##### 



NORTEL NETWORKS CORPORATION
Unaudited Pro Forma Condensed Consolidated Statement of Operations
Year ended December 31, 2004
 Nortel
    
    
    PECNetworks
    
    
    Solutions,
    
    
    Pro forma
    
    
    
    
    
    
    Pro forma(millions of U.S. dollars, except per share amounts)
    
    Corporation
    
    
    Inc.
    
    
    adjustments
    
    
    Note
    
    
    totalRevenues
    
    $
    9,828
    
    
    $
    203
    
    
    $
    4
    
    
    4(a)
    
    $
    10,035Cost of revenues
    
    
    5,750
    
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    5,877Gross profit
    
    
    4,078
    
    
    
    76
    
    
    
    4
    
    
    
    
    
    
    
    4,158Selling, general and administrative expense
    
    
    2,138
    
    
    
    47
    
    
    
    16
    
    
    4(b)(c)(d)
    
    
    2,201Research and development expense
    
    
    1,959
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,959Amortization of intangibles
    
    
    10
    
    
    
    2
    
    
    
    3
    
    
    4(b)
    
    
    15Special charges
    
    
    180
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    180(Gain) loss on sale of businesses and assets
    
    
    (98
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (98
    )Operating earnings (loss)
    
    
    (111
    )
    
    
    27
    
    
    
    (15
    )
    
    
    
    
    
    
    (99
    )Other income  net
    
    
    231
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    233Interest expenseLong-term debt
    
    
    (193
    )
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    (196
    )Other
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )Earnings (loss) from continuing operations
before income taxes and minority interests
    
    
    (83
    )
    
    
    26
    
    
    
    (15
    )
    
    
    
    
    
    
    (72
    )Income tax benefit (expense)
    
    
    29
    
    
    
    (10
    )
    
    
    10
    
    
    4(e)
    
    
    29(54
    )
    
    
    16
    
    
    
    (5
    )
    
    
    
    
    
    
    (43
    )Minority interests  net of tax
    
    
    (46
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (46
    )Net earnings (loss) from continuing operations
    
    $
    (100
    )
    
    $
    16
    
    
    $
    (5
    )
    
    
    
    
    
    $
    (89
    )Basic and diluted earnings (loss) per common
share
from continuing operations
    
    $
    (0.02
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (0.02
    )Weighted average number of shares outstandingBasic and diluted (in millions)
    
    
    4,337
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,337
 See accompanying notes to unaudited pro forma condensed consolidated statements of operations.




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##### 



NORTEL NETWORKS CORPORATION
Unaudited Pro Forma Condensed Consolidated Statement of Operations
Six months ended June 30, 2005
 PEC Solutions, Inc.Nortel
    
    
    Three months
    
    
    PeriodNetworks
    
    
    ended
    
    
    April 1, 2005,
    
    
    
    
    
    
    Pro forma
    
    
    Pro forma(millions of U.S. dollars, except per share amounts)
    
    Corporation
    
    
    March 31, 2005
    
    
    to June 3, 2005
    
    
    Note
    
    
    adjustments
    
    
    Note
    
    totalRevenues
    
    $
    5,391
    
    
    $
    64
    
    
    $
    45
    
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    5,500Cost of revenues
    
    
    3,099
    
    
    
    41
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,159Gross profit
    
    
    2,292
    
    
    
    23
    
    
    
    26
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,341Selling, general and administrative expense
    
    
    1,153
    
    
    
    14
    
    
    
    22
    
    
    
    
    
    
    
    13
    
    
    4(b)(d)
    
    
    1,202Research and development expense
    
    
    953
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    953Amortization of intangibles
    
    
    4
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    4(b)
    
    
    6Special charges
    
    
    111
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111(Gain) loss on sale of businesses and assets
    
    
    37
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37Operating earnings (loss)
    
    
    34
    
    
    
    8
    
    
    
    4
    
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    32Other income (expense)  net
    
    
    104
    
    
    
    1
    
    
    
    (49
    )
    
    4(d)
    
    
    42
    
    
    4(d)
    
    
    98Interest expenseLong-term debt
    
    
    (101
    )
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (102
    )Other
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )Earnings (loss) from continuing operations
before income taxes, minority interests and equity in net earnings of associated companies
    
    
    33
    
    
    
    8
    
    
    
    (45
    )
    
    
    
    
    
    
    28
    
    
    
    
    
    
    
    24Income tax benefit (expense)
    
    
    (9
    )
    
    
    (3
    )
    
    
    1
    
    
    
    
    
    
    
    2
    
    
    4(e)
    
    
    (9
    )24
    
    
    
    5
    
    
    
    (44
    )
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    15Minority interests  net of tax
    
    
    (31
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (31
    )Equity in net earnings of associated
companies  net of tax
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Net earnings (loss) from continuing operations
    
    $
    (5
    )
    
    $
    5
    
    
    $
    (44
    )
    
    
    
    
    
    $
    30
    
    
    
    
    
    
    $
    (14
    )Basic and diluted earnings (loss) per common
share from continuing operations
    
    $
    (0.00
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (0.00
    )Weighted average number of shares outstandingBasic and diluted (in millions)
    
    
    4,338
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,338
 See accompanying notes to unaudited pro forma condensed consolidated statements of operations.




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##### 



Notes to Pro Forma Condensed Consolidated Statements of Operations (unaudited)  Year ended December 31, 2004 and six months ended June 30, 2005
(millions of U.S. dollars, except per share amounts, unless otherwise stated)
 1.
    
    Description of transaction:On June 3, 2005, Nortel Networks Inc. (NNI), an indirect subsidiary of Nortel Networks
Corporation (Nortel), indirectly acquired approximately 26,693,725 shares of PEC Solutions,
Inc. (PEC) representing approximately 95.6 percent of the outstanding shares of common
stock of PEC (the Acquisition), through a cash tender
offer at a price of $15.50 per share. Any shares that were not purchased in the tender offer ceased to be outstanding and
were converted into the right to receive cash in the amount of $15.50 per share.
The aggregate purchase consideration for accounting purposes in connection with the
acquisition of PEC was approximately $449, including estimated costs
of acquisition of $8.All outstanding vested stock options of PEC that had an exercise price of less than $15.50
per option were purchased by PEC for $15.50 per option less the applicable exercise price, or
approximately $42 in aggregate. Of this amount, Nortel reimbursed PEC $33, which is included
in the purchase price consideration. All outstanding unvested stock options of PEC that had
an exercise price of less than $15.50 per option will be purchased for $15.50 per option less
the applicable exercise price, or approximately $1 in aggregate. All other outstanding stock
options of PEC were cancelled. PEC also had an employee share purchase plan, and all
outstanding units under this plan were purchased for $15.50 per unit less the stock price of
PEC as of January 1, 2005, or approximately $1 in aggregate.In order to comply with the U.S. National Industrial Security Program and to mitigate foreign
ownership, control or influence, voting control of PEC must be vested in citizens of the U.S.
Accordingly, proxy holders for Nortels shares of PEC were appointed and approved by the
U.S. Defense Security Service. In accordance with a proxy agreement executed in July 2005,
the proxy holders exercise all prerogatives of ownership with complete freedom to act
independently and have assumed full responsibility for the voting stock. The Acquisition has
been accounted for using the Purchase method as Nortel has determined that PEC is a Variable
Interest Entity and Nortel is the primary beneficiary.Certain employees of PEC have agreed to place in escrow a portion of the cash proceeds they
received (the Escrow Proceeds), 50% of which is to be released on each of the first and
second anniversary dates of the Acquisition, provided certain conditions are satisfied,
including that the option holders are employees of PEC or its successor at that time.2.
    
    Basis of presentation:Pro forma condensed consolidated statements of operationsThe accompanying unaudited pro forma condensed consolidated statements of operations (the
Statements) give effect to the Acquisition as if it had been consummated on January 1,
2004.The Statements have been prepared by management in accordance with accounting principles
generally accepted in the United States (GAAP) and the rules and regulations of the United
States Securities and Exchange Commission (SEC). The accounting policies used in the
preparation of the Statements are consistent with those used by Nortel in the preparation of
Nortels consolidated financial statements for the year ended December 31, 2004 and the three
and six months ended June 30, 2005.




---



##### 



The Statements have been prepared using the following
information and such other supplementary information as was considered necessary to
reflect the Acquisition in the Statements and should be read in
conjunction with the financial statements listed below:
 (i)
    
    Audited consolidated financial statements of Nortel for the year ended
December 31, 2004;(ii)
    
    Audited consolidated financial statements of PEC for the year ended December 31, 2004;(iii)
    
    Unaudited consolidated interim financial statements of Nortel
for the three and six months ended June 30, 2005; and(iv)
    
    Unaudited consolidated interim financial statements of PEC
for the three months ended March 31, 2005.
 The Statements do not include the anticipated financial benefits arising from the
Acquisition, including anticipated cost savings. The Statements should not be considered
indicative of the actual results of operations or the financial position that would have
resulted had the Acquisition been effected on the date indicated, or the results that may be
obtained in the future.Certain elements of the Nortel and PEC consolidated financial statements have been
reclassified to provide a consistent classification format.3.
    
    Accounting for the Acquisition:The acquisition is accounted for using the purchase method of accounting. The total purchase
price consideration is comprised of the following:
 Cash
    
    $
    441Estimated transaction costs
    
    
    8$
    449
 The purchase price will be allocated to the assets acquired (including identifiable
intangible assets arising from the purchase) and liabilities assumed based on their estimated
fair value at the date of acquisition.The allocation of the purchase price presented below is based on managements best current
estimate of the relative values of the assets acquired and liabilities assumed in the
Acquisition. However, because a full valuation of those assets and liabilities has not yet
been finalized, the final allocation of the purchase price may differ from the allocation
presented below, and the difference may be material.




---



##### 



The following table sets out the preliminary purchase price allocation information for the
Acquisition:
 Purchase price
    
    $
    449Assets acquired:Cash and cash equivalents
    
    $
    26Accounts receivable  net
    
    
    65Other current assets
    
    
    34Investments
    
    
    8Plant and equipment
    
    
    32Other intangible assets
    
    
    84Goodwill
    
    
    271Other assets
    
    
    5525Less liabilities assumed:Trade and other accounts payable
    
    
    6Payroll and benefit-related
liabilities
    
    
    15Other accrued liabilities
    
    
    19Long-term debt
    
    
    33Other liabilities
    
    
    376Fair value of net assets acquired
    
    $
    449
 As a result of the Acquisition, a net deferred tax liability of $23 was recognized, due
to differences between the estimated fair value of assets acquired and liabilities assumed,
and PECs tax basis in those assets and liabilities. This deferred tax liability is fully
offset, however, by an adjustment to Nortels deferred tax valuation allowance because Nortel
will be able to offset the tax liability by drawing down previously unrecognized loss
carryforwards.4.
    
    Pro forma assumptions and adjustments:The unaudited pro forma condensed consolidated statements of operations for the six months
ended June 30, 2005 and the year ended December 31, 2004 incorporate the following
adjustments:
 (a)
    
    Revenue recognized by PEC on certain contracts prior to the finalization of
applicable amendments was adjusted to conform to Nortels revenue recognition policy.
Nortel recognizes revenue on its contracts when applicable contract amendments are
finalized. Revenue has been increased by nil and $4 for the six months ended June 30,
2005 and the year ended December 31, 2004, respectively, to reflect the impact of
these adjustments in those periods.(b)
    
    Effective upon the Acquisition, all of PECs previously recorded intangible
assets were revalued as described below. Pro forma amortization expense has been reduced by $2 and $2
for the six months ended June 30, 2005 and the year ended December 31, 2004,
respectively, to reflect the elimination of historical amortization expense recognized
on these intangible assets in those periods.




---



##### 



A portion of the purchase price was allocated to intangible assets arising in the
Acquisition based on managements best estimate of fair values based on preliminary
studies undertaken by management. Estimated fair values and amortization periods of
intangible assets, other than goodwill, are as follows:
 AmortizationFair value
    
    
    period (years)Trade name
    
    $
    7
    
    
    
    4Software licenses
    
    
    1
    
    
    
    10Customer contracts and relationships
    
    
    76
    
    
    
    10Total intangible assets
    
    $
    84
 Pro forma amortization expense has been increased by $3 and $5 for the six months
ended June 30, 2005 and the year ended December 31, 2004, respectively, to reflect the
amortization of intangible assets arising on the Acquisition. An extension in the
estimated average useful life of the PEC customer contracts and relationships, trade
name and software licenses by one year would reduce the pro forma amortization expense
and pro forma net loss by $1 and $1 for the six months ended June 30, 2005 and the year
ended December 31, 2004, respectively.Pro forma depreciation expense has been reduced by nil and $1 for the six months ended
June 30, 2005 and the year ended December 31, 2004, respectively, to reflect the
elimination of depreciation expense recognized in those periods on certain PEC plant and
equipment. Due to PECs equity interest in a limited liability corporation (LLC) that
owns one of PECs office facilities, PEC was treated for accounting purposes as the
owner of the office facility. Upon the Acquisition, as legal ownership of the
facilities resides with the LLC, Nortel did not record the asset and the related
liability.However, as the office facility lease qualifies as a capital lease for accounting
purposes, Nortel recorded the present value of the future minimum lease payments in
plant and equipment and related long-term capital lease obligation as part of the
acquired assets and liabilities assumed. Pro forma depreciation has been increased by
$1 and $2 for the six months ended June 30, 2005 and the year ended December 31, 2004,
respectively, to reflect the amortization of assets acquired under capital lease over
the average lease term, being 13.5 years.(c)
    
    Interest expense has been adjusted to eliminate the interest expense
recognized by PEC on the long-term lease obligation recorded as a result of its
involvement with the construction of one of its office facilities and to record the
interest expense related to the capital lease obligation for the same office facility
(note 4(b)). In addition, rent expense has been adjusted to eliminate the portion of
the lease payments PEC had allocated to the rental of the land, as the capital lease
obligations relates to both the land and building for this office facility.
 Six months ended
    
    
    Year endedJune 30,
    
    
    December 31,Increase (decrease)
    
    2005
    
    
    2004Interest expense:Long-term lease obligation  PEC
    
    $
    (1
    )
    
    $
    (3
    )Long-term debt
    
    
    1
    
    
    
    3Selling, general and administrative expense
    
    
    
    
    
    
    (1
    )
 (d)
    
    Pursuant to the terms of the Acquisition, PEC, or its successor, has
agreed to purchase unvested options as they vest at a price of $15.50 per option less
the applicable exercise price per option. As a result, $2 has been recorded as
deferred compensation expense, and is amortized to expense over the applicable vesting
periods of the unvested options.




---



##### 



Escrow Proceeds are treated as deferred compensation and are recognized in the
Statements as compensation expense over the escrow period of two years. Pro forma
selling, general and administrative (SG&A) expense has been increased by $5 and $10
for the six months ended June 30, 2005 and the year ended December 31, 2004,
respectively, to reflect the amortization of the deferred compensation. In addition,
immediately prior to the Acquisition, PEC recognized an expense of $42 related to the
agreement to purchase all vested options with an exercise price less than $15.50 per
option. As this purchase relates directly to the Acquisition, pro forma other income
has been increased by $42 for the six months ended June 30, 2005, to reflect the
elimination of expense recognized by PEC.Nortel expenses employee stock-based compensation using the fair value based method for
all awards granted or modified after January 1, 2003. PEC accounts for its stock-based
compensation in accordance with the provisions of Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees. Accordingly, PEC has not recorded
any stock-based compensation cost, as all options granted under PECs stock option plans
had an exercise
price equal to the market value of the underlying common stock on the date of grant. In
order to conform the accounting policies of PEC to those of Nortel, the following
adjustments have been made:
 Six months ended
    
    
    Year endedJune 30,
    
    
    December 31,Increase (decrease)
    
    2005
    
    
    2004Increase in selling, general and administrative
expense to recognize the
deferred compensation expense
    
    $
    
    
    
    $
    2Increase in selling, general and administrative
expense to recognize the
deferred compensation expense
    
    
    5
    
    
    
    10Increase in selling, general and administrative
expense to account for
PEC options using the fair value based method
    
    
    7
    
    
    
    4
 (e)
    
    Income tax expense of PEC in the amount of $2 and $10 for the six months ended
June 30, 2005 and the year ended December 31, 2004, respectively, has been eliminated
on a pro forma consolidated basis as Nortel can offset this expense with a reduction
in its valuation allowance recorded against its deferred tax assets.




---



##### 



5.
    
    Pro forma earnings per share:The following table sets forth the calculation of pro forma basic and diluted earnings (loss)
per share from continuing operations:
 Six months
    
    
    Yearended
    
    
    endedJune 30,
    
    
    December 31,2005
    
    
    2004Numerator:Pro forma net earnings (loss) from continuing operations
    
    $
    (14
    )
    
    $
    (89
    )Denominator:Weighted average number of shares outstanding -
basic and diluted
    
    
    4,338
    
    
    
    4,337Pro forma loss per share -Basic and diluted
    
    $
    (0.00
    )
    
    $
    (0.02
    )