a loss. The Finance Vice
Presidents of the business units and two of the three regions, the Asia Controller, the CFO, the
Controller, and the CEO knew, or ought to have known, that U.S. GAAP did not permit the release,
without proper justification, of excess provisions into the income statement. Nortel has since
determined 120




---



##### Table of Contents



that many of these releases in this quarter were not in accordance with U.S. GAAP, and has reversed
those releases in the First and Second Restatements and restated the releases into proper quarters. When presenting the preliminary results for the quarter to the Audit Committee, the Controller
inaccurately represented that the vast majority of these releases were business as usual and in
compliance with U.S. GAAP, and that the remaining releases were one time, non-recurring events and
in compliance with U.S. GAAP. Further, the CFO and the Controller failed to advise the Audit
Committee and/or the Board of Directors that release of excess corporate provisions was required to
achieve profitability and make up for the shortfall in operational results; that such releases were
needed to cover the cost of the bonus compensation; that no event in the quarter triggered the
releases (as required by U.S. GAAP); that the releases implicated Staff Accounting Bulletin 99
(relating to materiality) because they turned a loss for the quarter into a profit; and that they
retained a significant amount of excess provisions on the balance sheet to be used, when needed, in
a subsequent quarter. In separate executive sessions held by the Audit Committee with the CFO and
the Controller, neither the CFO nor the Controller raised quality of earnings issues nor questioned
the payment of the RTP bonus. Based on managements representations, the Audit Committee approved
the quarterly results, and the Board approved the award of the RTP bonus. Second quarter, 2003.Seeking to continue to show profitability in the second quarter and
meet the first RSU milestone and the second tranche of the RTP bonus, senior corporate management
developed internal EBT targets to achieve pro forma profitability. As was the case in the first
quarter, it became clear during the quarter that operational results would be a loss. At the
request of finance management in each business unit, finance employees again identified hard
provisions from the balance sheet, and, together, they determined which provisions to release to
close the gap and achieve the internal EBT targets. Nortel has since determined that many of these
releases were not in accordance with U.S. GAAP, and has reversed those releases in the First and
Second Restatements and restated the releases into proper quarters. In both the first and second
quarters of 2003, the dollar value of many individual releases was relatively small, but the
aggregate value of the releases made the difference between a pro forma loss and profit in each
quarter. The CEO, the CFO and the Controller failed to advise the Audit Committee or the Board of Directors
that operations of the business units were running at a loss during the second quarter and that the
validity of many of the numerous provision releases, totaling more than $370 million, could be
questionable. Based on managements representations, the Audit Committee approved the quarterly
results, and the Board approved payment of the second tranche of the RTP bonus and awarded
restricted stock under the RSU plan. Third and fourth quarters, 2003.In light of concerns raised by the inappropriate
accounting judgments outlined above, the Audit Committee expanded its investigation to determine
whether excess provisions were released to meet internal EBT targets in each of these two quarters.
No evidence emerged to suggest an intent to release provisions strategically in those quarters to
meet EBT targets. Given the significant volume of provision releases in these two quarters, the
Audit Committee directed management to review provision releases, down to a low threshold, using
the same methods used to evaluate the releases made in the first half of the year. This review has
resulted in additional adjustments for these quarters, which are reflected in the Second
Restatement. Governing Principles for Remedial Measures The Audit Committee asked WCPHD to recommend governing principles, based on its independent
inquiry, to prevent recurrence of the inappropriate accounting conduct, to rebuild a finance
environment 121




---



##### Table of Contents



based on transparency and integrity, and to ensure sound financial reporting and comprehensive
disclosure. The recommendations developed by WCPHD and provided to the Audit Committee were
directed at:  
    
    Establishing standards of conduct to be enforced through appropriate discipline;
    
    Infusing strong technical skills and experience into the finance organization;
    
    Requiring comprehensive, on-going training on increasingly complex accounting standards;
    
    Strengthening and improving internal controls and processes;
    
    Establishing a compliance program throughout the Company which is appropriately staffed
and funded;
    
    Requiring management to provide clear and concise information, in a timely manner, to
the Board to facilitate its decision-making; and
    
    Implementing an information technology platform that improves the reliability of
financial reporting and reduces the opportunities for manipulation of results. These recommendations were grouped into three categories  people, processes and technology  and
are discussed below:  
    
    People An effective tone at the top requires effective policies and procedures, but these alone are not
sufficient. Those who manage and lead the Company, and are its officers, must exercise the highest
fiduciary duties to the Company and shareholders and must be accountable, both to corporate
management and the Board, for accurately reporting financial results. Based on periodic reports by WCPHD on the progress of the independent inquiry, the Audit Committee
recommended, and the Board of Directors approved, termination for cause of the CEO, the CFO, the
Controller, and seven additional senior finance employees. The Board of Directors determined that
each of these individuals had significant responsibilities for Nortels financial reporting as a
whole, or for their respective business units and geographic regions, and that each was aware, or
ought to have been aware, that Nortels provisioning activity, described above, did not comply with
U.S. GAAP. Nortel has formally demanded the return of all bonus compensation paid to each of these
individuals in 2003. Once the Board receives responses to this demand, it should determine the
appropriate course of action to pursue with each of these ten former employees. Senior corporate officers, including the four Presidents of the business units during the period
covered by this inquiry, the four Presidents of the regions, and the President of Global
Operations, now recognize that inappropriate activity involving provisioning occurred on their
watch. While they lacked an understanding that certain provisioning activities in their
respective business units were not in compliance with U.S. GAAP, they now recognize that such
conduct was instrumental in achieving the reported results in the fourth quarter of 2002 and the
first and second quarters of 2003. To demonstrate personal commitment to the governing principles
stated above and to lead the Company forward, each of these officers has volunteered to return to
the Company the entire RTP bonus that he or she was awarded, net of taxes already paid, and to
disclaim any opportunity to receive the third and fourth installments of the RSU bonus, which the
Board has accepted. In light of the Boards expectation that senior employees of the Company will
lead by example, the Board should decline to award the third and fourth tranches of the RSU plan to
the remaining eligible employees, irrespective of whether the profitability metrics for such
bonuses are met as a result of the Second Restatement. 122




---



##### Table of Contents



The Board of Directors must make clear that it has not tolerated, and will not in the future
tolerate, accounting conduct that involves the misapplication of U.S. GAAP. It must further
communicate its expectation that every Nortel employee will adhere to the highest ethical
standards; will have training and experience commensurate with his or her job responsibilities; and
will be held accountable for his or her actions and decisions. The Board of Directors and
management should continue to address the issues associated with the inappropriate use of
provisions. Recent experience has shown that the Nortel finance organization lacks sufficient technical
accounting expertise. Many finance employees are career Nortel employees and learned accounting
at Nortel. Whatever basic accounting knowledge is resident within Nortel is largely knowledge of
Canadian GAAP, not U.S. GAAP. Nortel reported in accordance with Canadian GAAP until 2000, when
it switched to reporting in accordance with U.S. GAAP. High quality finance employees are critical
to the soundness of the Companys financial reporting systems and controls so that the results of
operations are reported accurately and in a timely manner. The Board of Directors should direct
management to recruit, from outside Nortel, individuals with strong accounting and financial
reporting skills and a proven record of integrity and ethical behavior to fill key finance
positions. The Board should also direct management to review the training and experience of Nortel
mid-level finance employees and to supplement this expertise, where appropriate, by hiring
individuals from outside Nortel with strong accounting training and background. Nortel has long had an internal technical accounting group to which finance employees were
supposed to turn for resolution of difficult accounting questions and for technical accounting
interpretations. While this practice is a sound one, the practical application has fallen short.
Finance employees did not regularly turn to this group for resolution of an issue, and it was far
from clear that this group had the last word on such issues. That technical accounting group
should be led by a very senior finance executive with in-depth knowledge of, and experience in
applying, U.S. GAAP. Management should be directed to conduct a benchmarking study to evaluate
whether the technical accounting group is properly organized; its personnel component is consistent
with other similar companies; its staff has appropriate and current expertise; and its authority to
resolve accounting issues and technical interpretations is clearly defined within the organization. Notwithstanding the enormous time and resources that the Company has devoted to restatement
activities for the past year, many employees appear to lack a clear understanding of the accounting
issues that gave rise to the restatements. That is perhaps not surprising in light of the lack of
basic U.S. GAAP training and expertise in the finance organization. Management has taken
significant steps to remedy this deficit by requiring mandatory training, developed by external
consultants, and taught by knowledgeable finance employees. These remedial training programs are
an important first step, but much more must be done to ensure that the finance organization is
fluent in governing accounting standards and principles. Widespread training, by outside experts,
at all levels of the finance organization, must continue so that all finance employees receive
comprehensive training in U.S. GAAP and in the consequences of failing to follow U.S. GAAP. Going
forward, management should develop in depth, on-going continuing education programs that explain
continuously evolving complex accounting standards. Management should assess the staffing of its
training organization, and the adequacy of its trainers. Every Nortel employee, including each
finance employee, must now acknowledge annually, in writing, that he or she has read Nortels code
of conduct and will adhere to that code. The certification for each finance employee should be
expanded to include an acknowledgement that each such employee is familiar with all applicable U.S.
GAAP requirements. In addition, the Board should consider whether each finance employee should be
required to complete a certain number of hours of continuing professional education each year. 123




---



##### Table of Contents




    
    Processes A basic component of sound corporate oversight is the control structure. Internal controls  the
Companys accounting policies, organizational structure, systems, processes, employees, leadership,
and culture  working together, foster accurate financial reporting and sound disclosure in a
timely manner. While management has recognized weaknesses in existing processes and controls, and
has taken steps to remedy these deficiencies, more needs to be done. Nortel is a multi-national organization that has changed organizational structure over the past
several years. One legacy of this changing structure is a matrix organization in which there is no
clear assignment of responsibility for assessing the adequacy and usage of contractual liability
provisions; even where responsibility is clear, it is unlikely that sufficient monitoring is in
place to make sure that provisioning activity is in accord with U.S. GAAP. The need for the matrix
organization must be re-examined in light of the risks that it poses to financial discipline and
accountability and, if a matrix structure continues to be used, clear accountability must be
established. Historically, finance employees responsible for meeting EBT targets had authority to record and
release provisions. That practice must end immediately. The control organization must have sole
authority to make these decisions and record these entries. The Board of Directors must insist
that the re-engineering of the control organization be a management priority. In addition, the
Controller and the control organization, working with the General Counsel, must develop standards
of transparency in financial reporting that meet both the letter and the spirit of legal
requirements. Nortels written accounting policies must be reviewed and, where necessary, rewritten to ensure
strict adherence to U.S. GAAP and provide numerous real life examples of practical applications.
Procedures must be adopted to identify evolving interpretations of accounting standards and best
practices under U.S. GAAP and to develop and conform Nortels policies in a timely manner.
Employees charged with responsibility for Nortels accounting policies must have substantial
knowledge of the strengths and weaknesses of the financial organization and knowledge of best
practices in similarly situated companies and ensure that accounting practices follow Nortels
policies. These policies must be communicated to finance and control employees, and management
must stress the importance of adherence to the policies and impose sanctions if they are not
followed. The internal audit function must be strengthened and must provide an independent check on the
integrity of financial reporting. Historically, Nortels internal auditor focused solely on
operational reviews and had no role in determining whether Nortels accounting policies were in
compliance with U.S. GAAP or in evaluating whether these policies were properly applied. The Audit
Committee has already established new priorities for the internal auditor relating to the
evaluation of risk exposures for financial reporting. Internal audit should continue its practice
of proposing an annual work plan, and should ensure that the work plan focuses on the new
priorities set by the Audit Committee. The Company is currently conducting a search to fill the
vacant position of internal auditor. The internal audit function requires a leader with
substantial experience in applying U.S. GAAP in a similarly-situated company and great familiarity
in applying professional standards issued by the Institute of Internal Auditors. The internal
auditor should report to the CEO to remove any potential threat to independence. The internal
auditor should continue to have direct and regular access to the Board and the Audit Committee.
Staffing of internal audit must be consistent with its mandate. These governing principles are an effort to forge a framework for rebuilding the Nortel finance
environment. Equally important, the Board, the CEO, and the CFO must continue to promote high
ethical standards throughout the Company. Words announcing adherence to the highest standard of
integrity are 124




---



##### Table of Contents



relatively easy to express, but it is actions, not words, that count. The Board has established
the position of a Chief Ethics and Compliance Officer. The Board has also adopted a code of
ethical conduct and business practices which outlines principles to guide ethical decision-making
and provides practical answers to ethics questions regularly asked in the workplace. The Board
should direct management to enhance significantly the existing compliance program. Together, the
code and a strengthened compliance program set the tone and the standards of behavior that the
Company expects from its employees. Employees must be convinced of the Companys commitment to an
ethical climate, and of the central role that they play in ensuring that the Companys code is
followed. They must view compliance with the Companys code of conduct, standards, and control
systems as a central priority, and understand they will be rewarded for ethical behavior, even if
it uncovers some problem that others might prefer to remain undisclosed. On a regular basis, the
Board should review the activities of the compliance office, the strength of the compliance
program, and the risks it has addressed. The Board must receive from management, in sufficient time prior to meetings, all materials
necessary for it to monitor and act on business risks affecting Nortel and information relating to
decisions the Board is being asked to make. The Audit Committee needs clear and concise
information relating to Nortels financial reporting. The Board should implement a process whereby
management would provide a quarterly assessment of the overall quality and transparency of Nortels
financial reporting and suggestions for improvements in form and content, which the external
auditors would review and comment. The Boards practice of receiving all information respecting
Nortels financial performance on a consolidated basis, and of each of its business units, only
from the CFO should change. The heads of each business unit should be expected to take full
responsibility for the financial results of their respective businesses and to provide quarterly
presentations to the Board with the senior finance employee in that business unit. Periodically,
the Audit Committee should have separate, executive sessions with the chief operations and finance
employees for each business unit to discuss issues specific to their businesses.  
    
    Technology Management has announced that it intends to acquire and install a SAP information technology
platform to facilitate production of accurate financial results in a timely and cost effective
manner. The objectives of any technology platform implemented by Nortel should include
identification of existing control procedures that are redundant or inefficient;
prevention/detection and correction of errors on a timely basis; prevention or detection of fraud;
simplification of systems and increased productivity; reduction of opportunities for manual
intervention; ability to trace transactions from start to finish; improved operation of controls;
and substantive analysis of results, including both operating and financial metrics. In sum, those
responsible for implementing SAP should have a strong focus on re-engineering existing processes so
that the control elements intrinsic to the SAP system are effective. * * * * * * After thorough consideration, the Audit Committee has recommended, and the Board of Directors has
approved, adoption of each of these recommendations. The Board of Directors has directed
management to develop a detailed plan and timetable for the implementation of these recommendations
and intends to monitor the implementation of these principles by management. * * * * * * [End of Independent Review Summary] 125




---



##### Table of Contents



Current Management Conclusions Concerning Disclosure Controls and Procedures In January 2005, we carried out an evaluation under the supervision and with the participation of
management, including the current CEO and current CFO, pursuant to Rule 13a-15 under the Exchange
Act, of the effectiveness of our disclosure controls and procedures as at December 31, 2003 (the
end of the period covered by this report) and as at January 10, 2005. The CEO and CFO were
appointed to such positions as at April 28, 2004, with the CFO having served in such capacity on an
interim basis since March 15, 2004. In making this evaluation, the CEO and CFO considered, among other matters:  
    
    the Second Restatement and the revisions to our preliminary unaudited results for the
year ended December 31, 2003;
    
    the findings of the Independent Review summarized above in the Independent Review
Summary;
    
    the terminations for cause of our former president and chief executive officer, former
chief financial officer, former controller and seven additional senior finance employees
during the course of the Independent Review and the reasons therefor as described in the
Independent Review Summary;
    
    the material weaknesses in our internal control over financial reporting that we and our
external auditor, D&T have identified (as more fully described below);
    
    the measures we have identified, developed and begun to implement beginning in November
2003 to remedy those material weaknesses (as more fully described below);
    
    our omission of 1999 and 2000 selected financial data from this report, and our decision
not to amend our 2002 Form 10-K/A and our 2003 quarterly reports (as more fully described
below); and
    
    the decision of the Audit Committee to undertake the Revenue Independent Review (as more
fully described below). Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and
procedures, as at December 31, 2003 and January 10, 2005, were not effective to provide reasonable
assurance that information required to be disclosed in the reports we file and submit under the
Exchange Act is recorded, processed, summarized and reported as and when required. In light of this conclusion and as part of the extensive work undertaken in connection with the
Second Restatement, we have applied compensating procedures and processes as necessary to ensure
the reliability of our financial reporting. Accordingly, management believes, based on its
knowledge, that (i) this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under
which they were made, not misleading with respect to the period covered by this report and (ii) the
financial statements, and other financial information included in this report, fairly present in
all material respects our financial condition, results of operations and cash flows as at, and for,
the periods presented in this report. The Second Restatement and other matters listed above have also resulted in the re-evaluation, in
January 2005, of the effectiveness of our disclosure controls and procedures as at December 31,
2002, March 31, 2003, June 30, 2003 and September 30, 2003. Based on these evaluations and in
consideration of the Second Restatement and other matters listed above, the CEO and CFO have
concluded that our disclosure controls and procedures, as at December 31, 2002, March 31, 2003,
June 30, 2003 and September 30, 2003, were not effective to provide reasonable assurance that
information required to be disclosed in the 126




---



##### Table of Contents



reports we file and submit under the Exchange Act is recorded, processed, summarized and reported
as and when required. These new conclusions are in contrast to conclusions reached as a result of previous evaluations
carried out under the supervision and with the participation of management, including the former
chief executive officer and former chief financial officer. In particular, these conclusions
differ from the conclusions stated in our 2002 Annual Report on Form 10-K and Quarterly Reports on
Form 10-Q for the quarters ended March 31, 2003 and June 30, 2003 that our disclosure controls and
procedures were so effective as at December 31, 2002, March 31, 2003 and June 30, 2003,
respectively. They also differ from the conclusions based upon the re-evaluations carried out in
December 2003 under the supervision and with the participation of management, including the former
president and chief executive officer and former chief financial officer, as stated in our amended
2002 Annual Report on Form 10-K/A, or the 2002 Form 10-K/A, and amended Quarterly Reports on Form
10-Q for the quarters ended March 31, 2003 and June 30, 2003, or the 2003 Form 10-Q/As, that our
disclosure controls and procedures were so effective as at December 31, 2002, March 31, 2003 and
June 30, 2003, respectively, after taking into account the First Restatement and the identification
of certain material weaknesses. These new conclusions also differ from the conclusions stated in
our Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 that our disclosure
controls and procedures were so effective as at September 30, 2003, after taking into account the
First Restatement and the identification of certain material weaknesses. * * * * * * Additional Background This section provides additional information with respect to the identified material weaknesses and
other deficiencies, as well as certain additional background information regarding the First
Restatement and the Second Restatement. In this report, unless otherwise indicated, the terms material weakness and reportable
condition have the meanings as formerly set forth under standards established by the AICPA, which
were applicable with respect to 2003. The AICPA then defined a (i) reportable condition as a
matter that comes to an auditors attention that represents a significant deficiency in the design
or operation of internal control that could adversely affect an entitys ability to initiate,
record, process and report financial data consistent with the assertions of management in the
financial statements and (ii) material weakness as a reportable condition in which the design or
operation of one or more of the internal control components does not reduce to a relatively low
level the risk that misstatements caused by error or fraud in amounts that would be material in
relation to the financial statements being audited may occur and not be detected within a timely
period by employees in the normal course of performing their assigned functions.  First Restatement  Overview In May 2003, we commenced certain balance sheet reviews at the direction of certain members of
former management that led to the Comprehensive Review, which resulted in the First Restatement.
Each of the former members of management terminated for cause had responsibility for their
respective positions at the time of the Comprehensive Review and First Restatement. As disclosed
in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, the Comprehensive Review
was initiated [I]n light of a period of unprecedented industry adjustment and subsequent
restructuring actions, including workforce reductions and asset write-downs.... The amounts
under review were recorded when our balance sheet 127




---



##### Table of Contents



and income statement were much larger. Specifically, what would have been relatively minor amounts
in prior periods may be considered to be material to current periods. As noted in the Independent
Review Summary, Nortel posted significant losses in 2001 and 2002 and downsized its work force by
nearly two-thirds. The remaining employees were asked to undertake significant additional
responsibilities with no additional increase in pay and no bonuses. The Companys former senior
corporate management asserted, at the start of the inquiry, that the Companys downturn, and
concomitant downsizing of operations and workforce, led to a loss of documentation and a decline in
financial discipline. Those factors, in their view, were primarily responsible for the significant
excess provisions on the balance sheet as at June 30, 2003, which resulted in the First
Restatement. While that downturn surely played a part in the circumstances leading to the First
Restatement, the root causes ran far deeper. The root causes of the First Restatement, as
identified in the Independent Review, are more fully discussed in the Independent Review Summary. The Comprehensive Review purported to (i) identify balance sheet accounts that, as at June 30,
2003, were not supportable and required adjustment; (ii) determine whether such adjustments related
to the third quarter of 2003 or prior periods; and (iii) document certain account balances in
accordance with our accounting policies and procedures. The Comprehensive Review, as supplemented
by additional procedures carried out between July 2003 and November 2003 to quantify the effects of
potential adjustments in the relevant periods and review the appropriateness of releases of certain
contractual liability and other related provisions (also called accruals, reserves or accrued
liabilities) in the six fiscal quarters ending with the fiscal quarter ended June 30, 2003, formed
the basis for the adjustments made to the financial statements in the First Restatement. On December 23, 2003, we filed with the SEC the 2002 Form 10-K/A and the 2003 Form 10-Q/As
reflecting the First Restatement. As disclosed in those reports, the net effect of the First
Restatement adjustments was a reduction in accumulated deficit of $486 million, $171 million and
$32 million as at December 31, 2002, 2001 and 2000, respectively. The following were the principal
adjustments of the First Restatement:  
    
    Approximately $924 million and $507 million of certain liabilities (primarily accruals
and provisions) carried on our previously reported consolidated balance sheet as at
December 31, 2002 and 2001, respectively, were released to income in prior periods.
    
    We determined to correct certain known errors 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
that should have been deferred instead of recognized in a particular period.
    
    We made adjustments to correct errors related to deferred income tax assets and foreign
currency translation accounts and made reclassification adjustments within the
consolidated balance sheet to better reflect the underlying nature of certain items.
These reclassifications did not impact our net assets as at the end of any period.  Material Weaknesses and Other Deficiencies in Internal Control over Financial
Reporting Identified at the Time of the First Restatement In 2003, we, together with D&T, identified a number of deficiencies in our internal control over
financial reporting. On July 24, 2003, D&T first informed the Audit Committee that deficiencies in documentary support
for certain accruals and provisions on our balance sheet as at June 30, 2003 constituted a
reportable condition, but not a material weakness, in our internal control over financial
reporting. In particular, 128




---



##### Table of Contents



D&T concluded, in respect of this reportable condition, that it was unclear, due to the lack of
documentation regarding support for certain provisions and accruals, the passage of time and the
turnover of personnel, as to what adjustments, if any, should have been made in prior years. D&T
noted that its assessment was based on such information as was available at the date of its
communication to the Audit Committee and the materiality of the underlying amounts in the context
of 2003 reported results. This conclusion was initially disclosed in our Quarterly Report on Form
10-Q for the quarter ended June 30, 2003. On November 18, 2003, as part of the communications by D&T to the Audit Committee with respect to
D&Ts interim audit procedures for the year ended December 31, 2003, D&T informed the Audit
Committee that there were two reportable conditions, each of which constituted a material weakness
in our internal control over financial reporting. No other reportable conditions were communicated
by D&T to the Audit Committee at the time of the First Restatement. These reportable conditions
were as follows:  
    
    lack of compliance with established Nortel Networks procedures for monitoring and
adjusting balances related to certain accruals and provisions, including restructuring
charges; and
    
    lack of compliance with established Nortel Networks procedures for appropriately
applying U.S. GAAP to the initial recording of certain liabilities, including those
described in SFAS No. 5, and to foreign currency translation as described in SFAS No. 52. The foregoing material weaknesses contributed to the need for the First Restatement. Upon
completion of our assessment of our internal control over financial reporting as at December 31,
2004 pursuant to Section 404(a) of the Sarbanes-Oxley Act of 2002 and related SEC rules, or SOX
404, we currently expect to conclude that these material weaknesses continue to exist as at
December 31, 2004, and we continue to identify, develop and begin to implement remedial measures to
address them, as described below.  Second Restatement  Independent Review In late October 2003, the Audit Committee initiated the Independent Review in order to, as noted in
the Independent Review Summary, gain a full understanding of the events that caused significant
excess liabilities to be maintained on the balance sheet that needed to be restated, and to
recommend that the Board of Directors adopt, and direct management to implement, necessary remedial
measures to address personnel, controls, compliance and discipline. As noted in the Independent
Review Summary, [t]he [Independent Review] focused initially on events relating to the
establishment and release of contractual liability and other related provisions... in the second
half of 2002 and the first half of 2003, including the involvement of senior corporate leadership.... As the [Independent Review] evolved, its focus broadened to include specific provisioning
activities in each of the business units and geographic regions. In light of concerns raised in
the initial phase of the [Independent Review], the Audit Committee expanded the review to include
provisioning activities in the third and fourth quarters of 2003. As discussed more fully above in the Independent Review Summary, the Independent Review concluded
that [i]n summary, former corporate management (now terminated for cause) and former finance
management (now terminated for cause) in the Companys finance organization endorsed, and employees
carried out, accounting practices relating to the recording and release of provisions that were not
in compliance with [U.S. GAAP] in at least four quarters, including the third and fourth quarters
of 2002 and the first and second quarters of 2003. In three of those four quarters  when Nortel
was at, or close to, break even  these practices were undertaken to meet internally imposed
pro-forma earnings before taxes 129




---



##### Table of Contents



... targets. While the dollar value of most of the individual provisions was relatively small,
the aggregate value of the provisions made the difference between a profit and a reported loss, on
a pro forma basis, in the fourth quarter of 2002 and the difference between a loss and a reported
profit, on a pro forma basis, in the first and second quarters of 2003. Second Restatement Process As noted in the Independent Review Summary, [a]s the [Independent Review] progressed, the Audit
Committee directed new corporate management to examine in-depth the concerns identified by WCPHD
regarding provisioning activity and to review provision releases in each of the four quarters of
2003, down to a low threshold. That examination, and other errors identified by management, led to
[the Second Restatement].... In addition to this examination of provisioning activity, management, including our new CFO,
undertook various initiatives aimed at ensuring the reliability and integrity of the audited
consolidated financial statements included in this report. As part of these efforts, our new CFO
encouraged employees across our finance organization to raise any questions or concerns regarding
other potential accounting errors that should be reviewed for possible adjustment in the Second
Restatement. In addition, as management identified individual customer contracts and transactions
for re-examination of the establishment and release of provisions, management also undertook a
review of many of those contracts and transactions more generally to understand the broader nature
of the original accounting for the contract or transaction. This individual contract and
transaction review also identified additional accounting issues. As a result of these initiatives,
management, with the assistance of outside consultants, then undertook further detailed reviews of
our significant accounting policies, specific transactions and communications and other documents
relating to the identified issues. As a result, the Second Restatement included adjustments to
correct errors relating to a number of accounting issues other than provisioning. In particular, management identified various errors involving recognition of revenues. To
identify, assess and remedy these errors, management, assisted by outside consultants, reviewed a
substantial number of individual transactions as well as significant accounting policies across all
of our major product lines and geographical regions. As part of our review of individual
contracts, we analyzed the relevant contractual provisions (such as delivery and acceptance terms),
delivery and other data from our logistics systems, characteristics of the particular products and
customers and the manner in which revenue recognition policies were applied. We also utilized
databases within our accounting systems to identify additional contracts that might raise revenue
recognition issues. In light of the increasing magnitude of the total revenue adjustments
identified by the beginning of November 2004, the Board of Directors directed management to conduct
additional focused revenue reviews in selected periods in order to test the conclusions we had
reached and identify any potential additional revenue adjustments. Management has completed these
reviews. Overall in the Second Restatement, as a result of adjustments to correct errors related to revenue
recognition, we increased revenues by an aggregate of $1,491 million in 2001 and $440 million in
2002. We also decreased previously reported revenues for the first three quarters of 2003 by an
aggregate of $55 million. Most of these adjustments constituted the recognition of revenues that
had previously been improperly recognized in prior years and should have been deferred (often over
a number of years). This also had the effect of reducing previously reported revenues in 1998,
1999 and 2000 by approximately $158 million, $355 million and $2,866 million, respectively. Of
these adjustments identified in the Second Restatement, approximately $1,200 million of revenues
has been deferred to the fourth quarter of 2003 and to years after 2003, while approximately $250
million of revenues was permanently reversed, as described below. 130




---



##### Table of Contents



In light of the total magnitude of these revenue adjustments, we present below an overview of the
principal revenue adjustments required in the Second Restatement to correct accounting errors
related to revenue recognition and the general circumstances that gave rise to them. In addition,
as described under Revenue Independent Review, the Audit Committee has determined to review the
facts and circumstances leading to the restatement of these revenues for specific transactions
identified in the Second Restatement. The Revenue Independent Review will have a particular
emphasis on the underlying conduct that led to the initial recognition of these revenues, and will
consider any appropriate additional remedial measures, including those involving internal controls
and processes.  
    
    Title and deliveryAn increase of $1,624 million in 2001 and $211 million in 2002. Of this amount, we made adjustments of approximately $870 million in 2001 and $200 million in 2002
to correct errors relating to passage of product title or risk of loss. Both employee input and
our review of the broader original accounting treatment of certain individual contracts identified
a specific customer contract as warranting re-examination of the timing of revenue recognition
relative to the timing of passage of product title. Following a detailed review, we determined that
revenues had been recorded erroneously before title had passed. We also reviewed other similar
contracts and determined that corrections were also required where title or risk of loss had not
passed. These corrections principally impacted North American contracts in our Optical and
Wireline businesses. Some of the adjustments related to title and risk of loss issues described above resulted in a
permanent reversal of revenues, rather than a deferral of revenues to later periods. In certain
cases, revenues were recognized in error in a particular period (before title had passed and the
criteria for revenue recognition had been met) and a bad debt expense was subsequently recorded due
to collectibility issues. In such cases, both entries were reversed. Following those corrections,
if title in fact never passed or the other criteria were never met, and the customer failed to pay,
the revenues were not recognized in subsequent periods but instead permanently reversed. We
permanently reversed a total of approximately $150 million of revenues in 2000 and $25 million in
2001 as a result of title and risk of loss adjustments. We also identified errors related to title and delivery issues in connection with arrangements
known as bill and hold transactions, in which revenue is recognized before actual delivery of the
product. Corrections of these errors resulted in the deferral of revenue into later periods, which
had the effect of a net increase to revenues of approximately $760 million in 2001 and $10 million
in 2002. Our scrutiny of this issue was similarly prompted by employee input. In this situation,
we determined that the relevant accounting policy had been incorrectly applied to a number of
contracts, and revenues were recognized where the relevant criteria had not been fully met. In
reviewing individual contracts, we examined, among other things: whether significant product
returns had occurred in later periods, the accounts receivable history, whether better pricing was
provided for the particular purchase order to incent a customer to enter into a bill and hold
arrangement, whether purchase orders were eventually placed by the customer and whether third-party
corroboration was available as to whether the arrangement was at the request of the customer or
Nortel Networks. As a result of our consideration of these factors, we deferred all revenues
associated with bill and hold arrangements to subsequent periods. We no longer recognize revenue
on bill and hold arrangements before delivery occurs and all other criteria of revenue recognition
are fully met.  
    
    Undelivered elements and liquidated damagesA decrease of $190 million in 2001 and
an increase of $45 million in 2002. Another area of review prompted by our review of the broader original accounting treatment of
certain individual contracts was related to certain optical product transactions where revenues
related to 131




---



##### Table of Contents



undelivered product elements were erroneously recognized. In these cases, revenues for customer
orders were recognized upon delivery of interim product solutions pending the availability of the
later generation optical product that the customer had ordered. In this circumstance, revenues for
the order should have been deferred until the undelivered element was delivered as we did not have
evidence supporting the fair value of the undelivered element. Accordingly, we restated the
recorded revenues, deferring recognition to subsequent periods, which had the effect of a net
decrease to revenues of approximately $40 million in 2001 and an increase to revenues of
approximately $190 million in 2002. We also focused on accounting for software revenue recognition more generally, particularly in our
Optical business. In Fall 2004, we sought the views of the SECs Office of the Chief Accountant,
or OCA, on one issue with respect to our historical and continuing accounting treatment under U.S.
GAAP of revenues recognized on sales of certain optical products containing embedded software. We
advised the OCA that we believed our historical accounting treatment of these optical products was
appropriate, and we were fully supported in this conclusion by D&T. We, in consultation with D&T,
nevertheless decided to obtain the views of the OCA on our analysis and conclusions due to the
judgments involved in the applicable accounting analysis and the significant impact a different
conclusion could have had on our reported revenues (namely, the deferred recognition of substantial
revenues over a number of subsequent years). Following discussions with us, the OCA did not
approve or disapprove our accounting in this area, and we concluded that we would not make any
adjustments to our accounting treatment of the sales of these optical products as part of the
Second Restatement. We also considered revenue recognition policies related to post-contract support, or PCS, with
respect to all business lines, and identified certain Enterprise products that presented issues.
For these products, we recognized revenues at the time of delivery of the product but before
completion of PCS or other future services agreed to in the contract. Because in some cases we did
not have vendor specific objective evidence of fair value for those services (for example, where we
made available free software upgrades on our website), U.S. GAAP requires the revenues to be
recognized over the PCS period. Accordingly, we corrected this error and deferred the revenues to
subsequent periods, resulting in a net decrease to revenues of approximately $140 million in 2001
and $155 million in 2002.  
    
    Fixed or determinable feesAn increase of $133 million in 2002. As a result of our focus on accounting for software revenue recognition more generally as described
above, we identified a specific contract for which revenue for sales had been recognized but the
criteria for revenue recognition had not been met, including the criteria that contract fees be
either fixed or determinable. Accordingly, we corrected this error and deferred the revenues to
subsequent periods when customer payments became due and all criteria for revenue recognition were
met.  
    
    Reseller transactionsAn increase of $151 million in 2001. As a result of employee input, we determined that a certain reseller lacked economic substance
apart from Nortel Networks at the time of the relevant transaction. In such a case, we should have
deferred revenues and recognized them only upon the resellers sale of the products to an end
customer. Accordingly, we corrected this error and deferred the revenues to subsequent periods.  
    
    Reciprocal arrangementsA decrease of approximately $55 million in 2000 and $20
million in 2001. 132




---



##### Table of Contents



In our review of a particular contract in connection with other issues described above, we
determined that it also involved a reciprocal arrangement with the customer. Instead of
recognizing the full amount of revenues we received on the sale of products or services, the
amounts we paid the customer under the reciprocal arrangement should have been treated as a
reduction of revenues. Through our review of a substantial number of individual contracts, as
noted above, we also identified a limited number of other reciprocal arrangements, which were
recorded as permanent reductions in revenue.  
    
    Application of SOP 81-1 and other revenue recognition itemsA decrease of
approximately $40 million in 2001 and an increase of approximately $80 million in 2002. As we continued to review the application of our accounting policies, as well as specific
contracts, we discovered errors related principally to the incorrect application of percentage of
completion accounting for certain transactions. Our review also included an analysis of the
accounting for product credits, liquidated damages and other incentives. We corrected these
errors, which resulted in both deferrals of revenues to subsequent periods and movement of revenues
to earlier periods. Other accounting practices that management examined and adjusted as part of the Second Restatement
included, among other things, the following (as described in more detail below):  
    
    our foreign exchange accounting, as part of the plan to address the identified material
weakness related to foreign currency translation described above;
    
    intercompany balances that did not eliminate upon consolidation and related provisions;
    
    special charges relating to inventory impairment, contract settlement costs
and other charges; and
    
    the accounting treatment of certain elements of discontinued operations. In sum, the key components of the Second Restatement process were as follows:  
    
    involvement and oversight by current senior finance personnel, with regular
communications to the global finance organization to monitor progress and ensure
consistency, and open and regular dialogue with our external auditors;
    
    maintenance of a restatement database to track issues and adjustments;
    
    establishment of a process to evaluate certain provisions and releases that may not have
been fully addressed in the First Restatement, including a review of all First Restatement
processes, and enhanced balance sheet reviews at the business unit, regional and statutory
entity levels;
    
    establishment of processes to evaluate certain potential restatement items related to
our revenue recognition policies and practices and other accounting issues;
    
    validation processes, including detailed review of supporting documentation to ensure
adjustments were appropriately substantiated; and
    
    identification, development and initial implementation of remedial actions, as further
described under Remedial Measures below. As discussed above under Current Management Conclusions Concerning Disclosure Controls and
Procedures, as a result of the extensive work undertaken in connection with the Second
Restatement, management believes, based on its knowledge, that (i) this report does not contain any
untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which they were made, not misleading with
respect to the period covered by this 133




---



##### Table of Contents



report and (ii) the financial statements, and other financial information included in this report,
fairly present in all material respects our financial condition, results of operations and cash
flows as at, and for, the periods presented in this report. Principal Adjustments The following are the principal Second Restatement adjustments:  
    
    Adjustments to the previously reported 2003 quarterly
revenues and net earnings applicable to common shares as follows:  
    
    a decrease of $81 million in previously reported
revenues and $108
million in previously reported net earnings applicable to common shares for the first quarter of 2003,
resulting in our reporting a net loss rather than net earnings for the period;
    
    a decrease of $52 million in previously reported revenues and $149
million in previously reported net earnings applicable to common shares for the second quarter of 2003,
resulting in our reporting a net loss rather than net earnings for the period; and
    
    an increase of $78 million in previously reported revenues and a
decrease of $68 million in previously reported net earnings applicable to common shares for the third quarter
of 2003.  
    
    An increase of $440 million in previously reported
revenues and a reduction of $456
million in previously reported net loss applicable to common shares for the year ended December 31, 2002, with the
following adjustments on a quarterly basis:  
    
    an increase of $246 million in previously reported revenues and a
decrease of $174 million in previously reported net loss applicable to common shares for the first quarter of
2002;
    
    an increase of $131 million in previously reported revenues and a
decrease of $159 million in previously reported net loss applicable to common shares for the second quarter of
2002;
    
    a decrease of $28 million in previously reported
revenues and $232
million in previously reported net loss applicable to common shares for the third quarter of 2002; and
    
    an increase of $91 million in previously reported revenues and $109
million in previously reported net loss applicable to common shares for the fourth quarter of 2002.  
    
    An increase of $1,491 million in previously reported
revenues and a reduction of $917
million in previously reported net loss applicable to common shares for the year ended December 31, 2001. The principal adjustments primarily relate to the following matters (each of which reflects a
number of related adjustments that have been aggregated for disclosure purposes):  
    
    Adjustments to revenues and cost of revenues to address various aspects of our revenue
recognition policies and practices increased revenues by a total of $440 million in 2002
and $1,491 million in 2001, and increased cost of revenues by a total of $149 million in
2002 and $422 million in 2001. The revenue matters adjusted are discussed in detail above
under Second Restatement Process.
    
    Foreign exchange adjustments increased our pre-tax loss by a total of $57 million in
2002 and $113 million in 2001. These adjustments resulted from the re-examination of the
determination of the functional currency for certain entities and the incorrect treatment
of significant long-term inter-company positions, and the incorrect classification of
certain foreign exchange gains and losses.
    
    Correction of certain inter-company balances that did not properly eliminate upon
consolidation and related provisions resulted in a decrease of $36 million and an increase
of $42 million to pre-tax loss for 2002 and 2001, respectively.
    
    Adjustments to previously recorded special charges relating to goodwill, inventory
impairment, contract settlement costs and other charges resulted in a total decrease to
special charges of $77 134




---



##### Table of Contents



million in 2002 and $150 million in 2001. These adjustments consisted primarily of the
following:  
    
    inventory impairments incorrectly classified as special charges were
reclassified to cost of revenues; and
    
    contract settlement costs and other items were adjusted primarily due
to changes in estimates and/or assumptions that were previously recorded in the
incorrect period.  
    
    Corrections to various accruals, provisions or other transactions, primarily due to the
incorrect application of U.S. GAAP to the initial recording of such liabilities, or the
failure to subsequently adjust such liabilities in the correct period, resulted in a
decrease of $324 million and an increase of $47 million in our net loss in 2002 and 2001,
respectively.
    
    Adjustments to the accounting treatment of certain components of discontinued
operations, initially recorded by us in June 2001, resulted in an increase of $122 million
and a decrease of $493 million to the net loss from discontinued operations  net of tax
in 2002 and 2001, respectively. For additional information concerning adjustments made in the Second Restatement, see notes 3 and
23 to the accompanying audited consolidated financial statements and Developments in
2004Restatements in the MD&A section of this report. Use of Estimates in Financial Reporting; Omission of 1999 and 2000 Selected
Financial Data; Decision Not to Amend Certain Previous Filings As described above, two material weaknesses in our internal control over financial reporting were
identified at the time of the First Restatement. During the Second Restatement process, a number
of additional material weaknesses in our internal control over financial reporting were identified,
as described below. Due to, among other factors, these material weaknesses, the significant
turnover in our finance personnel, changes in accounting systems, documentation weaknesses and the
passage of time generally, the Second Restatement involved the efforts of hundreds of our finance
personnel and a number of outside consultants and advisors. As described above, the process
required the review and verification of a substantial number of documents and communications, and
related accounting entries, over multiple fiscal periods. In addition, the review of accruals and provisions and the application of accounting literature to
certain matters in the Second Restatement, including revenue recognition, foreign exchange, special
charges and discontinued operations, was complicated by the passage of time, the lack of
availability of supporting records and the turnover of finance personnel noted above. As a result
of this complexity, estimates and assumptions that impact both the quantum of the various recorded
adjustments and the fiscal period to which they were attributed were required in the determination
of certain of the Second Restatement adjustments. We believe the procedures followed in
determining such estimates were appropriate and reasonable using the best available information. Also as a result of the above factors, as well as a likely inability to obtain third party
corroboration in certain cases due to the substantial industry adjustment in the telecommunications
industry beginning in 2001, we believe that extensive additional efforts over an extended period of
time would be required to restate our 1999 and 2000 selected financial data. We also believe that
selected financial data for these periods would not be meaningful to investors due to this industry
adjustment, which significantly impacted our financial results in 2001 and subsequent periods and
limits the relevance of financial results in periods prior to 2001 for purposes of analysis of
trends in subsequent periods. Given the long delay in filing the Reports, we believed that
investor understanding would be better aided by the dedication of our resources to the preparation
of the current financial and other information included in this and future 135




---



##### Table of Contents



reports. As a result, except for the selected balance sheet data as at December 31, 2000,
financial data for the years ended December 31, 1999 and 2000 has not been restated or presented in
the Selected Financial Data (Unaudited) section of this report. This omitted data is normally
required to be included in an Annual Report on Form 10-K. A number of our and NNCs past filings with the SEC remain subject to ongoing review by the SECs
Division of Corporation Finance (which could result in the need to amend this or our other
filings). In addition, the Second Restatement involved the restatement of our consolidated
financial statements for 2001 and 2002 and the first, second and third quarters of 2003. Amendments
to our prior filings with the SEC would be required in order for us to be in full compliance with
our reporting obligations under the Exchange Act. However, for the same reasons discussed above,
we do not believe that it would be feasible for us to amend our 2002 Form 10-K/A. In addition, we
believe that amended disclosure in the 2002 Form 10-K/A, 2003 Form 10-Q/As and 2003 Form 10-Q would
in large part repeat the disclosure in this report and expected to be contained in the 2004 Form
10-Qs. Accordingly, we do not plan to amend our 2002 Form 10-K/A, 2003 Form 10-Q/As or 2003 Form
10-Q. We believe that we have included in this report all information needed for current investor
understanding and will take similar steps in our 2004 Form 10-Qs. Material Weaknesses in Internal Control over Financial Reporting Identified During
the Second Restatement Over the course of the Second Restatement process, we, together with D&T, identified a number of
reportable conditions, each constituting a material weakness, in our internal control over
financial reporting as at December 31, 2003. In September 2004, management first notified the
Audit Committee of the possibility of additional material weaknesses. Over the remainder of the
Second Restatement process, management and D&T identified a total of six material weaknesses. On
January 10, 2005, D&T confirmed to the Audit Committee that it had identified these six material
weaknesses. No other reportable conditions were identified by us or D&T at the time of the Second
Restatement. The material weaknesses identified were:  
    
    lack of compliance with written Nortel Networks procedures for monitoring and adjusting
balances related to certain accruals and provisions, including restructuring charges and
contract and customer accruals;
    
    lack of compliance with Nortel Networks procedures for appropriately applying
applicable GAAP to the initial recording of certain liabilities, including those described
in SFAS No. 5, and to foreign currency translation as described in SFAS No. 52;
    
    lack of sufficient personnel with appropriate knowledge, experience and training in
U.S. GAAP and lack of sufficient analysis and documentation of the application of U.S.
GAAP to transactions, including, but not limited to, revenue transactions;
    
    lack of a clear organization and accountability structure within the accounting
function, including insufficient review and supervision, combined with financial reporting
systems that are not integrated and which require extensive manual interventions;
    
    lack of sufficient awareness of, and timely and appropriate remediation of, internal
control issues by Nortel Networks personnel; and
    
    an inappropriate tone at the top, which contributed to the lack of a strong control
environment. As reported in the Independent Review Summary included above, there was a
Management tone at the top that conveyed the strong leadership message that earnings
targets could be met through application of accounting practices that finance managers
knew or ought to have known were not in compliance with U.S. GAAP and that questioning
these practices was not acceptable. 136




---



##### Table of Contents



The foregoing material weaknesses contributed to the need for the Second Restatement. Upon
completion of our assessment of our internal control over financial reporting as at December 31,
2004 pursuant to SOX 404, we currently expect to conclude that the first five of these six material
weaknesses continue to exist as at December 31, 2004, and we continue to identify, develop and
begin to implement remedial measures to address them, as described below. * * * * * * Current Status of Material Weaknesses in Internal Control Over Financial Reporting and Expectations
as to Required Management Conclusions and Independent Auditor Attestation Pursuant to Section 404
of the Sarbanes-Oxley Act As noted in MD&ARisk factors/Forward looking statements, our 2004 Form 10-K must comply with SOX
404, which requires management to assess the effectiveness of our internal control over financial
reporting annually and to include in our Annual Report on Form 10-K a management report on that
assessment, together with an attestation by our independent registered public accounting firm. As
noted above, upon completion of our assessment of our internal control over financial reporting as
at December 31, 2004, we currently expect to conclude that the first five of the six material
weaknesses in our internal control over financial reporting described immediately above continue to
exist as at December 31, 2004 (and also constitute material weaknesses as now defined under
standards established by the Public Company Accounting Oversight Board). Accordingly, management
expects to conclude that our internal control over financial reporting as at December 31, 2004 is
ineffective, and D&T has advised us that they expect their report on managements assessment of
internal control over financial reporting also to indicate that internal control over financial
reporting is ineffective. * * * * * * Revenue Independent Review As more fully described above, over the course of the Second Restatement process, management
identified certain accounting practices that it determined should be adjusted as part of the Second
Restatement. In particular, management identified certain errors related to revenue recognition
and undertook a process of revenue reviews. In light of the resulting adjustments to previously
reported revenues, the Audit Committee has determined to review the facts and circumstances leading
to the restatement of these revenues for specific transactions identified in the Second
Restatement. The Revenue Independent Review will have a particular emphasis on the underlying
conduct that led to the initial recognition of these revenues. The Audit Committee will seek a
full understanding of the historic events that required the revenues for these specific
transactions to be restated and will consider any appropriate additional remedial measures,
including those involving internal controls and processes. The Audit Committee has engaged WCPHD
to advise it in connection with the Revenue Independent Review. * * * * * * Remedial Measures At the recommendation of the Audit Committee, the Board of Directors adopted all of the
recommendations for remedial measures contained in the Independent Review Summary. The Board of
Directors has directed management to develop a detailed plan and timetable for the implementation
of these recommendations and will monitor their implementation. In addition, we have identified,
developed and begun to implement a number of measures to strengthen our internal control over
financial reporting 137




---



##### Table of Contents



and address the material weaknesses identified above, including pursuant to recommendations from
D&T. These measures are in the process of being reviewed in light of the recommendations of the
Independent Review and certain of these measures may be superseded by the plans for the
implementation of the recommendations of the Independent Review. A summary of these measures, as
well as previously announced personnel actions, follows.  
    
    Personnel Actions in Response to the First Restatement and Independent Review.  
    
    We terminated for cause our former president and chief executive
officer, former chief financial officer and former controller in April 2004
(the former chief financial officer and former controller having been placed
on paid leaves of absence in March 2004).
    
    We terminated for cause seven additional senior finance employees
with significant responsibilities for our financial reporting as a whole or
for their respective business units and geographic regions in August 2004.  
    
    Renewed Commitment to Best Corporate Practices and Ethical Conduct.  
    
    In August 2004, we adopted a new strategic plan that includes a
renewed commitment to best corporate practices and ethical conduct, including
the establishment of the office of a chief ethics and compliance officer
(which has been filled on an interim basis pending the permanent appointment
of Susan E. Shepard, as now announced).
    
    Over the course of the Second Restatement, our current CEO and
current CFO have communicated to employees the importance of the Second
Restatement process, reliable and transparent financial reporting and ethical
conduct. Those communications included formal presentations as part of our
annual executive conference in November 2004.
    
    In June 2004, management recommended, the joint leadership resources
committee recommended and the Board of Directors subsequently approved that
financial accountability be included as a key qualitative factor in the
individual leadership performance objectives for determination of incentive
cash awards under our annual incentive plan.  
    
    Extended Balance Sheet Reviews.  
    
    We have developed a plan to extend our balance sheet reviews through
the implementation of enhanced review procedures to:  
    
    require greater frequency of timely statutory and segment balance sheet
reviews,
    
    clarify responsibilities within Nortel Networks for organizing balance
sheet reviews, and
    
    establish minimum documentation requirements with respect to balance sheet
entries.  
    
    As part of the initial development of this plan, in the first quarter
of 2004, we increased our focus on the review of specific balance sheet
accounts.  
    
    Review of Finance Department Organizational Structure. We announced, and
began to implement, plans to transform our finance organization, which
include a renewed commitment to transparency as a fundamental goal. Measures
we have begun to implement include:  
    
    In the first quarter of 2004, we began to enhance our global
technical accounting group and establish global contract review and global
finance governance teams.
    
    We engaged Accenture, a global management consulting and technology
services firm, in the third quarter of 2004 to assess the finance
organizations structure, processes and systems, with an expected assessment
completion date of March 2005. 138




---



##### Table of Contents




    
    We established a global corporate finance Sarbanes-Oxley compliance
group beginning in the third quarter of 2004.
    
    We have hired additional full-time finance personnel (with a focus on
qualified accounting professionals) as part of an initiative introduced by
the CFO and controller in March 2004.  
    
    Training Initiatives.  
    
    We re-established our formal training group (led by the global
finance governance team described above) to implement ongoing training
programs for finance personnel globally. The groups focus includes training
with respect to SFAS No. 5; accounting for hedging and derivatives; revenue
recognition, accruals and provisions; and SFAS No. 52.  
    
    Internal Audit.  
    
    In the first quarter of 2004, we modified the mandate of our Internal
Audit function to place a greater emphasis on the adequacy of, and compliance
with, procedures relating to internal control over financial reporting.
    
    In October 2004, we engaged outside consultants to conduct a
strategic performance review of the internal audit function. The objective of
this review is to ensure that internal audit continues to meet professional
internal audit standards and moves towards audit best practices.  
    
    Manual Journal Entry Processes.  
    
    In the fourth quarter of 2003, we began to modify our manual journal
entry processes by implementing new procedures, with a focus on approvals of
manual journal entries, more stringent documentation processes and reduction
of user access to manual journal entry functions. As noted above, we continue to identify, develop and begin to implement remedial measures,
including the development of a detailed plan and timetable for the implementation of the
recommendations of the Independent Review. As part of the Revenue Independent Review, the Audit
Committee will also consider any appropriate additional remedial measures, including those
involving internal controls and processes. The above mentioned changes in internal control over financial reporting materially affected our
internal control over financial reporting, and these changes and expected changes as a result of
remedial measures to be developed and implemented are reasonably likely to materially affect our
internal control over financial reporting in the future. We intend to continue to make ongoing
assessments of our internal controls and procedures periodically and as a result of the
recommendations of the Independent Review and any additional recommendations of the Revenue
Independent Review. 139




---



##### Table of Contents



ITEM 10.
    
    Directors and Executive Officers of the Registrant 
 Directors of the registrant The
Companys directors are also directors of Nortel Networks Corporation. Each person who is appointed or
elected to the board of directors will hold that position until the earliest of: (i) the close of
the next annual meeting of shareholders; (ii) the date he or she ceases to be a director by
operation of law; or (iii) the date he or she resigns. The committee on directors of Nortel Networks Corporation and the boards of directors of the
Company and Nortel Networks Corporation remain committed to ensuring an orderly succession,
continuity and renewal. This process was commenced in 2003 and resulted in the appointment of Dr.
Bischoff and Mr. Manley in the second quarter of 2004. On January 10, 2005, the committee on
directors of Nortel Networks Corporation advised the board of directors that five of the current directors have decided not to
stand for re-election to the board of directors of the Company, and to the board
of directors of Nortel Networks Corporation at the next annual and special meeting of shareholders of Nortel Networks
Corporation to be held as soon as practicable after the completion and filing of the 2004 and 2003
audited annual financial statements (the AGM). These directors and the year of their initial
election to the board of directors are: Mr. Wilson (1991), Mr. Fortier (1992), Mr. Smith (1994),
Mrs. Saucier (1997) and Mr. Blanchard (1997). All of the current members of the board of directors
of the Company and Nortel Networks Corporation who will not be standing for re-election are committed to continuing in their
current roles until the next AGM. The committee on directors has identified two additional
candidates not listed below, who the board of directors expects will
be nominated as directors of the Company, and as directors of Nortel
Networks Corporation at the next AGM. On January 10, 2005, the board of directors of Nortel Networks Corporation appointed
Mr. McCormick and Mr. Pearce directors of Nortel Networks Corporation effective immediately after
the filing with the United States Securities and Exchange Commission of the Annual Report on Form
10-K of Nortel Networks Corporation for the year ended
December 31, 2003 (NNC Form 10-K). As a result of the
filing of the NNC Form 10-K, the appointment of
Mr. McCormick and Mr. Pearce became effective on
January 11, 2005. The board of directors
of the Company also appointed Mr. McCormick and Mr. Pearce directors of the Company, effective
immediately after the filing with the United States Securities and
Exchange Commission of this
Annual Report on Form 10-K of the Company for the year ended
December 31, 2003 (NNL Form 10-K). In addition, on January 17, 2005, the
boards of directors of the Company and Nortel Networks Corporation
appointed Messrs. McCormick and Pearce to the joint leadership
resources committee of the Company and Nortel Networks Corporation,
effective immediately after the filing of this NNL Form 10-K. Set out below is certain information concerning the individuals who currently have been
nominated to be elected as directors of the Company, and who have
also been nominated for election as directors of Nortel Networks Corporation at the next AGM
and certain information concerning the five directors who will not be standing for
re-election as directors of the Company, or as directors of Nortel
Networks Corporation at the AGM. Name
    
    Age
    
    Position with the CompanyDr. Manfred Bischoff
    
    
    62
    
    
    DirectorThe Hon. James Johnston Blanchard
    
    
    62
    
    
    Director (not standing for re-election)Robert Ellis Brown
    
    
    59
    
    
    DirectorJohn Edward Cleghorn
    
    
    63
    
    
    DirectorL. Yves Fortier
    
    
    69
    
    
    Director (not standing for re-election)Robert Alexander Ingram
    
    
    62
    
    
    DirectorJohn A. MacNaughton
    
    
    59
    
    
    NomineeThe Hon. John Manley
    
    
    55
    
    
    DirectorRichard D. McCormick
    
    
    64
    
    
    NomineeWilliam Arthur Owens
    
    
    64
    
    
    President and Chief Executive Officer and DirectorHarry J. Pearce
    
    
    62
    
    
    Nominee
 140




---



##### Table of Contents



Name
    
    Age
    
    Position with the CompanyGuylaine Saucier
    
    
    58
    
    
    Director (not standing for re-election)Sherwood H. Smith, Jr.
    
    
    70
    
    
    Director (not standing for re-election)Lynton Ronald Wilson
    
    
    64
    
    
    Chairman (non-executive) and Director (not
standing for re-election)
  (PIC. OF DR. M. BISCHOFF)
    
    DR. MANFRED BISCHOFF, 62, Starnberg, Federal Republic of Germany, was appointed
a director of the Company and Nortel Networks Corporation on April 29, 2004.
Dr. Bischoff has been Chairman of the Board of European Aeronautic Defence and
Space Company EADS N.V., an aerospace company, since July 2000 and Delegate for
Aerospace at DaimlerChrysler AG since January 2004. Dr. Bischoff was a member
of the board of management of DaimlerChrysler AG, an automotive manufacturing
company, from May 1995 to December 2003 and President and Chief Executive
Officer of DaimlerChrysler Aerospace AG from May 1995 to March 2000. He is
also a member of the Supervisory Board of Bayerische Hypo-und Vereinsbank AG,
Fraport AG, Gerling-Konzern Versicherungs-Beteiligungs-AG, J.M. Voith AG,
Lagardère SCA and Royal KPN N.V.(PIC. OF R. E. BROWN)
    
    ROBERT ELLIS BROWN, 59, Westmount, Québec, Canada, has been a director of the
Company since April 27, 2000 and of Nortel Networks Corporation since March 7,
2000. Mr. Brown has been President and Chief Executive Officer of CAE Inc., a
flight training, services and equipment company, since August 2004 and has been
a director of ACE Aviation Holdings Inc., the parent holding company under
which the reorganized Air Canada is held, since October 2004. After being
appointed a director of Air Canada, a commercial airline company, in March
2003, he was appointed Vice-Chairman of the Board from April 2003 to May 2003
and Chairman of the Board from May 2003 to September 2004. On April 1, 2003,
Air Canada obtained an initial order from the Ontario Superior Court of Justice
providing creditor protection under the Companies Creditors Arrangement Act,
such order being subsequently amended in connection with the proceedings. On
April 1, 2003, Air Canada also made a concurrent petition for recognition and
ancillary relief under Section 304 of the United States Bankruptcy Code. Air
Canada successfully completed its restructuring process and emerged from
creditor protection in September 2004. Mr. Brown served as a Director and
Chairman of the Board of Air Canada during its restructuring. Mr.
Brown has been the Chairman of Vanguard Response Systems Inc. since November
2003. Mr. Brown was the President and Chief Executive Officer of Bombardier
Inc. from February 1999 to December 2002.(PIC. OF J. E. CLEGHORN)
    
    JOHN EDWARD CLEGHORN, O.C., F.C.A., 63, Toronto, Ontario, Canada, has been a
director of the Company and of Nortel Networks Corporation since May 24, 2001.
Mr. Cleghorn was Chairman and Chief Executive Officer of the Royal Bank of
Canada from January 1995 to July 2001. He is also Chairman of the Board of
SNCLavalin Group Inc., an engineering and construction company, and a director
of Canadian Pacific Railway Company, Canadian Pacific Railway Limited, Finning
International Inc. and Molson Inc. He is Chancellor Emeritus of Wilfrid
Laurier University, Member of the Faculty of Management International Advisory
Board, McGill University and is the Immediate Past Chairman and a director of
the Historical Foundation of Canada.(PIC. OF R. A. INGRAM)
    
    ROBERT ALEXANDER INGRAM, 62, Durham, North Carolina, United States, has been a
director of the Company since April 29, 1999 and of Nortel Networks Corporation
since March 7, 2000. Mr. Ingram has been Vice-Chairman Pharmaceuticals of
GlaxoSmithKline plc, a corporation involved in the research, development,
manufacturing and sale of pharmaceuticals, since January 2003. Mr. Ingram was
the Chief Operating Officer and President, Pharmaceutical Operations of
GlaxoSmithKline plc from January 2001 to January 2003. He was Chief Executive
of Glaxo Wellcome plc from October 1997 to December 2000 and Chairman of Glaxo
Wellcome Inc., Glaxo Wellcome plcs United States subsidiary, from January 1999
to December 2000. Mr. Ingram is also non-executive Chairman of the Board of
OSI Pharmaceuticals, Inc., a biotechnology company, and a director of Edwards
Lifesciences Corporation, Lowes Companies, Inc., Misys plc, VALEANT
Pharmaceuticals International and Wachovia Corporation.
 141




---



##### Table of Contents



(PIC. OF J. A. MacNAUGHTON)
    
    JOHN A. MacNAUGHTON, C.M., 59, Toronto, Ontario, Canada, has been nominated for
election as a director of the Company and Nortel Networks Corporation for the
first time. Mr. MacNaughton has served since September 1999 as President and
Chief Executive Officer of the Canada Pension Plan Investment Board, a Crown
Corporation created by an Act of Parliament in 1997 to invest the assets of the
Canada Pension Plan. He is due to retire from that position on January 14,
2005. Prior to September 1999, he served as President of Nesbitt Burns Inc.,
the investment banking arm of Bank of Montreal, from September 1994 to March
1999. Mr. MacNaughton is a Trustee of the University Health Network, an
academic health science centre. He is a Governor of CCAF-FCVI Inc., a
research and education foundation focused on governance, accountability,
management and audit in the public sector.(PIC. OF J. MANLEY)
    
    THE HON. JOHN MANLEY, 55, Ottawa, Ontario, Canada, was appointed as a director
of the Company and Nortel Networks Corporation on May 26, 2004. Mr. Manley has
been a senior counsel at the law firm of McCarthy Tétrault LLP since May 2004.
Mr. Manley was previously the Member of Parliament for Ottawa South from
November 1988 to June 2004 and Chairman of the Ontario Power Generation Review
Committee, which was responsible for reviewing the state of the energy system
of Ontario, from December 2003 to March 2004. As a Member of Parliament, Mr.
Manley also held various positions in the Canadian federal government,
including Deputy Prime Minister of Canada from January 2002 to December 2003,
Minister of Finance from June 2002 to December 2003, Chair of the Cabinet
Committee on Public Security and Anti-Terrorism from October 2001 to December
2003, Minister of Foreign Affairs from October 2000 to January 2002 and
Minister of Industry prior thereto.(PIC. OF R. D. McCORMICK)
    
    RICHARD D. McCORMICK, 64, Denver, Colorado, United States, served as Chairman
of US WEST, Inc., a telecommunications company, from June 1998 until his
retirement in May 1999. He was chairman, president and chief executive officer
of US WEST, Inc. from 1992 until 1998. He is also a director of HealthTrio
Inc., United Technologies Corporation, Unocal Corporation and Wells Fargo and
Company. From 1994 to 2003, Mr. McCormick was also a director of UAL
Corporation, the parent holding company and sole shareholder of United Air
Lines, Inc. On December 9, 2002, UAL Corporation, United Air Lines, Inc. and
26 direct and indirect wholly owned subsidiaries of UAL Corporation filed
voluntary petitions to reorganize their businesses under Chapter 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of Illinois, Eastern Division.(PIC. OF W. A. OWENS)
    
    WILLIAM ARTHUR OWENS, 64, Kirkland, Washington, United States, has been a
director of the Company and of Nortel Networks Corporation since February 28,
2002. Mr. Owens has been President and Chief Executive Officer of the Company
and of Nortel Networks Corporation since April 2004. Mr. Owens was Chairman
and Chief Executive Officer of Teledesic LLC, a satellite communications
company, from December 2001 to April 2004, after having served as Vice Chairman
and Co-Chief Executive Officer from August 1998 to December 2001. Mr. Owens
was Vice-Chairman of the Board of Directors of Science Applications
International Corporation (or SAIC), a research and engineering firm
representing the largest employee-owned high technology company in the United
States, from March 1996 to August 1998, and served as SAICs President and
Chief Operating Officer from December 1996 to August 1998 and Vice-President
from March 1996 to December 1996. Prior to joining SAIC, Mr. Owens was Vice
Chairman of the Joint Chiefs of Staff, the second-ranking military officer in
the United States. As part of his role with the Joint Chiefs of Staff, he had
responsibility for the reorganization and restructuring of the armed forces in
the post-Cold War era. Mr. Owens is also a director of DaimlerChrysler AG.
Mr. Owens was the Chairman and founder of a private five-state wireless
telecommunication venture. Mr. Owens was also a director of IFusion Com
Corporation, a company involved in developing Internet services and systems,
for approximately one year, his tenure ending in March 1997. On March 28,
1997, IFusion Com Corporation filed a voluntary petition to reorganize its
businesses under Chapter 11 of the United States Bankruptcy Code in the United
States Bankruptcy Court for the Southern District of New York, United States.(PIC. OF H. J. PEARCE)
    
    HARRY J. PEARCE, 62, Bloomfield Hills, Michigan, United States, was Chairman of
the Board of Hughes Electronics Corporation (now The DIRECTV Group, Inc.), a
company engaged in digital television entertainment, broadband satellite and
network services as well as global video and data broadcasting, from June 2001
to January 2004. He was a director and Vice-Chairman of General Motors
Corporation from January 1996 to June 2001. Mr. Pearce is also a director of
Marriott International, Inc. and MDU Resources Group, Inc.
 142




---



##### Table of Contents



We would like to acknowledge the many years of contribution and service to the Company and
Nortel Networks Corporation by Messrs. Lynton Ronald Wilson, L. Yves Fortier, Sherwood H. Smith,
Jr., Mrs. Guylaine Saucier and the Honorable James Johnston Blanchard. Mr. Wilson has been a director of the Company since April 25, 1991 and of Nortel Networks
Corporation since March 7, 2000 and non-executive Chairman of the Board of the Company and of
Nortel Networks Corporation since February 2002. Mr. Wilson was executive Chairman of the Board of
the Company and of Nortel Networks Corporation from November 2001 to February 2002. He was
non-executive Chairman of the Board of the Company and of Nortel Networks Corporation from April
2001 to November 2001. Mr. Wilson was Chairman of the Board of Directors of BCE Inc., a
telecommunications company, from May 1998 to April 2000, serving in a non-executive capacity from
January 1999. He is Chairman of the Board of CAE Inc., a flight training, services and equipment
company, and a director of DaimlerChrysler AG and DaimlerChrysler Canada Inc. Mr. Fortier has been a director of the Company since April 30, 1992 and Nortel Networks
Corporation since March 7, 2000. He also serves on the pension fund policy committee of the
Company. He is a senior partner and Chairman of the law firm of Ogilvy Renault. Mr. Fortier was
Canadas Ambassador to the United Nations from 1988 to 1992. Since 2001, he has been a Trustee of
the International Accounting Standards Committee Foundation. He is also Chairman of the Board of
Alcan Inc., Governor (Chairman of the Board) of Hudsons Bay Company, and a director of NOVA
Chemicals Corporation and Royal Bank of Canada. Mr. Smith,
having reached the age of retirement and the term limit under the
Companys corporate
governance guidelines, will not be standing again for re-election as
a director of the Company, or as a director of Nortel Networks
Corporation at the AGM. Mr. Smith has been a
director of the Company since April 28, 1994 and of Nortel Networks Corporation since March 7,
2000. He serves on the audit committee and the joint leadership resources committee of Nortel
Networks Corporation, and on the audit committee, the joint leadership resources committee and the
pension fund policy committee (Chairman) of the Company. Mr. Smith is Chairman Emeritus of the
Board at CP&L. He is also a trustee of Northwestern Mutual Life Insurance Company, Chairman of the
Triangle Universities Center for Advanced Studies and Vice-Chairman of the Research Triangle
Foundation. Mrs. Saucier has been a director of the Company since May 1, 1997 and of Nortel Networks
Corporation since March 7, 2000. Mrs. Saucier was Chair of the Joint Committee on Corporate
Governance, which was established by the Canadian Institute of Chartered Accountants, the Canadian
Venture Exchange, and the Toronto Stock Exchange in 2000 to review the state of corporate
governance in Canada and make recommendations thereon. She was also Chair of The Canadian
Institute of Chartered Accountants from June 1999 to June 2000. Mrs. Saucier was Chairman of the
Board and a director of the Canadian Broadcasting Corporation, a public broadcaster, from April
1995 to December 2000. She is also a director of Altran Technologies SA, AXA Assurances Inc., Bank
of Montreal, Petro-Canada and Tembec Inc. Mr. Blanchard has been a director of the Company since May 1, 1997 and of Nortel Networks
Corporation since March 7, 2000. Mr. Blanchard has been a partner in the law firm of Piper Rudnick
LLP (now DLA Piper Rudnick Gray Cary) since October 2002 and prior to October 2002 was a
shareholder in the law firm of Verner, Liipfert, Bernhard, McPherson and Hand, Chartered since
April 1996. He was previously United States Ambassador to Canada, Governor of the State of
Michigan and a member of the United States House of Representatives. Mr. Blanchard is also a
director of Bennett Environmental, Inc., Brascan Corporation, Enbridge Inc., LDMI Communications,
Inc. and Teknion Corporation. 143




---



##### Table of Contents



Executive officers and certain other non-executive board appointed officers of the Registrant The executive officers and certain other non-executive board appointed officers of the
Company are appointed, and may be removed, by the Board of Directors of the Company. Generally,
executive officers and other non-executive officers hold their offices until a successor is
appointed or until the officer resigns. As of December 31, 2004, the names of the executive
officers and non-executive board appointed officers of the Company, their ages, offices currently
held and year of appointment thereto were as follows: Year ofName and age
    
    Office and position currently
held
    
    
    AppointmentMartha Helena Bejar (42)
    
    President, CALA
    
    
    2004Chahram Bolouri (50)
    
    President, Global Services
    
    
    2004Malcolm Kevin Collins (44)
    
    President, Enterprise Networks
    
    
    2002Tracy Sarah Jane Connelly McGilley (33)*
    
    Assistant Secretary and Counsel  Securities
    
    
    2004Gordon Allan Davies (42)*
    
    Assistant General Counsel  Securities and Corporate Secretary
    
    
    2004Pascal Debon (57)
    
    President, Carrier Networks
    
    
    2004Nicholas John DeRoma (57)
    
    Chief Legal Officer
    
    
    2000William John Donovan (47)
    
    Senior Vice-President, Human Resources
    
    
    2000John Marshall Doolittle (41)*
    
    Vice-President, Tax
    
    
    2002John Joseph Giamatteo (37)
    
    President, Asia Pacific
    
    
    2003Albert Roger Hitchcock (39)
    
    Chief Information Officer
    
    
    2002Dion Constandino Joannou (39)
    
    Chief Strategy Officer
    
    
    2004William Robert Kerr (50)
    
    Chief Financial Officer
    
    
    2004Richard Stephen Lowe (54)
    
    President, CDMA
    
    
    2004Peter David MacKinnon (42)
    
    President, GSM/UMTS
    
    
    2004Robert Yu Lang Mao (61)
    
    President and Chief Executive Officer, Greater China
    
    
    2003William F. McCauley** (73)
    
    Chief Ethics and Compliance Officer
    
    
    2004Brian William McFadden (51)
    
    Chief Technology Officer
    
    
    2004Donald Gregory Mumford (58)
    
    Special Advisor
    
    
    2004William Arthur Owens (64)
    
    President and Chief Executive Officer
    
    
    2004MaryAnne Elisabeth Pahapill (43)
    
    Controller
    
    
    2004Stephen Charles Pusey (43)
    
    President, Europe, Middle East and Africa
    
    
    2001Ralph Edward Clenton Richardson (43)
    
    Chief Marketing Officer
    
    
    2004Charles Raymond Saffell, Jr. (58)
    
    President, Federal Network Solutions
    
    
    2004Steven Leo Schilling (48)
    
    President, Enterprise Accounts
    
    
    2002Stephen Francis Slattery (45)
    
    President, Wireline/Optical
    
    
    2004Karen Elizabeth Sledge (43)*
    
    Assistant Controller
    
    
    2003Susan Louise Spradley (43)
    
    President, Global Operations
    
    
    2004Katharine Berghuis Stevenson (42)
    
    Treasurer
    
    
    2000Masood Ahmad Tariq (54)
    
    President, Global Alliances
    
    
    2003Tracey Lynn Vickruck* ** (46)
    
    Assistant Treasurer
    
    
    2004
  *
    
    Non-executive board appointed officers**
    
    Appointed on an interim basis
 All the above-named executive officers and non-executive board appointed officers of the
Company have been employed in their current position or other senior positions with Nortel Networks
during the past five years, except as follows:  
    
    T.S.J. Connelly McGilley, prior to her appointment as Assistant
Secretary effective in December 2004, held the position of Counsel
 Securities in the Companys legal department;
    
    J.M. Doolittle was, prior to returning to Nortel Networks in
September 1999, Vice President, Finance of The Bank of Montreal, a
Canadian chartered bank, from August 1997 and Director, Treasury,
Europe and Asia, Nortel Networks, prior thereto; 144




---



##### Table of Contents




    
    W.R. Kerr, prior to returning to Nortel Networks as Chief
Financial Officer in March 2004, held various senior finance
positions with Nortel Networks from January 1999 (and prior
thereto) until his retirement in December 2001. He has also
served as a director of Bank of China (Canada) since June 1,
1997;
    
    R.Y.L. Mao was, prior to returning to Nortel Networks in January
2003, Chairman and Chief Executive Officer of Foxconn (Beijing)
Precision Component Industries, Ltd., a manufacturer of mobile
communication terminal devices, from November 2002 to December
2002, and Chief Executive Officer, Nortel China, prior thereto;
    
    W.F. McCauley was a consultant prior to his appointment as Chief
Ethics and Compliance Officer of Nortel Networks effective October
28, 2004. Mr. McCauley was engaged in consulting on various
matters in a variety of industries during the period from 1998
until his appointment with Nortel Networks, except from September
1999 to June 2001 when he was a director of the Kyle Foundation, a
non-profit enterprise engaged in causes associated with child
cancer care. From August 2004 until his appointment as Chief
Ethics and Compliance Officer, he acted as an independent
consultant to Nortel Networks on matters related to the ethics and
compliance function of Nortel Networks Corporation and its
subsidiaries. In addition, Mr. McCauley is currently a member of
the respective advisory committees of Actuarial Consulting Group,
a pension planning and execution enterprise, and High-Tech
Engineering, a specialty steel and titanium manufacturing company,
as well as the Ship Systems Advisory Committee of Northrop Grumman
Corp., a company engaged in ship building, primarily for the U.S.
Navy. He is also a director, and member of the investment and
audit committees, of Pacific Specialty Insurance Group, a property
and casualty insurance enterprise, a foundation trustee of the
U.S. Naval Academy and a board trustee of Scripps Foundation, an
organization engaged in the oversight of six hospitals in southern
California;
    
    W.A. Owens was, prior to his appointment as President and Chief
Executive Officer in April 2004, Chairman and Chief Executive
Officer of Teledesic LLC, a satellite communications company, from
December 2001 to April 2004, after having served as Vice Chairman
and Co-Chief Executive Officer from August 1998 to December 2001.
Mr. Owens was Vice-Chairman of the Board of Directors of Science
Applications International Corporation (or SAIC), a research and
engineering firm representing the largest employee-owned high
technology company in the United States, from March 1996 to August
1998, and served as SAICs President and Chief Operating Officer
from December 1996 to August 1998 and Vice-President from March
1996 to December 1996. Prior to joining SAIC, Mr. Owens was Vice
Chairman of the Joint Chiefs of Staff, and the second-ranking
military officer in the United States. As part of his role with
the Joint Chiefs of Staff, he had responsibility for the
reorganization and restructuring of the armed forces in the
post-Cold War era. Mr. Owens is also a director of
DaimlerChrysler AG. Mr. Owens was the Chairman and founder of a
private five-state wireless telecommunication venture. Mr. Owens
has been a director of the Company and Nortel Networks Corporation
since February 2002;
    
    R.E.C. Richardson was, prior to his appointment as Chief Marketing
Officer effective October 1, 2004, Vice President, Global
Marketing Enterprise Networks from April 2004 to September 2004.
Mr. Richardson was a consultant from April 2003 to March 2004 and
prior thereto was Chief Sales and Marketing Officer, and member of
the board of directors, at T-Mobile UK, the UK wireless unit of
Deutsche Telekom AG, from April 2001 to March 2003. Prior to
that, Mr. Richardson was Vice President Worldwide Developer
Relations and Worldwide Solutions Marketing, Apple Computer, a
company engaged in the desktop and notebook computer industry as
well as the production of operating systems and professional
applications, from December 1997 to March 2001;
    
    C.R. Saffell, Jr. was, prior to his appointment as President,
Federal Network Solutions in October, 2004, Senior Vice President
for National Security Solutions, Titan Corporation, a technology
developer and systems integrator that provides a range of systems
solutions primarily for the Department of Defense, the Department
of Homeland Security, intelligence and other U.S. government
agencies, from December 1988 to March 2004;
    
    K.E. Sledge, prior to her appointment as Assistant Controller in
July 2003, held various finance positions with Nortel Networks;
and
    
    T.L. Vickruck was, prior to returning to Nortel Networks in August
2004, Team Leader, Corporate Treasury, Financial Controls Office
of Royal Bank of Canada, a Canadian chartered bank, from September
2003 to June 2004. She was Director, Global Treasury Centre,
Nortel Networks from September 2000 to June 2002 and prior thereto
was Director, Treasury Operations, Americas Nortel Networks from
January 1999 to September 2000. 145




---



##### Table of Contents



Subsequent appointment Susan E. Shepard, 61,will succeed Mr. W.F. McCauley in the position of Chief Ethics and
Compliance Officer effective February 21, 2005. Mr. McCauley will work with Ms. Shepard to
transition the position of Chief Ethics and Compliance Officer. Over the course of her career, Ms.
Shepard has served in a number of positions specifically related to ethics and compliance. Ms.
Shepard has been a Commissioner for the New York State Ethics Commission since May 2003. In
addition, prior to becoming engaged in private practice in 1997, Ms. Shepard was Commissioner of
Investigation for New York City (1990 to 1994), Chief Counsel to the New York State Commission of
Investigation (1986 to 1990) and an Assistant United States Attorney for the Eastern District of
New York (1976 to 1986). 
 Section 16(a) beneficial ownership reporting compliance Section 16(a) of the United States Securities Exchange Act of 1934 requires persons who
beneficially own more than 10 percent of the Companys equity securities and certain other persons
to file reports concerning their ownership of Company equity securities with the United States
Securities and Exchange Commission, the New York Stock Exchange, and the Company. Nortel Networks
Corporation, the sole owner of the Companys common shares, filed its required reports on a timely
basis during 2004 and 2003. Audit committee financial expert The boards of directors of the Company and Nortel Networks Corporation have determined
that Mr. J.E. Cleghorn meets the criteria required by the United States Securities and Exchange
Commission for an audit committee financial expert (United States GAAP). Mr. Cleghorn is
independent under the requirements for the independence of audit committee members under the
New York Stock Exchange (or NYSE) corporate governance listing standards. Audit committee The Company and Nortel Networks Corporation have audit committees in accordance with
Section 3(a)(58)(A) of the United States Securities Exchange Act of 1934, as amended. The audit
committees have identical memberships. The members of both audit committees are J.E. Cleghorn
(Chairman), M. Bischoff, R.E. Brown, R.A. Ingram, G. Saucier, and S.H. Smith, Jr. Code of ethics and other corporate governance matters The Company and Nortel Networks Corporation have adopted a code of business conduct and
ethics, known as Living the Values: A Guide to Ethical Business Practices at Nortel Networks,
which applies to the chief executive officer, chief financial officer and controller, and other
persons performing similar functions, as well as to directors and all other employees. Certain
waivers under the Guide if granted by the boards of directors or any committee thereof to directors
of the Company or Nortel Networks Corporation or officers will be posted on our website at
www.nortel.com, in accordance with applicable law and the requirements of the stock exchanges on
which the Company or Nortel Networks Corporation securities are listed and of securities regulatory
authorities as adopted or amended and in force from time to time. The audit committees of the Company and Nortel Networks Corporation have each adopted a
charter, known as the Audit Committee Mandate. The committee on directors of Nortel Networks
Corporation acts as the nominating committee and makes corporate governance recommendations to the
board of directors of Nortel Networks Corporation. The committee on directors has adopted a
charter, known as the Committee on Directors Mandate. The joint leadership resources committee
acts as the compensation committee of Nortel Networks. The joint leadership resources committee
has adopted a charter, known as the Joint Leadership Resources Committee Mandate. The Company
and Nortel Networks Corporation have adopted corporate governance guidelines, known as the
Statement of Governance Guidelines. 146




---



##### Table of Contents



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




---



##### Table of Contents



2004 Long TermCompensationAwards
    
    
    PayoutsAnnual Compensation
    
    
    SecuritiesName
    
    
    
    
    
    
    
    
    
    
    
    Other Annual
    
    
    Underlying
    
    
    LTIP
    
    
    All OtherAnd Principal
    
    
    
    
    
    Salary
    
    
    Bonus
    
    
    Compensation
    
    
    Options
    
    
    Payouts
    
    
    CompensationPosition
    
    
    Year
    
    
    ($)
    
    
    ($)(1)
    
    
    ($)
    
    
    (#)
    
    
    (#)
    
    
    ($)W.A. Owens*
President and Chief
Executive Officer
    
    
    2004
2003
2002
    
    
    681,818


    
    
    


    
    
    


    
    
    


    
    
    


    
    
    70,298(2)

P. Debon**
President, Carrier
Networks
    
    
    2004
20032002
    
    
    590,000
590,000537,143
    
    
    
743,400(6)
1,475,000(8)(9)

    
    
    10,445(3)

    
    
    
250,000
    
    
    
90,000(7)
745,000(10)

    
    
    85,577(4)(5)
92,346(4)(5)125,875(4)(5)(11)B.W. McFadden**
Chief Technology Officer
    
    
    2004
20032002
    
    
    530,000
501,667458,545
    
    
    
528,675(6)
1,291,000(8)(9)

    
    
    

    
    
    
250,000
    
    
    
90,000(7)
745,000(10)

    
    
    38,601(12)(13)
65,430(12)(13)16,503(12)(13)S.L. Spradley**
President, Global
Operations
    
    
    2004
2003
2002
    
    
    530,000
496,667
354,275
    
    
    
609,325(6)
1,285,000(8)(9)

    
    
    


    
    
    

291,999(15)
    
    
    
575,000(10)

    
    
    6,500(14)
6,000(14)
5,500(14)N.J. DeRoma
Chief Legal Officer
    
    
    2004
2003
2002
    
    
    526,000
526,000
526,000
    
    
    
524,685(6)
1,315,000(8)(9)

    
    
    

24,038(13)(16)
    
    
    

250,000
    
    
    
135,000(7)
535,000(10)

    
    
    31,960(12)(13)
54,494(12)(13)
17,885(12)(13)F.A. Dunn*
Former President and
Chief Executive Officer
    
    
    2004
2003
2002
    
    
    417,043(17)
868,750
825,000
    
    
    
 (18)
3,540,000(8)(19)

    
    
    


    
    
    

750,000(20)
    
    
    
225,000(7)
745,000(10)(19)

    
    
    9,138(12)(13)
26,145(12)(13)
24,747(12)(13)
  *
    
    On April 27, 2004, Mr. Dunns employment as President and Chief Executive Officer of the
Company and Nortel Networks Corporation was terminated for cause and Mr. Owens was appointed
President and Chief Executive Officer of the Company and Nortel Networks Corporation.**
    
    Prior to the change in positions effective October 1, 2004 in accordance with the corporate
reorganization announced by Nortel Networks Corporation on August 19, 2004, Messrs. Debon and
McFadden and Ms. Spradley held, respectively, the positions of: President, Wireless Networks;
President, Optical Networks; and President, Wireline Networks.(1)
    
    Incentive cash awards for each fiscal year under the Nortel Networks Limited SUCCESS
Incentive Plan (or SUCCESS Plan), including payments made in connection with the Return to
Profitability bonus program component of that plan, in respect of each of the fiscal years,
whether or not deferred by the named executive officer. On April 27, 2004, the Company and
Nortel Networks Corporation terminated for cause the employment of each of its then president
and chief executive officer, chief financial officer and controller. On August 19, 2004,
Nortel Networks Corporation announced that seven individuals with, or who had, significant
responsibilities for financial reporting at the line of business and regional levels were
terminated for cause. Nortel Networks has demanded from these individuals repayment of any
payments made under bonus plans in respect of 2003, including any awards under the SUCCESS
Plan. See footnotes (8) and (19) below.(2)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan ($1,038),
expatriate expenses related to Mr. Owens responsibilities as President and Chief Executive
Officer of the Company and Nortel Networks Corporation ($43,588) and fees earned as a
non-employee director prior to being appointed as President
 148




---



##### Table of Contents



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




---



##### Table of Contents



for Mr. McFadden; and Cdn$3,652,271 ($2,599,851) for Mr. DeRoma. Restricted stock units are
valued using the purchase price of the common shares of Nortel Networks Corporation on the date of purchase (for share
settlement) and on the average price for the specified 20 day trading period for cash
settlement (where applicable). Amounts have been converted using the exchange rates listed
in footnote (13) below. See Long-term incentive plans  awards in last two fiscal years 
2003 for a description of the applicable performance criteria. See footnote (19) below.(11)
    
    Certain payments paid in United Kingdom pounds have been converted to United States dollars
and included in this amount. Payments have been converted using the average of the exchange
rates in effect equal to US$1.00 = UK£0.6661 for 2002.(12)
    
    Represents contributions made under the Nortel
Networks Limited Investment Plan for Employees  Canada.(13)
    
    Represents the United States dollar equivalent of payments actually earned or paid in
Canadian dollars. Amounts have been converted using the average of the exchange rates in
effect during each year equal to US$1.00 = CDN$1.2978 for 2004, US$1.00 = Cdn$1.4048 for 2003
and US$1.00 = Cdn$1.5708 for 2002.(14)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan.(15)
    
    In June 2001, Nortel Networks Corporation commenced a voluntary stock option exchange program
whereby eligible employees could exchange certain then outstanding stock options for new
options based on a prescribed formula. In January 2002, new stock options were granted to
eligible employees who participated in the stock option exchange program, with exercise prices
at the fair market value of Nortel Networks Corporations common shares on the date of grant.
Prior to Ms. Spradleys appointment as an officer of the Company, she was an employee eligible
to participate in the voluntary stock option exchange program. As a result, 41,999 of the
stock options granted to Ms. Spradley in 2002 were granted pursuant to the voluntary stock
option exchange program.(16)
    
    Amounts paid to reimburse Mr. DeRoma for income taxes payable by him in accordance with his
employment agreement. Mr. DeRomas employment agreement is described below under Certain
Employment Arrangements.(17)
    
    Includes Cdn$151,898 base salary for accrued vacation paid as required in accordance with
corporate policy and applicable law as a result of the termination of employment for cause.(18)
    
    Mr. Dunn did not receive any annual incentive bonus under the SUCCESS Plan with respect to
2003. See footnotes (1), (8) and (19).(19)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, the
Company and Nortel Networks Corporation have demanded repayment of the Return to Profitability
program bonus award under the SUCCESS Plan of $3,540,000 and the 745,000 restricted stock
units issued and settled in respect of restricted stock units allocated under the 2003 program
of the RSU Plan. See footnotes (8) and (10).(20)
    
    These options terminated and expired automatically upon the termination of Mr. Dunns
employment for cause on April 27, 2004.
 150




---



##### Table of Contents



2003 Long Term
        CompensationAnnual Compensation
    Awards
    PayoutsNameAnd PrincipalPosition
    Year
    Salary($)
    Bonus($)(1)
    Other AnnualCompensation($)
    SecuritiesUnderlyingOptions(#)
    LTIPPayouts(#)
    All OtherCompensation($)F.A. Dunn*
    
    2003
    
    
    868,750
    
    
     (2)
    
    
    
    
    
    
    
    
    225,000(3)
    
    
    26,145(4)(5)President and Chief
    
    
    
    
    
    
    
    3,540,000(6)(7)
    
    
    
    
    
    
    
    
    745,000(7)(8)Executive Officer
    
    2002
    
    
    825,000
    
    
    
    
    
    
    
    
    750,000(9)
    
    
    
    
    
    24,747(4)(5)2001
    
    
    564,833
    
    
    
    
    
    
    
    
    1,500,000(9)(10)
    
    
    
    
    
    16,806(4)(5)P. Debon**
    
    2003
    
    
    590,000
    
    
    743,400(11)
    
    
    
    
    
    
    
    
    90,000(3)
    
    
    92,346(12)(13)President, Wireless
    
    
    
    
    
    
    
    1,475,000(6)(14)
    
    
    
    
    
    
    
    
    745,000(8)Networks
    
    2002
    
    
    537,143
    
    
    
    
    
    
    
    
    250,000
    
    
    
    
    
    125,875(12)(13)(15)2001
    
    
    440,417
    
    
    
    
    
    68,713(15)(16)
    
    
    650,000
    
    
    
    
    
    332,020(13)(15)S.L. Spradley**
    
    2003
    
    
    496,667
    
    
    609,325(11)
    
    
    
    
    
    
    
    
    575,000(8)
    
    
    6,000(17)President, Wireline
    
    
    
    
    
    
    
    1,285,000(6)(14)Networks
    
    2002
    
    
    354,275
    
    
    
    
    
    
    
    
    291,999(18)
    
    
    
    
    
    5,500(17)2001
    
    
    269,026
    
    
    
    
    
    
    
    
     (19)
    
    
    
    
    
    5,100(17)C. Bolouri**
    
    2003
    
    
    510,000
    
    
    589,050(11)
    
    
    
    
    
    
    
    
    135,000(3)
    
    
    63,404(4)(5)President, Global
    
    
    
    
    
    
    
    1,275,000(6)(14)
    
    
    
    
    
    
    
    
    535,000(8)Operations
    
    2002
    
    
    510,000
    
    
    
    
    
    
    
    
    250,000
    
    
    
    
    
    18,358(4)(5)2001
    
    
    459,000
    
    
    
    
    
    
    
    
    700,000
    
    
    
    
    
    27,440(4)(5)N.J. DeRoma
    
    2003
    
    
    526,000
    
    
    524,685(11)
    
    
    
    
    
    
    
    
    135,000(3)
    
    
    54,494(4)(5)Chief Legal Officer
    
    
    
    
    
    
    
    1,315,000(6)(14)
    
    
    
    
    
    
    
    
    535,000(8)2002
    
    
    526,000
    
    
    
    
    
    24,038(5)(20)
    
    
    250,000
    
    
    
    
    
    17,885(4)(5)2001
    
    
    493,750
    
    
    
    
    
    62,921(5)(20)
    
    
    650,000
    
    
    
    
    
    27,642(4)(5)
  *
    
    On April 27, 2004, Mr. Dunns employment as President and Chief Executive Officer of the
Company and Nortel Networks Corporation was terminated for cause and Mr. W.A. Owens was
appointed President and Chief Executive Officer of the Company and Nortel Networks
Corporation. The compensation for Mr. W.A. Owens, President and Chief Executive
Officer of the Company and Nortel Networks Corporation, is described below under Certain
Employment Arrangements.**
    
    In accordance with the corporate reorganization announced by Nortel Networks Corporation on
August 19, 2004, effective October 1, 2004, Messrs. Debon and Bolouri and Ms. Spradley were,
respectively, appointed to the positions of: President, Carrier Networks; President, Global
Services; and President, Global Operations.(1)
    
    Incentive cash awards for each fiscal year under the Nortel Networks Limited SUCCESS
Incentive Plan (or SUCCESS Plan), including payments made in connection with the Return to
Profitability bonus program component of that plan, in respect of each of the fiscal years,
whether or not deferred by the named executive officer. On April 27, 2004, the Company and
Nortel Networks Corporation terminated for cause the employment of each of their then
president and chief executive officer, chief financial officer and controller. On August 19,
2004, Nortel Networks Corporation announced that seven individuals with, or who had,
significant responsibilities for financial reporting at the line of business and regional
levels were terminated for cause. Nortel Networks has demanded from these individuals
repayment of any payments made under bonus plans in respect of 2003, including any awards
under the SUCCESS Plan. See footnotes (6) and (7) below.(2)
    
    Mr. Dunn did not receive any annual incentive bonus under the SUCCESS Plan with respect to
2003. See footnotes (1), (6) and (7).(3)
    
    Represents the number of restricted stock units issued and settled in respect of restricted
stock units allocated under the 2001 program of the Nortel Networks Limited Restricted Stock
Unit Plan (or RSU Plan). Restricted stock units allocated in 2001 had a two year performance
period that was divided into five shorter performance segments. The performance criteria
included resizing activity targets for the first segment, and corporate performance objectives
 151




---



##### Table of Contents



under the incentive plan for the remaining four segments. Although the joint leadership
resources committee determined that certain of the distinct performance objectives were not
achieved, it exercised its discretion in May 2003 to authorize the issuance and settlement
in the form of common shares of Nortel Networks Corporation (net of withholding taxes) of 90 percent of the
restricted stock units allocated under the 2001 program based on its consideration of the
improved financial performance of Nortel Networks Corporation during the two-year
performance period and Nortel Networks Corporations overall performance over that period as
compared to its key competitors. The total before tax value of the restricted stock units
that were issued and settled, using the purchase price of common
shares of Nortel Networks Corporation on the date of
purchase, was: Cdn$945,293 ($672,902) for Mr. Dunn; $274,050 for Mr. Debon; Cdn$567,176
($403,741) for Mr. Bolouri; and Cdn$567,176 ($403,741) for Mr. DeRoma. Amounts have been
converted using the exchange rates listed in footnote (5) below.(4)
    
    Represents contributions made under the Nortel
Networks Limited Investment Plan for Employees  Canada.(5)
    
    Represents the United States dollar equivalent of payments actually earned or paid in
Canadian dollars. Amounts have been converted using the average of the exchange rates in
effect during each year equal to US$1.00 = Cdn$1.4048 for 2003, US$1.00 = Cdn$1.5708 for 2002
and US$1.00 = Cdn$1.5489 for 2001.(6)
    
    Represents a Return to Profitability program award under the SUCCESS Plan. Nortel Networks
has demanded that the individuals described in footnote (1) whose employment was terminated
for cause repay any payments made under bonus plans in respect of 2003, including any Return
to Profitability program awards. See footnotes (1), (7) and (14).(7)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, the
Company and Nortel Networks Corporation have demanded repayment of the Return to Profitability
program bonus award under the SUCCESS Plan of $3,540,000 and the 745,000 restricted stock
units issued and settled in respect of restricted stock units allocated under the 2003 program
of the RSU Plan. See footnotes (6) and (8).(8)
    
    Represents the number of restricted stock units issued and settled in respect of restricted
stock units allocated under the 2003 program of the RSU Plan. Each unit entitled the holder
to receive one common share of Nortel Networks Corporation or, subject to certain conditions,
a cash payment equal to the common share value. In respect of payments made under the 2003
program of the RSU Plan, each named executive officer, other than Mr. Dunn, received in July
2003 restricted stock units in connection with the achievement of the first performance
threshold as at the end of the second fiscal quarter of 2003 (100% in the form of common
shares) and in February 2004 restricted stock units in connection with the achievement of the
second performance threshold as at the end of the third fiscal quarter of 2003 (50% in the
form of common shares and 50% in the form of cash). These individuals continue to hold the
common shares received as a result of the settlement of their restricted stock units. Mr.
Dunn received in July 2003 restricted stock units in connection with the achievement of the
first performance threshold (100% in the form of common shares) but did not receive restricted
stock units in connection with the achievement of the second performance threshold. The
before tax total value of restricted stock units issued and settled was: Cdn$2,983,204
($2,123,579) for Mr. Dunn; $3,783,743 for Mr. Debon; $2,920,339 for Ms Spradley; Cdn$3,652,271
($2,599,851) for Mr. Bolouri; and Cdn$3,652,271 ($2,599,851) for Mr. DeRoma. Restricted stock
units are valued using the purchase price of the common shares of
Nortel Networks Corporation on the date of purchase (for
share settlement) and on the average price for the specified 20 day trading period for cash
settlement (where applicable). Amounts have been converted using the exchange rates listed in
footnote (5) above. See Long-term incentive plans  awards in last two fiscal years  2003
for a description of the applicable performance criteria. See footnote (7) above.(9)
    
    These options terminated and expired automatically upon the termination of Mr. Dunns
employment for cause on April 27, 2004.(10)
    
    This amount has been reduced from the previously reported amount to reflect Mr. Dunns
voluntary return for immediate cancellation in June 2003 of 250,000 stock options that were
originally granted in 2001.(11)
    
    Represents a SUCCESS Plan annual incentive award. Nortel Networks has demanded that the
individuals described in footnote (1) whose employment was terminated for cause repay any
payments made under bonus plans in respect of 2003, including any SUCCESS Plan annual
incentive awards.
 152




---



##### Table of Contents



(12)
    
    Certain payments paid in euros have been converted and included in this amount. Payments
have been converted using the average of the exchange rates in effect during each year equal
to US$1.00 = .8830 euros for 2003 and US$1.00 = 1.0615 euros for 2002.(13)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan or Nortel
Networks (UK) Pension Plan, as applicable ($7,200 in 2003, $8,467 in 2002 and $6,068 in 2001),
and expatriate, permanent transfer and other similar expenses related to Mr. Debons global
responsibilities as President, Wireless Networks ($85,146 in 2003, $117,408 in 2002 and
$325,952 in 2001).(14)
    
    Mr. Debon, Bolouri, Ms. Spradley and
Mr. DeRoma have voluntarily undertaken to pay to Nortel Networks
Corporation over a three year period an amount equal to their Return to Profitability program
bonus awarded in 2003 (net of taxes deducted at the source). The following additional current
members of senior management have similarly voluntarily agreed to pay their respective Return
to Profitability program bonus awards: Messrs. Collins, Donovan, Giamatteo, Joannou, Mao,
McFadden, Mumford and Pusey. See Voluntary undertaking: Return to Profitability bonus
program and 2003 restricted stock unit program.(15)
    
    Certain payments paid in United Kingdom pounds have been converted and included in this
amount. Payments have been converted using the average of the exchange rates in effect during
each year equal to US$1.00 = UK£0.6661 for 2002 and US$1.00 = UK£0.6909 for 2001.(16)
    
    Mr. Debons responsibilities during 2001 as President, Wireless Networks were global in
nature and his offices and personal residences spanned several geographies. As a result,
transportation services and benefits (automobile benefits, commercial air travel, train and
car services) for Mr. Debon totaled $48,010 in 2001.(17)
    
    Represents contributions under the Nortel Networks Long-Term Investment Plan.(18)
    
    In June 2001, Nortel Networks Corporation commenced a voluntary stock option exchange program
whereby eligible employees could exchange certain then outstanding stock options for new
options based on a prescribed formula. In January 2002, new stock options were granted to
eligible employees who participated in the stock option exchange program, with exercise prices
at the fair market value of Nortel Networks Corporations common shares on the date of grant.
Prior to Ms. Spradleys appointment as an officer of the Company, she was an employee eligible
to participate in the voluntary stock option exchange program. As a result, 41,999 of the
stock options granted to Ms. Spradley in 2002 were granted pursuant to the voluntary stock
option exchange program.(19)
    
    All of Ms. Spradleys options that were granted in 2001 were cancelled in connection with her
participation in the voluntary stock option exchange program. See footnote (18) above.(20)
    
    Amounts paid to reimburse Mr. DeRoma for income taxes payable by him in accordance with his
employment agreement. Mr. DeRomas employment agreement is described below under Certain
Employment Arrangements.
 
 Annual cash incentive awards Annual cash bonus awards under the SUCCESS Plan are based on achieving corporate and
individual performance objectives for a calendar year. The joint leadership resources committee
retains full discretion in determining whether, and the extent to which, corporate performance
objectives have been met and whether, and to what extent, an annual award under the SUCCESS Plan
will be made. An annual award is determined as a percentage of annual base salary by reference to
individual job scope, complexity, and responsibilities, and by individual performance and
contribution, as well as corporate performance. The joint leadership resources committee recommended the corporate performance objectives for
2004, which were approved by the boards of directors of the Company and Nortel Networks Corporation
in January 2004. The corporate performance objectives for 2004 were revenue, earnings, cash flow
and leadership (which included customer engagement, technology leadership and market perception).
The joint leadership resources committee also have discretion to consider other business factors in
making a final determination of corporate performance for 2004. In June 2004, management
recommended, and the joint leadership resources committee and the boards of directors of the
Company and Nortel Networks Corporation subsequently approved, that financial accountability be
included as a key quantitative factor in the individual leadership performance objectives for
determination of incentive cash awards under the SUCCESS Plan. The financial 153




---



##### Table of Contents



accountability objective includes, among other things: (i) compliance with financial reporting
obligations under United States and Canadian securities laws and the requirements of the
Sarbanes-Oxley Act of 2002; (ii) an assessment of training with respect to financial reporting
responsibilities and understanding of generally accepted accounting principles across Nortel
Networks; and (iii) progress on the implementation of process and system improvements related to
accounting and management information systems across Nortel Networks. As of the date of this
report, no annual cash bonus awards have been made with respect to the fiscal year ended December
31, 2004. 
 Voluntary undertaking: Return to Profitability bonus program and 2003 restricted stock unit program In a letter, dated January 10, 2005, to Mr. Lynton (Red) Wilson, the Chairman of the
board of directors of the Company and Nortel Networks Corporation, the members of the core
executive leadership team of Nortel Networks (each, a Member) affirmed their voluntary,
unilateral and unconditional undertaking to (i) pay to Nortel Networks Corporation over a three
year period an amount equal to the entire Return to Profitability (RTP) bonus paid to each such
Member in 2003 (net of any taxes deducted at the source) regardless of whether the profitability
metrics associated with the RTP were met on a restated basis and (ii) not accept, and accordingly
disclaim, any potential award of either the third or fourth tranches of 2003 restricted stock units
(regardless whether applicable financial targets for these bonuses were achieved). The Members
indicated in their letter that, while they did not engage in the improper accounting activities
identified by the Independent Review, they share the board of directors deep disappointment in
these actions and events and are determined to make clear to Nortel Networks employees, investors
and others that such activities are unacceptable to them. The following table sets forth the amount of the RTP bonus (the RTP Amount) to be paid by
each Member: Member
    RTP Amount (Net)Chahram Bolouri
    Cdn. $891,697Malcolm Kevin Collins
    GBP £395,409Pascal Debon
    U.S. $1,078,963Nicholas John DeRoma
    Cdn. $953,747William John Donovan
    U.S. $640,271John Joseph Giamatteo
    U.S. $259,875Dion Constandino Joannou
    U.S. $328,412Robert Yu Lang Mao
    U.S. $627,500Brian William McFadden
    Cdn. $899,630Donald Gregory Mumford
    Cdn. $921,500Stephen Charles Pusey
    GBP £473,173Susan Louise Spradley
    U.S. $967,694
 
 Option grants in 2004 and 2003 No options were granted to any of the named executive officers for 2004 during the fiscal
year ended December 31, 2004 and no options were granted to any of the named executive officers for
2003 during the fiscal year ended December 31, 2003. 154




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



(3)
    
    As Nortel Networks Corporation grants both United States dollar and Canadian dollar stock
options, the options are listed separately for each currency, where applicable. Unless
otherwise stated, all options are United States dollar options.(4)
    
    As at December 31, 2003, all of the outstanding exercisable or unexercisable United States
dollar or Canadian dollar stock options held by the named executive officers had an exercise
price that exceeded the closing price of Nortel Networks Corporations common shares on the
last trading day of the year on, respectively, the New York Stock Exchange for United States
stock options and on the Toronto Stock Exchange for Canadian stock options. On December 31,
2003, the closing price of Nortel Networks Corporations common shares on the New York Stock
Exchange and the Toronto Stock Exchange was $4.23 and Cdn$5.49, respectively. The weighted
average exercise price of the outstanding exercisable and unexercisable United States dollar
and Canadian dollar stock options as at December 31, 2003 was: Cdn$8.95 for options held by
Mr. Dunn; $14.51 for options held by Mr. Debon; $6.30 for options held by Ms. Spradley;
Cdn$37.06 for options held by Mr. Bolouri; and Cdn$25.18 for Mr. DeRomas Canadian dollar
stock options and $11.29 for his United States dollar stock options. Where applicable,
weighted average price has been calculated assuming that replacement options that currently do
not have set exercise prices will have exercise prices equal to the exercise prices of the
corresponding initial options. See footnote (2) above.(5)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, all
options held by Mr. Dunn terminated and expired automatically on April 27, 2004, including all
performance accelerated stock options. Previously, in June 2003, Mr. Dunn voluntarily
returned for immediate cancellation 934,668 previously granted Canadian dollar stock options,
comprised of 851,334 exercisable plus 83,334 unexercisable options as well as 120,000
exercisable replacement options referenced in footnote (2) above. See also footnote (7)
below.(6)
    
    One third of the performance accelerated stock options previously granted to Messrs. Dunn,
Debon, Bolouri and DeRoma in 2001 vested and became exercisable in December 2003. Other than
Mr. Dunn, who did not have any additional performance accelerated stock options accelerated,
the remaining two thirds of the performance accelerated stock options held by Messrs. Debon,
Bolouri and DeRoma vested and became exercisable in January 2004.(7)
    
    In June 2003, Mr. Dunn voluntarily turned in for immediate cancellation 200,000 unexercisable
United States dollar stock options originally granted in July 1999.(8)
    
    Prior to Ms. Spradleys appointment as an officer of the Company and Nortel Networks
Corporation, she was an employee eligible to participate in the voluntary stock option
exchange program. As a result, 41,999 of the stock options granted to Ms. Spradley in 2002
were granted pursuant to the voluntary stock option exchange program. Of those options,
35,332 were exercisable as of December 31, 2003.
 157




---



##### Table of Contents



Long-term incentive plans  awards in last two fiscal years No long-term incentives were granted under any long-term incentive plan to any of the
named executive officers for 2004 during the fiscal year ended December 31, 2004. The following table sets forth certain information concerning the allocation of restricted
stock units to the named executive officers for 2003 under the Nortel Networks Limited Restricted
Stock Unit Plan (or RSU Plan) during the fiscal year ended December 31, 2003. Performance or Other
        Period Until
        Maturation or Payout
        (2)
    
    Estimated Future Payouts Under Non-Share
        Price Based PlansNumber of Shares,
        Units or Other Rights
        (#)(1)(2)Name
    
    
    
    Threshold (#)
    
    Target (#)
    
    Maximum (#)(2)F.A. Dunn
    
    
    2,980,000(3)
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    2,980,000(3)P. Debon
    
    
    1,490,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,490,000S.L. Spradley
    
    
    1,150,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,150,000C. Bolouri
    
    
    1,070,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,070,000N.J. DeRoma
    
    
    1,070,000
    
    
    
    2003 to 2005
    
    
    
    0
    
    
    
    0
    
    
    
    1,070,000
  (1)
    
    When issued and settled, a restricted stock unit entitles the holder to receive one
common share of Nortel Networks Corporation or, in the discretion of the joint leadership
resources committee or at the election of the holder in certain circumstances, cash in lieu
thereof.(2)
    
    The 2003 program has a three-year performance period ending December 31, 2005. The
three-year performance period includes four performance thresholds that may be achieved at any
time during the performance period. The performance criteria for each of the four thresholds
are distinct Return on Sales before Tax (or ROSBT) percentage targets, calculated on a
rolling four-quarter basis. The joint leadership resources committee assesses Nortel Networks
Corporations performance on a quarterly basis against each of these thresholds and further
considers Nortel Networks Corporations performance as compared to its competitors and certain
business, financial, competitive, political and other relevant criteria in determining, in the
committees discretion, whether any or a portion of the allocated restricted stock units will
be issued and settled to participants. In respect of 2003, the committee exercised its
discretion to authorize the issuance of restricted stock units to the named executive officers
based, among other things, on the achievement of two performance thresholds. On January 10,
2005, the joint leadership resources committee exercised the discretion reserved to it with
respect to the 2003 program of the RSU Plan and determined, and the boards of directors of the
Company and Nortel Networks Corporation confirmed and approved, that no additional restricted
stock units will be issued with respect to the 2003 program (including in connection with the
achievement of the third and fourth ROSBT performance targets or otherwise) and that all
unissued restricted stock units under the 2003 program are immediately terminated and
cancelled in their entirety. Information regarding restricted stock units issued and settled
under the 2003 program of the RSU Plan is disclosed in the Summary Compensation Table  2003
above under Long Term Compensation  Payouts. On April 27, 2004, the Company and Nortel
Networks Corporation terminated for cause the employment of each of their then chief financial
officer and controller. The Company and Nortel Networks Corporation have demanded repayment
from the chief financial officer and controller of the restricted stock units issued and
settled in July 2003 with respect to the achievement of the first performance threshold and,
with respect to the controller, the restricted stock units issued and settled in January 2004
with respect to the achievement of the second performance threshold. All restricted stock
units allocated to the chief financial officer and the controller that were not issued have
been forfeited. See footnote (3) regarding restricted stock units allocated to the president
and chief executive officer.(3)
    
    As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, Mr.
Dunns allocated but unissued restricted stock units were automatically forfeited. With
respect to the restricted stock units issued to him and settled in July 2003 with respect to
the achievement of the first performance threshold, the Company and Nortel Networks
Corporation have demanded repayment as noted in the Summary Compensation Table above.
 158




---



##### Table of Contents



Retirement plans Nortel Networks Corporation has several pension plans. The following descriptions relate
to pension plans to which the named executive officers for 2004 and the named executive officers
for 2003 are eligible to participate. The non-contributory defined benefit pension plans (or base plans) in Canada and in the United
States are generally available to employees and executives who were participants prior to May 1,
2000. There is also the Nortel Networks Supplementary Executive Retirement Plan which is available
to eligible executives. The benefit calculated under the Supplementary Executive Retirement Plan
is reduced by the pension benefits payable under the registered/qualified defined benefit pension
plans and the non-qualified/excess plans. Effective January 1, 2000, the Supplementary Executive
Retirement Plan was closed to new participants. Defined Benefit Pension Plan  Canada A defined benefit pension plan, the Nortel Networks Limited Managerial and Non-Negotiated
Pension Plan, is maintained for eligible employees and executives in Canada. This plan has two
different formulas, called Part I and Part II. The Part I formula provides a monthly benefit at retirement based on years of service and a
pension accrual of 1.3 percent of the average annual earnings of the best three consecutive years.
An early retirement reduction applies for retirement prior to age 60. Eligible earnings include
base salary and, where applicable, overtime, off-shift differentials and an individual sales
commission factor. Effective January 1, 1999, the Part I defined benefit formula was closed to new
participants. The Part II formula was introduced January 1, 1999. Employees who were participants in Part I
could continue to participate in Part I, or move to the new Part II formula, at their election.
Part II provides a benefit based on pension credits and the average annual earnings for the highest
three consecutive years in the last ten years prior to retirement or other termination of
employment. Pension credits are earned during each year of participation based on the
participants age attained in the year and on years of service. Eligible earnings include base
salary and, where applicable, incentive awards or bonuses, if any, paid under the Nortel Networks
Limited SUCCESS Incentive Plan (or SUCCESS Plan), overtime, off-shift differentials and sales
commissions. Effective May 1, 2000, the Part II defined benefit formula was closed to new
participants. The Part II benefit can be paid in a lump sum or as an actuarially equivalent annuity. Under
the annual income option, there are reductions for retirement prior to normal retirement age of 65.
Certain grandfathering rules exist for employees and executives who were participating in the
pension plan as at December 31, 1998. The Income Tax Act (Canada) (or ITA) limits the amount of pension that may be paid under a
registered pension plan. Pension benefits within the ITA limit are funded by a pension trust that
is separate from the general assets of the Company. Pension benefits that exceed the ITA limits
are paid from an excess plan, and are funded from the Companys general assets and the general
assets of Nortel Networks Technology Corporation (or NNTC), an
affiliate of the Company. Defined Benefit Pension Plan  United States A defined benefit pension plan, the Nortel Networks Retirement Income Plan, is maintained for
eligible employees and executives in the United States. Benefits are paid to plan participants
under one of two formulas, depending on elections made by the plan participant: the Pension
Service Plan (or PSP) formula or the Cash Balance Plan formula. The PSP formula is available for participants who are employees of Nortel Networks Inc. (or
NNI) or other Nortel Networks subsidiaries located in the United States who enrolled in the plan
prior to May 1, 2000, and who elected prior to May 1, 2000 to be covered by the PSP formula. As of
May 1, 2000, the PSP formula under the Nortel Networks Retirement Income Plan was closed to new
participants. The PSP formula provides a benefit based on pension credits and average earnings for
the highest 1,095 consecutive calendar days of compensation out of the last 3,650 days prior to
retirement or other termination of employment. Pension credits are earned during each year of
participation based on the participants age attained in the year and on years of service.
Eligible earnings include base salary and, where applicable, incentive awards or bonuses, if any,
paid under the SUCCESS Plan, overtime, off-shift differentials and sales commissions. 159




---



##### Table of Contents



A new defined benefit pension formula, the Cash Balance Plan, was established, effective May
1, 2000, based on pay credits and interest credits. Employees who were participants in the PSP
could continue to participate in the PSP, or move to the new Cash Balance Plan, or elect to opt out
of the pension plan. The Cash Balance Plan formula provides a monthly credit equal to 4% of
eligible earnings, with interest being credited monthly based on the months starting balance.
Eligible earnings include base salary and, where applicable, incentive awards or bonuses, if any,
paid under the SUCCESS Plan, overtime, off-shift differentials and sales commissions earned prior
to retirement or other termination of employment. The PSP and Cash Balance Plan benefits can be paid in a lump sum or as an actuarially
equivalent annuity. Certain grandfathering rules exist for employees and executives who were participating in the
pension plan as at December 31, 1998. Federal laws place limitations on compensation amounts that may be included under a qualified
pension plan ($205,000 in 2004) as well as limitations on the total benefit that may be paid from
such plans. Pension benefits within the limit are funded by a pension trust that is separate from
the general assets of NNI. Pension benefits applicable to compensation that exceeds federal
limitations and pension benefits in excess of the limitations on total benefits are paid from a
restoration (excess) plan, and are funded from NNIs general assets. Supplementary Executive Retirement Plan Eligible executives in Canada and the United States also participate in the Supplementary
Executive Retirement Plan (or SERP). Effective January 1, 2000, the SERP was closed to new
participants and there are only 19 executives who remain eligible to participate in the SERP. For Canadian executives participating in the SERP as at December 31, 1998 who elected,
effective January 1, 1999, to remain in Part I of the pension plan, the SERP formula provides a
benefit based on years of service and a pension accrual of 1.3 percent of the final average
earnings of the best three consecutive years. An early retirement reduction of seven percent a
year prior to age 60 applies in the case of retirement prior to this age. The maximum total annual
retirement benefit cannot exceed 60 percent of an executives final average earnings at retirement.
Eligible earnings include base salary plus the incentive award or bonus, if any, paid under the
SUCCESS Plan, and commissions, however a bonus or commissions will not be included in a given year
to the extent that it exceeds 60 percent of a participants base salary for that calendar year. New SERP plan provisions, which became effective January 1, 1999 and are applicable to Part II
members participating in the Canadian plan and to US PSP formula members, provide a benefit based
on pension credits and final average earnings for the highest three consecutive years in the last
ten years prior to retirement, to a maximum benefit of 550 percent of final average earnings.
Pension credits are earned during each year of participation based on the participants age
attained in the year and on years of service. Eligible earnings include base salary plus the
incentive award or bonus, if any, paid under the SUCCESS Plan, and commissions, however a bonus or
commissions will not be included in a given year to the extent that it exceeds 60 percent of a
participants base salary for that calendar year. All participating executives at December 31, 1998 have their benefits protected under the
pre-1999 grandfathered SERP formula. Pension benefits from the SERP are funded from the general assets of, respectively, the
Company and NNTC in Canada and Nortel Networks Inc. in the United States. The following tables show the aggregate approximate annual retirement benefits for an eligible
executive officer for certain compensation and years of service categories assuming retirement at
age 65, and assuming grandfathering provisions do not apply. Table I estimates the total retirement benefit (including the SERP) for all participating
United States executives (PSP formula members), and for participating Canadian executives who
elected and continue to participate in Part II of the Nortel Networks Limited Managerial and
Non-Negotiated Pension Plan. It estimates the benefit payable as a life annuity with a 60 percent
survivor pension. The approximate benefits for the service of Messrs. Debon, McFadden and DeRoma (named
executive officers in 2004) and Mr. Bolouri (a named executive officer in 2003, along with Messrs.
Debon and DeRoma) are shown in Table I. The approximate total eligible earnings and years of
credited pensionable service at December 31, 2004 was: $808,525 and 160




---



##### Table of Contents



4.92 years of United States service for Mr. Debon; $708,816 and 27.50 years of Canadian
service for Mr. McFadden; and $823,931 and 5.58 years of Canadian pensionable service for Mr.
DeRoma. Mr. DeRoma is also eligible to receive additional credited pensionable service, up to a
maximum of 8.125 years, under the terms of his employment agreement. See Certain Employment
Arrangements. The approximate total eligible earnings and years of credited pensionable service
for Mr. Bolouri at December 31, 2003 was $696,984 and 22 years of Canadian service. Table I Years of ServiceTotal Earnings
    15
    20
    25
    30
    35$600,000
    
    $138,578
    
    
    $169,034
    
    
    $207,612
    
    
    $235,023
    
    
    $273,602700,000
    
    161,674
    
    
    197,206
    
    
    242,215
    
    
    274,194
    
    
    319,202800,000
    
    184,770
    
    
    225,379
    
    
    276,817
    
    
    313,365
    
    
    364,802900,000
    
    207,866
    
    
    253,551
    
    
    311,419
    
    
    352,535
    
    
    410,4031,000,000
    
    230,963
    
    
    281,724
    
    
    346,021
    
    
    391,706
    
    
    456,0031,100,000
    
    254,059
    
    
    309,896
    
    
    380,623
    
    
    430,876
    
    
    501,6031,200,000
    
    277,155
    
    
    338,068
    
    
    415,225
    
    
    470,047
    
    
    547,2031,300,000
    
    300,251
    
    
    366,241
    
    
    449,827
    
    
    509,217
    
    
    592,8041,400,000
    
    323,348
    
    
    394,413
    
    
    484,429
    
    
    548,388
    
    
    638,4041,500,000
    
    346,444
    
    
    422,585
    
    
    519,031
    
    
    587,558
    
    
    684,0041,600,000
    
    369,540
    
    
    450,758
    
    
    553,633
    
    
    626,729
    
    
    729,6051,700,000
    
    392,636
    
    
    478,930
    
    
    588,235
    
    
    665,900
    
    
    775,2051,800,000
    
    415,733
    
    
    507,102
    
    
    622,837
    
    
    705,070
    
    
    820,8051,900,000
    
    438,829
    
    
    535,275
    
    
    657,439
    
    
    744,241
    
    
    866,4062,000,000
    
    461,925
    
    
    563,447
    
    
    692,042
    
    
    783,411
    
    
    912,006
 Table II estimates the benefits calculated under the United States Cash Balance Plan formula
under the Nortel Networks Retirement Income Plan for participating employees and executives,
payable as a straight life annuity. The approximate benefits for Mr. Owens and Ms. Spradleys service are shown in Table II. The
approximate total eligible earnings and years of credited service at December 31, 2004 for Mr.
Owens was $680,328 and .75 years of United States service and $1,139,325 and 16.67 years of United
States service for Ms. Spradley. As Mr. Owens and Ms. Spradley are in the Cash Balance Plan,
eligible earnings for 2004 reflect 2004 base salary and for Ms. Spradley it also included the
one-time award paid during 2004 under the SUCCESS Plan. Mr. Owens is also eligible for a Special
Pension Arrangement. See Certain Employment Arrangements. 161




---



##### Table of Contents



Table II Years of ServiceTotal Earnings
    5
    10
    15
    20
    25
    30
    35$600,000
    
    $10,330
    
    
    $20,659
    
    
    $30,989
    
    
    $41,318
    
    
    $51,648
    
    
    $61,978
    
    
    $72,308700,000
    
    12,051
    
    
    24,102
    
    
    36,153
    
    
    48,204
    
    
    60,256
    
    
    72,307
    
    
    84,359800,000
    
    13,773
    
    
    27,546
    
    
    41,318
    
    
    55,091
    
    
    68,864
    
    
    82,637
    
    
    96,411900,000
    
    15,494
    
    
    30,989
    
    
    46,483
    
    
    61,977
    
    
    77,472
    
    
    92,967
    
    
    108,4621,000,000
    
    17,216
    
    
    34,432
    
    
    51,648
    
    
    68,863
    
    
    86,080
    
    
    103,296
    
    
    120,5131,100,000
    
    18,938
    
    
    37,875
    
    
    56,813
    
    
    75,750
    
    
    94,688
    
    
    113,626
    
    
    132,5651,200,000
    
    20,659
    
    
    41,318
    
    
    61,977
    
    
    82,636
    
    
    103,296
    
    
    123,956
    
    
    144,6161,300,000
    
    22,381
    
    
    44,762
    
    
    67,142
    
    
    89,522
    
    
    111,904
    
    
    134,285
    
    
    156,6671,400,000
    
    24,103
    
    
    48,205
    
    
    72,307
    
    
    96,409
    
    
    120,512
    
    
    144,615
    
    
    168,7191,500,000
    
    25,824
    
    
    51,648
    
    
    77,472
    
    
    103,295
    
    
    129,120
    
    
    154,945
    
    
    180,7701,600,000
    
    27,546
    
    
    55,091
    
    
    82,636
    
    
    110,181
    
    
    137,728
    
    
    165,274
    
    
    192,8211,700,000
    
    29,267
    
    
    58,534
    
    
    87,801
    
    
    117,068
    
    
    146,336
    
    
    175,604
    
    
    204,8731,800,000
    
    30,989
    
    
    61,978
    
    
    92,966
    
    
    123,954
    
    
    154,944
    
    
    185,933
    
    
    216,9241,900,000
    
    32,711
    
    
    65,421
    
    
    98,131
    
    
    130,840
    
    
    163,552
    
    
    196,263
    
    
    228,9752,000,000
    
    34,432
    
    
    68,864
    
    
    103,296
    
    
    137,727
    
    
    172,160
    
    
    206,593
    
    
    241,027
 On April 27, 2004, the Company and Nortel Networks Corporation terminated for cause the
employment of each of their then president and chief executive officer, chief financial officer and
controller. On August 19, 2004, Nortel Networks Corporation announced that seven individuals with,
or who had, significant responsibilities for financial reporting at the line of business and
regional levels were terminated for cause and that Nortel Networks will demand repayment of
payments made under bonus plans in respect of 2003. As a result, where applicable and permitted
under applicable law, the pension benefits for the terminated executives were recalculated to
include base salary only in 2003. As a result of the termination of Mr. Dunns employment for cause on April 27, 2004, he was no
longer eligible for any SERP benefit that would have otherwise applied as a result of his past
election to remain in Part I of the pension plan. Upon the termination of his employment for
cause, Mr. Dunn received Cdn$2,416,517.18 representing the commuted value of the pension benefits
accrued pursuant to the Nortel Networks Limited Managerial and Non-Negotiated Pension Plan. The
payment was calculated based on Mr. Dunns 27.92 years of service in accordance with the Part I
formula described under Defined Benefit Pension Plan  Canada. 
 Certain employment arrangements On August 31, 2004, the Company and Nortel Networks Corporation entered into an
employment agreement with William A. Owens confirming Mr. Owens appointment as President and Chief
Executive Officer of the Company and Nortel Networks Corporation as of April 27, 2004. The
agreement provides that Mr. Owens will receive a base salary of $1,000,000 and will be eligible for
a targeted annual bonus of 170% of base salary under the Nortel Networks Limited SUCCESS Incentive
Plan. Under the agreement, Mr. Owens will receive a special pension benefit that will accrue
ratably over the first five years of his employment as President and Chief Executive Officer.
Assuming retirement at the end of such five years, Mr. Owens will receive an estimated monthly
pension benefit of $33,540, payable over the five year period following his retirement. Mr. Owens is based at the registrants offices in Ontario, Canada. In connection with his
relocation to Ontario, Mr. Owens will be eligible for certain benefits under the Nortel
Networks-International Assignment Relocation program, in accordance with the generally applicable
terms of such program and consistent with his senior executive position. Mr. DeRoma entered into an employment agreement in April 1997, prior to commencing employment
as Vice-President and Deputy General Counsel. Pursuant to the
agreement, the Company agreed to make a gross-up payment to Mr. DeRoma for calendar years 1997 through 2000.
The gross-up payment was intended to place Mr. DeRoma in the same after-tax position with respect
to his base salary and any annual incentive award as if he were a 162




---



##### Table of Contents



resident of the State of Connecticut and a taxpayer in the United States. After June 2000,
this gross-up was subject to annual review by the joint leadership resources committee of the
boards of directors of the Company and Nortel Networks Corporation, and was not renewed subsequent
to March 2002. Under the terms of the agreement, Mr. DeRoma is also eligible for the Nortel
Networks Limited Special Pension Credit Program which covered new executive hires older than age
35. Mr. DeRoma will be credited, for pension purposes, with additional years and months equal to
one half of the years between the age of 35 and Mr. DeRomas age at the time of hire, if he retires
after the age of 60, to a maximum of 8.125 years. Other than Mr. Dunn, each of the named executive officers and certain other executive officers
of the Company, including the current President and Chief Executive Officer, currently participate
in the Nortel Networks Corporation Executive Retention and Termination Plan (or ERTP). The ERTP
provides that if a participants employment is terminated without cause within a period commencing
30 days prior to the date of a change in control of Nortel Networks Corporation and ending 24
months after the date of a change in control of Nortel Networks Corporation, or the participant
resigns for good reason (including, among other things, a reduction in overall compensation,
geographic relocation or reduction in responsibility, in each case without the consent of the
participant) within 24 months following the date of a change in control of Nortel Networks
Corporation, the participant will be entitled to certain payments and benefits, including (i) the
payment of an amount equal to three times (in the case of the chief executive officer) and two
times (in the case of the other named executive officers) of the participants annual base salary;
(ii) the payment of an amount equal to 300 percent (in the case of the chief executive officer) and
200 percent (in the case of the other named executive officers) of the participants target annual
incentive bonus; (iii) accelerated vesting of all or substantially all stock options; and (iv) the
pay-out at target of any restricted stock units under the Nortel Networks Limited Restricted
Stock Unit Plan. For purposes of the ERTP, a change in control is deemed to occur if:  (i)
    
    any party or group acquires beneficial ownership of securities of Nortel
Networks Corporation representing more than 20 percent of the outstanding securities
entitled to vote in the election of directors of Nortel Networks Corporation;(ii)
    
    Nortel Networks Corporation participates in a business combination, including,
among other things, a merger, amalgamation, reorganization, sale of all or
substantially all of its assets, or plan of arrangement, unless the business
combination only involves Nortel Networks Corporation and/or its affiliates or,
following the completion of the business combination, Nortel Networks Corporations
common shareholders beneficially own, directly or indirectly, more than 50 percent of
the then-outstanding voting shares of the entity resulting from the business
combination (or of an entity which ultimately controls such entity) and a majority of
the members of the board of directors of the entity resulting from the business
combination (or the entity ultimately controlling such entity) were members of the
board of directors of Nortel Networks Corporation when the business combination was
approved or the initial agreement in connection with the business combination was
executed;(iii)
    
    the persons who were directors of Nortel Networks Corporation on the effective
date of the ERTP cease (for reasons other than death or disability) to constitute at
least a majority of Nortel Networks Corporations board of directors; provided, that
any person who was not a director on the effective date of the ERTP shall be deemed to
be an incumbent director if such person was elected or appointed to Nortel Networks
Corporations board of directors by, or on the recommendation of or with the approval
of, at least two-thirds of the directors who then qualify as incumbent directors unless
such election, appointment, recommendation or approval was the result of any actual or
publicly threatened proxy contest for the election of directors; or(iv)
    
    any other event occurs which Nortel Networks Corporations board of directors
determines in good faith could reasonably be expected to give rise to a change in
control. Until June 30, 2003, each of the named executive officers (other than Mr. Dunn) and certain
other executive officers of Nortel Networks Corporation were eligible to participate in the Nortel
Networks Corporation Special Retention Plan (or SRP). The SRP provided that if a participants
employment was terminated by the participant for good reason or by Nortel Networks Corporation
without cause during the period from November 1, 2001 to June 30, 2003, that participant would have
been entitled to certain payments and benefits. Other than payments made in accordance with the
SRP in March 2003 in connection with a former executive officers previously announced termination
of employment, no amounts were paid or became payable in 2003 to any executive officer prior to
June 30, 2003. 163




---



##### Table of Contents



Compensation of directors Effective January 1, 2002, each non-employee director of the Company and Nortel Networks
Corporation elected to receive all compensation for services rendered as a member of the board of
directors of the Company and Nortel Networks Corporation, any committees thereof, and as board or
committee chairperson, in the form of share units, instead of cash, under the Directors Deferred
Share Compensation Plans maintained by the Company and Nortel Networks Corporation. The share
units are settled a specified number of trading days following the release of Nortel Networks
Corporations financial results after the director ceases to be a member of the applicable board,
and each share unit entitles the holder to receive one common share of Nortel Networks Corporation.
Effective January 1, 2004, each non-employee director of the Company and Nortel Networks
Corporation was entitled to elect to receive fees in cash, in share units under the Directors
Deferred Share Compensation Plans or in a combination of cash and share units. The compensation of directors is considered on a combined basis in light of the overall
governance structure of the Company and Nortel Networks Corporation. Director compensation is set
solely on an annual fee basis (paid quarterly in arrears) and fees are not paid for board or
committee meeting attendance. From January 1, 2002 to December 31, 2003, directors of the Company
and Nortel Networks Corporation, who were not salaried employees of the Company or any of its
subsidiaries, received an annual Company board retainer of $50,000, an annual
committee membership retainer of $12,500 (or $6,250 each for membership on the same committee of
the boards of the Company and Nortel Networks Corporation) and, except as noted below, an annual
committee chairperson fee of $7,500 (or $3,750 each for chairing the same committee of the boards
of the Company and Nortel Networks Corporation). Effective July 25, 2002, the fee for the audit
committee chairperson was increased to $17,500 (or $8,750 for each audit committee of the Company
and Nortel Networks Corporation) in recognition of the significant responsibilities assumed by the
audit committee chairperson. Annual directors fees were initially increased effective January 1, 2004, after having been
essentially unchanged for the previous two year period, as described above. However, in light of
the challenges subsequently faced by the Company and Nortel Networks Corporation, the boards of
directors in July 2004 decreased the annual directors fees back to the fees in effect prior to
January 1, 2004. The boards of directors also determined that the directors fees to be paid
during the remainder of 2004 would be reduced so that the total amount of the directors fees paid
for 2004 would equal the amount of fees that would have been paid under the 2003 directors fee
schedule. Accordingly, the net effect of these determinations was that the directors fees paid to
non-employee directors remain essentially unchanged since January 1, 2002. Between January 1, 2004 to June 30, 2004, directors of the Company and Nortel Networks
Corporation, who were not salaried employees of Nortel Networks Corporation or any of its
subsidiaries, received an annual Company board retainer of $60,000 and an
annual committee membership retainer and, except as described below, an annual committee
chairperson retainer of $12,500 (or $6,250 each for membership on or chairing the same committee of
the boards of the Company and Nortel Networks Corporation). The fee for the audit committee
chairperson was $27,500 or $13,750 for each audit committee, in recognition of the significant
responsibilities assumed by the audit committee chairperson. Nortel Networks Corporation maintains, at its cost, life insurance for directors, who are not
salaried employees of the Company and Nortel Networks Corporation. Such insurance is in an amount
of Cdn$100,000 while a director and in an amount of Cdn$75,000 following retirement at or after age
65 or, at any lesser age after ten years of board membership (including Company board membership). Directors entitled to the above remuneration are also reimbursed for reasonable travel and
living expenses properly incurred by them in attending any meetings of the boards of directors of
the Company and Nortel Networks Corporation or their committees or for performing services as
directors. Effective January 1, 2004, amended share ownership guidelines adopted by the boards of
directors of the Company and Nortel Networks Corporation require each non-chairman
director to own, directly or indirectly, common shares of Nortel Networks Corporation having a fair
market value of at least $300,000 within five years from the earlier of the date he or she was
first elected or appointed to the boards of directors of the Company or Nortel Networks
Corporation. Share ownership guideline compliance must thereafter be maintained during an
individuals tenure as a director. The chairman of the board must own, directly or indirectly,
common shares of Nortel Networks Corporation having a fair market value of at least $1,600,000
within five years from the earlier of the date he or she was first appointed as chairman of the
boards of directors of the Company or Nortel Networks Corporation. A newly elected director is
required to elect to receive at least 50 percent of his or her annual compensation for serving as a
director of the Company and Nortel 164




---



##### Table of Contents



Networks Corporation or, in the case of a newly appointed chairman of the board of directors, at
least 50 percent of his or her annual compensation for serving as a director and as chairman of the
board of directors of the Company and Nortel Networks Corporation, in the form of share units until
such time as the share ownership guidelines are met. Share units credited under the Directors
Deferred Share Compensation Plans are included in the calculation of the number of common shares of
Nortel Networks Corporation owned by a director for this purpose. Messrs. Bischoff and Manley have been prevented
under applicable securities laws from participating in the Directors Deferred Share Compensation
Plans due to the delay in the filing of the restated financial statements and related periodic
reports of the Company and Nortel Networks Corporation. Retirement benefits are not paid to non-employee directors of Nortel Networks
Corporation, or to non-employee directors of the Company elected after
January 1, 1996. Non-employee directors of the Company elected prior to January 1, 1996 are
entitled to receive retirement benefits equal to 75 percent of the greater of $27,500 and the
annual retainer paid to each director at retirement, indexed to reflect approximately half of the
increase in directors retainers after retirement. The benefits are payable for a maximum of ten
years. From his appointment in April 2001 to December 31, 2003, Mr. Wilsons additional compensation
for serving as non-executive chairman of the board of directors of the Company and Nortel Networks
Corporation from each of the Company and Nortel Networks Corporation was $45,000 per fiscal
quarter. As with the directors annual fees, Mr. Wilsons additional compensation for serving as
non-executive chairman of the board of the Company and of Nortel Networks Corporation was initially
increased to $50,000 per fiscal quarter from each of the Company and Nortel Networks Corporation
for the period from January 1, 2004 to June 30, 2004. Effective July 1, 2004, his additional
compensation for serving as non-executive chairman of the board of directors of the Company and of
Nortel Networks Corporation was reduced back to the $45,000 per fiscal quarter that was being paid
prior to January 1, 2004 by each of the Company and Nortel Networks Corporation. The boards of
directors also determined that the amount of additional compensation for serving as non-executive
chairman paid to Mr. Wilson from July 1, 2004 to December 31, 2004 would be reduced so that the
total amount of additional compensation to be paid to Mr. Wilson in 2004 for serving as
non-executive Chairman would equal his pre-2004 compensation. The net effect of these
determinations was that the additional fees paid to Mr. Wilson for serving as non-executive
Chairman remain unchanged since his original appointment. 
 Compensation committee interlocks and insider participation The joint leadership resources committee of the boards of directors of the Company and
Nortel Networks Corporation is comprised of members from the boards of directors of the Company and
Nortel Networks Corporation. The members of the joint committee are Messrs. R.E. Brown (chairman),
S.H. Smith, Jr., and L.R. Wilson. Mr. Owens served as a member of the joint committee until April
27, 2004, but resigned from the committee prior to being appointed President and Chief Executive
Officer of the Company and Nortel Networks Corporation. No other changes to the membership of the
joint committee have occurred during 2004 or 2003. No member of the joint committee was an officer
(within the meaning of applicable United States securities rules) or employee of Nortel Networks
Corporation or any of its subsidiaries at any time during 2004 or 2003. No executive officer of the Company serves on the board of directors or compensation committee
of any other entity that has or has had one or more of its executive officers serving as a member
of the Companys board of directors. 165




---



##### Table of Contents



ITEM 12.   Security Ownership of Certain Beneficial Owners and Management 
 Security ownership of certain beneficial owners The following table shows the number of common shares of the Company beneficially owned
by persons who are known to the Company to be beneficial owners of more than five percent of the
Companys common shares as of December 31, 2004. Name and Address ofBeneficial Owner
    
    
    
    Title of Classof Security
    
    
    
    Amount and Nature ofBeneficial Ownership
    
    
    
    Percent ofClassNortel Networks Corporation8200 Dixie Road, Suite 100Brampton, Ontario, Canada L6T 5P6
    
    
    
    Common shares of the Company
    
    
    
    1,460,978,638
    
    
    
    100
 
 
 Security ownership of directors and management The following table shows the number of common shares of Nortel Networks Corporation and
Bookham Technology plc beneficially owned, as of January 7, 2005 (unless otherwise noted), by each
of the Companys directors, nominees for directors and the individuals named in the 2004 and 2003
summary compensation tables set forth above under Executive Compensation, as well as by the
directors and executive officers as a group, with the exception that common shares held under
Canadian and U.S. investment plans and common shares subject to stock options are as of December
31, 2004. Bookham Technology plc was an affiliate of the Company as
of December 31, 2004. None of the directors, nominees for
election as director, or executive officers of the Company
beneficially own any common or preferred shares of the Company. A person is deemed to be a beneficial owner of a common share if that person has, or shares,
the power to direct the vote or investment of the common share. Under applicable United States
securities laws, a person is also deemed to be a beneficial owner of a common share if such person
has the right to acquire the share within 60 days (whether or not, in the case of a stock option,
the current market price of the underlying common share is below the stock option exercise price).
More than one person may be deemed a beneficial owner of a common share and a person need not have
an economic interest in a share to be a beneficial owner. 166




---



##### Table of Contents



Amount and Nature ofName of Beneficial Owner
    
    
    Title of Class of Security
    
    
    Beneficial Ownership(1)M. Bischoff*
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    J.J. Blanchard
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    19,392
114,395
    (2)
(3)R.E. Brown
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    417,281
123,254
    (4)
(3)J.E. Cleghorn
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    29,000
132,249
    (5)
(3)L.Y. Fortier
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    22,585
132,889
    (6)
(3)R.A. Ingram
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    10,756 
133,243
    (7)
(3)J.A. MacNaughton**
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    42,804,520


(8)J. Manley*
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    R.D. McCormick**
    
    
    Common shares of Nortel Networks Corporation
    
    
    

100,000W.A. Owens
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    
103,917
    (3)H.J. Pearce**
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    10,000G. Saucier
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    28,673 
129,397
    (9)
(3)S.H. Smith, Jr.
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    131,192
157,173
    (10)
(3)L.R. Wilson
    
    
    Common shares of Nortel Networks Corporation
Share units
    
    
    
    1,201,871
564,470
    (11)
(3)F.A. Dunn***
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    793,510
    (12)P. Debon
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,958,167
    (13)B.W. McFadden
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,718,388
    (14)S.L. Spradley
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    615,255
    (15)C. Bolouri****
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,909,380
    (16)N.J. DeRoma
    
    
    Common shares of Nortel Networks Corporation
    
    
    
    1,919,233
    (17)Directors and executive
officers as a group
(consisting of 36 persons,
comprised of the current
directors and current
executive officers)
    
    
    Common shares of Nortel Networks Corporation
Share units
Common shares of Bookham Technology plc
    
    
    

23,396,591
1,590,987

    (18)(3)
  *
    
    Messrs. Bischoff and Manley were each appointed a director of the Company and of Nortel
Networks Corporation on April 29, 2004 and May 26, 2004, respectively. Messrs. Bischoff and
Manley have been prevented under applicable securities laws from participating in the
Directors Deferred Share Compensation Plans due to the delay in the filing of the restated
financial statements and related periodic reports of the Company and Nortel Networks
Corporation and, since May 31, 2004, have been subject to an Ontario Securities Commission
management cease trade order prohibiting trading by directors, officers and certain current
and former employees in securities of Nortel Networks Corporation until after the filing of
the restated financial statements and related periodic reports of the Company and Nortel
Networks Corporation.**
    
    Nominee for election as a director of the Company for the
first time.***
    
    Mr. Dunn ceased to be President and Chief Executive Officer of the Company and Nortel
Networks Corporation on April 27, 2004 and ceased to be a director of the Company and Nortel
Networks Corporation on May 21, 2004.****
    
    A named executive officer in 2003 only.(1)
    
    Except as set forth below, each person has sole investment and voting power with respect to
the common shares beneficially owned by such person. Includes common shares subject to stock
options exercisable by December 31, 2004 or that become exercisable within 60 days from
December 31, 2004 (whether or not the market price of the
 167




---



##### Table of Contents



underlying common shares is below the stock option exercise price). As of December 31,
2004, each director and named executive officer individually, and the directors and
executive officers as a group, beneficially owned less than 1.0 percent of the outstanding
common shares of Nortel Networks Corporation.(2)
    
    Includes 8,000 common shares subject to stock options.(3)
    
    Share units issued under the Nortel Networks Corporation Directors Deferred Share
Compensation Plan and the Nortel Networks Limited Directors Deferred Share Compensation Plan.
Each share unit represents the right to receive one common share of Nortel Networks
Corporation. Those plans are described under Compensation of directors.(4)
    
    Includes 8,000 common shares subject to stock options. Excludes 94 common shares
beneficially owned by Mr. Browns son residing with Mr. Brown and 671 common shares
beneficially owned by Mr. Browns spouse. Mr. Brown disclaims beneficial ownership of those
excluded shares.(5)
    
    Includes 4,000 common shares subject to stock options.(6)
    
    Includes 8,000 common shares subject to stock options. Excludes 5,000 common shares
beneficially owned by Mr. Fortiers spouse. Mr. Fortier disclaims beneficial ownership of
those excluded shares.(7)
    
    Includes 8,000 common shares subject to stock options and 1,800 common shares as to which Mr.
Ingram shares investment and voting power with his spouse.(8)
    
    Represents common shares beneficially owned as of December 31, 2004 by the Canada Pension
Plan Investment Board of which Mr. MacNaughton is the President and Chief Executive Officer.
He is due to retire from that position on January 14, 2005. Mr. MacNaughton disclaims
beneficial ownership of these shares.(9)
    
    Includes 8,000 common shares subject to stock options and 20,673 common shares beneficially
owned by a corporation that is wholly-owned by Mrs. Saucier.(10)
    
    Includes 8,000 common shares subject to stock options. Excludes 1,600 common shares
beneficially owned by Mr. Smiths spouse. Mr. Smith disclaims beneficial ownership of those
excluded shares.(11)
    
    Includes 38,000 common shares subject to stock options and 1,157,855 common shares
beneficially owned by a corporation that is wholly-owned by Mr. Wilson. Excludes 2,204 common
shares beneficially owned by Mr. Wilsons spouse. Mr. Wilson disclaims beneficial ownership
of those excluded shares.(12)
    
    Includes 5,000 common shares beneficially owned by Mr. Dunns son as to which Mr. Dunn shares
investment power. Excludes 10,000 common shares beneficially owned by Mr. Dunns spouse and
daughter residing with Mr. Dunn. Mr. Dunn disclaims beneficial ownership of those 15,000
included and excluded shares. As Mr. Dunn was no longer an insider of the Company effective
May 21, 2004, the number of common shares reported as part of his holdings is based on
information in our corporate records and Mr. Dunns filings on the Canadian insider reporting
system, the System for Electronic Disclosure by Insiders, as at May 12, 2004 and reports filed
pursuant to Section 16(a) of the U.S. Securities Exchange Act of 1934.(13)
    
    Includes 1,442,000 common shares subject to stock options.(14)
    
    Includes 1,217,000 common shares subject to stock options.(15)
    
    Includes 321,999 common shares subject to stock options.(16)
    
    Includes 1,498,000 common shares subject to stock options.(17)
    
    Includes 1,453,334 common shares subject to stock options and 397,127 common shares as to
which Mr. DeRoma shares investment and voting power with his spouse.
 168




---



##### Table of Contents



(18)
    
    Includes 15,124,239 common shares subject to stock options. Also includes 420,920 common
shares as to which investment and voting power is shared with one or more other persons.
Excludes 52,854 common shares as to which beneficial ownership is disclaimed.
 
 ITEM 13.   Certain Relationships and Related Transactions Nortel Networks Corporation and its subsidiaries paid the law firm of Ogilvy Renault, of
which Mr. Fortier is a senior partner and Chairman, fees for legal services with respect to
several matters in 2003 and 2004 and are expected to continue to pay fees for legal services in
2005. Nortel Networks Corporation and its subsidiaries paid the law firm of Piper Rudnick LLP, of
which Mr. Blanchard is a partner, fees for legal services with respect to several matters in 2003
and 2004 and are expected to continue to pay fees for legal services in 2005. Nortel Networks Corporation and its subsidiaries paid the law firm of McCarthy Tétrault LLP
fees for legal services in 2003 and 2004. In May 2004, Mr. Manley became a senior counsel of the
law firm of McCarthy Tétrault LLP, serving as an independent consultant but not a partner.
McCarthy Tétrault LLP represents a former executive of Nortel Networks in connection with matters
related to his former association with Nortel Networks, including certain civil proceedings
commenced in 2001, the fees for which are being paid by Nortel Networks Corporation pursuant to
indemnification provisions of applicable law. 
 Indebtedness of management Nortel Networks Corporation and the Company provide relocation assistance to employees
who are requested to relocate that is designed to minimize the financial exposure to employees as a
result of the move. In the past, the assistance has included housing loans, advances on real
estate equity, and payments on behalf of employees of direct costs associated with the move. The
assistance offered is specific to each employee and is structured to be competitive in the area to
which the employee is relocated, subject to the overall relocation policy. Effective July 30,
2002, and in accordance with the United States Sarbanes-Oxley Act of 2002, Nortel Networks
Corporation and the Company no longer offers its executive officers housing loans as part of their
relocation assistance. No loans have been extended by Nortel Networks Corporation and the Company or its subsidiaries
to any director or executive officer of the Company since January 1, 2003. Neither Nortel Networks
Corporation, the Company nor its subsidiaries have given any guarantee, support agreement, letter
of credit, or similar arrangement or understanding, to any other entity in connection with
indebtedness of current and former directors or executive officers since January 1, 2003. As at December 31, 2004, approximately $3.6 million of indebtedness was owed by current and
former employees to Nortel Networks Corporation, the Company and its subsidiaries. Except for the
indebtedness previously owed by a recently appointed executive officer as set out in the table
below, no current or former director or executive officer had any loans outstanding since January
1, 2003. Table of Indebtedness of Directors and Executive Officers Name and Principal
        Position
    
    Involvement of
        Company or Subsidiary
    
    
    Largest Amount Outstanding
        January 1, 2003 -        
        December 31, 2004 ($)
    
    
    Amount Outstanding
        as at December 31, 2004 ($)Martha H. Bejar(1)
        President, CALA
    
    Lender
    
    
    200,000
    
    
    0
  (1)
    
    A subsidiary of Nortel Networks Corporation extended a housing loan to Ms. Bejar in 2001
in connection with a relocation. The loan was for a period of 10 years, interest-free and
secured against Ms. Bejars residence. The full amount of this indebtedness was repaid by Ms.
Bejar prior to her appointment as an executive officer effective October 1, 2004.
 169




---



##### Table of Contents



Related party transactions The Company and its subsidiaries engage in transactions with Nortel Networks Corporation
and its subsidiaries (other than the Company). These transactions include sales, purchases, research
and development services and other financial arrangements and funding activities between such
entities. 2004 As at June 30, 2004, the balance in trade and other payables owing from Nortel Networks
Corporation was $74 million, and the balance in trade and other payables owing from Nortel Networks
subsidiaries (other than the Company) was $121 million. 2003 As at December 31, 2003, the balance in trade and other payables owing from Nortel Networks
Corporation was $67 million, and the balance in trade and other
payables owing from Nortel Networks subsidiaries (other than the Company) was $87 million. During the year ended
December 31, 2003, Nortel Networks Corporation and its subsidiaries (other than the Company)
provided research and development services to the Company for $30 million. 
 ITEM 14.   Principal Accountant Fees and Services Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective
affiliates (or, collectively, the Deloitte Entities) are the principal independent accountants of
the Company and Nortel Networks Corporation. In accordance with applicable laws and the requirements of stock exchanges and securities
regulatory authorities, the audit committees of the Company and Nortel Networks Corporation
pre-approve all audit and non-audit services to be provided by the Deloitte Entities. In addition,
in April 2002, the audit committees of the Company and Nortel Networks Corporation recommended for
approval, and the boards of directors of the Company and Nortel Networks Corporation approved, a
policy that thereafter the Companys and Nortel Networks Corporations auditors would be retained
solely to provide audit and audit-related services and advice with respect to tax matters, and that
the auditors would not be retained to provide consulting services, such as information technology
services. The boards policy applies to new engagements and did not affect limited term
engagements in effect at the time the policy was approved. Certain services in each fee category below were not subject to the audit committee
pre-approval requirements as the fees related to engagements for services prior to the audit
committee pre-approval requirements coming into effect. Five percent of the fees billed for 2003
are for engagements that were undertaken prior to the pre-approval requirements coming into effect
and were primarily for tax compliance services. Services for which the fees were less than one
percent of the total fees billed by the Deloitte Entities for 2003 were inadvertently not
pre-approved by the audit committees but were promptly brought to the attention of the audit
committees and, in accordance with applicable laws and the requirements of securities regulatory
authorities, were approved prior to the completion of the services associated with those fees. 
 Audit Fees The Company and Nortel Networks Corporation prepare financial statements in accordance with
United States generally accepted accounting principles (or US GAAP) and Canadian generally accepted
accounting principles (or Canadian GAAP). Deloitte Entities billed to date Nortel Networks
Corporation and its subsidiaries $14.3 million for 2004 for the following audit services: (i)
interim audit work related to the audit of the annual consolidated financial statements of the
Company and Nortel Networks Corporation for the year ended December 31, 2004; (ii) reviews of the
financial statements of the Company and Nortel Networks Corporation included as comparative
financial statements in Forms 10-Q for the periods ended March 31, 2004 and June 30, 2004; and (ii)
audit of internal controls over financial reporting as required under the United States
Sarbanes-Oxley Act of 2002. Deloitte Entities billed to date Nortel Networks Corporation and its
subsidiaries $55.0 million and $8.1 million for 2003 and 2002, respectively, for the following
audit services: (i) audits of the annual consolidated financial statements of the Company and
Nortel Networks Corporation included in annual reports on Form 10-K 170




---



##### Table of Contents



and annual reports to shareholders for the fiscal years ended December 31, 2003 and 2002; (ii)
reviews of the interim financial statements of the Company and Nortel Networks Corporation included
in quarterly reports on Form 10-Q and quarterly reports to shareholders for the periods ended March
31, June 30 and September 30, 2003 and 2002 (and in the Companys amended Form 10-Q/A for the
period ended September 30, 2003); (iii) audits and reviews of the restated financial statements of
the Company and Nortel Networks Corporation included in their respective amended annual reports on
Form 10-K/A for the fiscal year ended December 31, 2002 and amended quarterly reports on Form
10-Q/A for the periods ended March 31 and June 30, 2003; (iv) audits and reviews of the restated
financial statements of the Company and Nortel Networks Corporation included as comparative
financial statements in their respective Form 10-K for the fiscal year ended December 31, 2003; (v)
audits of individual subsidiary statutory financial statements; and (vi) comfort letters, attest
services, statutory and regulatory audits, consents and other services related to United States
Securities and Exchange Commission matters. 
 Audit-Related Fees Deloitte Entities billed to date Nortel Networks Corporation and its subsidiaries $2.8
million, $3.1 million and $1.1 million for 2004, 2003 and 2002, respectively, for the following
audit-related services: (i) audit of pension plan financial statements; (ii) financial accounting
and reporting consultations; (iii) information system reviews; (iv) advisory services related to
the United States Sarbanes-Oxley Act of 2002; (v) accounting consultations and audits in connection
with dispositions; (vi) internal control reviews; and (vii) accounting consultations regarding
financial accounting standards for various local business-related transactions. 
 Tax Fees Deloitte Entities billed Nortel Networks Corporation and its subsidiaries $7.1 million, $14.6
million and $13.7 million for 2004, 2003 and 2002, respectively for tax compliance services. Tax
compliance services are services rendered based upon facts already in existence or transactions
that have already occurred to document, compute and obtain government approval for amounts to be
included in tax filings and consisted of: (i) assistance in filing tax returns in various
jurisdictions; (ii) sales and use, property and other tax return assistance; (iii) research and
development tax credit documentation and analysis for purposes of filing amended returns; (iv)
transfer pricing documentation; (v) requests for technical advice from taxing authorities; (vi)
assistance with tax audits and appeals; and (vii) preparation of expatriate tax returns. 
 All Other Fees Deloitte Entities billed Nortel Networks Corporation and its subsidiaries $0, $0 and $1.7
million for 2004, 2003 and 2002, respectively, for the following services: (i) non-financial
information systems design and implementation; (ii) financial information systems design and
implementation; (iii) immigration services; and (iv) review of import/export and social security
requirements/reports. Approximately $1.0 million of the above services billed by Deloitte Entities
in 2002 were for services provided by Deloitte Consulting. 171




---



##### Table of Contents



PART IV 
  ITEM 15.
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON
  FORM 8-K  1.
    
    Financial StatementsThe index to the Consolidated Financial Statements appears on
page 1142.
    
    Financial Statement Schedules PageQuarterly Financial Data (Unaudited)
    
    
    F-91Report of Independent Registered Chartered Accountants
    
    
    182II  Valuation and Qualifying Accounts and Reserves, Provision for Uncollectibles
    
    
    183Audited 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, 2003
    
    
    184
 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, 2003.  3.
    
    Reports on Form 8-K Nortel Networks Limited filed a Current Report on Form 8-K dated October 24, 2003 related to
its financial results for the third quarter of 2003. Nortel Networks Limited filed a Current Report on Form 8-K dated November 13, 2003 related to a
press release announcing the expected timing for the filing of its Form 10-Q for the third quarter
of 2003. Nortel Networks Limited filed a Current Report on Form 8-K dated December 23, 2003 relating to a
press release announcing the confirmation of the filing of a Form 10-K/A for 2002, a Form 10-Q/A
for the first quarter of 2003 and a Form 10-Q/A for the second quarter of 2003. Nortel Networks Limited filed a Current Report on Form 8-K dated January 29, 2004 concerning its
financial results for the fourth quarter of 2003 and full year 2003. Nortel Networks Limited filed a Current Report on Form 8-K dated March 10, 2004 related to a press
release announcing the delay of filing of its financial results for the fiscal year of 2003. Nortel Networks Limited filed a Current Report on Form 8-K dated March 15, 2004 related to a press
release announcing the appointments of a new Chief Financial Officer and Controller on an interim
basis. Nortel Networks Limited filed a Current Report on Form 8-K dated March 30, 2004 related to a press
release announcing the waiver from Export Development Canada and update regarding the timing of the
first quarter 2004 results announcement and Annual Shareholders Meeting. Nortel Networks Limited filed a Current Report on Form 8-K dated April 5, 2004 related to a press
release updating the status of the Securities and Exchange Commission inquiry. 172




---



##### Table of Contents



Nortel Networks Limited filed a Current Report on Form 8-K dated April 14, 2004 related to a press
release updating the status of the Ontario Securities Commission inquiry. Nortel Networks Limited filed a Current Report on Form 8-K dated April 28, 2004 related to a press
release announcing the appointment of William A. Owens as President and Chief Executive Officer,
other management changes and an update on a number of matters, including the status of certain
prior year financial statements. Nortel Networks Limited filed a Current Report on Form 8-K/A dated April 28, 2004 amending debt
securities information contained in a press release dated March 10, 2004. Nortel Networks Limited filed a Current Report on Form 8-K dated April 29, 2004 related to a press
release announcing the appointment of Dr. rer. Pol. Manfred Bischoff to the Nortel Networks Board
of Directors. Nortel Networks Limited filed a Current Report on Form 8-K dated May 14, 2004 related to a press
release announcing Nortel Networks receipt of a federal grand jury subpoena from the U.S.
Attorneys Office for the production of certain documents. Nortel Networks Limited filed a Current Report on Form 8-K dated May 18, 2004 related to a press
release announcing a temporary cease trade order issued by the Ontario Securities Commission. Nortel Networks Limited filed a Current Report on Form 8-K dated May 25, 2004 related to the
resignation of Frank Andrew Dunn as a director effective May 21, 2004. Nortel Networks Limited filed a Current Report on Form 8-K dated May 26, 2004 related to a press
release announcing the appointment of The Hon. John Manley to the Nortel Networks Board of
Directors. Nortel Networks Limited filed a Current Report on Form 8-K dated May 31, 2004 related to a press
release announcing that Nortel Networks Limited had obtained a new waiver from Export Development
Canada. Nortel Networks Limited filed a Current Report on Form 8-K dated June 2, 2004 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated June 15, 2004 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated June 23, 2004 related to a press
release announcing court approval for extending the time for calling the 2004 Annual Shareholders
Meeting. Nortel Networks Limited filed a Current Report on Form 8-K dated June 24, 2004 related to a letter
received from the Toronto Stock Exchange advising of a breach of its financial statements filing
requirements. Nortel Networks Limited filed a Current Report on Form 8-K dated June 29, 2004 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated July 6, 2004 related to an
agreement reached with Flextronics International Ltd. Nortel Networks Limited filed a Current Report on Form 8-K dated July 13, 2004 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated July 27, 2004 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated August 10, 2004 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated August 17, 2004 related to a press
release providing a status update of the RCMP review. 173




---



##### Table of Contents



Nortel Networks Limited filed a Current Report on Form 8-K dated August 19, 2004 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated August 20, 2004 related to a press
release announcing a new waiver from Export Development Canada. Nortel Networks Limited filed a Current Report on Form 8-K dated September 2, 2004 related to a
press release providing a status update on its financial restatement process and other related
matters. Nortel Networks Limited filed a Current Report on Form 8-K dated September 2, 2004 related to an
employment agreement with William Owens, President and Chief Executive Officer. Nortel Networks Limited filed a Current Report on Form 8-K dated September 16, 2004 related to a
press release providing a status update on its financial restatement process and other related
matters. Nortel Networks Limited filed a Current Report on Form 8-K dated September 30, 2004 related to a
press release providing a status update on its financial restatement process and announcing a new
waiver from Export Development Canada. Nortel Networks Limited filed a Current Report on Form 8-K/A dated September 30, 2004 amending
details of its previously announced work plan contained in a press release dated August 19, 2004. Nortel Networks Limited filed a Current Report on Form 8-K dated October 14, 2004 related to a
press release providing a status update on its financial restatement process and other related
matters. Nortel Networks Limited filed a Current Report on Form 8-K/A dated October 18, 2004 amending
certain information concerning the timing and implementation of certain matters under the existing
agreement with Flextronics International Ltd. contained in a press release dated June 29, 2004. Nortel Networks Limited filed a Current Report on Form 8-K dated October 27, 2004 related to a
press release providing a status update on its financial restatement process and other matters. Nortel Networks Limited filed a Current Report on Form 8-K dated November 2, 2004 related to a
press release announcing a new waiver from Export Development Canada. Nortel Networks Limited filed a Current Report on Form 8-K dated November 12, 2004 related to a
press release providing a status update on its financial restatement process and other matters. Nortel Networks Limited filed a Current Report on Form 8-K dated November 19, 2004 related to a
press release announcing a new waiver from Export Development Canada. Nortel Networks Limited filed a Current Report on Form 8-K dated November 24, 2004 related to
a press release providing a status update on its financial restatement process and other matters. Nortel Networks Limited filed a Current Report on Form 8-K dated November 30, 2004 updating certain
information concerning Nortel Networks Corporations Annual Shareholders Meeting. Nortel Networks Limited filed a Current Report on Form 8-K dated December 8, 2004 related to a
press release providing a status update on its financial restatement process and other matters. Nortel Networks Limited filed a Current Report on Form 8-K dated December 10, 2004 related to a
press release announcing a new waiver from Export Development Canada. Nortel Networks Limited filed a Current Report on Form 8-K dated December 16, 2004 related to a
press release providing limited estimated unaudited financial results for the third quarter of
2004, and updated limited estimated unaudited results for the first and second quarters of 2004 and
for the years 2001, 2002 and 2003. Nortel Networks Limited filed a Current Report on Form 8-K dated December 22, 2004 related to a
press release providing a status update on its financial restatement process and other related
matters. 174




---



##### Table of Contents



Nortel Networks Limited filed a Current Report on Form 8-K dated January 4, 2005 related to a press
release advising that the New York Stock Exchange has granted a three month extension to file the
2003 Annual Reports on Form 10-K with the Securities and Exchange Commission. Nortel Networks Limited filed a Current Report on Form 8-K dated January 7, 2005 related to a press
release providing a status update on its financial restatement process and other related matters. Nortel Networks Limited filed a Current Report on Form 8-K dated January 10, 2005 related to a
press release regarding the filing of Nortel Networks Corporations 2003 Financial Statements. Nortel Networks Limited filed a Current Report on Form 8-K dated January 11, 2005 related to a
press release announcing the filing of Nortel Network Corporations Form 10-K. Nortel Networks Limited filed a Current Report on Form 8-K dated January 13, 2005 related to an
employment agreement with Susan E. Shepard in connection with her appointment as Chief Ethics and
Compliance Officer and the appointment of Richard McCormick and Harry Pearce as directors. Nortel Networks Limited filed a Current Report on Form 8-K dated January 14, 2005 related to a
press release announcing a new waiver from Export Development Canada. 175




---



##### Table of Contents



4.
    
    Exhibit Index The items listed as Exhibits 10.2 to 10.7, 10.27 to 10.37 and item 10.41 relate to management
contracts or compensatory plans or arrangements. Exhibit Number
    
    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).
    176




---



##### Table of Contents



Number
    
    Description*4.5
    
    Instrument of Resignation, Appointment and Acceptance entered into as of December 19,
2002, effective as of January 2, 2003, among Nortel Networks Limited, as issuer and
guarantor, Nortel Networks Capital Corporation, as issuer, Citibank, N.A. and Deutsche
Bank Trust Company Americas, with respect to the Indenture dated as of December 5,
2000, as supplemented by a First Supplemental Indenture dated as of February 1, 2001
related to debt securities (filed as Exhibit 4.5 to Nortel Networks Limiteds Annual
Report on Form 10-K for the year ended December 31, 2002).*4.6
    
    Indenture dated as of August 15, 2001 between Nortel Networks Corporation, Nortel
Networks Limited, as guarantor, and Bankers Trust Company, as trustee, related to
convertible debt securities and guarantees authenticated and delivered thereunder,
which comprised the 4.25% Convertible Senior Notes due 2008 (filed as Exhibit 4 to
Nortel Networks Corporations Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001).*10.1
    
    Third Amended and Restated Reciprocal Credit Agreement dated as of December 19, 2002
between Nortel Networks Corporation, Nortel Networks Limited, and the other parties who
have executed the agreement (filed as Exhibit 10.1 to Nortel Networks Limiteds Annual
Report on Form 10-K for the year ended December 31, 2002).*10.2
    
    Nortel Networks Supplementary Executive Retirement Plan, as amended effective October
18, 2001 and October 23, 2002 (filed as Exhibit 10.2 to Nortel Networks Limiteds
Annual Report on Form 10-K for the year ended December 31, 2002).*10.3
    
    Agreement dated April 29, 1997 related to the remuneration of the Chief Legal Officer
(filed as Exhibit 10.3 to Nortel Networks Limiteds Annual Report on Form 10-K for the
year ended December 31, 2001).*10.4
    
    Acknowledgement effective as of June 1, 2000 related to the remuneration of the Chief
Legal Officer (filed as Exhibit 10.4 to Nortel Networks Limiteds Annual Report on Form
10-K for the year ended December 31, 2001).*10.5
    
    Statement describing the retirement arrangements of the former President and Chief
Executive Officer (filed as Exhibit 10.5 to Nortel Networks Limiteds Annual Report on
Form 10-K for the year ended December 31, 2001).*10.6
    
    Nortel Networks Corporation Executive Retention and Termination Plan, as amended and
restated, effective from June 26, 2002 (filed as Exhibit 10.1 to Nortel Networks
Corporations Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).*10.7
    
    Nortel Networks Corporation Special Retention Plan effective August 1, 2001 and expired
on June 30, 2003 (filed as Exhibit 10.3 to Nortel Networks Corporations Quarterly
Report on Form 10-Q for the quarter ended September 30, 2001).*10.8
    
    Assumption Agreement between Nortel Networks Corporation and Nortel Networks Limited
dated March 5, 2001, regarding the assumption and agreement by Nortel Networks
Corporation to perform certain covenants and obligations of Nortel Networks Limited
under the Nortel Networks Limited Executive Retention and Termination Plan (filed as
Exhibit 10.25 to Nortel Networks Corporations Annual Report on Form 10-K for the year
ended December 31, 2000).
    177




---



##### Table of Contents



Number
    
    Description*10.9
    
    Five Year Credit Agreement dated as of April 12, 2000, among Nortel Networks Limited,
as borrower, various banks, as lenders, Royal Bank of Canada and Toronto Dominion Bank,
as co-syndication agents, and J.P. Morgan Canada, as administrative agent (filed as
Exhibit 10.4 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter
ended June 30, 2001).*10.10
    
    Five Year Credit Agreement dated as of April 12, 2000, among Nortel Networks Limited,
as guarantor, Nortel Networks Inc., as borrower, various banks, as lenders, ABN AMRO
Bank N.V., Bank of America N.A. and Citibank N.A., as co-syndication agents, and Morgan
Guaranty Trust Company of New York, as administrative agent (which terminated on April
28, 2004) (filed as Exhibit 10.5 to Nortel Networks Limiteds Quarterly Report on Form
10-Q for the quarter ended June 30, 2001).*10.11
    
    U.S. Guarantee and Security Agreement dated as of the first day of the Collateral
Period (as defined therein) among Nortel Networks Limited, Nortel Networks Inc. and
certain of their subsidiaries and JPMorgan Chase Bank, as Collateral Agent (filed as
Exhibit 99.1 to Nortel Networks Limiteds Current Report on Form 8-K dated January 18,
2002).*10.12
    
    Amendment No. 1 dated as of December 12, 2002 to the U.S. Guarantee and Security
Agreement dated as of April 4, 2002 among Nortel Networks Limited, Nortel Networks
Inc., the Subsidiary Lien Grantors party thereto and JPMorgan Chase Bank, as Collateral
Agent (filed as Exhibit 99.2 to Nortel Networks Limiteds Current Report on Form 8-K
dated December 13, 2002).*10.13
    
    Canadian Guarantee and Security Agreement dated as of the first day of the Collateral
Period (as defined therein) among Nortel Networks Limited and certain of its
subsidiaries and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 99.1 to
Nortel Networks Limiteds Current Report on Form 8-K dated February 4, 2002).*10.14
    
    Amendment No. 1 dated as of December 12, 2002 to the Canadian Guarantee and Security
Agreement dated as of April 4, 2002 among Nortel Networks Limited, Nortel Networks
Inc., the Subsidiary Guarantors party thereto and JPMorgan Chase Bank, as Collateral
Agent (filed as Exhibit 99.3 to Nortel Networks Limiteds Current Report on Form 8-K
dated December 13, 2002).*10.15
    
    Form of Nortel Networks Limited Foreign Subsidiary Guarantee dated as of April 4, 2002
and schedule thereto listing the specific foreign subsidiary guarantees which are not
attached as exhibits (filed as Exhibit 10.5 to Nortel Networks Limiteds Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002).*10.16
    
    Amendment No. 1 dated as of December 12, 2002 to certain Foreign Subsidiary Guarantees
dated as of April 4, 2002 among Nortel Networks (Ireland) Limited, Nortel Networks UK
Limited, Nortel Networks (Asia) Limited and JPMorgan Chase Bank, as Collateral Agent
(filed as Exhibit 99.4 to Nortel Networks Limiteds Current Report on Form 8-K dated
December 13, 2002).*10.17
    
    Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, the
Subsidiary Guarantors party thereto and JPMorgan Chase Bank, as Collateral Agent (filed
as Exhibit 10.6 to Nortel Networks Limiteds Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002).
    178




---



##### Table of Contents



Number
    
    Description*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).*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).
    179




---



##### Table of Contents



Number
    
    Description*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 as amended and restated on July 28, 2003 with
effect from January 1, 2003 (filed as Exhibit 10.1 to Nortel Networks Limiteds
Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).*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 (filed as Exhibit 10.30 to
Nortel Networks Limiteds Annual Report on Form 10-K for the year ended December 31,
2002).10.31
    
    Resolutions of the Board of Directors of Nortel Networks Limited dated December 18,
2003, related to the remuneration of the chairman of the board, directors and chairman
of the audit committee, effective January 1, 2004.*10.32
    
    Resolutions of the Board of Directors of Nortel Networks Limited dated December 17,
1993, as amended by resolutions of the Board of Directors of Nortel Networks Limited
dated February 29, 1996, providing for retirement compensation of directors who are not
salaried employees of Nortel Networks Limited or its subsidiaries (filed as Exhibit
10.32 to Nortel Networks Limiteds Annual Report on Form 10-K for the year ended
December 31, 2002).*10.33
    
    Agreement between a director of Nortel Networks Corporation and Nortel Networks Limited
and the respective companies dated June 22, 2001, setting forth the arrangements with
respect to serving as non-executive chairman of each of the board of directors of
Nortel Networks Corporation and Nortel Networks Limited (filed as Exhibit 10.1 to
Nortel Networks Limiteds Quarterly Report on Form 10-Q for the quarter ended June 30,
2001).*10.34
    
    Amended General description of cash bonus for employees and executives of Nortel
Networks Corporation and Nortel Networks Limited as originally filed as Exhibit 10.3 to
Nortel Networks Corporations Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002 (filed as Exhibit 10.1 to the Nortel Networks Limiteds Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).
    180




---



##### Table of Contents



Number
    
    Description*10.35
    
    Nortel Networks Limited Restricted Stock Unit Plan dated as of January 30, 1997, as
amended effective April 29, 1999, September 1, 1999, February 15, 2000, May 1,
2000,November 15, 2000 and January 23, 2003 (filed as Exhibit 10.1 to Nortel Networks
Limiteds Quarterly Report on Form 10-Q for the quarter ended March 31, 2003).10.36
    
    Nortel Networks Limited Directors Deferred Share Compensation Plan effective June 30,
1998 and amended and restated as of May 1, 2000, as amended and restated effective
January 1, 2002, as amended and restated May 29, 2003, as amended and restated December
18, 2003 effective January 1, 2004.*10.37
    
    Nortel Networks U.S. Deferred Compensation Plan (filed as Exhibit 4.3 to Post-Effective
Amendment No. 1 to Nortel Networks Corporations Registration Statement on Form S-8
(No. 333-11558)).*10.38
    
    Master Facility Agreement dated as of February 14, 2003 between Nortel Networks Limited
and Export Development Canada (filed as Exhibit 99.2 to Nortel Networks Limiteds
Current Report on Form 8-K dated February 14, 2003).*10.39
    
    Master Indemnity Agreement dated as of February 14, 2003 between Nortel Networks
Limited and Export Development Canada (filed as Exhibit 99.3 to Nortel Networks
Limiteds Current Report on Form 8-K dated February 14, 2003).*10.40
    
    Amending Agreement No. 1 dated as of July 10, 2003 to the Master Facility Agreement
dated as of February 14, 2003 between Nortel Networks Limited and Export Development
Canada (filed as Exhibit 99.2 to Nortel Networks Limiteds Current Report on Form 8-K
dated July 10, 2002).*10.41
    
    Letter dated June 23, 2003 from the former President and Chief Executive Officer of
Nortel Networks, to the Joint Leadership Resources Committee of the Board of Directors
of Nortel Networks Corporation and Nortel Networks Limited regarding the voluntary
return for cancellation of certain stock options to purchase common shares of Nortel
Networks Corporation (filed as Exhibit 10.3 to the Nortel Networks Limiteds Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).21.
    
    Subsidiaries of the Registrant.23.1
    
    Consent of Deloitte & Touche LLP.23.2
    
    Consent of Deloitte & Associes.24.
    
    Power of Attorney of certain directors and officers.31.1
    
    Rule 13a  14(a)/15d  14(a) Certification of the President and Chief Executive Officer.31.2
    
    Rule 13a  14(a)/15d  14(a) Certification of the Chief Financial Officer.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.
    181




---



##### Table of Contents



INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS 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, 2003 and 2002, and for each of the three years
in the period ended December 31, 2003, and have issued our report thereon dated January 10, 2005,
which report expresses an unqualified opinion and includes explanatory paragraphs relating to the
restatement of the consolidated financial statements as of December 31, 2002 and 2001 and for each
of the years then ended and the change in the method of accounting for stock-based compensation,
asset retirement obligations and goodwill; such report is included elsewhere in this Form 10-K.
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 on this consolidated financial statement schedule based
on our audits. In our opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein. /s/ Deloitte & Touche LLP Independent Registered Chartered Accountants Toronto, Canada
January 10, 2005 182




---



##### Table of Contents



Schedule II
Consolidated NORTEL NETWORKS LIMITED
Valuation and Qualifying Accounts and Reserves
Provision For Uncollectibles(a)(millions of U.S. dollars) AdditionsBalance at
    
    
    charged
    
    
    
    
    
    
    Balance atbeginning of
    
    
    to costs
    
    
    
    
    
    
    end ofU.S. GAAP
    
    year
    
    
    and expenses
    
    
    Deductions(b)
    
    
    year(c)Year 2003
    
    $
    1,282
    
    
    $
    (179
    )
    
    $
    612
    
    
    $
    491Year 2002(d)
    
    $
    1,537
    
    
    $
    292
    
    
    $
    547
    
    
    $
    1,282Year 2001(d)
    
    $
    807
    
    
    $
    1,789
    
    
    $
    1,059
    
    
    $
    1,537
 (a)
    
    Excludes Discontinued Operations.(b)
    
    Includes acquisitions and disposals of subsidiaries and divisions and amounts written off, and foreign exchange translation adjustments.(c)
    
    Includes provisions for uncollectibles on long-term accounts receivable of $297, $780, and $761 as of December 31, 2003,
2002, and 2001, respectively.(d)
    
    As restated (see note 3 to the accompanying consolidated financial statements).
 183




---



##### Table of Contents



NORTEL NETWORKS S.A. (A Subsidiary of Nortel Networks Limited) For the three years ended December 31, 2003           184




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors of Nortel Networks S.A. We have audited the accompanying consolidated balance sheets of Nortel Networks S.A., a subsidiary
of Nortel Networks Limited, and its subsidiaries as of December 31, 2003 and 2002 and the related
consolidated statements of operations, shareholders equity and cash flows for each of the three
years in the period ended December 31, 2003 (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 the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether 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 S.A. and its subsidiaries as of December 31, 2003 and
2002 and the results of their operations and their cash flows for each of the three years in the
period ended December 31, 2003 in conformity with accounting principles generally accepted in the
United States of America. As described in note 3 to the consolidated financial statements, the accompanying consolidated
financial statements of Nortel Networks S.A. as of December 31, 2002, and for each of the two
years in the period then ended have been restated. As described in note 4 to the consolidated financial statements, effective January 1, 2003, Nortel
Networks S.A. changed its method of accounting for stock-based compensation in accordance with
Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-based
Compensation  Transition and Disclosure. Also, as described in note 4, effective January 1,
2002, Nortel Networks S.A. changed its method of accounting for goodwill in accordance with SFAS
No. 142, Goodwill and Other Intangible Assets. Deloitte &
Associés
(formerly Deloitte Touche Tohmatsu)  /s/ Nicholas L.E. ROLT Neuilly, France January 10, 2005 185




---



##### Table of Contents



NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Consolidated Statements of Operations for the years ended December 31 (thousands of Euros)
    
    2003
    
    
    2002
    
    
    2001As restated*
    
    
    As restated*Revenues  external
    
    
    344,008
    
    
    
    356,316
    
    
    
    767,713 related parties
    
    
    515,478
    
    
    
    458,918
    
    
    
    439,072859,486
    
    
    
    815,234
    
    
    
    1,206,785Cost of revenues
    
    
    657,128
    
    
    
    600,367
    
    
    
    1,116,766Gross profit
    
    
    202,358
    
    
    
    214,867
    
    
    
    90,019Selling, general and administrative expense
    
    
    70,274
    
    
    
    69,482
    
    
    
    175,433Research and development expense
    
    
    236,967
    
    
    
    264,275
    
    
    
    249,603Amortization of intangiblesAcquired technology and other
    
    
    255
    
    
    
    
    
    
    
    Goodwill
    
    
    
    
    
    
    
    
    
    
    3,434Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    20,607Other special charges
    
    
    24,563
    
    
    
    83,427
    
    
    
    74,772(Gain) loss on sale of businesses and assets
    
    
    13,883
    
    
    
    16,171
    
    
    
    (10,243
    )Operating earnings (loss)
    
    
    (143,584
    )
    
    
    (218,488
    )
    
    
    (423,587
    )Other income (expense)  net
    
    
    2,015
    
    
    
    23,038
    
    
    
    53,998Foreign exchange gain (loss)
    
    
    1,043
    
    
    
    (5,531
    )
    
    
    (1,710
    )Interest expense
    
    
    (3,221
    )
    
    
    (9,885
    )
    
    
    (11,286
    )Earnings (loss) before income taxes and minority interest
    
    
    (143,747
    )
    
    
    (210,866
    )
    
    
    (382,585
    )Minority interest
    
    
    (756
    )
    
    
    3,052
    
    
    
    8,973Income tax benefit
    
    
    5,614
    
    
    
    1,640
    
    
    
    34,073Net earnings (loss)
    
    
    (138,889
    )
    
    
    (206,174
    )
    
    
    (339,539
    )
 * See note 3 The accompanying notes are an integral part of these financial statements 186




---



##### Table of Contents



NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Consolidated Balance Sheets as at December 31 (thousands of Euros)
    
    2003
    
    
    2002As restated*ASSETSCurrent assetsCash and cash equivalents
    
    
    74,352
    
    
    
    150,419Accounts receivable (less provisions of 19,324 for 2003, 32,499 for 2002)
    
    
    113,411
    
    
    
    83,955Inventories  net
    
    
    66,197
    
    
    
    80,070Receivables from related parties
    
    
    254,697
    
    
    
    234,071Other current assets
    
    
    17,469
    
    
    
    106,364Total current assets
    
    
    526,126
    
    
    
    654,879Long-term receivable from related party
    
    
    
    
    
    
    140,010Investments at cost
    
    
    
    
    
    
    16,176Plant and equipment  net
    
    
    184,169
    
    
    
    218,121Goodwill
    
    
    19,683
    
    
    
    Intangible assets  net
    
    
    8,929
    
    
    
    3,454Deferred income taxes  net
    
    
    47,510
    
    
    
    43,268Other assets
    
    
    
    
    
    
    6Total assets
    
    
    786,417
    
    
    
    1,075,914LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNote payable to related party
    
    
    160
    
    
    
    Trade and other accounts payable
    
    
    141,799
    
    
    
    91,151Payables to related parties
    
    
    32,002
    
    
    
    89,326Payroll and benefit-related liabilities
    
    
    68,960
    
    
    
    50,809Contractual liabilities
    
    
    23,822
    
    
    
    37,818Restructuring
    
    
    9,224
    
    
    
    13,346Other accrued liabilities
    
    
    105,739
    
    
    
    174,260Long-term debt due within one year
    
    
    3,241
    
    
    
    3,073Total current liabilities
    
    
    384,947
    
    
    
    459,783Other liabilities
    
    
    9,615
    
    
    
    2,837Long-term deferred income
    
    
    18,092
    
    
    
    17,231Long-term debt
    
    
    73,217
    
    
    
    76,457Long-term note payable to related party
    
    
    70,000
    
    
    
    220,000Total liabilities
    
    
    555,871
    
    
    
    776,308Minority interest
    
    
    
    
    
    
    9,757Commitments (note 13)SHAREHOLDERS EQUITYCommon shares, 0.005 par value  Authorized shares: unlimited;Issued and outstanding: 91,308,951 for 2003 and 61,308,951 for 2002
    
    
    456,544
    
    
    
    306,544Additional paid-in capital
    
    
    (26,417
    )
    
    
    43,997Accumulated deficit
    
    
    (199,581
    )
    
    
    (60,692
    )Total shareholders equity
    
    
    230,546
    
    
    
    289,849Total liabilities and shareholders equity
    
    
    786,417
    
    
    
    1,075,914
 * See note 3 The accompanying notes are an integral part of these financial statements 187




---



##### Table of Contents



NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Consolidated Statements of Shareholders Equity Additional
    
    
    Retained
    
    
    TotalCommon
    
    
    paid-in
    
    
    earnings
    
    
    shareholders(thousands of Euros)
    
    shares
    
    
    capital
    
    
    (deficit)
    
    
    equityBalance at December 31, 2000 as restated*
    
    
    35,762
    
    
    
    202,171
    
    
    
    148,039
    
    
    
    385,972Payment of dividends
    
    
    
    
    
    
    
    
    
    
    (35,773
    )
    
    
    (35,773
    )Net earnings (loss)
    
    
    
    
    
    
    
    
    
    
    (339,539
    )
    
    
    (339,539
    )Balance at December 31, 2001 as restated*
    
    
    35,762
    
    
    
    202,171
    
    
    
    (227,273
    )
    
    
    10,660Common shares issued
    
    
    485,363
    
    
    
    
    
    
    
    
    
    
    
    485,363Capital restructuring
    
    
    (214,581
    )
    
    
    (158,174
    )
    
    
    372,755
    
    
    
    Net earnings (loss)
    
    
    
    
    
    
    
    
    
    
    (206,174
    )
    
    
    (206,174
    )Balance at December 31, 2002 as restated*
    
    
    306,544
    
    
    
    43,997
    
    
    
    (60,692
    )
    
    
    289,849Common shares issued
    
    
    150,000
    
    
    
    
    
    
    
    
    
    
    
    150,000Stock based compensation
    
    
    
    
    
    
    1,333
    
    
    
    
    
    
    
    1,333Acquisition of Northern Telecom France
    
    
    
    
    
    
    (83,800
    )
    
    
    
    
    
    
    (83,800
    )Acquisition of Nortel Networks France
    
    
    
    
    
    
    (31,017
    )
    
    
    
    
    
    
    (31,017
    )Gain on related party transactions
    
    
    
    
    
    
    43,070
    
    
    
    
    
    
    
    43,070Net earnings (loss)
    
    
    
    
    
    
    
    
    
    
    (138,889
    )
    
    
    (138,889
    )Balance at December 31, 2003
    
    
    456,544
    
    
    
    (26,417
    )
    
    
    (199,581
    )
    
    
    230,546
 * See note 3 A Statement of Other Comprehensive Income (Loss) has not been presented as there are no other comprehensive income (loss) items. The accompanying notes are an integral part of these financial statements 188




---



##### Table of Contents



NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Consolidated Statements of Cash Flows for the years ended December 31 (thousands of Euros)
    
    2003
    
    
    2002
    
    
    2001As restated*
    
    
    As restated*Cash flows from (used in) operating activitiesNet loss
    
    
    (138,889
    )
    
    
    (206,174
    )
    
    
    (339,539
    )Adjustments to reconcile net loss to net cash from (used in)
operating activities:Amortization and depreciation
    
    
    63,536
    
    
    
    45,964
    
    
    
    50,060Non-cash portion of special charges and related assets write down
    
    
    
    
    
    
    
    
    
    
    20,607Deferred income taxes
    
    
    (4,242
    )
    
    
    (3,728
    )
    
    
    (37,249
    )(Gain) loss on disposal of assets
    
    
    13,883
    
    
    
    16,171
    
    
    
    5,997(Gain) loss on disposal of investments
    
    
    
    
    
    
    
    
    
    
    (16,240
    )Current and deferred stock option compensation
    
    
    1,333
    
    
    
    
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (29,456
    )
    
    
    22,451
    
    
    
    124,235Receivables from related parties
    
    
    27,947
    
    
    
    246,248
    
    
    
    24,699Inventories
    
    
    13,873
    
    
    
    31,612
    
    
    
    40,672Accounts payable and accrued liabilities
    
    
    (17,843
    )
    
    
    (25,908
    )
    
    
    (179,972
    )Payables to related parties
    
    
    (57,165
    )
    
    
    (437,236
    )
    
    
    257,754Income taxes
    
    
    4
    
    
    
    (161
    )
    
    
    (27,416
    )Other operating assets and liabilities
    
    
    89,510
    
    
    
    (36,488
    )
    
    
    44,679Net cash used in operating activities
    
    
    (37,509
    )
    
    
    (347,249
    )
    
    
    (31,713
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (41,246
    )
    
    
    (57,631
    )
    
    
    (108,601
    )Expenditure for investments
    
    
    (154,192
    )
    
    
    (2,490
    )
    
    
    (9,296
    )Proceeds on disposal of investments
    
    
    58,940
    
    
    
    9,909
    
    
    
    23,834Proceeds on disposal of plant and equipment
    
    
    596
    
    
    
    754
    
    
    
    8,855Divestiture of investments & businesses  net cash divested
    
    
    
    
    
    
    
    
    
    
    (6,614
    )Increase (decrease) in other financial assets
    
    
    9,147
    
    
    
    (7,147
    )
    
    
    Net cash used in investing activities
    
    
    (126,755
    )
    
    
    (56,605
    )
    
    
    (91,822
    )Cash flows from (used in) financing activitiesIssuance of common shares
    
    
    
    
    
    
    204,363
    
    
    
    (Increase) decrease in receivables from related parties  net
    
    
    91,437
    
    
    
    (142,329
    )
    
    
    2,319Increase (decrease) in notes payable to related parties  net
    
    
    
    
    
    
    320,000
    
    
    
    181,000(Increase) decrease in long-term receivables
    
    
    
    
    
    
    
    
    
    
    531Increase (decrease) in notes payable
    
    
    (3,240
    )
    
    
    (3,295
    )
    
    
    4,750Dividend paid
    
    
    
    
    
    
    
    
    
    
    (29,736
    )Net cash from financing activities
    
    
    88,197
    
    
    
    378,739
    
    
    
    158,864Net increase (decrease) in cash and cash equivalents
    
    
    (76,067
    )
    
    
    (25,115
    )
    
    
    35,329Cash and cash equivalents, beginning of year
    
    
    150,419
    
    
    
    175,534
    
    
    
    140,205Cash and cash equivalents, end of year
    
    
    74,352
    
    
    
    150,419
    
    
    
    175,534
 * See note 3 The accompanying notes are an integral part of these financial statements 189




---



##### Table of Contents



NORTEL NETWORKS S.A.
(a Subsidiary of Nortel Networks Limited)
Notes to Consolidated 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. (NNIF&H 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.  On June 24, 2003, Nortel Networks S.A. acquired the outstanding
 shares of Northern Telecom France S.A. (Northern Telecom France)
from Nortel Networks Inc. (NNI), a subsidiary of Nortel Networks
(see note 9). Northern Telecom France is a holding company that
was then holding interests of 17.8 percent in Nortel Networks
France S.A.S. (Nortel Networks France) and 13.2 percent in EADS
Telecom S.A.S., formerly EADS Defence and Security Networks S.A.S.
(EADS Telecom).  On December 18, 2003, through a series of transactions Nortel
Networks S.A. acquired all outstanding shares of Nortel Networks
France not already under its control from Nortel Networks and from
NNIF&H B.V. (see note 9). Nortel Networks France primarily
distributes Wireline, Optical and Enterprise products of Nortel
Networks in France either directly or through various distribution
channels.  2.
    
    Significant accounting policies  Basis of presentationThe consolidated financial statements of Nortel Networks S.A. have been prepared in
accordance with accounting principles generally accepted in the United States (U.S.) (GAAP)
and the rules and regulations of the U.S. Securities and Exchange Commission (the SEC) for the
preparation of financial statements.Nortel Networks S.A. and certain affiliates entered into a series of complex transactions during
the periods presented that constituted a reorganization and transfers of share ownership of
entities under common control (see note 9). The transactions have been accounted for at
historical cost in a manner similar to a pooling of interest, and in accordance with Statement
of Financial Accounting Standards (SFAS) No. 141 Business Combinations (SFAS 141) all
prior period financial statements presented have been restated as if the reorganization took
place at the beginning of such periods.As described in note 3, the consolidated statements of operations, shareholders equity and cash
flows for the years ended December 31, 2002 and 2001 and the consolidated balance sheet as of
December 31, 2002, including the applicable notes, were restated.These financial statements have been prepared on the basis that Nortel Networks S.A. is a going
concern. Nortel Networks S.A. has received a pledge of support from Nortel Networks.  (a)
    
    Principles of consolidationThe financial statements of entities which are controlled by Nortel Networks S.A. through
voting equity interests, referred to as subsidiaries, are consolidated. Entities which are
jointly controlled, referred to as joint ventures, and entities which are not controlled but
over which Nortel Networks S.A. has the ability to exercise significant influence, referred
to as associated companies, are accounted for using the equity method. Variable Interest
Entities (VIEs) (which include, but are not limited to, special purpose entities, trusts,
partnerships, certain joint ventures and other legal structures), as defined by the
Financial Accounting Standards Board (FASB) in FASB Interpretation (FIN) No. 46 (Revised
2003), Consolidation of Variable Interest Entities  an Interpretation of Accounting
Research Bulletin No. 51 (FIN 46R), are entities in which equity investors do not have
the characteristics of a controlling financial interest or there is not sufficient equity
at risk for the entity to finance its activities without additional subordinated financial
support. VIEs are consolidated by Nortel Networks S.A. when it is determined, that it will,
as the primary beneficiary, absorb the majority of the VIEs expected losses and/or 190




---



##### Table of Contents



expected residual returns. Intercompany accounts and transactions are eliminated upon
consolidation and unrealized intercompany gains and losses are eliminated when accounting
under the equity method.(b)
    
    Use of estimatesNortel Networks S.A. makes estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities as of the date of
the consolidated financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results may differ from those estimates. Estimates are
used when accounting for items and matters such as revenue recognition, allowances for
uncollectible accounts receivable and customer financing, receivables sales, inventory
obsolescence, product warranty, amortization, asset valuations, impairment assessments,
employee benefits, taxes, restructuring and other provisions, stock-based compensation and
contingencies.(c)
    
    Translation of foreign currenciesThe functional currency of Nortel Networks S.A. is the euro.Transactions and financial statement items denominated in a currency other than the euro are
translated into euros at the exchange rates in effect at the balance sheet dates for
monetary assets and liabilities, and at historical exchange rates for non-monetary assets
and liabilities. Revenue and expenses are translated at average rates for the period,
except for amortization and depreciation which are translated on the same basis as the
related assets. Resulting translation gains or losses are reflected in net earnings (loss).(d)
    
    Revenue recognitionNortel Networks S.A. products and services are generally sold as part of a contract and the
terms of the contracts, taken as a whole, determine the appropriate revenue recognition
methods.Depending upon the terms of the contract and types of products and services sold, Nortel
Networks S.A. recognizes revenue under American Institute of Certified Public Accountants
Statement of Position (SOP) 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts (SOP 81-1), SOP 97-2, Software Revenue Recognition
(SOP 97-2), and SEC Staff Accounting Bulletin (SAB) 104, Revenue Recognition (SAB
104), which was preceded by SAB 101, Revenue Recognition in Financial Statements (SAB
101). Revenue is recognized net of cash discounts and allowances.Effective July 1, 2003, for contracts involving multiple deliverables, where the
deliverables are governed by more than one authoritative accounting standard, Nortel
Networks S.A. generally applies the FASB Emerging Issues Task Force (EITF) Issue No.
00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21), and evaluates each
deliverable to determine whether it represents a separate unit of accounting based on the
following criteria: (a) whether the delivered item has value to the customer on a
standalone basis, (b) whether there is objective and reliable evidence of the fair value of
the undelivered item(s), and (c) if the contract includes a general right of return relative
to the delivered item, delivery or performance of the undelivered item(s) is considered
probable and substantially in the control of Nortel Networks S.A. If objective and reliable
evidence of fair value exists for all units of accounting in the contract, revenue is
allocated to each unit of accounting or element based on relative fair values. In
situations where there is objective and reliable evidence of fair value for all undelivered
elements, but not for delivered elements, the residual method is used to allocate the
contract consideration. Under the residual method, the amount of revenue allocated to
delivered elements equals the total arrangement consideration less the aggregate fair value
of any undelivered elements. Each unit of accounting is then accounted for under the
applicable revenue recognition guidance.For arrangements that include hardware and software where software is considered more than
incidental to the hardware, provided that the software is not essential to the functionality
of the hardware and the hardware and software represent separate units of accounting,
revenue related to the software element is recognized under SOP 97-2 and revenue related to
the hardware element is recognized under SOP 81-1 or SAB 104. For arrangements where the
software is considered more than incidental and essential to the functionality of the
hardware, or where the hardware is not considered a separate unit of accounting from the
software deliverables, revenue is recognized for the software and the hardware as a single
unit of accounting pursuant to SOP 97-2 for off-the-shelf products and pursuant to SOP 81-1
for customized products.Prior to July 1, 2003, for contracts involving multiple elements, Nortel Networks S.A.
allocated revenue to each element based on the relative fair value or the residual method,
as applicable. Provided none of the undelivered elements are essential to the functionality
of the delivered elements, revenue related to the software element is 191




---



##### Table of Contents



recognized under SOP 97-2 and revenue related to the hardware element is recognized under
SOP 81-1 or SAB 101.For accounting units related to customized network solutions and certain network build outs,
revenues are recognized under SOP 81-1 using the percentage-of-completion method. In using
the percentage-of-completion method, revenues are generally recorded based on a measure of
the percentage of costs incurred to date on a contract relative to the estimated total
expected contract costs. Profit estimates on long-term contracts are revised periodically
based on changes in circumstances and any losses on contracts are recognized in the period
that such losses become known. Generally, the terms of long-term contracts provide for
progress billing based on completion of certain phases of work. Contract revenues
recognized, based on costs incurred towards the completion of the project, that are unbilled
are accumulated in the contracts in progress account included in accounts receivable  net.
Billings in excess of revenues recognized to date on long-term contracts are recorded as
advance billings in excess of revenues within other accrued liabilities.Revenue for hardware that does not require significant customization, and where any software
is considered incidental, is recognized under SAB 104. Under SAB 104, revenue is recognized
provided that persuasive evidence of an arrangement exists, delivery has occurred or
services have been rendered, the fee is fixed or determinable, and collectibility is
reasonably assured. For hardware, delivery is considered to have occurred upon shipment
provided that risk of loss, and title in certain jurisdictions, have been transferred to the
customer.Engineering, installation and other service revenues are recognized as the services are
performed.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
sale at the time of shipment to the distribution channel when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable and collection
is reasonably assured. Accruals for estimated sales returns and other allowances are
recorded at the time of revenue recognition and are based on contract terms and prior claims
experience.Software revenue is generally recognized under SOP 97-2. For software arrangements
involving multiple elements, Nortel Networks allocates revenue to each element based on the
relative fair value or the residual method, as applicable, and using vendor specific
objective evidence of fair values, which is based on prices charged when the element is sold
separately. Software revenue accounted for under SOP 97-2 is recognized when: persuasive
evidence of an arrangement exists; the software is delivered in accordance with all terms
and conditions of the customer contracts; the fee is fixed or determinable; and collection
is reasonably assured. Revenue related to post-contract support, including technical
support and unspecified when-and-if available software upgrades (PCS), is recognized
ratably over the PCS term. Nortel Networks S.A. 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 S.A. 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.Under SAB 104 or SOP 97-2, if fair value does not exist for any undelivered element, revenue
is not recognized until the earlier of (i) the undelivered element is delivered or (ii) fair
value of the undelivered element exists, unless the undelivered element is a service, in
which case revenue is recognized as the service is performed once the service is the only
undelivered element.(e)
    
    Research and developmentResearch and development (R&D) costs are charged to net earnings (loss) in the periods in
which they are incurred. However, costs incurred pursuant to specific contracts with third
parties for which Nortel Networks S.A. is obligated to deliver a product are charged to cost
of revenues in the same period as the related revenue is recognized. Related global
investment tax credits are deducted from the income tax provision.(f)
    
    Income taxesNortel 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 consequence of events recognized
in the consolidated financial statements and tax returns. Deferred income taxes are
adjusted to reflect the effects of changes in tax laws or enacted tax rates. 192




---



##### Table of Contents



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
remaining net deferred tax assets or a portion thereof will be realized.(g)
    
    Cash and cash equivalentsCash and cash equivalents consist of cash on hand, balances with banks and short-term
investments. All highly liquid investments with original maturities of three months or less
are classified as cash and cash equivalents. The fair value of cash and cash equivalents
approximates the amounts shown in the consolidated financial statements.(h)
    
    Provision for doubtful accountsThe provision for doubtful accounts for trade, notes and long-term receivables due from
customers is established based on an assessment of a customers credit quality, as well as
subjective factors and trends, including the aging of receivable balances. Generally, these
credit assessments occur prior to the inception of the credit exposure and at regular
reviews during the life of the exposure.(i)
    
    InventoriesInventories are valued at the lower of cost (calculated generally on a first-in, first-out
basis) or market. The cost of finished goods and work in process is comprised of material,
labor and manufacturing overhead. Provisions for inventory are based on estimates of future
customer demand for products, including general economic conditions, growth prospects within
the customers ultimate marketplaces and market acceptance of current and pending products.
In addition, full provisions are generally recorded for surplus inventory in excess of one
years forecast demand or inventory deemed obsolete.(j)
    
    Receivables salesTransfers of accounts receivable that meet the criteria for surrender of control under FASB
Statement of Financial Accounting Standard (SFAS) No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, are accounted for as
sales. Generally, Nortel Networks S.A. retains servicing rights and, in some cases,
provides limited recourse when it sells receivables. A gain or loss is recorded in other
income (expense)  net at the date of the receivables sale and is based upon, in part, the
previous carrying amount of the receivables involved in the transfer allocated between the
assets sold and the retained interests based on their relative fair 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. Retained interests are classified as available for sale
securities.Nortel Networks S.A., 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 S.A., when acting as the servicing agent, to receive a servicing bonus at the
maturity of the transaction if certain performance criteria are met. The ultimate
collection of servicing bonuses is based primarily on the collectibility and credit
experience of the receivables sold and is sometimes paid at the discretion of the
transferee. Nortel Networks S.A. initially records the non-discretionary servicing bonus at
fair value which is the discounted value of the estimated future cash flows taking into
consideration future estimated interest rates and credit losses. Generally, the
discretionary servicing bonus is initially recorded at a fair value of nil due to the fact
that it is paid at the discretion of the transferee and based on the determination that
future credit losses will offset any such servicing bonus. Nortel Networks S.A. reviews the
fair value assigned to retained interests, including the servicing bonus, at each reporting
date subsequent to the date of the transfer to determine if there is an other than temporary
impairment. Fair value is reviewed using similar valuation techniques as those used to
initially measure the retained interest and, if a change in events or circumstances
warrants, the fair value is adjusted and any other than temporary impairments are recorded
in other income (expense)  net.(k)
    
    InvestmentsInvestments in equity securities of companies over which Nortel Networks S.A. does not exert
significant influence are accounted for using the cost method. Nortel Networks S.A.
monitors its investments for factors indicating other than temporary impairment and records
a charge to net earnings (loss) when appropriate. 193




---



##### Table of Contents



(l)
    
    Plant and equipmentPlant 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.(m)
    
    Impairment or disposal of long-lived assets (plant and equipment and other intangible
assets)Long-lived assets held and usedNortel Networks S.A. tests long-lived assets or asset groups held and used for
recoverability when events or changes in circumstances indicate that their carrying amount
may not be recoverable. Circumstances which could trigger a review include, but are not
limited to: significant decreases in the market price of the asset; significant adverse
changes in the business climate or legal factors; the accumulation of costs significantly in
excess of the amount originally expected for the acquisition or construction of the asset;
current period cash flow or operating losses combined with a history of losses or a forecast
of continuing losses associated with the use of the asset; and a current expectation that
the asset will more likely than not be sold or disposed of significantly before the end of
its estimated useful life.Recoverability is assessed based on the carrying amount of the asset and the sum of the
undiscounted cash flows expected to result from the use and the eventual disposal of the
asset or asset group. An impairment loss is recognized when the carrying amount is not
recoverable and exceeds the fair value of the asset or asset group. The impairment loss is
measured as the amount by which the carrying amount exceeds fair value.Long-lived assets held for saleLong-lived assets are classified as held for sale when certain criteria are met, which
include: managements commitment to a plan to sell the assets; the 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 have 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 or fair value less cost to sell. These assets are not depreciated. 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 saleNortel Networks S.A. classifies assets that will be disposed of other than by sale as held
and used until the disposal transaction occurs. The assets continue to be depreciated based
on revisions to their estimated useful lives until the date of disposal or abandonment.Recoverability is assessed based on the carrying amount of the asset and the sum of the
undiscounted cash flows expected to result from the remaining period of use and the eventual
disposal of the asset or asset group. An impairment loss is recognized when the carrying
amount is not recoverable and exceeds the fair value of the asset or asset group. The
impairment loss is measured as the amount by which the carrying amount exceeds fair value.(n)
    
    GoodwillGoodwill represents the excess of the purchase price of an acquired enterprise over the fair
value of the identifiable assets acquired and liabilities assumed. Nortel Networks S.A.
tests for impairment of goodwill on an annual basis as of October 1 and at any other time if
events occur or circumstances change that would indicate that it is more likely than not
that the fair value of the reporting unit has been reduced below its carrying amount (see
note 4(i)).Circumstances that could trigger an impairment test include: a significant adverse change in
the business climate or legal factors; an adverse action or assessment by a regulator;
unanticipated competition; the loss of key personnel; the likelihood that a reporting unit
or significant portion of a reporting unit will be sold or otherwise disposed of; the
results of testing for recoverability of a significant asset group within a reporting unit;
and the recognition of a goodwill impairment loss in the financial statements of a
subsidiary that is a component of a reporting unit. 194




---



##### Table of Contents



The impairment test for goodwill is a two-step process. Step one consists of a comparison
of the fair value of a reporting unit with its carrying amount, including the goodwill
allocated to the reporting unit. Measurement of the fair value of a reporting unit is based
on one or more fair value measures including present value techniques of estimated future
cash flows and estimated amounts at which the unit as a whole could be bought or sold in a
current transaction between willing parties. If the carrying amount of the reporting unit
exceeds the fair value, step two requires the fair value of the reporting unit to be
allocated to the underlying assets and liabilities of that reporting unit, resulting in an
implied fair value of goodwill. If the carrying amount of the reporting unit goodwill
exceeds the implied fair value of that goodwill, an impairment loss equal to the excess is
recorded in net earnings (loss).(o)
    
    Intangible assetsThe intangible assets are comprised principally of customer related intangibles which are
amortized over their estimated useful lives of approximately nine years.(p)
    
    Warranty costsAs part of the normal sale of product, Nortel Networks S.A. provides its customers with
product warranties that extend for periods generally ranging from one to six years from the
date of sale. A liability for the expected cost of warranty-related claims is established
when products are sold. In estimating warranty liability, historical material replacement
costs and the associated labor to correct the product defect are considered. Revisions are
made when actual experience differs materially from historical experience. Known product
defects are specifically accrued for as Nortel Networks S.A. becomes aware of such defects.(q)
    
    State sponsored pension plansAll employees are covered for pension entitlements under state sponsored pension plans,
funded by regular contributions that are reflected in net earnings (loss).(r)
    
    Financial instrumentsThe 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, when not held with related parties, 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. 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.(s)
    
    Stock-based compensationIn December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure  an Amendment of FASB Statement No. 123 (SFAS 148), which
amended the transitional provisions of SFAS No. 123, Accounting for Stock-based
Compensation (SFAS 123), for companies electing to recognize employee stock-based
compensation using the fair value based method.Prior to January 1, 2003, Nortel Networks S.A., as permitted under SFAS 123, applied the
intrinsic value method under Accounting Principles Board Opinion (APB) No. 25, Accounting
for Stock Issued to Employees (APB 25), and related interpretations in accounting for its
employee stock-based compensation plans.Effective January 1, 2003, Nortel Networks S.A. elected to expense employee stock-based
compensation using the fair value based method prospectively for all awards granted,
modified, or settled on or after January 1, 2003. The fair value at grant date of stock
options is estimated using the Black-Scholes option-pricing model. Compensation expense is
recognized on a straight line basis over the stock option vesting period. The impact of the
adoption of the fair value based method for expense recognition of employee awards resulted
in 1,333 (net of tax of nil) of stock option expense during 2003.Stock-based awards that are settled or may be settled in cash or shares purchased on the
open market at the option of employees or directors are recorded as liabilities. The
measurement of the liability and compensation cost for these awards is based on the
intrinsic value of the award and is recorded in net earnings (loss) over the vesting period
of the award. Changes in Nortel Networks payment obligation subsequent to vesting of the
award and prior 195




---



##### Table of Contents



to the settlement date are recorded in net earnings (loss) in the period incurred. The
payment amount is established for Stock Appreciation Rights (SARs) on the date of exercise
of the award by the employee, for Restricted Stock Units (RSUs) on the vesting date of the
award. Stock-based awards which are substantively discretionary in nature are recorded in
the period that the issuance and settlement of the award is approved.Under various stock option programs of Nortel Networks Corporation (NNC), the ultimate
parent company of Nortel Networks S.A., options may be granted to various eligible employees
and directors of Nortel Networks S.A. to purchase common shares of Nortel Networks
Corporation.NNC has stock purchase plans for eligible employees in eligible countries (including
France), to facilitate the acquisition of the common shares of Nortel Networks Corporation
at a discount (ESPPs). Nortel Networks S.A. contribution to the ESPPs is recorded as
compensation expense on a quarterly basis as the obligation to contribute is incurred.Had Nortel Networks S.A. applied the fair value based method to all stock-based awards in
all periods, reported net earnings (loss) would have been adjusted to the pro forma amounts
indicated below for the following years ended December 31: 2003
    
    
    2002
    
    
    2001Net earnings (loss)  reported
    
    
    (138,889
    )
    
    
    (206,174
    )
    
    
    (339,539
    )Stock-based compensation  reported(a)
    
    
    2,133
    
    
    
    463
    
    
    
    917Stock-based compensation  pro forma(b)
    
    
    (10,435
    )
    
    
    (34,685
    )
    
    
    (45,134
    )Net earnings (loss)  pro forma
    
    
    (147,191
    )
    
    
    (240,396
    )
    
    
    (383,756
    )
 (a)
    
    Stock-based compensation  reported, included, for the years ended December 31, 2003, 2002 and 2001:i.
    
    Stock option expense of 1,333, nil and nil, respectively, which was net of tax of nil in each period;ii.
    
    Employer portion of ESPPs contributions expense of 314, 463 and 917, respectively, which was net of tax of 25, 51 and 72, respectively;iii.
    
    RSUs expense of 486, nil and nil, respectively, which was net of tax of 98, nil and nil respectively.(b)
    
    Stock-based compensation  pro forma expense for the years ended December 31, 2003, 2002 and 2001, which was net of tax of nil.
  The following weighted average assumptions were used in computing the fair value of
stock options for purposes of expense recognition and pro forma disclosures, as applicable,
for the following periods: 2003
    
    
    2002
    
    
    2001Black-Scholes weighted-average assumptionsExpected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    92.49
    %
    
    
    71.33
    %
    
    
    70.36
    %Risk-free interest rate
    
    
    2.81
    %
    
    
    4.49
    %
    
    
    4.49
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4Weighted-average stock option fair value
per option granted (U.S.$)
    
    $
    1.6
    
    
    $
    3.5
    
    
    $
    8.4
  (t)
    
    Recent accounting pronouncementsIn March 2004, the EITF reached consensus on Issue
No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments (EITF 03-1).
EITF 03-1 provides guidance on determining when an investment is considered impaired,
whether that impairment is other than temporary and the measurement of an impairment loss.
EITF 03-1 is applicable to marketable debt and equity securities within the scope of SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115),
and SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations,
and equity securities that are not subject to the scope of SFAS 115 and not accounted for
under the equity method of accounting. In September 2004, the FASB issued FSP EITF 03-1-1,
Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1,
The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments, which delays
the effective date for the measurement and recognition criteria contained in EITF 03-1 until
final application guidance is issued. The delay does not suspend the requirement to
recognize other-than-temporary impairments as required by existing authoritative literature. The adoption of EITF 03-1 is not expected
to have a material impact on Nortel Networks S.A. results of operations and financial
position. 196




---



##### Table of Contents



Comparative figures  Certain 2002 and 2001 figures in the consolidated financial statements have been
reclassified to conform to the 2003 presentation and have been restated as set out in note 3.  3.
    
    Restatement  First RestatementIn May 2003, NNC and its subsidiaries (including Nortel Networks S.A.) commenced
certain balance sheet reviews at the direction of certain members of former management that led
to a comprehensive review and analysis of its assets and liabilities (the Comprehensive
Review), which resulted in the restatement (effected in
December 2003) of its consolidated financial
statements for the years ended December 31, 2002, 2001 and 2000 and for the quarters ended March
31, 2003 and June 30, 2003 (the First Restatement).The Comprehensive Review purported to (i) identify balance sheet accounts that, as of June 30,
2003, were not supportable and required adjustment; (ii) determine whether such adjustments
related to the third quarter of 2003 or prior periods; and (iii) document certain account balances
in accordance with NNC accounting policies and procedures. The
Comprehensive Review, as supplemented by additional procedures carried
out between July 2003 and November 2003 to quantify the effects of potential adjustments in the
relevant periods and review the
appropriateness of releases of certain contractual liability and other related provisions (also
called accruals, reserves or accrued liabilities) in the six fiscal quarters ending with the
fiscal quarter ended June 30, 2003, formed the basis for the adjustments made to the financial statements in the
First Restatement.On December 23, 2003, NNC filed with the SEC an amended Annual Report on Form 10-K/A
for the year ended December 31, 2002 (the 2002 Form 10-K/A) and amended Quarterly Reports on
Form 10-Q/A for the first and second quarters of 2003 (the 2003 Form 10-Q/As) reflecting the
First Restatement. As disclosed in those reports, the net effect of the First Restatement
adjustments for Nortel Networks S.A. was a reduction in accumulated deficit of 27,835 and 6,022 as of December 31, 2002
and 2001, respectively, and a reduction in the accumulated retained earnings of 1,975 as of
December 31, 2000.Second RestatementIn late October 2003, the Audit Committee of NNCs
and Nortel Networkss Boards of Directors (the Audit Committee) initiated an independent
review of the facts and circumstances leading to the First Restatement (the Independent
Review) and engaged the law firm now known as Wilmer Cutler Pickering Hale & Dorr LLP (WCPHD)
to advise it in connection with the Independent Review. The Audit Committee sought to gain a full understanding
of the events that caused significant excess liabilities to be maintained on the balance sheet
that needed to be restated, and to recommend that the Board adopt, and direct management to
implement, necessary remedial measures to address personnel, controls, compliance and
discipline. The Independent Review focused initially on events relating to the establishment
and release of contractual liability and other related provisions in the second half of 2002 and
the first half of 2003, including the involvement of senior corporate leadership. As the
Independent Review evolved, its focus broadened to include specific provisioning activities in
each of the business units and geographic regions. In light of concerns raised in the initial phase of the
Independent Review, the Audit Committee expanded the review to include provisioning activities
in the third and fourth quarters of 2003.As the Independent Review progressed, the Audit Committee directed new corporate management to
examine in depth the concerns identified by WCPHD regarding provisioning activity and to review
provision releases in each of the four quarters of 2003, down to a low threshold. That
examination, and other errors identified by management, led to the restatement of Nortel
Networks consolidated financial statements and Nortel Networks
S.A.s consolidated financial statements for the years ended December 31, 2002 and 2001 and
the quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003 and
2002 (the Second Restatement).Over the course of the Second Restatement process,
management identified certain accounting practices that it determined should be
adjusted as part of the Second Restatement. In particular, management identified certain
errors related to revenue recognition and undertook a process of revenue reviews.Due to, among other factors, significant turnover in NNC
finance personnel, changes in accounting systems, documentation
weaknesses, and identified material weaknesses in internal
controls over financial reporting the Second
Restatement involved hundreds of NNC
finance personnel and a number of outside consultants and advisors. The process required the
review and verification of a substantial number of documents and communications and related
accounting entries over multiple fiscal periods. In addition, the review of 197




---



##### Table of Contents



accruals and
provisions and the application of accounting literature to certain matters in the Second
Restatement, including revenue recognition, foreign exchange, special charges and discontinued
operations, was complicated by the passage of time, lack of availability of supporting records and the
turnover of finance personnel. As a result of this complexity, estimates and assumptions that
impact both the quantum of the various recorded adjustments and the fiscal period to which they
were attributed were required in the determination of certain of the Second Restatement adjustments.
Nortel Networks S.A. believes the procedures followed in determining such estimates were appropriate
and reasonable using the best available information.The following tables present the impact of the Second Restatement adjustments (and Pooling of
Interest adjustments, see notes 2 and 9) to Nortel Networks
S.A.s previously reported
consolidated statements of operations and a summary of the adjustments from the Second
Restatement for the years ended December 31, 2002 and 2001. The Second Restatement adjustments
related primarily to the following items, each of which reflect a number of related adjustments
that have been aggregated for disclosure purposes, and are described in the paragraphs following
the tables below:  
    
    Accruals and provisions
    
    Related party transactions
    
    Plant and equipment  Consolidated Statement of Operations for the year ended December 31, 2002 As
    
    
    Second
    
    
    Pooling of
    
    
    Aspreviously
    
    
    Restatement
    
    
    interest
    
    
    pooled andreported
    
    
    Adjustments
    
    
    Adjustments
    
    
    restatedRevenues  external
    
    
    214,922
    
    
    
    
    
    
    
    141,394
    
    
    
    356,316 related parties
    
    
    473,223
    
    
    
    (5,362
    )
    
    
    (8,943
    )
    
    
    458,918688,145
    
    
    
    (5,362
    )
    
    
    132,451
    
    
    
    815,234Cost of revenues
    
    
    595,637
    
    
    
    (45,011
    )
    
    
    49,741
    
    
    
    600,367Gross profit
    
    
    92,508
    
    
    
    39,649
    
    
    
    82,710
    
    
    
    214,867Selling, general and administrative expense
    
    
    31,998
    
    
    
    (3,700
    )
    
    
    41,184
    
    
    
    69,482Research and development expense
    
    
    257,585
    
    
    
    6,690
    
    
    
    
    
    
    
    264,275Special charges  other special charges
    
    
    58,854
    
    
    
    2,646
    
    
    
    21,927
    
    
    
    83,427(Gain) loss on sale of businesses and assets
    
    
    
    
    
    
    
    
    
    
    16,171
    
    
    
    16,171Operating earnings (loss)
    
    
    (255,929
    )
    
    
    34,013
    
    
    
    3,428
    
    
    
    (218,488
    )Other income (expenses)  net
    
    
    18,962
    
    
    
    (1,486
    )
    
    
    5,562
    
    
    
    23,038Foreign exchange gain (loss)
    
    
    (1,557
    )
    
    
    331
    
    
    
    (4,305
    )
    
    
    (5,531
    )Interest expense
    
    
    (6,524
    )
    
    
    (3,280
    )
    
    
    (81
    )
    
    
    (9,885
    )Earnings (loss) before income taxes and minority interest
    
    
    (245,048
    )
    
    
    29,578
    
    
    
    4,604
    
    
    
    (210,866
    )Minority interest  net of tax
    
    
    
    
    
    
    
    
    
    
    3,052
    
    
    
    3,052Income tax benefit
    
    
    1,680
    
    
    
    
    
    
    
    (40
    )
    
    
    1,640Net earnings (loss)
    
    
    (243,368
    )
    
    
    29,578
    
    
    
    7,616
    
    
    
    (206,174
    )
 198




---



##### Table of Contents



Summary of Restatement Adjustments for the year ended December 31, 2002: Accruals and
    
    
    Related party
    
    
    Plant and
    
    
    Totalprovisions
    
    
    transactions
    
    
    equipment
    
    
    adjustmentsRevenues  external
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Revenues  related parties
    
    
    
    
    
    
    (5,362
    )
    
    
    
    
    
    
    (5,362
    )
    
    
    
    (5,362
    )
    
    
    
    
    
    
    (5,362
    )Cost of revenues
    
    
    9,030
    
    
    
    (54,524
    )
    
    
    483
    
    
    
    (45,011
    )Gross profit
    
    
    (9,030
    )
    
    
    49,162
    
    
    
    (483
    )
    
    
    39,649Selling, general and administrative expense
    
    
    (420
    )
    
    
    
    
    
    
    (3,280
    )
    
    
    (3,700
    )Research and development expense
    
    
    6,690
    
    
    
    
    
    
    
    
    
    
    
    6,690Special charges  other special charges
    
    
    2,646
    
    
    
    
    
    
    
    
    
    
    
    2,646Other income (expense)  net
    
    
    (1,541
    )
    
    
    184
    
    
    
    (129
    )
    
    
    (1,486
    )Foreign exchange gain (loss)
    
    
    306
    
    
    
    25
    
    
    
    
    
    
    
    331Interest expense
    
    
    
    
    
    
    
    
    
    
    (3,280
    )
    
    
    (3,280
    )Total restatement adjustments
    
    
    (19,181
    )
    
    
    49,371
    
    
    
    (612
    )
    
    
    29,578
  Consolidated Statements of Operations for the year ended December 31, 2001 As
    
    
    Second
    
    
    Pooling of
    
    
    Aspreviously
    
    
    Restatement
    
    
    interest
    
    
    pooled andreported
    
    
    Adjustments
    
    
    Adjustments
    
    
    restatedRevenues  external
    
    
    275,915
    
    
    
    
    
    
    
    491,798
    
    
    
    767,713 related parties
    
    
    429,643
    
    
    
    9,800
    
    
    
    (371
    )
    
    
    439,072705,558
    
    
    
    9,800
    
    
    
    491,427
    
    
    
    1,206,785Cost of revenues
    
    
    809,472
    
    
    
    (74,439
    )
    
    
    381,733
    
    
    
    1,116,766Gross profit (loss)
    
    
    (103,914
    )
    
    
    84,239
    
    
    
    109,694
    
    
    
    90,019Selling, general and administrative expense
    
    
    74,617
    
    
    
    (2,876
    )
    
    
    103,692
    
    
    
    175,433Research and development expense
    
    
    253,327
    
    
    
    (13,677
    )
    
    
    9,953
    
    
    
    249,603Amortization of goodwill
    
    
    
    
    
    
    
    
    
    
    3,434
    
    
    
    3,434Special chargesGoodwill impairment
    
    
    
    
    
    
    
    
    
    
    20,607
    
    
    
    20,607Other special charges
    
    
    74,463
    
    
    
    (8,095
    )
    
    
    8,404
    
    
    
    74,772(Gain) loss on sale of businesses and assets
    
    
    
    
    
    
    
    
    
    
    (10,243
    )
    
    
    (10,243
    )Operating earnings (loss)
    
    
    (506,321
    )
    
    
    108,887
    
    
    
    (26,153
    )
    
    
    (423,587
    )Other income (expense)  net
    
    
    46,240
    
    
    
    (266
    )
    
    
    8,024
    
    
    
    53,998Foreign exchange gain (loss)
    
    
    4,442
    
    
    
    
    
    
    
    (6,152
    )
    
    
    (1,710
    )Interest expense
    
    
    (5,033
    )
    
    
    (2,821
    )
    
    
    (3,432
    )
    
    
    (11,286
    )Earnings (loss) before income taxes and minority interest
    
    
    (460,672
    )
    
    
    105,800
    
    
    
    (27,713
    )
    
    
    (382,585
    )Minority interest   net of tax
    
    
    
    
    
    
    
    
    
    
    8,973
    
    
    
    8,973Income tax benefit
    
    
    26,198
    
    
    
    
    
    
    
    7,875
    
    
    
    34,073Net earnings (loss)
    
    
    (434,474
    )
    
    
    105,800
    
    
    
    (10,865
    )
    
    
    (339,539
    )
 199




---



##### Table of Contents



Summary of Restatement Adjustments for the year ended December 31, 2001: Accruals and
    
    
    Related party
    
    
    Plant and
    
    
    Totalprovisions
    
    
    transactions
    
    
    equipment
    
    
    adjustmentsRevenues  external
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Revenues  related parties
    
    
    
    
    
    
    9,800
    
    
    
    
    
    
    
    9,800
    
    
    
    9,800
    
    
    
    
    
    
    
    9,800Cost of revenues
    
    
    (13,700
    )
    
    
    (60,747
    )
    
    
    8
    
    
    
    (74,439
    )Gross profit
    
    
    13,700
    
    
    
    70,547
    
    
    
    (8
    )
    
    
    84,239Selling, general and administrative expense
    
    
    (55
    )
    
    
    
    
    
    
    (2,821
    )
    
    
    (2,876
    )Research and development expense
    
    
    (13,358
    )
    
    
    
    
    
    
    (319
    )
    
    
    (13,677
    )Special charges  other special charges
    
    
    (8,095
    )
    
    
    
    
    
    
    
    
    
    
    (8,095
    )Other income (expense)  net
    
    
    (435
    )
    
    
    75
    
    
    
    94
    
    
    
    (266
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    (2,821
    )
    
    
    (2,821
    )Total restatement adjustments
    
    
    34,773
    
    
    
    70,622
    
    
    
    405
    
    
    
    105,800
  (a)
    
    Accruals and provisions  The adjustments primarily correct certain accruals, provisions or other transactions which were
either initially recorded incorrectly in prior periods or not properly released or adjusted for
changes in estimates and/or assumptions in the appropriate periods. The adjustments primarily
impacted cost of revenues, selling, general and administrative expense, research and development
expense, special charges and other expense and resulted in an increase to the net loss in the
year ending December 31, 2002 and a decrease to the net loss for the year ended December 31,
2001. These adjustments are described below. 2002
    
    
    2001Increase (decrease) from adjustments of accruals and provisionsCost of revenues
    
    
    9,030
    
    
    
    (13,700
    )Selling, general and administrative expense
    
    
    (420
    )
    
    
    (55
    )Research and development expense
    
    
    6,690
    
    
    
    (13,358
    )Special charges
    
    
    2,646
    
    
    
    (8,095
    )Other expense
    
    
    1,541
    
    
    
    435Foreign exchange
    
    
    (306
    )
    
    
    Net increase (decrease) to net loss
    
    
    19,181
    
    
    
    (34,773
    )
  Details of the items listed above are provided in the following tables.Cost of revenuesThe variations to cost of revenues were due to the following factors: 2002
    
    
    2001Increase (decrease) of cost of revenuesProduct related
    
    
    1,036
    
    
    
    (4,194
    )Customer related
    
    
    (1,042
    )
    
    
    (743
    )Related party
    
    
    (157
    )
    
    
    (500
    )Employee related
    
    
    4,423
    
    
    
    (4,330
    )Other accounts payable
    
    
    2,010
    
    
    
    (920
    )Tax
    
    
    2,645
    
    
    
    (3,110
    )Other
    
    
    115
    
    
    
    97Net increase (decrease) of cost of revenues
    
    
    9,030
    
    
    
    (13,700
    )
 200




---



##### Table of Contents



Selling, general and administrative expenseThe variations to selling, general and administrative expense were due to the following factors: 2002
    
    
    2001Increase (decrease) of selling, general and administrative expenseCustomer related
    
    
    (102
    )
    
    
    Employee related
    
    
    (300
    )
    
    
    Other accounts payable
    
    
    (28
    )
    
    
    (44
    )Tax
    
    
    1,910
    
    
    
    (1,910
    )Other
    
    
    (1,900
    )
    
    
    1,899Net increase (decrease) of selling, general and administrative expense
    
    
    (420
    )
    
    
    (55
    )
  Research and development expenseThe variations to research and development costs were due to the following factors: 2002
    
    
    2001Increase (decrease) of research and developmentProduct related
    
    
    (5,734
    )
    
    
    (1,585
    )Related party
    
    
    (150
    )
    
    
    Other accounts payable
    
    
    9,334
    
    
    
    (7,787
    )Tax
    
    
    3,521
    
    
    
    (3,986
    )Other
    
    
    (281
    )
    
    
    Net increase (decrease) of research and
development
    
    
    6,690
    
    
    
    (13,358
    )
  Special ChargesAs part of the Second Restatement process, the transactions impacting special charges were
reviewed. As a result, various adjustments have been made to correct certain items. The
adjustments resulted in an increase of 2,646 and a decrease of 8,095 to special charges for
the years ended December 31, 2002 and 2001, respectively. Adjustments for restructuring related
mainly to plant and equipment and real estate related items. Nortel Networks S.A. determined
that these items were accrued in error and the Second Restatement
therefore cancels the
original accruals in the period they were recorded. Accruals originally set-up in the year
ended December 31, 2002 amounting to 5,449 were adjusted. This adjustment was more than
offset by the cancellation of accruals amounting to 8,095 originally setup in the year ended
December 31, 2001 and released in the year ended December 31, 2002.Other expensesFor the year ended December, 31 2002 the 1,235 increase in the other expenses was primarily the
result of adjustments to provisions for litigations of 816, unrecoverable advances to suppliers
for 594 partially offset by foreign exchange gains of 306 relating to items provided
in error under restructuring. For the year ended December 31, 2001 the 435 increase in the other
expenses was the result of an adjustment for 497 to a payroll related accrual partially offset
by a gain recorded on payments received from doubtful accounts fully provided for 62.  (b)
    
    Related party transactions  A large portion of the activity of Nortel Networks S.A. is carried out with related parties. The
adjustments to the financial statements of Nortel Networks have therefore resulted in changes in
revenues and cost of revenues from and to related parties of Nortel Networks S.A. The analysis of out of
balances positions (see below) has also led to certain corrections of revenue and cost of
revenues with related parties. The following table summarizes the adjustments to related party
revenues and cost of revenues: 2002
    
    
    2001Increase (decrease) of revenue from related parties
    
    
    (5,362
    )
    
    
    9,800Increase (decrease) of cost of revenues to related partiesResidual profit sharing adjustment
    
    
    (49,668
    )
    
    
    (60,747
    )Other
    
    
    (4,856
    )
    
    
    Net increase (decrease) of gross profit from related
parties
    
    
    49,162
    
    
    
    70,547
 201




---



##### Table of Contents



Residual profit sharing  Adjustments to cost of revenues of Nortel Networks S.A. are primarily due to adjustments to the
results of Nortel Networks resulting from the restatements. These adjustments impact the cost of
revenues of Nortel Networks S.A. through the global profit split methodology implemented since
2001 (see note 10). The share of Nortel Networks S.A. in the global profit of Nortel Networks
was increased by 49,668 and 60,747 for the years ending December 31, 2002 and December 31,
2001 respectively.Related party revenues and cost of revenuesAdjustments to revenues from related parties of Nortel
Networks S.A. are primarily due to errors
in the timing of the revenue recognition from a profit split agreement by which Nortel Networks
S.A. is entitled to receive a share of the profit recognized by certain affiliated parties. An
amount of
9,800 of
revenue related to this agreement was recognized in the year ended December 31,
2002 whereas Nortel Networks S.A. determined that this revenue should have been recognized in
the year ended December 31, 2001.The reduction of 9,800 of related party revenues in the year ended December 31, 2002 resulting
from this adjustment is partially offset by another adjustment for an amount of 4,438 that was
recorded to correct a reduction in related party revenues recorded in the year ended December,
31 2002. The reduction of related party revenue recorded in the year ended December 31, 2002 was
a correction of related party revenues recorded in error in the year ended December 31,
2000. The adjustment is reprofiling the reduction of revenues from
related parties to the year
ended December 31, 2000. An adjustment was recorded to the cost of revenues to related parties
(see below) on the same transaction for the same amount resulting in an increase to cost of
revenues to related parties by 4,438.The reduction of 4,856 in cost of revenues to related parties in the year ended December 31,
2001 related mainly to the correction of an amount of 9,900 billed to Nortel Networks S.A. in
error under a profit split agreement partially offset by an increase of cost of revenues to
related parties for 4,438 due to the correction of an error recorded in the year ended
December, 31 2002 and that was correcting an error that had taken place in the year ended
December 31, 2000. Another adjustment for 365 to cost of revenues to related parties was
recorded to correct certain charges that had not been expensed in error.Related party out of balancesAs part of the Second Restatement process, Nortel Networks S.A. undertook a review of the
inter-company out-of-balance positions. The timing of the significant underlying out-of-balance
positions has been identified and corrections recorded in the appropriate periods. The
adjustments for the out-of-balance positions resulted in approximately a 61 and a 75 decrease
to the previously reported net loss for the years ended December 31, 2002 and 2001,
respectively.  (c)
    
    Plant and equipment  As a result of the Independent Review, various accounts were examined. Certain known errors
that were previously not recorded because the amount of the errors was not material to the
financial statements of Nortel Networks S.A. were also corrected. The following table summarizes
the adjustments relative to plant and equipment. 2002
    
    
    2001Net increase (decrease) from other adjustments to above itemsCost of revenues
    
    
    483
    
    
    
    8Selling, general and administrative expense
    
    
    (3,280
    )
    
    
    (2,821
    )Research and development expense
    
    
    
    
    
    
    (319
    )Other income (expense)  net
    
    
    129
    
    
    
    (94
    )Interest on long-term debt
    
    
    3,280
    
    
    
    2,821Net increase (decrease) from other adjustments to above items
    
    
    612
    
    
    
    (405
    )
 202




---



##### Table of Contents



Costs of revenues, research and development expenseAdjustments to cost of revenues and research and development were mainly driven by corrections
of errors in the depreciation periods of various plant and equipment, items that had been
classified as plant and equipment in error and that should have been expensed, as well as the
timing of the write off of certain plant and equipment. Adjustments to other expenses were
related to items that had been classified as fixed assets in error and that should have been
expensed, as well as a reclassification of selling, general and administration expense to
interest payment (see below Interest on long term debt).  Interest on long- term debtAs part of the Second Restatement process, the accounting for a lease transaction entered into
by Nortel Networks S.A. in 1999 was also reviewed and it was determined that the lease had
incorrectly been recorded as an operating lease. The lease should have been classified as a
capital lease in accordance with SFAS No. 98 and was therefore restated as such. The impact on
the balance sheet of Nortel Networks S.A. as of December 31, 2002 of that restatement was an
increase of plant and equipment by 79,028, an increase of the long term debt by 76,457 and an
increase of the short term debt by 3,073. The related interest expense were also reclassified
from selling, general and administration expense to interest expense for 3,280 and 2,821 for
the years ending December 31, 2002 and 2001 respectively. That restatement had no impact on net
earnings.Consolidated balance sheet as at December 31, 2002, as restatedIn addition to the effects on the consolidated statements of operations discussed above, the
restatement impacted the consolidated balance sheet as at December 31, 2002. The following
consolidated balance sheet presents the cumulative impact of the restatement adjustments
described above classified by balance sheet line item as at December 31, 2002. 203




---



##### Table of Contents



Consolidated Balance Sheets as of December 31, 2002 As
    
    
    Second
    
    
    Pooling of
    
    
    Aspreviously
    
    
    Restatement
    
    
    interest
    
    
    pooled andreported
    
    
    Adjustments
    
    
    Adjustments
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    
    66,687
    
    
    
    897
    
    
    
    82,835
    
    
    
    150,419Accounts receivable
    
    
    45,665
    
    
    
    164
    
    
    
    38,126
    
    
    
    83,955Inventories  net
    
    
    58,385
    
    
    
    838
    
    
    
    20,847
    
    
    
    80,070Receivables from related parties
    
    
    123,272
    
    
    
    115,237
    
    
    
    (4,438
    )
    
    
    234,071Other current assets
    
    
    99,490
    
    
    
    (2,972
    )
    
    
    9,846
    
    
    
    106,364Total current assets
    
    
    393,499
    
    
    
    114,164
    
    
    
    147,216
    
    
    
    654,879Long-term receivable from related party
    
    
    140,010
    
    
    
    
    
    
    
    
    
    
    
    140,010Investments at cost
    
    
    5,632
    
    
    
    
    
    
    
    10,544
    
    
    
    16,176Plant and equipment  net
    
    
    126,948
    
    
    
    82,629
    
    
    
    8,544
    
    
    
    218,121Goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Intangible assets  net
    
    
    
    
    
    
    
    
    
    
    3,454
    
    
    
    3,454Deferred income taxes  net
    
    
    35,304
    
    
    
    
    
    
    
    7,964
    
    
    
    43,268Other assets
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    6Total assets
    
    
    701,399
    
    
    
    196,793
    
    
    
    177,722
    
    
    
    1,075,914LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesTrade and other accounts payable
    
    
    80,257
    
    
    
    1,406
    
    
    
    9,488
    
    
    
    91,151Payables to related parties
    
    
    52,023
    
    
    
    (7,531
    )
    
    
    44,834
    
    
    
    89,326Payroll and benefit-related liabilities
    
    
    44,503
    
    
    
    333
    
    
    
    5,973
    
    
    
    50,809Contractual Liabilities
    
    
    33,818
    
    
    
    (1,488
    )
    
    
    5,488
    
    
    
    37,818Restructuring
    
    
    15,231
    
    
    
    (3,401
    )
    
    
    1,516
    
    
    
    13,346Other accrued liabilities
    
    
    161,005
    
    
    
    (4,500
    )
    
    
    17,755
    
    
    
    174,260Long-term debt due within one year
    
    
    
    
    
    
    3,073
    
    
    
    
    
    
    
    3,073Total current liabilities
    
    
    386,837
    
    
    
    (12,108
    )
    
    
    85,054
    
    
    
    459,783Other liabilities
    
    
    1,837
    
    
    
    268
    
    
    
    732
    
    
    
    2,837Long-term deferred Income
    
    
    
    
    
    
    
    
    
    
    17,231
    
    
    
    17,231Long-term debt
    
    
    
    
    
    
    76,457
    
    
    
    
    
    
    
    76,457Long-term note payable to related party
    
    
    200,000
    
    
    
    
    
    
    
    20,000
    
    
    
    220,000Total liabilities
    
    
    588,674
    
    
    
    64,617
    
    
    
    123,017
    
    
    
    776,308Minority interest
    
    
    
    
    
    
    
    
    
    
    9,757
    
    
    
    9,757SHAREHOLDERS EQUITYCommon shares, 0.005 par value
    
    
    306,544
    
    
    
    
    
    
    
    
    
    
    
    306,544Additional paid-in capital
    
    
    
    
    
    
    
    
    
    
    43,997
    
    
    
    43,997Accumulated deficit
    
    
    (193,819
    )
    
    
    132,176
    
    
    
    951
    
    
    
    (60,692
    )Total shareholders equity
    
    
    112,725
    
    
    
    132,176
    
    
    
    44,948
    
    
    
    289,849Total liabilities and shareholders equity
    
    
    701,399
    
    
    
    196,793
    
    
    
    177,722
    
    
    
    1,075,914
  4.
    
    Accounting changes  (a)
    
    GuaranteesIn November 2002, the FASB issued FIN 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others  an
interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB interpretation
No. 34 (FIN 45). FIN 45 defines a guarantee as a contract that contingently requires a
guarantor to pay a guaranteed party as a result of changes in an underlying economic
characteristic (such as interest rates or market value) that is related to an asset, a
liability or an equity security of the guaranteed party or a third partys failure to
perform under a specified agreement. FIN 45 requires that a liability be recognized for the
estimated fair value of the guarantee at its inception. Guarantees issued prior to January
1, 2003 are not subject to the recognition and measurement provisions, but are subject to
expanded disclosure requirements. Nortel Networks S.A. has entered into agreements that
contain features which meet the definition of a guarantee under FIN 45. Effective December
31, 2002, Nortel Networks S.A. adopted the disclosure requirements of FIN 45. In addition,
effective January 1, 2003, Nortel Networks S.A. adopted the initial recognition and
measurement provisions of FIN 45 which apply on a prospective basis to certain guarantees 204




---



##### Table of Contents



issued or modified after December 31, 2002. The adoption of FIN 45 did not have a material
impact on the results of operations and financial condition of Nortel Networks S.A. (see
note 12).(b)
    
    Asset retirement obligationsIn June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations
(SFAS 143), which applies to certain obligations associated with the retirement of
tangible long-lived assets. SFAS 143 requires that a liability be initially recognized for
the estimated fair value of the obligation when it is incurred. The associated asset
retirement cost is capitalized as part of the carrying amount of the long-lived asset and
depreciated over the remaining life of the underlying asset and the associated liability is
accreted to the estimated fair value of the obligation at the settlement date through
periodic accretion charges to net earnings (loss). When the obligation is settled, any
difference between the final cost and the recorded amount is recognized as income or loss on
settlement. Effective January 1, 2003, Nortel Networks S.A. adopted the initial recognition
and measurement provisions of SFAS 143 and identified certain asset retirement obligations
to remediate leased premises and buildings and equipment situated on leased land. The
adoption of SFAS 143 did not have a material impact on the results of operations and
financial condition of Nortel Networks S.A.(c)
    
    Accounting for costs associated with exit or disposal activitiesIn June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or
Disposal Activities (SFAS 146), which is effective for exit or disposal activities
initiated after December 31, 2002. SFAS 146 supercedes EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) (EITF 94-3). SFAS 146 requires
recognition of costs associated with an exit or disposal activity when the liability is
incurred, whereas under EITF 94-3, a liability for an exit cost was recognized when an entity committed to an
exit plan. In addition, SFAS 146 establishes that fair value is the objective for initial
measurement of the liability. The effect of SFAS 146 was to change the timing of
recognition and the basis for measuring certain liabilities and therefore created valuation
differences between SFAS 146 and EITF 94-3. Exit and disposal activities initiated before
December 31, 2002 continue to be accounted for under EITF 94-3. Nortel Networks S.A.
adopted the requirements of SFAS 146 effective January 1, 2003. The adoption of SFAS 146
did not have a material impact on Nortel Networks S.A. results of operations and financial
condition.(d)
    
    Consolidation of variable interest entitiesIn January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities an
Interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements
(FIN 46). FIN 46 clarifies the application of consolidation guidance to those entities
defined as VIEs (which includes, but is not limited to special purpose entities, trusts,
partnerships, certain joint ventures and other legal structures) in which equity investors
do not have the characteristics of a controlling financial interest or there is not
sufficient equity at risk for the entity to finance its activities without additional
subordinated financial support. FIN 46 applied immediately to all VIEs created after January
31, 2003 and by the beginning of the first interim or annual reporting period commencing
after June 15, 2003 for VIEs created prior to February 1, 2003. In October 2003, the FASB
issued FSP FIN 46-6, Effective Date of FASB Interpretation No. 46, deferring the effective
date for applying the provisions of FIN 46 for VIEs created prior to February 1, 2003 to the
end of the first interim or annual period ending after December 15, 2003. While the
criteria for deferral were met, Nortel Networks S.A. elected early application of FIN 46.
In December 2003, the FASB issued FIN 46R which amends and supercedes the original FIN 46.
Effective December 2003, Nortel Networks S.A. adopted FIN 46R. Any impacts of applying FIN
46R to an entity to which FIN 46 had previously been applied are considered immaterial to
Nortel Networks S.A. results of operations and financial condition and Nortel Networks S.A.
accounting treatment of VIEs.(e)
    
    Accounting for revenue arrangements with multiple deliverablesIn November 2002, the EITF reached a consensus on EITF 00-21. In the absence of higher
level accounting literature, EITF 00-21 governs how to separate and allocate revenue to
goods or services or both that are to be delivered in a bundled sales arrangement. EITF
00-21 applies to revenue arrangements entered into after June 30, 2003 and allows for either
prospective application or cumulative adjustment upon adoption. Nortel Networks S.A.
adopted the requirements of EITF 00-21 on a prospective basis effective July 1, 2003. On
October 1, 2003, Nortel Networks S.A. also adopted related interpretive guidance contained in
EITF 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables
in an Arrangement Containing More-Than-Incidental Software (EITF 03-5), which addresses
whether non-software deliverables included in an arrangement that contains software is more
than incidental to the products or services as a whole are included within the scope of 205




---



##### Table of Contents



SOP
97-2. The adoption of EITF 00-21 and EITF 03-5 did not have a material impact on Nortel
Networks S.A. results of operations and financial condition.(f)
    
    Amendment of SFAS 133 on derivative instruments and hedging activitiesIn April 2003, the FASB issued SFAS No. 149, Amendment of SFAS No. 133 on Derivative
Instruments and Hedging Activities (SFAS 149). SFAS 149 amends and clarifies accounting
for derivative instruments, including certain derivative instruments embedded in other
contracts and hedging activities under SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133). In particular, SFAS 149: clarifies under what
circumstances a contract with an initial net investment meets the characteristic of a
derivative as discussed in SFAS 133; clarifies when a derivative contains a financing
component; amends the definition of an underlying to conform it to the language used in
FIN 45; and amends certain other existing pronouncements. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003, except as stated below, and for
hedging relationships designated after June 30, 2003.The provisions of SFAS 149 that relate to guidance in SFAS 133 that have been effective for
fiscal quarters which began prior to June 15, 2003 continue to be applied in accordance with
their respective effective dates. In addition, certain provisions relating to forward
purchases or sales of when-issued securities or other securities that do not yet exist are
applied to both existing contracts as well as new contracts entered into after June 30,
2003.Effective July 1, 2003, Nortel Networks S.A. applied the requirements of SFAS 149 on a
prospective basis to contracts entered into or modified after June 30, 2003. The adoption
of SFAS 149 did not have a material impact on Nortel Networks S.A. results of operations and
financial condition.(g)
    
    Determining whether an arrangement contains a leaseIn May 2003, the EITF reached a consensus on Issue No. 01-8, Determining Whether an
Arrangement Contains a Lease (EITF 01-8). EITF 01-8 provides guidance on how to
determine whether an arrangement contains a lease that is within the scope of FASB Statement
No. 13, Accounting for Leases. The guidance in EITF 01-8 is based on whether the
arrangement conveys to the purchaser (or the lessee) the right to use or control the use of
a specific asset, and is effective for Nortel Networks S.A. for arrangements entered into or
modified after June 30, 2003. The impact of EITF 01-8 on Nortel Networks S.A. future
results of operations and financial condition will depend on the terms contained in
contracts signed or contracts amended in the future.(h)
    
    Stock-based compensationIn December 2002, the FASB issued SFAS 148, which amended the transitional provisions of
SFAS 123 for companies electing to recognize employee stock-based compensation using the
fair value based method. Effective January 1, 2003, Nortel Networks S.A. elected to expense
employee stock-based compensation using the fair value based method prospectively for all
awards granted, modified, or settled on or after January 1, 2003 (see note 2(s)).(i)
    
    Accounting for goodwill and other intangible assetsIn June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets (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 S.A. adopted the provisions of SFAS 142
effective January 1, 2002. 206




---



##### Table of Contents



The following table presents the impact on net earnings (loss) for the year ended December
31, 2001 of the SFAS 142 requirement to cease the amortization of goodwill as if the
standard had been in effect beginning January 1, 2001. 2001Net earnings (loss)  reported
    
    
    (339,539
    )Amortization of goodwill
    
    
    3,434Net earnings (loss)  adjusted
    
    
    (336,105
    )
  (j)
    
    Impairment or disposal of long-lived assets (plant and equipment)In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144), which addressed financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS 144 is applicable 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 superseded 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 Extraordinary, Unusual and Infrequently Occurring
Events and Transactions (APB 30), for the disposal of a segment of a business. Nortel
Networks S.A. 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 broadened 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. The
adoption of SFAS 144 did not have a material impact on Nortel Networks S.A. results of
operations and financial condition.(k)
    
    Derivative financial instrumentsEffective January 1, 2001, Nortel Networks S.A. adopted 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).The adoption of SFAS 133 did not have a material impact on Nortel Networks S.A. results of
operations and financial condition.  5.
    
    Consolidated financial statement details  The following consolidated financial statement details are presented as of December 31 for
the consolidated balance sheets and for each of the years ended December 31 for the consolidated
statements of operations and consolidated statements of cash flows.Consolidated statements of operationsResearch and development expense: 2003
    
    
    2002
    
    
    2001R&D expense
    
    
    236,967
    
    
    
    264,275
    
    
    
    249,603R&D costs incurred on
behalf of others(a)
    
    
    5,445
    
    
    
    9,098
    
    
    
    2,885Total
    
    
    242,412
    
    
    
    273,373
    
    
    
    252,488
 (a)
    
    These costs included R&D charged to customers of Nortel Networks S.A. pursuant to
contracts that provided for full recovery of the estimated cost of development, material,
engineering, installation and other applicable costs, which were accounted for as contract
costs. 207




---



##### Table of Contents



Other income (expense)  net: 2003
    
    
    2002
    
    
    2001Royalties(a)  net
    
    
    (4,479
    )
    
    
    16,559
    
    
    
    29,888Other  net
    
    
    6,494
    
    
    
    6,479
    
    
    
    24,110Other income
(expenses)  net
    
    
    2,015
    
    
    
    23,038
    
    
    
    53,998
 (a)
    
    Certain affiliated entities pay royalty fees to Nortel Networks S.A. on their total
Global System for Mobile communications (GSM) technology sales (4 percent of total GSM
sales in 2003, 5 percent in 2002, and 10 percent in 2001). Nortel Networks France pays 7
percent of its revenue to affiliated entities.  Consolidated balance sheets  Accounts receivable  net: 2003
    
    
    2002Total receivables
    
    
    77,924
    
    
    
    78,013Contracts in process
    
    
    35,487
    
    
    
    5,942Accounts receivable  net
    
    
    113,411
    
    
    
    83,955
  Inventories  net: 2003
    
    
    2002Raw materials
    
    
    11,628
    
    
    
    21,801Work in process
    
    
    42,244
    
    
    
    43,122Finished goods
    
    
    12,325
    
    
    
    15,147Inventories  net(a)
    
    
    66,197
    
    
    
    80,070
 (a)
    
    Net of inventory provisions of 41,064 and 31,638 as of December 31, 2003 and 2002,
respectively. Included in trade and other accounts payable are accruals of 12,941 as of
December 31, 2003 for cancellation charges, for inventory in excess of future demand and
for the settlement of certain other claims related to contract manufacturers or suppliers.  Other current assets: 2003
    
    
    2002Employee receivables
    
    
    1,196
    
    
    
    1,047Put
option(a)
    
    
    
    
    
    
    77,500Prepaid rent and other
    
    
    8,654
    
    
    
    15,250Other receivables
    
    
    7,619
    
    
    
    12,567Other current assets
    
    
    17,469
    
    
    
    106,364
 (a)
    
    The put option was exercised on July 1, 2003 (see note 9). 208




---



##### Table of Contents



Plant and equipment  net: 2003
    
    
    2002Cost:Land and buildings
    
    
    104,810
    
    
    
    114,660Leasehold improvements
    
    
    31,243
    
    
    
    38,310Machinery and equipment
    
    
    219,818
    
    
    
    203,553Furniture and fixtures
    
    
    44,058
    
    
    
    37,146Computers
    
    
    6,893
    
    
    
    22,130Other
    
    
    1,430
    
    
    
    15,885408,252
    
    
    
    431,684Less accumulated depreciation:Buildings
    
    
    (15,943
    )
    
    
    (16,681
    )Leasehold improvements
    
    
    (21,872
    )
    
    
    (34,356
    )Machinery and equipment
    
    
    (141,072
    )
    
    
    (115,201
    )Furniture and fixtures
    
    
    (38,604
    )
    
    
    (19,355
    )Computers
    
    
    (5,700
    )
    
    
    (19,340
    )Other
    
    
    (892
    )
    
    
    (8,630
    )(224,083
    )
    
    
    (213,563
    )Plant and equipment  net(a)(b)
    
    
    184,169
    
    
    
    218,121
 (a)
    
    Included assets held for sale with a carrying value of 10,897 and 14,799 as of
December 31, 2003 and 2002, respectively, related to owned facilities that were being
actively marketed. These assets were written down in previous periods to their estimated
fair values less costs to sell. The write downs were included in special charges. Nortel
Networks S.A. expects to dispose of all of these facilities by mid-2005.(b)
    
    Included leased assets as required by SFAS No. 98 of 75,927 and 79,028 as of December 31,
2003 and 2002, respectively.  Goodwill:The following table outlines goodwill by reportable segment: Wireless
    
    
    Enterprise
    
    
    Wireline
    
    
    OpticalNetworks
    
    
    Networks
    
    
    Networks
    
    
    Networks
    
    
    Other
    
    
    TotalBalance  net as of December 31, 2001
and 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Change:Additions(a)
    
    
    
    
    
    
    8,857
    
    
    
    8,070
    
    
    
    2,756
    
    
    
    
    
    
    
    19,683Foreign exchange
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance  net as of December 31, 2003
    
    
    
    
    
    
    8,857
    
    
    
    8,070
    
    
    
    2,756
    
    
    
    
    
    
    
    19,683
 (a)
    
    See note 9 for additional information.  During the year ended December 31, 2003, Nortel Networks
S.A. performed its annual goodwill
impairment test and concluded that there was no impairment.Intangible assets  net: 2003
    
    
    2002Other intangible assets  net(a)
    
    
    8,929
    
    
    
    3,454
 (a)
    
    Other intangible assets are being amortized over their estimated useful lives.
Amortization expense is expected to be 1,020 for each of the next eight years commencing
in 2004 and 769 thereafter.  Investment at cost  net: 2003
    
    
    2002European Aeronautic Defense & Space Telecom S.A.S
    
    
    
    
    
    
    15,871Matra Nortel Communication Distribution S.A.S
    
    
    
    
    
    
    305Investment at cost  net
    
    
    
    
    
    
    16,176
 209




---



##### Table of Contents



Other accrued liabilities: 2003
    
    
    2002Put option(a)
    
    
    
    
    
    
    77,500Selling, general and administrative related
    
    
    4,565
    
    
    
    9,079Customer deposit
    
    
    9,676
    
    
    
    19,994Product related
    
    
    4,772
    
    
    
    10,535Warranty
    
    
    6,379
    
    
    
    3,776Miscellaneous taxes
    
    
    4,755
    
    
    
    1,538Deferred income
    
    
    48,050
    
    
    
    15,181Research and development
    
    
    7,104
    
    
    
    16,114Contract manufacturers
    
    
    12,941
    
    
    
    7,958Guarantees to purchasers of disposed businesses
    
    
    3,856
    
    
    
    4,075Other
    
    
    3,641
    
    
    
    8,510Other accrued liabilities
    
    
    105,739
    
    
    
    174,260
 (a)
    
    The put option was exercised on July 1, 2003 (see note 9).  Long-term debt:The amounts of long-term debt payable for each of the years ending December 31 consisted of: 2003
    
    
    20022003
    
    
    
    
    
    
    3,0732004
    
    
    3,241
    
    
    
    3,2412005
    
    
    3,417
    
    
    
    3,4172006
    
    
    3,603
    
    
    
    3,6032007
    
    
    3,798
    
    
    
    3,7982008
    
    
    4,005
    
    
    
    4,005Thereafter
    
    
    58,394
    
    
    
    58,39376,458
    
    
    
    79,530Less: Long-term debt due within one year
    
    
    3,241
    
    
    
    3,073Long-term debt
    
    
    73,217
    
    
    
    76,457
  Long term debt is entirely related to the lease of a building entered into by Nortel Networks
S.A. in the year ended December 31, 1999. The lease is classified as a capital lease. As such,
the transaction has been recorded as a financing transaction and the building and related
accounts will continue to be recognized in the consolidated financial statements. The lease
term is May 2013. The payable amounts above exclude interest as such
interest is variable and is based on Euribor (2.1% at
December 31, 2003).Consolidated statements of cash flowsInterest and taxes paid (recovered): 2003
    
    
    2002
    
    
    2001Cash interest paid
    
    
    3,376
    
    
    
    9,937
    
    
    
    10,694Cash taxes paid (recovered)  net
    
    
    (1,801
    )
    
    
    (2,940
    )
    
    
    28,779
  Receivables sales: 2003
    
    
    2002
    
    
    2001Proceeds from collections reinvested in
revolving period securitizations
    
    
    
    
    
    
    30,273
    
    
    
    346,536
 210




---



##### Table of Contents





|6. |  | Segment information
|-- |  | -------------------
|  
|   |  | General description

During 2003 and up to September 30, 2004, Nortel Networks S.A. operations (including the
operations of Northern Telecom France and Nortel Networks France (see note 2)) were organized
around four reportable segments consisting of Wireless Networks, Enterprise Networks, Wireline
Networks and Optical Networks. Wireless Networks included network access and core networking
products for voice and data communications that span second and third generation wireless
technologies and most major global standards for mobile networks and related professional
services. Enterprise Networks included circuit and packet voice solutions, data networking and
security solutions and the related professional services used by enterprise customers. Wireline
Networks included circuit and packet voice solutions, data networking and security solutions and
the related professional services used by service provider customers. Optical Networks included
metropolitan, regional and long-haul optical transport and switching solutions and managed
broadband services and related professional services for both service provider and enterprise
customers.Other represented miscellaneous business activities and corporate functions. None of these
activities meet the quantitative criteria to be disclosed as reportable segments.Effective October 1, 2004, a new streamlined organizational structure was established that
involved, among other things, combining the businesses of Nortel Networks S.A. four segments
into two business organizations: (i) Carrier Networks and Global Operations, and (ii)
Enterprise Networks. Nortel Networks S.A. is reviewing the impact of these changes on its
reportable segments.Nortel Networks S.A. president and chief executive officer together with the president of Nortel
Networks France have been identified as the chief operating decision makers (the Decision
Makers) in assessing the performance of the segments and the allocation of resources to the
segments. The Decision Makers rely on the information derived directly from the Nortel Networks
Corporation management reporting system. The primary financial measure used by the Decision
Makers in assessing performance and allocating resources is management earnings (loss) before
income taxes (Management EBT), a measure that includes contribution margin, R&D expense,
interest expense, other income (expense)  net and minority interest. Previously, the primary
financial measure used by the Decision Makers in assessing performance and allocating resources
was contribution margin, a measure that was comprised of gross profit less SG&A. As both
contribution margin and Management EBT were available to the Decision Makers during 2003, Nortel
Networks S.A. has determined that it is appropriate to disclose both contribution margin and
Management EBT for the periods presented.Costs associated with shared services and other corporate costs are allocated to the segments
based on usage determined generally by headcount. Costs not allocated to the segments are
primarily related to corporate compliance and other non-operational activities
and are included in other. In addition, the Decision Makers do not review asset information on
a segmented basis in order to assess performance and allocate resources. The accounting policies
of the reportable segments are the same as those applied to the consolidated financial
statements. 211




---



##### Table of Contents



SegmentsThe following tables set forth information by segment for the years ended December 31: 2003
    
    
    2002
    
    
    2001RevenuesWireless Networks
    
    
    214,732
    
    
    
    164,829
    
    
    
    202,741Enterprise Networks
    
    
    51,018
    
    
    
    64,538
    
    
    
    87,860Wireline Networks
    
    
    50,729
    
    
    
    63,523
    
    
    
    130,322Optical Networks
    
    
    21,065
    
    
    
    40,083
    
    
    
    136,753Other
    
    
    6,464
    
    
    
    23,343
    
    
    
    210,037Total
    
    
    344,008
    
    
    
    356,316
    
    
    
    767,713Contribution MarginWireless Networks
    
    
    1,361
    
    
    
    51,869
    
    
    
    (105,374
    )Enterprise Networks
    
    
    9,956
    
    
    
    20,554
    
    
    
    (5,786
    )Wireline Networks
    
    
    28,774
    
    
    
    52,369
    
    
    
    52,157Optical Networks
    
    
    3,989
    
    
    
    16,728
    
    
    
    (19,765
    )Other
    
    
    88,004
    
    
    
    3,865
    
    
    
    (6,646
    )Total
    
    
    132,084
    
    
    
    145,385
    
    
    
    (85,414
    )Management EBTWireless Networks
    
    
    (150,465
    )
    
    
    (289,002
    )
    
    
    (265,215
    )Enterprise Networks
    
    
    13,735
    
    
    
    14,958
    
    
    
    (13,588
    )Wireline Networks
    
    
    27,681
    
    
    
    55,661
    
    
    
    44,421Optical Networks
    
    
    8,863
    
    
    
    14,003
    
    
    
    (34,813
    )Other
    
    
    (5,616
    )
    
    
    96,164
    
    
    
    (15,847
    )Total
    
    
    (105,802
    )
    
    
    (108,216
    )
    
    
    (285,042
    )Amortization of acquired technology and other
    
    
    255
    
    
    
    
    
    
    
    Amortization of Goodwill
    
    
    
    
    
    
    
    
    
    
    3,434Special charges
    
    
    24,563
    
    
    
    83,427
    
    
    
    95,379(Gain) loss on sale of businesses and assets
    
    
    13,883
    
    
    
    16,171
    
    
    
    (10,243
    )Income tax benefit
    
    
    (5,614
    )
    
    
    (1,640
    )
    
    
    (34,073
    )Net earnings (loss)
    
    
    (138,889
    )
    
    
    (206,174
    )
    
    
    (339,539
    )
  The Other segment includes disposed business such as the products contributed to EADS
Telecom (see note 9). These products would mainly have been reported in the Enterprise segment
prior to the contribution.Major customersThe following table sets forth information on revenue and receivables from two separate external
customers located in France for the years ended December 31: 2003
    
    
    2002
    
    
    2001Revenues from largest customers as a percentage of external revenues:Largest customer
    
    
    23
    %
    
    
    16
    %
    
    
    11
    %Second largest customer
    
    
    23
    %
    
    
    15
    %
    
    
    7
    %Receivables from largest customers as a percentage of external
receivablesLargest customer
    
    
    11
    %
    
    
    9
    %
    
    
    10
    %Second largest customer
    
    
    52
    %
    
    
    24
    %
    
    
    19
    %
 212




---



##### Table of Contents



Geographic informationThe following table sets forth external revenues by geographic region based on the location of
the customer for the years ended December 31: 2003
    
    
    2002
    
    
    2001External revenuesFrance
    
    
    264,398
    
    
    
    259,717
    
    
    
    614,648EMEA (a)- excluding France
    
    
    79,550
    
    
    
    95,950
    
    
    
    150,872Other
    
    
    60
    
    
    
    649
    
    
    
    2,193Total
    
    
    344,008
    
    
    
    356,316
    
    
    
    767,713
  (a)
    
    Europe, Middle East and Africa  Long-lived assetsSubstantially all long-lived assets are located in France.  7.
    
    Special charges  During 2003, Nortel Networks S.A. continued to implement its restructuring work plan
initiated in 2001. Special charges recorded from January 1, 2001 to December 31, 2003 were as
follows: Contractsettlement
    
    
    Plant and
    
    
    
    
    
    
    IntangibleWorkforce
    
    
    and lease
    
    
    equipment
    
    
    
    
    
    
    assetreduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    impairments
    
    
    TotalProvision balance as of January 1, 2001
    
    
    1,042
    
    
    
    
    
    
    
    
    
    
    
    661
    
    
    
    
    
    
    
    1,703Goodwill impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,607
    
    
    
    20,607Other special charges
    
    
    34,419
    
    
    
    17,123
    
    
    
    21,294
    
    
    
    1,936
    
    
    
    
    
    
    
    74,772Cash drawdowns
    
    
    (34,372
    )
    
    
    (176
    )
    
    
    
    
    
    
    (378
    )
    
    
    
    
    
    
    (34,926
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (21,294
    )
    
    
    
    
    
    
    (20,607
    )
    
    
    (41,901
    )Provision balance as of December 31, 2001
    
    
    1,089
    
    
    
    16,947
    
    
    
    
    
    
    
    2,219
    
    
    
    
    
    
    
    20,255Other special charges
    
    
    73,105
    
    
    
    612
    
    
    
    9,294
    
    
    
    416
    
    
    
    
    
    
    
    83,427Cash drawdowns
    
    
    (64,232
    )
    
    
    (13,208
    )
    
    
    
    
    
    
    (1,677
    )
    
    
    
    
    
    
    (79,117
    )Non-cash drawdowns
    
    
    
    
    
    
    (1,925
    )
    
    
    (9,294
    )
    
    
    
    
    
    
    
    
    
    
    (11,219
    )Provision balance as of December 31, 2002
    
    
    9,962
    
    
    
    2,426
    
    
    
    
    
    
    
    958
    
    
    
    
    
    
    
    13,346Other special charges
    
    
    19,133
    
    
    
    4,382
    
    
    
    776
    
    
    
    272
    
    
    
    
    
    
    
    24,563Cash drawdowns
    
    
    (24,399
    )
    
    
    (2,310
    )
    
    
    
    
    
    
    (1,200
    )
    
    
    
    
    
    
    (27,909
    )Non-cash drawdowns
    
    
    
    
    
    
    
    
    
    
    (776
    )
    
    
    
    
    
    
    
    
    
    
    (776
    )Provision balance as of December 31, 2003
    
    
    4,696
    
    
    
    4,498
    
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    9,224
  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 2001
    
    
    140
    
    
    
    170
    
    
    
    310During 2002
    
    
    41
    
    
    
    677
    
    
    
    718During 2003
    
    
    169
    
    
    
    24
    
    
    
    193RFT employee notifications as at December 31, 2003
    
    
    350
    
    
    
    871
    
    
    
    1221
  (a)
    
    Direct employees included employees performing manufacturing, assembly, test and
inspection activities associated with the production of Nortel Networks S.A. products.(b)
    
    Indirect employees included employees performing manufacturing management, sales,
marketing, research and development and administrative activities. 213




---



##### Table of Contents



Year ended December 31, 2003  For the year ended December 31, 2003, Nortel Networks S.A. recorded total special charges of
24,563.  Workforce reduction charges of 19,133 were related to severance and benefit costs associated
with the approximately 193 employees notified of termination. During 2003, the workforce
reduction provision balance was drawn down by cash payments of 24,399, resulting in an ending
provision balance for workforce reduction of 4,696. The remaining provision is expected to be
substantially drawn down by the end of 2004.Contract settlement and lease costs consisted of 4,382 for negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities that were identified as
no longer required. During 2003, the provision balance for contract settlement and lease costs
was drawn down by cash payments of 2,310 resulting in an ending balance of 4,498. The
remaining provision, net of approximately 2,953 in estimated sublease income, is expected to be
substantially drawn down by the end of 2008.Year ended December 31, 2002For the year ended December 31, 2002, Nortel Networks S.A. recorded total special charges
of 83,427.Workforce reduction charges of 73,105 were related to severance and benefit costs associated
with the approximately 718 employees notified of termination. During 2002, the workforce
reduction provision balance was drawn down by cash payments of 64,232, resulting in an ending
provision balance for workforce reduction of 9,962.Contract settlement and lease costs consisted of 612 negotiated settlements to cancel or
renegotiate contracts and net lease charges related to leased facilities that were identified as
no longer required. During 2002, the provision balance for contract settlement and lease costs
was drawn down by cash payments of 13,208, resulting in an ending provision balance of 2,426.Plant and equipment write downs of approximately 9,294 related primarily to 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.Year ended December 31, 2001For the year ended December 31, 2001, Nortel Networks S.A. recorded total special charges
of 95,379 related to streamlining its operations and activities.Workforce reduction charges of 34,419 were related to severance and benefit costs associated
with the approximately 310 employees notified of termination. During 2001, the workforce
reduction provision balance was drawn down by cash payments of 34,372, resulting in an ending
provision balance for workforce reduction of 1,089.Contract settlement and lease costs of 17,123 consisted of 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. future
contractual obligations under its applicable operating leases net of approximately 2,964 in
expected sublease revenue on leases that Nortel Networks S.A. cannot terminate. During 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 21,294 related primarily to the write down to
net realizable value of leasehold improvements and manufacturing equipment in the Châteaudun
facility.Other consisted primarily of contract settlement costs to either cancel or renegotiate existing
supply contracts.Goodwill impairment charge of 20,607 related to the goodwill of Nortel Networks France. 214




---



##### Table of Contents



8.
    
    Income taxes  The following is a reconciliation of income taxes, calculated at the French income tax
rate, to the income tax benefit (expense) included in the consolidated statements of operations
for the years ended December 31: 2003
    
    
    2002
    
    
    2001Income taxes at French rates
(2003 - 35.4% 2002 - 35.4% 2001 - 36.4%)
    
    
    50,886
    
    
    
    74,647
    
    
    
    139,325Research and development credit
    
    
    6,104
    
    
    
    6,098
    
    
    
    14,058Foreign tax
    
    
    (485
    )
    
    
    (2,119
    )
    
    
    (2,950
    )Change in valuation allowance
    
    
    (16,347
    )
    
    
    (77,259
    )
    
    
    (138,796
    )Other (a)
    
    
    (34,544
    )
    
    
    273
    
    
    
    22,436Income tax benefit/(provision)
    
    
    5,614
    
    
    
    1,640
    
    
    
    34,073Income tax benefit/(provision)Current
    
    
    (490
    )
    
    
    (2,270
    )
    
    
    5,068Deferred
    
    
    6,104
    
    
    
    3,910
    
    
    
    29,005Income tax benefit/(provision)
    
    
    5,614
    
    
    
    1,640
    
    
    
    34,073
  (a)
    
    Other includes rate differential as well as permanent differences.  The following table shows the significant components included in deferred income taxes as
of December 31: 2003
    
    
    2002Assets:Tax benefit of tax credits
    
    
    24,398
    
    
    
    20,065Tax benefit of losses
    
    
    302,380
    
    
    
    333,946Provisions and reserves
    
    
    12,710
    
    
    
    (40,719
    )339,488
    
    
    
    313,292Valuation allowance
    
    
    (263,894
    )
    
    
    (247,547
    )75,594
    
    
    
    65,745Liabilities:Plant and equipment
    
    
    28,084
    
    
    
    22,477Net deferred income tax assets
    
    
    47,510
    
    
    
    43,268
  The deferred income tax assets are all receivable in cash
from the French government within the next 3 years as of
December 31, 2003 or can be offset against taxes currently
payable in that same period.As of December 31, 2003, Nortel Networks S.A. had consolidated net operating loss carry
forwards of approximately 747,359 which will carry forward indefinitely and net capital loss
carryforwards of 73,997 which expire in 2006 to 2013.Nortel Networks S.A. and certain subsidiaries are currently subject to an examination by
taxation authorities in France and have received a preliminary notice
of proposed assessment for a material amount. No
amount has been included in the provision for income taxes for this notice of proposed
assessment as Nortel Networks S.A. believes that this proposed assessment is without merit.
However, if this matter is ultimately resolved unfavourably, it could have a material adverse
effect on the consolidated financial position, results of operations, cash flows or tax
carryforward attributes of Nortel Networks S.A. 215




---



##### Table of Contents



9.
    
    Acquisitions and divestituresAcquisitions  Northern Telecom FranceOn June 24, 2003, Nortel Networks S.A. acquired the outstanding shares of Northern Telecom
France from NNI for a purchase price of 83,800 in cash. The purchase price
has been presented as a decrease of 83,800 in the additional paid-in capital of Nortel Networks
S.A. as Northern Telecom France has already been included in the financial statement presentation
for all periods (see note 2). Northern Telecom France is a holding
company that was then holding interests of 17.8% in Nortel Networks
France and 13.2% in EADS Telecom.Nortel Networks France  On October 19, 2002, Nortel Networks S.A., and certain other subsidiaries of Nortel Networks,
entered into a number of conditional put option and call option agreements as well as a share
exchange agreement with European Aeronautic Defence and Space Company EADS N.V. (EADS), Nortel
Networks partner at that time in three European joint ventures. On July 1, 2003, EADS exercised
its put option to sell its minority interest of 45 percent in Nortel Networks France to Nortel
Networks S.A., which then immediately exercised its put option to sell this interest to Nortel
Networks. The transactions were completed on September 18, 2003. As a result, the put option
liability to EADS and the put option asset from Nortel Networks, both in the amount of 77,500,
were removed from the balance sheet of Nortel Networks S.A. as of that date.On December 18, 2003, Nortel Networks S.A. acquired the remaining interest in Nortel Networks
France from Nortel Networks and NNIF&H B.V. for a purchase price
of 39,375 (including 34,460 in
cash) and
31,017 respectively. The acquisition of the remaining interest in the net assets of Nortel
Networks France was recorded using their historical costs as recorded
by Nortel Networks and  NNIF&H B.V. The interest acquired from Nortel
Networks was recorded in the accompanying financial statements on
September 18, 2003, the date the interest was acquired by Nortel
Networks from EADS. This acquisition resulted in a reduction of
minority interest of
10,512 and
recording of
9,180 related
primarily to customer contracts and customer relationships
(customer related intangibles) and
19,683 of
goodwill. The customer related intangibles will be amortized over
their estimated useful lives averaging nine years. The purchase price
relating to the interest acquired from NNIF&H B.V. has been presented as a
decrease of
31,017 in
additional paid-in capital of Nortel Networks S.A. as this
interest in Nortel Networks France has already been included in the
financial statement presentation for all periods (see note 2).DivestituresEADS TelecomOn July 18, 2003, Nortel Networks and its subsidiaries exercised the call option and share
exchange rights to acquire the minority interest held by EADS of 42 percent in Nortel Networks
Germany GmbH & Co. KG (NNG) and to sell Nortel Networks equity interest of 41 percent in EADS
Telecom to EADS. These transactions were completed on September 18, 2003 along with the
purchase of Nortel Networks France. Nortel Networks S.A. held an aggregate interest in EADS
Telecom of 15 percent or 259,969 shares as of that date. During that period, Nortel Networks
S.A. sold 215,170 shares of EADS Telecom to NNIF&H B.V. for 48,783. The resulting gain from
this related party transaction of 35,648 has been recorded as additional paid-in capital.
Nortel Networks S.A. also sold 44,799 shares of EADS Telecom directly to EADS for 10,157 in
cash. As this transaction was part of a greater transaction between Nortel Networks S.A.
affiliates and EADS, the resulting gain of 7,422 has also been recorded as paid in capital.On May 29, 2001, Nortel Networks France contributed certain of its enterprise activities to EADS
Telecom in exchange for shares of EADS Telecom. The activities that were contributed were
assessed to be approximately 8 percent of the value of Nortel Networks France before the
contribution. The fair value of the net assets contributed to EADS Telecom was estimated to be
73,480. The contribution included the full ownership of five foreign subsidiaries
of Nortel Networks France. The contribution was effective as of May 1, 2001. A gain of 14,262
was recorded on that transaction.Subsequent to the contribution, Nortel Networks France transferred the shares received from EADS
Telecom in consideration for the contribution to its shareholders as an in-kind dividend.Matra Nortel Communication DistributionOn September 30, 2001, Nortel Networks France sold 80.1% of its participation in its subsidiary,
Matra Nortel Communication Distribution S.A.S. (MNCD), to third parties for 30,032 in cash.
Cash has been collected in 2002 and 2001, respectively for
9,909 and
20,123.
MNCD was the main distribution channel of Nortel Networks France and EADS Telecom in France. A
gain of 16,240 was recorded on that transaction.Following the sale of MNCD, Nortel Networks France subscribed
on December 10, 2002 for 249,000 common shares of SPIE Communication
(formerly MNCD) at par for an amount of
2,490. The
additional subscription represented 15.33 percent of the share
capital of SPIE Communication. 199,449 of the new shares of SPIE
Communication subscribed by Nortel Networks France representing
12.28 percent of the share capital of SPIE Communication were sold on
the same day to third parties for nil. A loss of
1,995 was
recorded on that transaction. Nortel Networks France had entered into
the transaction as part of the commitment taken in favour of the
purchasers of MNCD (see note 13).The remaining 3.05 percent interest of Nortel Networks
France in SPIE Communication was sold on June 30, 2003 to third
parties for an amount of
915 in cash.
A gain of 610
was recorded on that transaction.Nortel Networks France also granted in the year ended
December 31, 2002 a loan amounting to
9,146 to SPIE
Communication. The loan was refunded in the year ended
December 31, 2003. 216




---



##### Table of Contents



10.
    
    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: 2003
    
    
    2002
    
    
    2001Billed to related partiesRevenues
    
    
    515,478
    
    
    
    458,918
    
    
    
    439,072Other income (expense)  net
    
    
    19,572
    
    
    
    43,741
    
    
    
    58,389Billed from related partiesPurchases
    
    
    127,327
    
    
    
    230,763
    
    
    
    424,816Selling, general and administrative expense
    
    
    19,494
    
    
    
    44,085
    
    
    
    15,149Research and development expense
    
    
    16,536
    
    
    
    22,722
    
    
    
    18,105Interest expense
    
    
    778
    
    
    
    4,617
    
    
    
    627Capital acquisitions
    
    
    88
    
    
    
    4,450
    
    
    
    23,624Business transferred to related parties
    
    
    15,365
    
    
    
    33,755
    
    
    
    21,905Issuance of common shares
    
    
    150,000
    
    
    
    485,363
    
    
    
    
  The following table shows the balance sheet position in respect of related parties as of
December 31: 2003
    
    
    2002Receivables from related partiesDue from Nortel Networks Limited
    
    109,388
    
    
    
    152,892Due from affiliates
    
    145,309
    
    
    
    81,179Payables to related partiesDue to Nortel Networks Limited
    
    
    1,991
    
    
    
    12,529Due to affiliates
    
    
    30,011
    
    
    
    76,797Long-term notes receivable from Nortel Networks Limited
    
    
    
    
    
    
    140,010Notes payable to related partiesCurrent
    
    
    160
    
    
    
    Long-term
    
    
    70,000
    
    
    
    220,000
  Head office costNortel Networks S.A. was charged until December 31, 2001 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 in 2001.Global profit splitNortel Networks S.A. participates with Nortel Networks and certain of Nortel Networks S.A.
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. 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. received a charge in 2001 of approximately 114,271, a credit of approximately 65,013 for
2002 and a charge of approximately 58,224 for 2003. These were all allocated to the cost of
revenues.Other profit sharing agreementsNortel Networks S.A. has entered into certain agreements with a related party under which the
profit or loss that the affiliate is recording on certain contracts with external customers is
split on a defined basis between the affiliate and Nortel Networks S.A. The agreements are aimed
to produce arms length results and pricing for Nortel Networks S.A. and remunerate the know-how
that Nortel Networks S.A. is sharing with the affiliate. 217




---



##### Table of Contents



In accordance with these agreements Nortel Networks S.A. recorded related party revenues of
approximately
35,903,
3,000, and
28,963 in the years 2003, 2002, and 2001 respectively. No cost of
revenues to related parties are directly linked to these transactions.Representative activityNortel Networks France is acting as the representative of certain of its affiliates in certain
transactions with a French based customer. The benefit of these transactions is not retained by
Nortel Networks France and is transferred back to the affiliates having actually performed the
transaction. No revenue is recognized by Nortel Networks France on these transactions. The
amounts billed to Nortel Networks France under these agreements were 15,365, 33,755 and
21,905 for 2003, 2002 and 2001, respectively.RoyaltiesNortel Networks France pays royalties amounting to seven percent of its revenue to certain of
its affiliates in remuneration for the right to market Nortel Networks products in the French
market. The amounts billed to Nortel Networks France under these agreements were 6,527, 9,997
and 21,694 for 2003, 2002 and 2001, respectively.Sale of investmentThrough a series of complex transactions taking place from
July 2003 to September 2003, Nortel
Networks S.A. sold the interest it was holding in EADS Telecom to NNIF&H B.V. and EADS. As these
transactions were part of a greater transaction between Nortel Networks S.A.s affiliates and EADS the resulting gain of 43,070 has
been recorded as paid in capital (see note 9).Financing transactionsOn 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 note payable to a
related party. 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. 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 (3.1 percent at December 31, 2003). 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. The amount
outstanding under that loan as of December 31, 2003 and 2002 was
50,000 and 200,000,
respectively. The loan is payable upon the discretion of Nortel Networks S.A.
and has been classified as long-term in the accompanying balance
sheet as management does not intend on repayment prior to
January 1, 2005.On December 19, 2002, Nortel Networks S.A. provided Nortel Networks with a revolving loan in the
amount of 200,000. This loan is classified as a long-term note receivable to a related party.
The loan bears interest at a rate per annum equal to Euribor plus one percent. Interest is
accrued and due unless an amount larger than the outstanding amount of advances is outstanding
under the subordinated loan. The term of the loan is two year and can be accelerated at the
request of Nortel Networks S.A. The amount outstanding under that loan as of December 31, 2003
and 2002 was 48,573 and 140,010 respectively.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.On December 31, 2002, Nortel Networks provided Nortel Networks France with a subordinated loan
in the aggregate amount of 20,000. This loan is classified as a long-term note payable to a
related party. This loan is included in the balance due to related parties for Nortel Networks
S.A. as of December 31, 2003, as a result of the acquisition of Nortel Networks France (see note
9). The repayment of the loan, in case of bankruptcy, insolvency or liquidation, is
subordinated to the prior repayment of any of Nortel Networks Frances existing or future
secured and unsecured creditors. Nortel Networks France 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 plus one percent (3.1 percent at December 31, 2003). Interest is payable at the end of
each interest period, subject to Nortel Networks France having positive net earnings and the
interest payments not exceeding 40 percent of the positive net earnings. 218




---



##### Table of Contents



11.
    
    Financial instruments  Share pledgeThe security agreements that were entered into in connection with the December 2001 364-day
syndicated credit facilities of Nortel Networks and its subsidiary, NNI , provided for the
granting of security in the event that Nortel Networks debt ratings fell below investment grade.
As of December 31, 2003, the security included pledges by Nortel Networks and NNIF&H B.V. of
their shares of Nortel Networks S.A. (see note 16).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 were terminated in the fourth quarter of 2002; the
April 2000 five year syndicated credit facilities of Nortel Networks and NNI, which were
terminated in the second quarter of 2004 (the Five Year Facilities); Nortel Networks
consolidated outstanding public debt securities; and Nortel Networks guarantee of NNCs 4.25%
Convertible Senior Notes due September 1, 2008.On February 14, 2003, Nortel Networks entered into an agreement with Export Development Canada
(EDC) regarding arrangements to provide for support, on a secured basis, of certain
performance related obligations arising out of normal course business activities for the benefit
of Nortel Networks (the EDC Support Facility). On February 14, 2003, Nortel Networks
obligations under the EDC Support Facility became secured on an equal and ratable basis under
the security agreements with the banks under the Five Year Facilities and the public debt
holders.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 Five Year Facilities and the EDC Support
Facilities are terminated, or expire, the security and guarantees will also be released in full
(see note 16). Nortel Networks may provide EDC with cash collateral in an amount equal to the
total amount of its outstanding obligations and undrawn commitments and expenses under the EDC
Support Facility (or any other alternative collateral or arrangements acceptable to EDC) in lieu
of the security provided under the security agreements. Accordingly, if the EDC Support Facility
is secured by cash or other alternate collateral or arrangements acceptable to EDC and if the
Five Year Facilities are terminated or expire, the security and guarantees will also be released
in full for additional information related to the security agreements, the
termination of the pledges of the Five Year Facilities subsequent to
December 31, 2003 (and the resulting termination by Nortel Networks and NNIF&H B.V. of their shares in
Nortel Networks S.A., see note 16).Receivables salesIn 2002 and 2001, Nortel Networks S.A. entered into various agreements to sell certain of
its receivables. These receivables were sold at a discount of 463 and 2,884 from book value
for the years ended December 31, 2002 and 2001, respectively, at annualized discount rates of
approximately 3 percent to 4.5 percent and 5 percent to 6 percent for the years ended December
31, 2002 and 2001, respectively. These programs were discontinued in 2002.  12.
    
    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 as a contract that
contingently requires Nortel Networks S.A. to make payments (either in cash, financial
instruments, other assets, or through the provision of services) to a third party based on
changes in an underlying economic characteristic (such as interest rates or market value) that
is related to an asset, a liability or an equity security of the guaranteed party or a third
partys failure to perform under a specified agreement. A description of the major types of
Nortel Networks S.A. outstanding guarantees as of December 31, 2003 is provided below.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 and/or 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 76,457. The lease pursuant to which the
guarantee was provided is a capital lease and this liability is, therefore, part of the debt of
Nortel Networks S.A.The maximum potential losses resulting from the other types of lease guarantees cannot be
reasonably estimated. The difficulties in assessing the amount of liability result primarily
from the unpredictability of the triggering events of the 219




---



##### Table of Contents



guarantees and the lack of limitations
on the potential liability. 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.Other indemnification agreementsNortel Networks S.A. has also entered into other agreements that provide indemnifications
to counterparties in certain transactions including investment banking agreements and asset sale
agreements. These indemnification agreements generally require Nortel Networks S.A. to
indemnify the counterparties for costs incurred as a result of changes in laws and regulations
(including tax legislation) or in the interpretations of such laws and regulations and/or as a
result of losses from litigation that may be suffered by the counterparties arising from the
transactions. These types of indemnification agreements normally extend over an unspecified
period of time from the date of the transaction and do not typically provide for any limit on
the maximum potential payment amount.The nature of such agreements prevents Nortel Networks S.A. from making a reasonable estimate of
the maximum potential amount it could be required to pay to its counterparties. The
difficulties in assessing the amount of liability result primarily from the unpredictability of
future changes in laws, the inability to determine how laws apply to counterparties and the lack
of limitations on the potential liability.Historically, Nortel Networks S.A. has not made any significant indemnification payments under
such agreements and no significant liability has been accrued in the consolidated financial
statements with respect to the obligations associated with these guarantees.Product warrantiesThe following summarizes the accrual for product warranties that was recorded as part of
other accrued liabilities in the consolidated balance sheets as of December 31: 2003
    
    
    2002Balance at beginning of the year
    
    
    14,311
    
    
    
    31,223Payments
    
    
    (37,697
    )
    
    
    (43,092
    )Warranties issued
    
    
    34,537
    
    
    
    26,180Balance at the end of the year
    
    
    11,151
    
    
    
    14,311
  13.
    
    CommitmentsBid, performance related and other bonds  Nortel Networks S.A. has entered into bid, performance related and other bonds associated
with various contracts. Bid bonds generally have a term of less than twelve months, depending
on the length of the bid period for the applicable contract. Performance related and other
bonds generally have a term of twelve months and are typically renewed, as required, over the
term of the applicable contract. The various contracts to which these bonds apply generally
have terms ranging from two to five years. Any potential payments which might become due under
these bonds would be related to Nortel Networks S.A. non-performance under the applicable
contract. Historically, Nortel Networks S.A. has not had to make material payments under these
types of bonds and does not anticipate that any material payments will be required in the
future. The total amount of the bonds that were available and undrawn was 31,719, as of
December 31, 2003, 31,674, as of December 31, 2002 and 29,398 as of December 31, 2001.Joint ventures/minority interests/disposed businessNortel Networks France entered into an agreement on December 31, 1997 under which
Financière Matra Communication (Fimacom) (a subsidiary of Nortel Networks France) was sold to
a third party. Fimacoms business was to finance Nortel Networks Frances customers and certain
volume commitments were undertaken by Nortel Networks France to the purchaser for the following
ten years. Through December 31, 2003, the cumulative actual volumes realized by the purchaser
are above the commitments of Nortel Networks France but, because the commitments are larger each
year and the business has been shrinking for the last three years, it is probable that the
targeted cumulative volumes for 2004 and the following years will not be met. Depending on the
actual volume booked by the purchaser in 2004, Nortel Networks France
could be obliged to pay up
to a maximum of 6,629 to the purchaser as a result of the transaction (in 2004 or in any
subsequent year until December 31, 2007). In this regard, an amount of 5,055 was accrued
during 2003, the related liability is included within Other liabilities. 220




---



##### Table of Contents



On September 30, 2001, Nortel Networks France sold its subsidiary MNCD to a third party. Under
this transaction, Nortel Networks France has taken certain commitments relative to the amount of
the net assets of MNCD as of September 30, 2001. Nortel Networks France has already had to make
several payments under this commitment. An amount of 2,226 was accrued
and is included in Other accrued liabilities. Further costs could be incurred in relation to this
transaction that cannot be reasonably estimated at this time.Operating leases and other commitmentsAs of December 31, 2003, the future minimum payments under both operating leases and
outsourcing contracts consisted of: Operating
    
    
    Outsourcingleases*
    
    
    contracts*2004
    
    
    6,796
    
    
    
    18,8872005
    
    
    2,805
    
    
    
    17,4832006
    
    
    2,502
    
    
    
    17,2602007
    
    
    291
    
    
    
    17,0492008
    
    
    
    
    
    
    16,843Thereafter
    
    
    
    
    
    
    16,646Total future minimum payments
    
    
    12,394
    
    
    
    104,168
 *
    
    All figures exclude value added taxes.
  Rental expense on operating leases for the years ended December 31, 2003, 2002 and 2001
amounted to 7,928, 27,441 and 31,960, respectively.Expenses related to outsourcing contracts for the years ended December 31, 2003, 2002 and 2001
amounted to 15,614, 23,341 and 16,026, respectively, and were for services provided to Nortel
Networks S.A. primarily related to a portion of information services, accounts payable and
purchasing. The amount payable under Nortel Networks S.A. outsourcing contracts is variable to
the extent that Nortel Networks S.A. workforce fluctuates from the baseline levels contained in
the contracts. The table above shows the minimum commitment contained in the outsourcing
contracts.  14.
    
    Shareholders equity  On December 30, 2003, Nortel Networks S.A. issued 30,000,000
common shares to Nortel Networks for proceeds of 150,000, which was comprised of a conversion
of the subordinated loan granted by Nortel Networks (see note 10).On December 18, 2003, Nortel
Networks S.A. purchased the outstanding shares of Nortel Networks France under the control of
NNIF&H B.V. (see note 9). As a result of the acquisition of these shares the additional
paid-in capital of Nortel Networks S.A. was decreased by 31,017.On July 18, 2003, Nortel Networks S.A. sold the shares of EADS Telecom that it was then holding
to NNIF&H B.V. and EADS (see note 9). A gain of 43,070 was recorded on that related party
transaction that was recorded as additional paid-in capital.On June 24, 2003, Nortel Networks S.A. purchased the outstanding shares of Northern Telecom
France (see note 9). As a result of the acquisition of these shares the additional paid in
capital of Nortel Networks S.A. was decreased by 83,800.On December 16, 2002 Nortel Networks S.A. issued 40,872,534 common shares to Nortel Networks for
net cash proceeds of 204,363.On May 21, 2002, Nortel Networks S.A. issued 11,677,519 common shares to Nortel Networks and
6,451,612 shares to NNIF&H B.V. for net proceeds of 281,000, which was comprised of a
conversion of long-term notes payable.On May 21, 2002 Nortel Networks S.A. Board of Directors approved a reorganization of Nortel
Networks S.A. 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. 221




---



##### Table of Contents



On June 30, 2001 the shareholders meeting of Nortel Networks France approved a dividend payment
of 61,812 payable in EADS Telecom shares that resulted in the reduction of retained earnings of
21,912 and
minority interest of
27,816. An amount of 12,084 was paid to other companies pooled by Nortel Networks S.A.On June 25, 2001 the shareholders meeting of Nortel Networks France approved a dividend payment
of 35,275
payable in cash that resulted in the reduction of retained earnings
of 13,861,
and the reduction of minority interest of
15,874. An
amount of
5,540 was paid to other companies pooled by Nortel Networks S.A.  15.
    
    Stock-based compensation plansStock options  Nortel Networks Corporation grants options to purchase Nortel Networks Corporation common
 shares under two existing stock option plans, Nortel Networks Corporation 2000 Stock Option Plan
(the 2000 Plan) and Nortel Networks Corporation 1986 Stock Option Plan As Amended and Restated
(the 1986 Plan). Under these two plans, options to purchase Nortel Networks Corporation
common shares may be granted to employees, and under the 2000 Plan, options may be granted to
directors of Nortel Networks that entitle the holders to purchase one common share at a
subscription price of not less than 100 percent of market value on the effective date of the
grant. Subscription prices are stated and payable in U.S. dollars for U.S. options and in
Canadian dollars for Canadian options. Generally options granted prior to 2003 vest 33 1/3
percent on the anniversary date of the grant for three years. Options granted in 2003 generally
vest 25 percent each year over a four year period on the anniversary date of the grant. The
committee of the Board of Directors of Nortel Networks that administers both plans has the
discretion to vary the period during which the holder has the right to exercise options and, in
certain circumstances, may accelerate the right of the holder to exercise options, but in no
case shall the exercise period exceed ten years.Options granted under the 2000 Plan and 1986 Plan may be granted with or without a SAR. A SAR
entitles the holder to receive payment of an amount equivalent to the excess of the market value
of a common share at the time of exercise of the SAR over the subscription price of the common
share to which the option relates. Options with SARs may be granted on a cancellation basis, in
which case the exercise of one causes the cancellation of the other, or on a simultaneous basis,
in which case the exercise of one causes the exercise of the other.As of December 31, 2003, the maximum number of common shares authorized by the shareholders and
reserved for issuance by the Board of Directors of Nortel Networks Corporation under the 1986
Plan and 2000 Plan is as follows: (number of common shares in thousands)
    
    Maximum1986 Plan(a)Issuable to employees(b)
    
    
    469,7182000 Plan(a)Issuable to non-employee directors
    
    
    500Issuable to employees
    
    
    94,000
 (a)
    
    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. No Key Contributor
Program options were granted for the years ended December 31, 2003, 2002 and 2001,
respectively, under both stock option plans.(b)
    
    As of December 31, 2003, the maximum number of Nortel Networks Corporation common
shares with respect to which options may be granted in any given year under the 1986 Plan
is three percent of Nortel Networks Corporation common shares issued and outstanding at the
commencement of the year, subject to certain adjustments.
  Nortel Networks S.A. assumed stock options plans in connection with the acquisition of
various companies and granted options to purchase Nortel Networks Corporation common shares. 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.On June 20, 2001, NNC commenced a voluntary stock option exchange program (the Exchange
Program) for Nortel Networks S.A. employees allowing employees to exchange certain outstanding
stock options for new stock options, based on a prescribed formula. The terms of the Exchange
Program required that the new grants of options would be made at least six months and a day from
the cancellation date of the options tendered for exchange, which was July 27, 2001. Nortel
Networks Corporation then Board of Directors and its then board appointed officers were not
eligible to participate in the Exchange Program. 222




---



##### Table of Contents



The following is a summary of the total number of outstanding stock options issued to employees
of Nortel Networks S.A.: Outstanding
    
    
    Weightedoptions
    
    
    average exercise(thousands)
    
    
    price (U.S.$)Balance at December 31, 2000
    
    
    6,976
    
    
    $
    38.10Granted options under all stock option plans
    
    
    1,320
    
    
    $
    30.36Options exercised
    
    
    (157
    )
    
    $
    8.91Options cancelled
    
    
    (1,086
    )
    
    $
    47.84Options cancelled under stock option exchange
program(a)
    
    
    (3,604
    )
    
    $
    51.43Balance at December 31, 2001
    
    
    3,449
    
    
    $
    19.47Granted options under all stock option plans(a)
    
    
    5,556
    
    
    $
    6.39Options exercised
    
    
    
    
    
    $
    Options cancelled
    
    
    (1,312
    )
    
    $
    13.56Balance at December 31, 2002
    
    
    7,693
    
    
    $
    11.03Eligible employees transferred out of Nortel Networks S.A.
    
    
    (681
    )
    
    $
    9.77Eligible employees transferred in Nortel Networks S.A.
    
    
    227
    
    
    $
    10.21Granted options under all stock option plans
    
    
    4,247
    
    
    $
    2.37Options exercised
    
    
    (4
    )
    
    $
    2.89Options cancelled
    
    
    (843
    )
    
    $
    11.40Balance at December 31, 2003
    
    
    10,639
    
    
    $
    7.70
 (a)
    
    Approximately 3,604 stock options were tendered for exchange and cancelled. On
January 29, 2002, Nortel Networks granted approximately 2,264 new stock options in
connection with the Exchange Program with exercise prices in the range of U.S.$7.16 to
U.S.$7.39 per common share.
  The following table summarizes information about stock options outstanding as of December
31, 2003: Options outstanding
    
    
    Options exercisableWeightedaverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedNumber
    
    
    Remaining
    
    
    average
    
    
    Number
    
    
    averageoutstanding
    
    
    contractual
    
    
    exercise
    
    
    exercisable
    
    
    exerciseRange of exercise prices
    
    (thousands)
    
    
    life(in years)
    
    
    price (U.S.$)
    
    
    (thousands)
    
    
    price (U.S.$)U.S.$1.0600  U.S.$2.3900
    
    
    4,001
    
    
    
    9.1
    
    
    $
    2.34
    
    
    
    38
    
    
    $
    1.96U.S.$2.3901  U.S.$3.5852
    
    
    304
    
    
    
    9.1
    
    
    $
    2.58
    
    
    
    4
    
    
    $
    3.34U.S.$3.5853  U.S.$5.3779
    
    
    96
    
    
    
    1.9
    
    
    $
    4.50
    
    
    
    85
    
    
    $
    4.52U.S.$5.3780  U.S.$8.0670(a)
    
    
    4,006
    
    
    
    7.4
    
    
    $
    6.44
    
    
    
    2,182
    
    
    $
    6.77U.S.$8.0671  U.S.$12.1006(a)
    
    
    933
    
    
    
    4.6
    
    
    $
    9.51
    
    
    
    870
    
    
    $
    9.61U.S.$12.1007  U.S.$18.1510
    
    
    130
    
    
    
    4.8
    
    
    $
    15.31
    
    
    
    130
    
    
    $
    15.31U.S.$18.1511  U.S.$27.2267
    
    
    914
    
    
    
    5.8
    
    
    $
    23.21
    
    
    
    884
    
    
    $
    23.35U.S.$27.2268  U.S.$40.8402
    
    
    98
    
    
    
    6.6
    
    
    $
    34.30
    
    
    
    74
    
    
    $
    33.99U.S.$40.8403  U.S.$61.2605
    
    
    68
    
    
    
    6.3
    
    
    $
    50.47
    
    
    
    69
    
    
    $
    50.47U.S.$61.2606  U.S.$84.6834
    
    
    89
    
    
    
    6.2
    
    
    $
    74.41
    
    
    
    89
    
    
    $
    74.4110,639
    
    
    
    7.6
    
    
    $
    7.70
    
    
    
    4,425
    
    
    $
    13.30
 (a)
    
    Includes approximately 1,591 stock options granted on January 29, 2002 under the
Exchange Program.
  Employee stock purchase plans  Nortel Networks has ESPPs (including in France) to facilitate the acquisition of common
 shares of Nortel Networks Corporation at a discount and the retention of such common shares by
eligible employees. The ESPPs 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 223




---



##### Table of Contents



compensation
deducted from their pay during each offering period to contribute towards the purchase of Nortel
Networks Corporation common shares. The Nortel Networks Corporation common shares are purchased
by an independent broker through the facilities of the TSX and/or NYSE, and held by a custodian
on behalf of the plan participants.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; or(iii)
    
    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 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 ESPP in France. Under the PEE, which is a
collective savings scheme governed by French labor law, participants hold units of a Nortel
Networks collective investment fund of which approximately 60% 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.  16.
    
    Subsequent eventsNortel Networks Audit Committee Independent Review; restatements; related matters  As previously announced by NNC in October 2003, in late
October 2003 the Audit Committee
initiated the Independent Review of the facts and circumstances
leading to the First Restatement and engaged WCPHD to advise it in
connection with the Independent Review.On March 10, 2004, NNC announced that as a result of the work done to date in connection with
the Independent Review, it was re-examining the establishment, timing of, support for and
release to income of certain accruals and provisions in prior periods. Further, it was likely
that NNC and Nortel Networks would need to revise its previously announced unaudited results for
the year ended December 31, 2003, and the results reported in certain of its quarterly reports
for 2003, and to restate its previously filed financial results for one or more earlier periods.
NNC announced on March 15, 2004 that the filing of NNC and Nortel Networks annual reports on
Form 10-K for the year ended December 31, 2003 (the 2003 Annual Reports) would be delayed
beyond March 30, 2004.On April 5, 2004, NNC announced that the SEC had issued a formal order of investigation in
connection with NNCs previous restatement of its financial results for certain periods, as
announced in October 2003, and NNCs announcements in March 2004 regarding the likely need to
revise certain previously announced results and restate previously filed financial results for
one or more earlier periods. The matter had been the subject of an informal SEC inquiry. On
April 13, 2004, NNC announced that it had received a letter from the staff of the Ontario
Securities Commission (OSC) advising that there is an OSC Enforcement Staff investigation into
the same matters that are the subject of the SEC investigation.On April 28, 2004, NNC announced that the Independent Review was extended to include the second
half of 2003 and it was determined that the previously announced unaudited results for the year
ended December 31, 2003 needed to be revised and that the financial results reported in each of
NNCs and Nortel Networks quarterly periods of 2003 and for earlier periods including 2002 and
2001 needed to be restated. NNC announced that it and Nortel Networks were not expected to
timely file their first quarter 2004 financial statements and, in accordance with Canadian
securities regulations, their 2003 Canadian GAAP audited financial statements and Annual
Information Form.In April 2004, NNC terminated for cause its former president
and chief executive officer, former chief financial officer and
former controller and, in August 2004, seven additional senior
finance employees with significant responsibilities for NNC financial
reporting as a whole or for their respective business units and
geographic regions in August 2004.On May 14, 2004, NNC announced that it had received a Federal Grand Jury Subpoena for the
production of certain documents, including financial statements and corporate, personnel and
accounting records, prepared during the period from January 1, 2000 to the date of the subpoena.
The materials sought are pertinent to an ongoing criminal investigation being conducted by the U.S. Attorneys Office for the Northern District of Texas,
Dallas Division. 224




---



##### Table of Contents



On May 17, 2004, NNC announced that the OSC had issued a temporary order that prohibits all
trading by directors, officers and certain current and former employees in the securities of
Nortel Networks and NNC, which temporary order was replaced with a final order issued on May 31,
2004. The final order remains in effect until two full business days following the receipt by
the OSC of all filings required to be made by Nortel Networks and NNC pursuant to Ontario
securities laws.On June 29, 2004, NNC announced that it did not expect to timely file financial statements for
the second quarter of 2004 and related periodic reports in accordance with U.S. and Canadian
securities laws.On August 16, 2004, NNC received a letter from the Integrated Market Enforcement Team of the
Royal Canadian Mounted Police (RCMP) advising NNC that the RCMP would be commencing a criminal
investigation into NNCs financial accounting situation.On August 19, 2004, NNC announced a new streamlined organizational structure,
effective October 1, 2004, that involved, among other things,
combining the businesses of NNCs four segments into two business organizations: (i) Carrier Networks and Global
Operations, and (ii) Enterprise Networks. Further, a focused workforce reduction of
approximately 3,250 employees was announced. In addition, the Audit Committee anticipated that
there would be work done, in addition to that portion of the inquiry which affects Nortel
Networks and NNCs ability to finalize their 2003 audited financial statements, in connection
with its Independent Review, on remedial measures, internal controls and improvements to
processes.On October 27, 2004, NNC announced that Nortel Networks and NNC did not expect to file their
third quarter 2004 financial statements, and the related periodic reports, by the required
deadlines in November 2004 in compliance with certain U.S. and Canadian securities regulations.Subsequent to the March 10, 2004 announcement, numerous class action complaints, including ERISA
class action complaints, have been filed against Nortel Networks and NNC in the U.S. and Canada.
In addition, a derivative action complaint has been filed against NNC. Nortel Networks and NNC
are subject to significant pending civil litigation which, if decided against Nortel Networks
and NNC, could result in substantial damages or other penalties which, in turn, could have a
material adverse effect on the business, results of operations, financial condition and
liquidity of Nortel Networks.In January 2005, the Audit Committee reported the findings of
the Independent Review, together with its recommendations for
governing principles for remedial measures that were developed for
the Audit Committee by WCPHD. Each of NNC and Nortel Networks
Boards of Directors has adopted those recommendations in their
entirety and directed management to develop a detailed plan and
timetable for their implementation, and will monitor their
implementation.Also in January 2005, the Audit Committee determined to
review the facts and circumstances leading to the restatement of
certain revenues for specific transactions identified in the Second
Restatement. This review will have a particular emphasis on the
underlying conduct that led to the initial recognition of these
revenues. The Audit Committee will develop any appropriate additional
remedial measures, and has engaged WCPHD to advise it in connection
with such review.Security agreementsOn April 28 2004, Nortel Networks notified the lenders under the Five Year Facilities that
it was terminating the Five Year Facilities. As a result of the termination of the Five Year
Facilities, certain foreign security agreements entered into by Nortel Networks and various of
its subsidiaries, including the pledges by Nortel Networks and NNIF&H B.V. of their shares in
Nortel Networks S.A, also terminated in accordance with their terms.Stock-based compensation plansAs a result of Nortel Networks March 10, 2004 announcement, as described above under
Nortel Networks Audit Committee Independent Review; restatements; related matters, Nortel
Networks suspended as of March 10, 2004: the purchase of Nortel Networks Corporation common
 shares under the ESPPs; the exercise of outstanding options granted under the 2000 Plan or 1986
Plan, or the grant of any additional options under those plans, or the exercise of outstanding
options granted under employee stock option plans previously assumed by Nortel Networks in
connection with mergers and acquisitions; and the purchase of units in a Nortel Networks stock
fund or purchase of Nortel Networks Corporation common shares under Nortel Networks defined
contribution and investments plans, until such time that Nortel Networks is in compliance with
U.S. and Canadian regulatory securities filing requirements.Evolution of Nortel Networks supply chain strategyOn June 29, 2004, Nortel Networks announced an agreement with Flextronics International
Ltd. (Flextronics), regarding the divestiture of substantially all of Nortel Networks
remaining manufacturing operations, including product integration, testing and repair operations
carried out in Nortel Networks Systems Houses in Calgary and Montreal, Canada and Campinas,
Brazil, as well as certain activities related to these locations, including the
management of the supply chain, related suppliers, and third-party logistics. In Europe,
Flextronics has made an offer 225




---



##### Table of Contents



to purchase similar operations at the Nortel Networks Monkstown,
Northern Ireland and Chateaudun, France Systems Houses, subject to the completion of the
required information and consultation process. The Chateaudun System House is a property of
Nortel Networks S.A.          226




---



##### Table of Contents



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 17th day of January, 2005. NORTEL NETWORKS LIMITEDBy:
    /s/ William A. Owens(William A. Owens, President andChief Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the
capacities indicated on the 17th day of January, 2005. Signature
    
    TitlePrincipal Executive Officer/s/ William A. Owens
    
    President and Chief Executive
Officer, and aDirector(WILLIAM A. OWENS)Principal Financial Officer/s/ William R. Kerr
    
    Chief Financial Officer(WILLIAM R. KERR)Principal Accounting Officer/s/ Maryanne E. Pahapill
    
    Controller(MARYANNE E. PAHAPILL)
 227




---



##### Table of Contents



Directors: M. Bischoff*
    
    R.A. Ingram*(M. BISCHOFF)
    
    (R.A. INGRAM)J.J. Blanchard*
    
    J.P. Manley*(J.J. BLANCHARD)
    
    (J. MANLEY)R.E. Brown*
    
    W.A. Owens*(R.E. BROWN)
    
    (W.A. OWENS)J.E. Cleghorn*
    
    G. Saucier*(J.E. CLEGHORN)
    
    (G. SAUCIER)L.Y. Fortier*
    
    S.H. Smith, JR.*(L.Y. FORTIER)
    
    (S.H. SMITH, JR.)L.R. Wilson*(L.R. WILSON)By:*
    /s/ Gordon A. Davies(GORDON A. DAVIES, as attorney-in fact)
January 17th, 2005
 228