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

FORM 10-Q/A

Amendment No. 1

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


Commission file number 001-07260

Nortel Networks Corporation

(Exact name of registrant as specified in its charter)


Canada
    
    [Not Applicable](State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)8200 Dixie Road, Suite 100, Brampton, Ontario, Canada
(Address of principal executive offices)
    
    L6T 5P6
(Zip Code)


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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days.

Yesü     
            No

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

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

3,952,885,068 without nominal or par value



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TABLE OF CONTENTS



|                                                                                              |  |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 
|ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|ITEM 3. Quantitative and Qualitative Disclosures About Market Risk                           
|ITEM 4. Controls and Procedures                                                              
|PART II                                                                                      
|ITEM 6. Exhibits And Reports On Form 8-K                                                     
|SIGNATURES                                                                                   
|EX-31.1                                                                                      
|EX-31.2                                                                                      
|EX-32                                                                                        



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EXPLANATORY NOTE

This Amendment No. 1 to our Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2003 initially filed with the Securities and Exchange
Commission (SEC) on August 11, 2003 (the Originally Filed 10-Q) is being
filed to reflect restatements of the following (unaudited) financial
statements: consolidated statements of operations and cash flows for the three
and six month periods ended June 30, 2003 and 2002, and consolidated balance
sheets as at June 30, 2003 and December 31, 2002. On October 23, 2003, we
announced that we would restate our consolidated financial statements for the
years ended December 31, 2002, 2001 and 2000; and for the quarters ended March
31, 2003 and June 30, 2003 in connection with our previously announced
comprehensive review and analysis of our assets and liabilities and certain
related reviews. For a description of the restatements, see Restatements in
note 2 to the accompanying (unaudited) consolidated financial statements and
Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations  Recent developments  Restatements in this Amendment
No. 1.

This Amendment No. 1 amends and restates Items 1, 2, 3 and 4 of Part I and Item
6 of Part II of the Originally Filed 10-Q and, except for such items and
Exhibits 31.1, 31.2, and 32, no other information in the Originally Filed 10-Q
is amended hereby. The explanatory caption at the beginning of each item of
the Amendment No. 1 sets forth the nature of the revisions to that item.

We did not amend our Annual Reports on Form 10-K or Quarterly Reports on Form
10-Q for periods affected by the restatements that ended prior to December 31,
2002, and the financial statements, auditors reports and related financial
information for the affected periods contained in such reports should no longer be relied upon. We are
concurrently filing Amendment No. 1 to our Annual Report on Form 10-K for the
year ended December 31, 2002, initially filed with the SEC on March 10, 2003,
which includes the following (audited) restated financial statements:
consolidated statements of operations, shareholders equity and cash flows for
the years ended December 31, 2002, 2001 and 2000, and consolidated balance
sheets as at December 31, 2002 and 2001.

For a discussion of events and developments subsequent to June 30, 2003, see:



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



| |  | our other filings subsequent to June 30, 2003.
| | - | ----------------------------------------------

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TABLE OF CONTENTS

PAGEPART IFINANCIAL INFORMATIONITEM 1.
    
    Consolidated Financial Statements (unaudited)
    
    
    4ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    46ITEM 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    95ITEM 4.
    
    Controls and Procedures
    
    
    95PART IIOTHER INFORMATIONITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    
    97Signatures
    
    99


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

NORTEL NETWORKS, NORTEL NETWORKS LOGO, NT and the GLOBEMARK are trademarks of Nortel Networks.
MOODYS is a trademark of Moodys Investors Services, Inc.

S&P 100, S&P 500 and STANDARD & POORS is a trademark of The McGraw-Hill Companies, Inc.

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PART I
FINANCIAL INFORMATION

The (unaudited) restated consolidated financial statements and supplementary data,
including the notes to the restated consolidated financial statements, set
forth in this Item 1 have been revised to reflect the restatements and, except
for these revisions, do not reflect events and developments subsequent to June
30, 2003.

ITEM 1.    Consolidated Financial Statements (unaudited)



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


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NORTEL NETWORKS CORPORATION
Consolidated Statements of Operations (unaudited)

Three months ended June 30,
    
    Six months ended June 30,(millions of U.S. dollars, except per share amounts)
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002As restated
    *
    
    As restated
    *
    
    As restated
    *
    
    As restated
    *Revenues
    
    $
    2,338
    
    
    $
    2,788
    
    
    $
    4,715
    
    
    $
    5,694Cost of revenues
    
    
    1,310
    
    
    
    1,775
    
    
    
    2,643
    
    
    
    3,862Gross profit
    
    
    1,028
    
    
    
    1,013
    
    
    
    2,072
    
    
    
    1,832Selling, general and administrative expense
    
    
    413
    
    
    
    756
    
    
    
    927
    
    
    
    1,463Research and development expense
    
    
    481
    
    
    
    571
    
    
    
    985
    
    
    
    1,153Amortization of acquired technology
    
    
    33
    
    
    
    41
    
    
    
    66
    
    
    
    84Deferred stock option compensation
    
    
    17
    
    
    
    20
    
    
    
    35
    
    
    
    44Special charges
    
    
    (2
    )
    
    
    361
    
    
    
    110
    
    
    
    824Gain on sale of businesses
    
    
    (4
    )
    
    
    (2
    )
    
    
    (8
    )
    
    
    (18
    )Operating earnings (loss)
    
    
    90
    
    
    
    (734
    )
    
    
    (43
    )
    
    
    (1,718
    )Other income (expense)  net
    
    
    23
    
    
    
    (23
    )
    
    
    27
    
    
    
    (32
    )Interest expenseLong-term debt
    
    
    (44
    )
    
    
    (57
    )
    
    
    (89
    )
    
    
    (116
    )Other
    
    
    (2
    )
    
    
    (9
    )
    
    
    (10
    )
    
    
    (21
    )Earnings
(loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    
    67
    
    
    
    (823
    )
    
    
    (115
    )
    
    
    (1,887
    )Income tax benefit
    
    
    10
    
    
    
    196
    
    
    
    28
    
    
    
    52477
    
    
    
    (627
    )
    
    
    (87
    )
    
    
    (1,363
    )Minority interests  net of tax
    
    
    (19
    )
    
    
    6
    
    
    
    (16
    )
    
    
    (2
    )Equity in net loss of associated companies  net of tax
    
    
    (20
    )
    
    
    (11
    )
    
    
    (30
    )
    
    
    (19
    )Net earnings (loss) from continuing operations
    
    
    38
    
    
    
    (632
    )
    
    
    (133
    )
    
    
    (1,384
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    (1
    )
    
    
    3
    
    
    
    189
    
    
    
    19Net
earnings (loss) before cumulative effect of accounting change
 net of tax
    
    
    37
    
    
    
    (629
    )
    
    
    56
    
    
    
    (1,365
    )Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    Net earnings (loss)
    
    $
    37
    
    
    $
    (629
    )
    
    $
    48
    
    
    $
    (1,365
    )Basic and diluted earnings (loss) per common share from continuing operations
    
    $
    0.01
    
    
    $
    (0.18
    )
    
    $
    (0.03
    )
    
    $
    (0.42
    ) from discontinued operations
    
    $
    0.00
    
    
    
    0.00
    
    
    
    0.04
    
    
    
    0.01Basic and diluted earnings (loss) per common share
    
    $
    0.01
    
    
    $
    (0.18
    )
    
    $
    0.01
    
    
    $
    (0.41
    )


* See note 2

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

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NORTEL NETWORKS CORPORATION
Consolidated Balance Sheets (unaudited)

June 30,
    
    
    December 31,(millions of U.S. dollars)
    
    2003
    
    
    2002As restated
    *
    
    As restated
    *ASSETSCurrent assetsCash and cash equivalents
    
    $
    4,190
    
    
    $
    3,791Restricted cash and cash equivalents
    
    
    115
    
    
    
    249Accounts receivable (less provisions of $370 at June 30, 2003, $517 at December 31, 2002)
    
    
    1,826
    
    
    
    2,163Inventories  net
    
    
    879
    
    
    
    986Income taxes recoverable
    
    
    57
    
    
    
    58Deferred income taxes  net
    
    
    399
    
    
    
    790Other current assets
    
    
    429
    
    
    
    681Total current assets
    
    
    7,895
    
    
    
    8,718Investments
    
    
    199
    
    
    
    248Plant and equipment  net
    
    
    1,380
    
    
    
    1,467Goodwill
    
    
    2,202
    
    
    
    2,201Intangible assets  net
    
    
    33
    
    
    
    98Deferred income taxes  net
    
    
    3,443
    
    
    
    2,579Other assets
    
    
    687
    
    
    
    802Total assets
    
    $
    15,839
    
    
    $
    16,113LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    48
    
    
    $
    30Trade and other accounts payable
    
    
    770
    
    
    
    872Payroll and benefit-related liabilities
    
    
    629
    
    
    
    507Contractual liabilities
    
    
    1,008
    
    
    
    1,215Restructuring
    
    
    303
    
    
    
    548Other accrued liabilities
    
    
    2,504
    
    
    
    2,974Long-term debt due within one year
    
    
    184
    
    
    
    233Total current liabilities
    
    
    5,446
    
    
    
    6,379Long-term debt
    
    
    3,700
    
    
    
    3,749Deferred income taxes  net
    
    
    501
    
    
    
    345Other liabilities
    
    
    2,426
    
    
    
    2,32312,073
    
    
    
    12,796Minority interests in subsidiary companies
    
    
    662
    
    
    
    665Guarantees, commitments and contingencies (notes 10, 11 and 17)SHAREHOLDERS EQUITYCommon shares, without par value  Authorized shares: unlimited; issued and outstanding shares:3,945,156,167 at June 30, 2003 and 3,850,169,343 at December 31, 2002
    
    
    33,722
    
    
    
    33,583Additional paid-in capital
    
    
    3,625
    
    
    
    3,754Deferred stock option compensation
    
    
    (53
    )
    
    
    (91
    )Accumulated deficit
    
    
    (33,191
    )
    
    
    (33,239
    )Accumulated other comprehensive loss
    
    
    (999
    )
    
    
    (1,355
    )Total shareholders equity
    
    
    3,104
    
    
    
    2,652Total liabilities and shareholders equity
    
    $
    15,839
    
    
    $
    16,113


* See note 2

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

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NORTEL NETWORKS CORPORATION
Consolidated Statements of Cash Flows (unaudited)

Six months ended June 30,(millions of U.S. dollars)
    
    2003
    
    
    2002As restated
    *
    
    As restated
    *Cash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (133
    )
    
    $
    (1,384
    )Adjustments to reconcile net loss from continuing operations to net cash used
in operating activities, net of effects from acquisitions and divestitures of businesses:Amortization and depreciation
    
    
    282
    
    
    
    386Non-cash portion of special charges and related asset write downs
    
    
    7
    
    
    
    382Equity in net loss of associated companies
    
    
    30
    
    
    
    19Current and deferred stock option compensation
    
    
    47
    
    
    
    44Deferred income taxes
    
    
    7
    
    
    
    (536
    )Other liabilities
    
    
    65
    
    
    
    (30
    )Gain on repurchases of outstanding debt securities
    
    
    (4
    )
    
    
    (Gain) loss on sale or write down of investments and businesses
    
    
    28
    
    
    
    (26
    )Other  net
    
    
    (16
    )
    
    
    245Change in operating assets and liabilities:Accounts receivable
    
    
    334
    
    
    
    562Inventories
    
    
    137
    
    
    
    135Income taxes
    
    
    (7
    )
    
    
    1,280Restructuring
    
    
    (343
    )
    
    
    (655
    )Accounts payable and accrued liabilities
    
    
    (504
    )
    
    
    (465
    )Other operating assets and liabilities
    
    
    (71
    )
    
    
    (176
    )Net cash used in operating activities of continuing operations
    
    
    (141
    )
    
    
    (219
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    (56
    )
    
    
    (208
    )Proceeds on disposals of plant and equipment
    
    
    21
    
    
    
    76Decrease (increase) restricted cash and cash equivalents
    
    
    144
    
    
    
    (22
    )Increase in long-term receivables
    
    
    (11
    )
    
    
    (209
    )Decrease in long-term receivables
    
    
    197
    
    
    
    105Acquisitions of investments and businesses  net of cash acquired
    
    
    (2
    )
    
    
    (25
    )Proceeds on sale of investments and businesses
    
    
    8
    
    
    
    73Net cash from (used in) investing activities of continuing operations
    
    
    301
    
    
    
    (210
    )Cash flows from (used in) financing activitiesDecrease in notes payable  net
    
    
    (14
    )
    
    
    (102
    )Proceeds from long-term debt
    
    
    
    
    
    
    31Repayments of long-term debt
    
    
    (94
    )
    
    
    (6
    )Decrease in capital leases payable
    
    
    (2
    )
    
    
    (5
    )Issuance of common shares
    
    
    
    
    
    
    862Issuance of prepaid forward purchase contracts
    
    
    
    
    
    
    623Net cash from (used in) financing activities of continuing operations
    
    
    (110
    )
    
    
    1,403Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    78
    
    
    
    46Net cash from continuing operations
    
    
    128
    
    
    
    1,020Net cash from discontinued operations
    
    
    271
    
    
    
    288Net increase in cash and cash equivalents
    
    
    399
    
    
    
    1,308Cash and cash equivalents at beginning of period  net
    
    
    3,791
    
    
    
    3,460Cash and cash equivalents at end of period  net
    
    $
    4,190
    
    
    $
    4,768


* See note 2

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

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NORTEL NETWORKS CORPORATION

Notes to Consolidated Financial Statements (unaudited)
(millions of U.S. dollars, except per share amounts, unless otherwise stated)




|1. |  | Significant accounting policies
|-- |  | -------------------------------



| |  | Basis of presentation
| |  | ---------------------



| |  | The accompanying unaudited consolidated financial statements of Nortel
Networks Corporation (Nortel Networks) include all majority owned
subsidiaries over which Nortel Networks exercises control and have been
prepared in accordance with the rules and regulations of the United States
Securities and Exchange Commission (the SEC) for the preparation of interim
financial information. They do not include all information and notes
required by accounting principles generally accepted in the United States
(GAAP) in the preparation of annual consolidated financial statements. The
accounting policies used in the preparation of the accompanying unaudited
consolidated financial statements are the same as those described in Nortel
Networks audited consolidated financial statements prepared in accordance
with GAAP for the three years ended December 31, 2002, except as described in
note 3. Although Nortel Networks is headquartered in Canada, the accompanying
unaudited consolidated financial statements are expressed in United States
dollars as the greater part of Nortel Networks financial results and net
assets are denominated in United States dollars.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As described in note 2, the consolidated statements of operations and cash
flows for the three and six month periods ended June 30, 2003
and 2002 and
consolidated balance sheets as at June 30, 2003 and December 31, 2002,
including the applicable notes, have been restated.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In the opinion of management, all adjustments necessary to effect a fair
statement of the results for the periods presented have been made and all
such adjustments were of a normal recurring nature. The financial results
for the three months and six months ended June 30, 2003 are not necessarily
indicative of financial results for the full year. The accompanying
unaudited consolidated financial statements should be read in conjunction
with Nortel Networks Annual Report on Form 10-K for the year ended December
31, 2002 filed with the SEC on March 10, 2003, as subsequently amended by
Amendment No. 1 to the Annual Report on Form 10K/A for the year ended
December 31, 2002, filed with the SEC on December 23, 2003 (Nortel Networks
2002 Annual Report).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Recent accounting pronouncements
| |  | --------------------------------



| | (a) | In May 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150,
Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity (SFAS 150). SFAS 150 clarifies the
accounting for certain financial instruments with characteristics of
both liabilities and equity and requires that those instruments be
classified as liabilities in the balance sheets. Previously, many of
those financial instruments were classified as equity. SFAS 150 is
effective for financial instruments entered into or modified after May
31, 2003 and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. Nortel Networks expects
that this pronouncement will not have a material impact on its results
of operations and financial condition.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | In April 2003, the FASB issued SFAS No. 149, Amendment of SFAS No.
133 on Derivative Instruments and Hedging Activities (SFAS 149).
SFAS 149 amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts and
for hedging activities under SFAS No. 133 Accounting for Derivative
Instruments and Hedging Activities (SFAS 133). In particular, it (1)
clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative as discussed in SFAS
133, (2) clarifies when a derivative contains a financing component, (3)
amends the definition of an underlying to conform it to the language
used in FASB Interpretation No. (FIN) 45, Guarantor Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45) and (4) amends certain other existing
pronouncements. SFAS 149 will be effective for contracts entered into
or modified after June 30, 2003, except as stated below, and for hedging
relationships designated after June 30, 2003.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | The provisions of SFAS 149 that relate to guidance in SFAS 133
Implementation Issues that have been effective for fiscal quarters which
began prior to June 15, 2003, will continue to be applied in accordance
with their respective effective dates. In addition, certain provisions
relating to forward purchases or sales of when-issued securities or other
securities that do not yet exist, will be applied to both existing
contracts as well as new contracts entered into after June 30, 2003.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks will apply the provisions of SFAS 149 on a prospective
basis to contracts entered into or modified after June 30, 2003 and
expects that this pronouncement will not have a material impact on its
results of operations and financial condition.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities (FIN 46). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements
to those entities defined as Variable Interest Entities (more commonly
referred to as special purpose entities) in which equity investors do
not have the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other
parties. FIN 46 applies immediately to all Variable Interest Entities
created after January 31, 2003 and by the beginning of the first interim
or annual reporting period commencing after June 15, 2003 for Variable
Interest Entities created prior to February 1, 2003.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has conducted certain receivable sales and lease financing
transactions through special purpose entities. Receivable sales
transactions are generally conducted either directly with financial
institutions or with multi-seller conduits. As at June 30, 2003, Nortel
Networks did not expect to be required to consolidate any of these special
purpose entities or provide any of the additional disclosures set out in
FIN 46.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Certain lease financing transactions are structured through single
transaction special purpose entities that currently do not have sufficient
equity at risk as defined in FIN 46. In addition, Nortel Networks retains
certain risks associated with guaranteeing recovery of the unamortized
principal balance of the debt which is expected to represent the majority
of the risks associated with the special purpose entities activities. The
amount of the guarantee will be adjusted over time as the underlying debt
matures. Therefore, Nortel Networks will be required to consolidate the
assets, liabilities and any non-controlling interests of these special
purpose entities in the next interim fiscal period. The total assets and
total liabilities held by these entities at June 30, 2003 were each
approximately $181 and these amounts represented both the collateral and
maximum exposure to loss, as a result of Nortel Networks involvement with
these entities.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | In November 2002, the FASB Emerging Issues Task Force (EITF)
reached a consensus on Issue 00-21, Accounting for Revenue Arrangements
with Multiple Deliverables (EITF 00-21). In the absence of higher
level accounting literature, EITF 00-21 governs how to separate and
allocate revenue to goods or services or both that are to be delivered
in a bundled sales arrangement. EITF 00-21 applies to revenue
arrangements entered into after June 30, 2003 and allows for either
prospective application or cumulative adjustment upon adoption. Nortel
Networks will apply the guidance of EITF 00-21 on a prospective basis
and expects that this pronouncement will not have a material impact on
its results of operations and financial condition.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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

9



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##### Table of Contents





| |  | workforce declined significantly from January 1, 2001 to June 30, 2003 and
over the same time period Nortel Networks significantly reduced its
facilities.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Based on the completion of the comprehensive review and certain related
reviews (collectively, the comprehensive review), Nortel Networks has
determined that approximately $952 and $935 of certain liabilities (primarily
accruals and provisions) carried on its previously reported consolidated
balance sheets as at June 30, 2003 and December 31, 2002, respectively,
needed to be released to income. These provisions were either initially
recorded incorrectly in prior periods or not properly released or adjusted
for changes in estimates in the appropriate periods. In certain cases, costs
were incorrectly charged to operations rather than to the appropriate
provisions. Following its determination to restate its consolidated
financial statements for the periods noted above, Nortel Networks also
determined that it would correct certain known errors that were previously
not recorded because the amount of the errors was not material to the
consolidated financial statements. Specifically, among other items, Nortel
Networks has made certain revenue adjustments to reflect revenue which should
have been deferred instead of recognized in a particular period. Also, as
part of the restatements, Nortel Networks made adjustments to correct errors
related to its deferred income tax assets and foreign currency translation
accounts. In addition, Nortel Networks made reclassification adjustments
within the consolidated balance sheets to better reflect the underlying
nature of certain items; these reclassifications did not impact the net
assets as at the end of any period. The net effect of all of these
adjustments was a reduction in accumulated deficit of $505 and $497 as at
June 30, 2003 and December 31, 2002, respectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Three months ended
    
    December 31,June 30,
    
    
    March 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Prior
    
    
    Total2003
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    years (a)
    
    
    adjustmentsRevenuesAs previously reported
    
    $
    2,326
    
    
    $
    2,399
    
    
    $
    10,560
    
    
    $
    17,511
    
    
    $
    27,948Adjustments
    
    
    12
    
    
    
    (22
    )
    
    
    9
    
    
    
    (103
    )
    
    
    (17
    )
    
    $
    (1
    )
    
    $
    (122
    )As restated
    
    $
    2,338
    
    
    $
    2,377
    
    
    $
    10,569
    
    
    $
    17,408
    
    
    $
    27,931Earnings (loss)Earnings (loss) from
continuing operationsAs previously reported
    
    $
    (14
    )
    
    $
    (136
    )
    
    $
    (3,585
    )
    
    $
    (24,307
    )
    
    $
    (2,995
    )Adjustments
    
    
    52
    
    
    
    (35
    )
    
    
    299
    
    
    
    133
    
    
    
    27
    
    
    $
    4
    
    
    $
    480As restated
    
    $
    38
    
    
    $
    (171
    )
    
    $
    (3,286
    )
    
    $
    (24,174
    )
    
    $
    (2,968
    )Earnings (loss) from discontinued
operations  net of taxAs previously reported
    
    $
    
    
    
    $
    190
    
    
    $
    
    
    
    $
    (3,010
    )
    
    $
    (475
    )Adjustments
    
    
    (1
    )
    
    
    
    
    
    
    20
    
    
    
    14
    
    
    
    
    
    
    $
    
    
    
    $
    33As restated
    
    $
    (1
    )
    
    $
    190
    
    
    $
    20
    
    
    $
    (2,996
    )
    
    $
    (475
    )Net earnings (loss)As previously reported
    
    $
    (14
    )
    
    $
    54
    
    
    $
    (3,585
    )
    
    $
    (27,302
    )
    
    $
    (3,470
    )Adjustments
    
    
    51
    
    
    
    (43
    )
    
    
    319
    
    
    
    147
    
    
    
    27
    
    
    $
    4
    
    
    $
    505As restated
    
    $
    37
    
    
    $
    11
    
    
    $
    (3,266
    )
    
    $
    (27,155
    )
    
    $
    (3,443
    )
 (a)
    
    The amount in prior years relates to net adjustments in the years
1997 through 1999 which have been reflected as an adjustment to
accumulated deficit as of January 1, 2000.




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

10



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##### Table of Contents





| |  | The following presents details by category, aggregating to the net
improvement in the net earnings (loss) for the three months and six months
ended June 30, 2003 and 2002, resulting from the restatement adjustments:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Net decrease in net (loss)/Net increase in net earnings
| |  | -------------------------------------------------------



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Contract and customer-related accruals
    
    $
    (3
    )
    
    $
    85
    
    
    $
    27
    
    
    $
    144Special charges related to restructuring actions
    
    
    13
    
    
    
    47
    
    
    
    39
    
    
    
    75Other accruals and provisions
    
    
    
    
    
    
    (16
    )
    
    
    (96
    )
    
    
    54Total accruals and provisions adjustments
    
    
    10
    
    
    
    116
    
    
    
    (30
    )
    
    
    273Income tax adjustments
    
    
    3
    
    
    
    (33
    )
    
    
    19
    
    
    
    (79
    )Revenue adjustments
    
    
    12
    
    
    
    15
    
    
    
    (10
    )
    
    
    9Foreign currency translation adjustments  Brazilian operations
    
    
    26
    
    
    
    (30
    )
    
    
    29
    
    
    
    (30
    )Net decrease in net (loss)/Net increase in net earnings
    
    $
    51
    
    
    $
    68
    
    
    $
    8
    
    
    $
    173




| |  | Descriptions of the categories of the restatement adjustments to Nortel
Networks net earnings (loss) for the three months and six months ended June
30, 2003 and 2002 that were determined as a result of its comprehensive
review are set forth below.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Adjustments related to certain contract and customer-related accruals were
approximately $3 expense and $85 income for the three months ended, and $27
and $144 income for the six months ended, June 30, 2003 and 2002,
respectively. These accruals were identified as having been accrued in error
and were reversed in the appropriate periods. Nortel Networks identified
situations in which additional accruals related to certain contracts were
recognized when circumstances did not justify such accruals. Certain of
these accruals were not supported by adequate documentation. In addition,
Nortel Networks identified situations where accruals had been released in
inappropriate periods. Therefore, certain adjustments have been made to
recognize these releases in the appropriate periods.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | During the period January 1, 2000 to June 30, 2003, Nortel Networks recorded,
prior to the restatement adjustments, $5,636 of special charges related to
workforce reductions, contract settlement and lease costs, plant and
equipment write-downs and other ancillary special charges in connection with
the implementation of specific restructuring actions to streamline its
operations and activities around core markets and operations. As part of the
restatements, Nortel Networks has reduced special charges by $13 and $47 for
the three months ended, and $39 and $75 for the six months ended, June 30,
2003 and 2002, respectively. The following table provides details of the
total adjustments related to these special charges for the following periods:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Severance and fringe benefits calculations
    
    $
    (1
    )
    
    $
    27
    
    
    $
    13
    
    
    $
    45Plant and equipment and real estate related adjustments
    
    
    (5
    )
    
    
    15
    
    
    
    2
    
    
    
    19Contract settlements
    
    
    19
    
    
    
    5
    
    
    
    24
    
    
    
    11Total
adjustments related to special charges (a)
    
    $
    13
    
    
    $
    47
    
    
    $
    39
    
    
    $
    75
 (a)
    
    The majority of the total adjustments related to special charges
impacted Special charges in the consolidated statements of operations.
However, $6 and $5 for the three months ended, and $10 and $9 for the
six months ended, June 30, 2003 and 2002, respectively, of the above
noted amounts, impacted other lines in the consolidated statements of
operations.




| |  | Adjustments were made relating to special charges for costs associated with
severance and fringe benefits offered to terminated employees. These
adjustments were due to calculation errors that resulted in excess charges
being recorded at the time of initial recognition, or the failure to properly
release or adjust accruals for subsequent changes in estimates and
assumptions. In addition, Nortel Networks identified situations where
accruals had been released in inappropriate periods. Therefore, certain
adjustments have been made to recognize these releases in the appropriate
periods.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

11



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



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



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



| |  | Nortel Networks determined that certain accruals and provisions should not
have been recorded as the appropriate conditions and documentation supporting
the establishment of these accruals and provisions did not exist at the time
of such recognition. The restatement adjustments included the reversal of
these accruals and provisions in the periods in which they were originally
recorded. Nortel Networks also identified situations where accruals
had been released in inappropriate periods. Therefore, certain
adjustments have been made to recognize these releases in the
appropriate periods. The net impact of these adjustments was nil and a $16 increase to
net loss for the three months ended, and a $96 decrease to net earnings and a
$54 decrease to net loss for the six months ended, June 30, 2003 and 2002,
respectively. The following table details the amounts related to each of
these adjustments for each of the following periods:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Release (reverse previously released) provisions
related to inter-company out of balance amounts
    
    $
    15
    
    
    $
    (4
    )
    
    $
    (20
    )
    
    $
    (4
    )Release (reverse previously released) accruals
related to financial information system upgrades
    
    
    
    
    
    
    
    
    
    
    (15
    )
    
    
    10Reverse accruals related to discretionary bonuses
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    15Other adjustments to modify accruals
    
    
    (15
    )
    
    
    (15
    )
    
    
    (61
    )
    
    
    33Total adjustments related to other accruals and provisions
    
    $
    
    
    
    $
    (16
    )
    
    $
    (96
    )
    
    $
    54




| |  | These restatement adjustments included the release of provisions previously
established to bring into balance certain inter-company payables and
receivables, the reversal of accruals for costs associated with programs to
upgrade certain financial information systems and the reversal of accruals
for discretionary bonuses in excess of amounts reasonably expected to be
paid. Other adjustments made in connection with the restatements related to
the need to make modifications to accruals in a number of specific areas,
including adjustments to accounts payable balances, warranty provisions, and
other accruals and provisions.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Adjustments related to income taxes were a $3 increase and a $33 decrease to
the income tax benefit for the three months ended June 30, 2003 and 2002,
respectively, which resulted primarily from the tax impacts of the
restatement adjustments. The adjustment related to income taxes for the six
months ended June 30, 2003 was a $19 increase to the income tax benefit which
included $20 from the reversal of a previously written-off withholding tax
receivable partially offset by the tax impacts of the restatement
adjustments. The write-off of the receivable had been recorded in
inappropriate periods and adjustments have been made to recognize the
write-off in the appropriate periods. The adjustment related to income
taxes for the six months ended June 30, 2002 was a $79 decrease in the income
tax benefit which resulted primarily from the tax impacts of the restatement
adjustments.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

12



---



##### Table of Contents





| |  | periods and released associated
accrued costs in the appropriate periods. The
net impact for these adjustments were increases to revenue of $12 and $15 for
the three months ended, and a $10 decrease and a $9 increase for the
six months ended, June 30, 2003 and 2002, respectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks had recorded the
net impact from the translation of foreign
currency denominated balances of its Brazilian entities in the currency
translation adjustment account included in accumulated other comprehensive
loss on its balance sheet. These net impacts were a $26 decrease and a $30
increase in net loss for the three months ended, and a $29 increase in net
earnings and a $30 increase in net loss for the six months ended, June 30,
2003 and 2002, respectively. In connection with the comprehensive review,
Nortel Networks determined that the appropriate accounting treatment would
have been to record the foreign exchange impact in its statement of
operations in the appropriate periods.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  | Consolidated statement of operations for the three months ended June 30, 2003
as restated
| |  | -----------------------------------------------------------------------------------------



| |  | Net loss for the three months ended June 30, 2003 was reduced by $51 from a
net loss of $14 to net earnings of $37. The major components of the
reduction included:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $12 improvement in gross profit which resulted primarily from
an increase in revenues which had been deferred from prior periods;
and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------



| |  | a $17 increase in other income which included $26 of foreign
exchange adjustments related to Nortel Networks Brazilian operations
and $21 which resulted from the release of accruals for inter-company
out of balance amounts partially offset by $30 of other items.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated statement of operations for the six months ended June 30, 2003
as restated
| |  | ---------------------------------------------------------------------------------------



| |  | Net earnings for the six months ended June 30, 2003 increased by $8 from $40
to $48. The major components of the increase included:
| |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  | a $27 improvement in gross profit which included a $10
reduction in revenues which resulted from revenue deferrals and a $37
reduction to cost of revenues which resulted primarily from
adjustments to contract and customer-related accruals;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $24 increase in selling, general and administrative expense
which resulted primarily from the reversal of previously recorded
releases of accruals and provisions, including $15 of accruals
associated with programs to upgrade certain financial information
systems;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $17 increase in research and development expense which
resulted primarily from the reversal of previously recorded releases
of accruals and provisions;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $29 decrease which resulted from the release of special
charges related to costs associated with severance and fringe
benefits for terminated employees, plant and equipment and contract
settlements, partially offset by an increase in special charges
related to certain real estate facilities; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $27 decrease in other income which included $29 from the
reversal of previously recorded releases of other accruals and
provisions (including $9 for accruals for inter-company out of
balance amounts) and $27 net of other items partially offset by $29
of foreign exchange adjustments related to Nortel Networks Brazilian
operations.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Net loss for the three months ended June 30, 2002 was reduced by $68 from
$697 to $629. The major components of the reduction included:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  | a $55 improvement in gross profit which resulted primarily from
a $15 increase in revenues which had been deferred from prior periods
and a $40 improvement in cost of revenues which resulted primarily
from adjustments to contract and customer-related accruals;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

13



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##### Table of Contents





| |  | a $11 decrease in selling, general and administrative expense
and a $8 decrease in research and development expense, each due to a
net decrease in other accruals and provisions;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $42 decrease which resulted from the release of special
charges primarily related to costs associated with severance and
fringe benefits for terminated employees; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $14 increase in other expense which resulted from adjustments
related to other accruals and provisions.
| | - | ---------------------------------------------------------------------------------------------------------



| |  | Consolidated statement of operations for the six months ended June 30, 2002
as restated
| |  | ---------------------------------------------------------------------------------------



| |  | Net loss for the six months ended June 30, 2002 was reduced by $173 from
$1,538 to $1,365. The major components of the reduction included:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $116 improvement in gross profit which resulted primarily
from adjustments to contract and customer-related accruals;
| | - | -----------------------------------------------------------------------------------------------------------------------



| |  | a $48 decrease in selling, general and administrative expense
which resulted primarily from the release of accruals and provisions,
including $15 of accruals for discretionary bonuses in excess of
amounts reasonably expected to be paid and $10 of accruals associated
with programs to upgrade certain financial information systems;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $21 decrease in research and development expense which
resulted primarily from the release of other accruals and provisions;
| | - | ------------------------------------------------------------------------------------------------------------------------------



| |  | a $66 decrease which resulted from the release of special
charges related to costs associated with severance and fringe
benefits for terminated employees; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $19 adjustment to discontinued operations for items
previously recorded incorrectly as an expense in discontinued
operations.
| | - | -------------------------------------------------------------------------------------------------------------------------------



| |  | Consolidated balance sheets as at June 30, 2003 and December 31, 2002
| |  | ---------------------------------------------------------------------



| |  | Restatements
| |  | ------------



| |  | The consolidated balance sheets below present the cumulative impact of the
restatement adjustments described above classified by balance sheet line item
as at June 30, 2003 and December 31, 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | In addition to the restatement adjustments, reclassification adjustments were
made between line items which also impacted the consolidated balance sheets
as at June 30, 2003 and December 31, 2002. The principal reclassifications
are set forth below.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As at June 30, 2003
| |  | -------------------



| |  | a $118 increase in accounts receivable-net which included a
$137 increase primarily to recognize advance billings in excess of
revenues as a liability partially offset by a $19 increase in
allowance for doubtful accounts for financed receivables which
resulted from a reclassification from other long-term assets;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a $37 increase in net inventory with related reductions of $18 in other current assets and of $19 in other long-term assets; and
| | - | --------------------------------------------------------------------------------------------------------------------------------



| |  | a $137 increase in other accrued liabilities related to accounts receivable-net (as noted above).
| | - | -------------------------------------------------------------------------------------------------



| |  | As at December 31, 2002
| |  | -----------------------



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



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



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

14



---



##### Table of Contents





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

15



---



##### Table of Contents



Consolidated Statements of Operations (unaudited)

Three months ended June 30, 2003
    
    Six months ended June 30, 2003As
    
    
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    As
    
    
    previously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restated
    
    
    reported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    2,326
    
    
    $
    12
    
    
    $
    2,338
    
    
    $
    4,725
    
    
    $
    (10
    )
    
    $
    4,715Cost of revenues
    
    
    1,310
    
    
    
    
    
    
    
    1,310
    
    
    
    2,680
    
    
    
    (37
    )
    
    
    2,643Gross profit
    
    
    1,016
    
    
    
    12
    
    
    
    1,028
    
    
    
    2,045
    
    
    
    27
    
    
    
    2,072Selling, general and administrative expense
    
    
    416
    
    
    
    (3
    )
    
    
    413
    
    
    
    903
    
    
    
    24
    
    
    
    927Research and development expense
    
    
    479
    
    
    
    2
    
    
    
    481
    
    
    
    968
    
    
    
    17
    
    
    
    985Amortization of acquired technology
    
    
    33
    
    
    
    
    
    
    
    33
    
    
    
    66
    
    
    
    
    
    
    
    66Deferred stock option compensation
    
    
    17
    
    
    
    
    
    
    
    17
    
    
    
    32
    
    
    
    3
    
    
    
    35Special charges
    
    
    5
    
    
    
    (7
    )
    
    
    (2
    )
    
    
    139
    
    
    
    (29
    )
    
    
    110Gain on sale of businesses
    
    
    
    
    
    
    (4
    )
    
    
    (4
    )
    
    
    
    
    
    
    (8
    )
    
    
    (8
    )Operating earnings (loss)
    
    
    66
    
    
    
    24
    
    
    
    90
    
    
    
    (63
    )
    
    
    20
    
    
    
    (43
    )Other income (expense)  net
    
    
    6
    
    
    
    17
    
    
    
    23
    
    
    
    54
    
    
    
    (27
    )
    
    
    27Interest expenseLong-term debt
    
    
    (44
    )
    
    
    
    
    
    
    (44
    )
    
    
    (89
    )
    
    
    
    
    
    
    (89
    )Other
    
    
    (2
    )
    
    
    
    
    
    
    (2
    )
    
    
    (9
    )
    
    
    (1
    )
    
    
    (10
    )Earnings (loss) from continuing operations
before income taxes, minority interests and
equity in net loss of associated companies
    
    
    26
    
    
    
    41
    
    
    
    67
    
    
    
    (107
    )
    
    
    (8
    )
    
    
    (115
    )Income tax benefit
    
    
    7
    
    
    
    3
    
    
    
    10
    
    
    
    9
    
    
    
    19
    
    
    
    2833
    
    
    
    44
    
    
    
    77
    
    
    
    (98
    )
    
    
    11
    
    
    
    (87
    )Minority interests  net of tax
    
    
    (27
    )
    
    
    8
    
    
    
    (19
    )
    
    
    (25
    )
    
    
    9
    
    
    
    (16
    )Equity in net loss of associated companies  net of tax
    
    
    (20
    )
    
    
    
    
    
    
    (20
    )
    
    
    (27
    )
    
    
    (3
    )
    
    
    (30
    )Net earnings (loss) from continuing operations
    
    
    (14
    )
    
    
    52
    
    
    
    38
    
    
    
    (150
    )
    
    
    17
    
    
    
    (133
    )Net earnings (loss) from discontinued operations  net of tax
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    190
    
    
    
    (1
    )
    
    
    189Net earnings (loss) before cumulative effect of accounting
change  net of tax
    
    
    (14
    )
    
    
    51
    
    
    
    37
    
    
    
    40
    
    
    
    16
    
    
    
    56Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    (8
    )Net earnings (loss)
    
    $
    (14
    )
    
    $
    51
    
    
    $
    37
    
    
    $
    40
    
    
    $
    8
    
    
    $
    48Basic and diluted earnings (loss) per common share from continuing operations
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    0.00
    
    
    $
    (0.03
    ) from discontinued operations
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.04
    
    
    
    0.00
    
    
    
    0.04Basic and diluted earnings (loss) per common share
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.00
    
    
    $
    0.01


16



---



##### Table of Contents



Consolidated Statements of Operations (unaudited)

Three months ended June 30, 2002
    
    Six months ended June 30, 2002As
    
    
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    As
    
    
    previously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restated
    
    
    reported
    
    
    Adjustments
    
    
    restatedRevenues
    
    $
    2,773
    
    
    $
    15
    
    
    $
    2,788
    
    
    $
    5,685
    
    
    $
    9
    
    
    $
    5,694Cost of revenues
    
    
    1,815
    
    
    
    (40
    )
    
    
    1,775
    
    
    
    3,969
    
    
    
    (107
    )
    
    
    3,862Gross profit
    
    
    958
    
    
    
    55
    
    
    
    1,013
    
    
    
    1,716
    
    
    
    116
    
    
    
    1,832Selling, general and administrative expense
    
    
    767
    
    
    
    (11
    )
    
    
    756
    
    
    
    1,511
    
    
    
    (48
    )
    
    
    1,463Research and development expense
    
    
    579
    
    
    
    (8
    )
    
    
    571
    
    
    
    1,174
    
    
    
    (21
    )
    
    
    1,153Amortization of acquired technology
    
    
    41
    
    
    
    
    
    
    
    41
    
    
    
    84
    
    
    
    
    
    
    
    84Deferred stock option compensation
    
    
    21
    
    
    
    (1
    )
    
    
    20
    
    
    
    46
    
    
    
    (2
    )
    
    
    44Special charges
    
    
    403
    
    
    
    (42
    )
    
    
    361
    
    
    
    890
    
    
    
    (66
    )
    
    
    824Gain on sale of businesses
    
    
    
    
    
    
    (2
    )
    
    
    (2
    )
    
    
    (14
    )
    
    
    (4
    )
    
    
    (18
    )Operating earnings (loss)
    
    
    (853
    )
    
    
    119
    
    
    
    (734
    )
    
    
    (1,975
    )
    
    
    257
    
    
    
    (1,718
    )Other income (expense)  net
    
    
    (9
    )
    
    
    (14
    )
    
    
    (23
    )
    
    
    (28
    )
    
    
    (4
    )
    
    
    (32
    )Interest expenseLong-term debt
    
    
    (55
    )
    
    
    (2
    )
    
    
    (57
    )
    
    
    (113
    )
    
    
    (3
    )
    
    
    (116
    )Other
    
    
    (9
    )
    
    
    
    
    
    
    (9
    )
    
    
    (21
    )
    
    
    
    
    
    
    (21
    )Earnings (loss) from continuing operations
before income taxes, minority interests and
equity in net loss of associated companies
    
    
    (926
    )
    
    
    103
    
    
    
    (823
    )
    
    
    (2,137
    )
    
    
    250
    
    
    
    (1,887
    )Income tax benefit
    
    
    229
    
    
    
    (33
    )
    
    
    196
    
    
    
    603
    
    
    
    (79
    )
    
    
    524(697
    )
    
    
    70
    
    
    
    (627
    )
    
    
    (1,534
    )
    
    
    171
    
    
    
    (1,363
    )Minority interests  net of tax
    
    
    10
    
    
    
    (4
    )
    
    
    6
    
    
    
    10
    
    
    
    (12
    )
    
    
    (2
    )Equity in net loss of associated companies  net of tax
    
    
    (10
    )
    
    
    (1
    )
    
    
    (11
    )
    
    
    (14
    )
    
    
    (5
    )
    
    
    (19
    )Net earnings (loss) from continuing operations
    
    
    (697
    )
    
    
    65
    
    
    
    (632
    )
    
    
    (1,538
    )
    
    
    154
    
    
    
    (1,384
    )Net earnings (loss) from
discontinued operations  net of tax
    
    
    
    
    
    
    3
    
    
    
    3
    
    
    
    
    
    
    
    19
    
    
    
    19Net earnings (loss)
    
    $
    (697
    )
    
    $
    68
    
    
    $
    (629
    )
    
    $
    (1,538
    )
    
    $
    173
    
    
    $
    (1,365
    )Basic and diluted earnings (loss) per common share from continuing operations
    
    $
    (0.20
    )
    
    $
    0.02
    
    
    $
    (0.18
    )
    
    $
    (0.46
    )
    
    $
    0.04
    
    
    $
    (0.42
    ) from discontinued operations
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.01
    
    
    
    0.01Basic and diluted earnings (loss) per common share
    
    $
    (0.20
    )
    
    $
    0.02
    
    
    $
    (0.18
    )
    
    $
    (0.46
    )
    
    $
    0.05
    
    
    $
    (0.41
    )


17



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##### Table of Contents



Consolidated Balance Sheet (unaudited)

June 30, 2003Aspreviously
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    
    Restatement
    
    
    Reclassification
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    4,190
    
    
    $
    
    
    
    $
    
    
    
    $
    4,190Restricted cash and cash equivalents
    
    
    115
    
    
    
    
    
    
    
    
    
    
    
    115Accounts receivable  net
    
    
    1,717
    
    
    
    (9
    )
    
    
    118
    
    
    
    1,826Inventories  net
    
    
    830
    
    
    
    12
    
    
    
    37
    
    
    
    879Income taxes recoverable
    
    
    57
    
    
    
    
    
    
    
    
    
    
    
    57Deferred income taxes  net
    
    
    400
    
    
    
    (1
    )
    
    
    
    
    
    
    399Other current assets
    
    
    439
    
    
    
    8
    
    
    
    (18
    )
    
    
    429Total current assets
    
    
    7,748
    
    
    
    10
    
    
    
    137
    
    
    
    7,895Investments
    
    
    209
    
    
    
    (10
    )
    
    
    
    
    
    
    199Plant and equipment  net
    
    
    1,380
    
    
    
    
    
    
    
    
    
    
    
    1,380Goodwill
    
    
    2,202
    
    
    
    
    
    
    
    
    
    
    
    2,202Intangible assets  net
    
    
    33
    
    
    
    
    
    
    
    
    
    
    
    33Deferred income taxes  net
    
    
    3,600
    
    
    
    (157
    )
    
    
    
    
    
    
    3,443Other assets
    
    
    669
    
    
    
    11
    
    
    
    7
    
    
    
    687Total assets
    
    $
    15,841
    
    
    $
    (146
    )
    
    $
    144
    
    
    $
    15,839LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    48
    
    
    $
    
    
    
    $
    
    
    
    $
    48Trade and other accounts payable
    
    
    802
    
    
    
    (32
    )
    
    
    
    
    
    
    770Payroll and benefit-related liabilities
    
    
    635
    
    
    
    (6
    )
    
    
    
    
    
    
    629Contractual liabilities
    
    
    1,355
    
    
    
    (347
    )
    
    
    
    
    
    
    1,008Restructuring
    
    
    637
    
    
    
    (334
    )
    
    
    
    
    
    
    303Other accrued liabilities
    
    
    2,560
    
    
    
    (193
    )
    
    
    137
    
    
    
    2,504Long-term debt due within one year
    
    
    184
    
    
    
    
    
    
    
    
    
    
    
    184Total current liabilities
    
    
    6,221
    
    
    
    (912
    )
    
    
    137
    
    
    
    5,446Long-term debt
    
    
    3,694
    
    
    
    (1
    )
    
    
    7
    
    
    
    3,700Deferred income taxes  net
    
    
    488
    
    
    
    13
    
    
    
    
    
    
    
    501Other liabilities
    
    
    2,416
    
    
    
    10
    
    
    
    
    
    
    
    2,42612,819
    
    
    
    (890
    )
    
    
    144
    
    
    
    12,073Minority interests in subsidiary companies
    
    
    623
    
    
    
    39
    
    
    
    
    
    
    
    662SHAREHOLDERS EQUITYCommon shares, without par value  Authorized shares: unlimited;
issued and outstanding shares: 3,945,156,167 at June 30, 2003
    
    
    33,726
    
    
    
    (4
    )
    
    
    
    
    
    
    33,722Additional paid-in capital
    
    
    3,587
    
    
    
    38
    
    
    
    
    
    
    
    3,625Deferred stock option compensation
    
    
    (53
    )
    
    
    
    
    
    
    
    
    
    
    (53
    )Accumulated deficit
    
    
    (33,696
    )
    
    
    505
    
    
    
    
    
    
    
    (33,191
    )Accumulated other comprehensive loss
    
    
    (1,165
    )
    
    
    166
    
    
    
    
    
    
    
    (999
    )Total shareholders equity
    
    
    2,399
    
    
    
    705
    
    
    
    
    
    
    
    3,104Total liabilities and shareholders equity
    
    $
    15,841
    
    
    $
    (146
    )
    
    $
    144
    
    
    $
    15,839


18



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##### Table of Contents



Consolidated Balance Sheet (unaudited)

December 31, 2002Aspreviously
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    
    Restatement
    
    
    Reclassification
    
    
    restatedASSETSCurrent assetsCash and cash equivalents
    
    $
    3,861
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    3,791Restricted cash and cash equivalents
    
    
    249
    
    
    
    
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    1,910
    
    
    
    (12
    )
    
    
    265
    
    
    
    2,163Inventories  net
    
    
    889
    
    
    
    7
    
    
    
    90
    
    
    
    986Income taxes recoverable
    
    
    58
    
    
    
    
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    791
    
    
    
    (1
    )
    
    
    
    
    
    
    790Other current assets
    
    
    718
    
    
    
    15
    
    
    
    (52
    )
    
    
    681Total current assets
    
    
    8,476
    
    
    
    9
    
    
    
    233
    
    
    
    8,718Investments
    
    
    246
    
    
    
    2
    
    
    
    
    
    
    
    248Plant and equipment  net
    
    
    1,444
    
    
    
    23
    
    
    
    
    
    
    
    1,467Goodwill
    
    
    2,201
    
    
    
    
    
    
    
    
    
    
    
    2,201Intangible assets  net
    
    
    98
    
    
    
    
    
    
    
    
    
    
    
    98Deferred income taxes  net
    
    
    2,723
    
    
    
    (144
    )
    
    
    
    
    
    
    2,579Other assets
    
    
    783
    
    
    
    9
    
    
    
    10
    
    
    
    802Total assets
    
    $
    15,971
    
    
    $
    (101
    )
    
    $
    243
    
    
    $
    16,113LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    100
    
    
    $
    
    
    
    $
    (70
    )
    
    $
    30Trade and other accounts payable
    
    
    902
    
    
    
    (30
    )
    
    
    
    
    
    
    872Payroll and benefit-related liabilities
    
    
    521
    
    
    
    (14
    )
    
    
    
    
    
    
    507Contractual liabilities
    
    
    1,547
    
    
    
    (332
    )
    
    
    
    
    
    
    1,215Restructuring
    
    
    785
    
    
    
    (237
    )
    
    
    
    
    
    
    548Other accrued liabilities
    
    
    2,894
    
    
    
    (226
    )
    
    
    306
    
    
    
    2,974Long-term debt due within one year
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    6,982
    
    
    
    (839
    )
    
    
    236
    
    
    
    6,379Long-term debt
    
    
    3,719
    
    
    
    (1
    )
    
    
    31
    
    
    
    3,749Deferred income taxes  net
    
    
    344
    
    
    
    1
    
    
    
    
    
    
    
    345Other liabilities
    
    
    2,352
    
    
    
    (5
    )
    
    
    (24
    )
    
    
    2,32313,397
    
    
    
    (844
    )
    
    
    243
    
    
    
    12,796Minority interests in subsidiary companies
    
    
    614
    
    
    
    51
    
    
    
    
    
    
    
    665SHAREHOLDERS EQUITYCommon shares, without par value  Authorized shares: unlimited;
issued and outstanding shares: 3,850,169,343 at December 31, 2002
    
    
    33,587
    
    
    
    (4
    )
    
    
    
    
    
    
    33,583Additional paid-in capital
    
    
    3,734
    
    
    
    20
    
    
    
    
    
    
    
    3,754Deferred stock option compensation
    
    
    (96
    )
    
    
    5
    
    
    
    
    
    
    
    (91
    )Accumulated deficit
    
    
    (33,736
    )
    
    
    497
    
    
    
    
    
    
    
    (33,239
    )Accumulated other comprehensive loss
    
    
    (1,529
    )
    
    
    174
    
    
    
    
    
    
    
    (1,355
    )Total shareholders equity
    
    
    1,960
    
    
    
    692
    
    
    
    
    
    
    
    2,652Total liabilities and shareholders equity
    
    $
    15,971
    
    
    $
    (101
    )
    
    $
    243
    
    
    $
    16,113


19



---



##### Table of Contents





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



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



| |  | Prior to fiscal 2003, Nortel Networks, as permitted under SFAS No. 123,
Accounting for Stock-based Compensation (SFAS 123), applied Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees (APB 25) and related interpretations in accounting and
providing disclosures for its stock-based compensation plans. In December
2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure  an Amendment of FASB
Statement No. 123 (SFAS 148), which amended the transitional provisions
of SFAS 123 for entities choosing to recognize stock-based compensation
under the fair value based method of SFAS 123.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Effective January 1, 2003, Nortel Networks elected to expense employee
stock-based compensation using the fair value based method prospectively
for all awards granted or modified after January 1, 2003. The fair value
at grant date of stock options is estimated using the Black-Scholes
option-pricing model. Compensation expense is recognized over the stock
option vesting period. Nortel Networks has also adopted the amended
disclosure provisions of SFAS 148. Stock option expense (pre-tax)
recorded during the three months and six months ended June 30, 2003 was $7
and $12, respectively.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Had Nortel Networks applied the fair value based method to all stock-based
awards, reported net earnings (loss) and earnings (loss) per common share
would have decreased (increased) to the pro forma amounts indicated below
for the following periods:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Net earnings (loss)  reported
    
    $
    37
    
    
    $
    (629
    )
    
    $
    48
    
    
    $
    (1,365
    )Stock-based compensation  reported (a)
    
    
    26
    
    
    
    3
    
    
    
    42
    
    
    
    6Deferred stock option compensation  reported (b)
    
    
    17
    
    
    
    12
    
    
    
    35
    
    
    
    26Stock-based compensation  pro forma (c)
    
    
    (104
    )
    
    
    (253
    )
    
    
    (200
    )
    
    
    (506
    )Net loss  pro forma
    
    $
    (24
    )
    
    $
    (867
    )
    
    $
    (75
    )
    
    $
    (1,839
    )Basic and diluted earnings (loss) per common share:Reported
    
    $
    0.01
    
    
    $
    (0.18
    )
    
    $
    0.01
    
    
    $
    (0.41
    )Pro forma
    
    $
    (0.01
    )
    
    $
    (0.25
    )
    
    $
    (0.02
    )
    
    $
    (0.55
    )
 (a)
    
    Stock-based compensation  reported included stock option
expense, employer portion of stock purchase plan contributions and
restricted stock units expense. For the three months and six months
ended June 30, 2003, the amounts were net of tax of nil. For the
three months and six months ended June 30, 2002, the amounts were net
of tax of $2 and $3, respectively.(b)
    
    Deferred stock option compensation  reported represented the
amortization of deferred stock option compensation related primarily
to unvested stock options held by employees of companies acquired in
a purchase acquisition. For the three months and six months ended
June 30, 2003, the amounts were net of tax of nil. For the three
months and six months ended June 30, 2002, the amounts were net of
tax of $8 and $18, respectively.(c)
    
    Stock-based compensation  pro forma included stock option
expense, pro forma stock option expense, employer portion of stock
purchase plan contributions, restricted stock units expense and
deferred stock option compensation. For the three months and six
months ended June 30, 2003, the amounts were net of tax of nil. For
the three months and six months ended June 30, 2002, the amounts were
net of tax of $83 and $168, respectively.


20



---



##### Table of Contents





| |  | The following weighted average assumptions were used in computing the fair
value of stock options used to compute pro forma net loss and pro forma
loss per common share for the following periods:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Black-Scholes weighted-average assumptionsExpected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    92.86
    %
    
    
    74.27
    %
    
    
    92.48
    %
    
    
    71.32
    %Risk-free interest rate
    
    
    2.48
    %
    
    
    4.26
    %
    
    
    2.81
    %
    
    
    4.49
    %Expected option life in years
    
    
    4
    
    
    
    4
    
    
    
    4
    
    
    
    4Weighted average stock option fair value
per option granted
    
    $
    1.91
    
    
    $
    1.45
    
    
    $
    1.57
    
    
    $
    3.51




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



| |  | Nortel Networks has entered into agreements that contain features which
meet the definition of a guarantee under FIN 45. FIN 45 defines a
guarantee to be a contract that contingently requires Nortel Networks to
make payments (either in cash, financial instruments, other assets, common
shares of Nortel Networks or through the provision of services) to a third
party based on changes in an underlying economic characteristic (such as
interest rates or market value) that is related to an asset, a liability
or an equity security of the other party. 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. FIN 45 requires that a liability be
recognized for the estimated fair value of the guarantee at its inception.
The adoption of FIN 45 did not have a material impact on the results of
operations and financial condition of Nortel Networks (see note 10).
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS 143), which applies to certain obligations
associated with the retirement of tangible long-lived assets. SFAS 143
requires that a liability is initially recognized for the estimated fair
value of the obligation when it is incurred. The associated asset
retirement cost is capitalized as part of the carrying amount of the
long-lived asset and depreciated over the remaining life of the underlying
asset and the associated liability is accreted to the estimated fair value
of the obligation at the settlement date through periodic accretion
charges to net earnings (loss). When the obligation is settled, any
difference between the final cost and the recorded liability is recognized
as income or loss on settlement. Effective January 1, 2003, Nortel
Networks adopted the initial recognition and measurement provisions of
SFAS 143. The adoption of SFAS 143 resulted in a decrease to net earnings
of $8 (net of tax of nil) which has been reported as a cumulative effect
of an accounting change, the recording of a long-lived asset of $5 and an
asset retirement obligation liability of $13.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | Accounting for costs associated with exit or disposal activities
| | --- | ----------------------------------------------------------------



| |  | In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), which is
effective for exit or disposal activities initiated after December 31,
2002. SFAS 146 supercedes EITF Issue No. 94-3 Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in Restructuring) (EITF 94-3). SFAS
146 requires that costs associated with an exit or disposal activity be
recognized when the liability is incurred, whereas EITF 94-3 requires
recognition of a liability when an entity committed to an exit plan. The
effect of SFAS 146 is to change the timing of recognition and basis for
measuring certain liabilities. No material valuation differences between
SFAS 146 and EITF 94-3 are expected. Exit and disposal plans 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.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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



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



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



June 30,
    
    
    December 31,2003
    
    
    2002Raw materials
    
    $
    331
    
    
    $
    343Work in process
    
    
    258
    
    
    
    308Finished goods
    
    
    290
    
    
    
    335Inventories  net (a)
    
    $
    879
    
    
    $
    986
 (a)
    
    Net of inventory provisions of $997 and $1,070 as at June 30, 2003
and December 31, 2002, respectively. Included in other accrued
liabilities were accruals of $146 and $167 at June 30, 2003 and December
31, 2002, respectively, for cancellation charges, inventory in excess of
future demand and the settlement of certain other claims related to
contract manufacturers or suppliers.




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



June 30,
    
    
    December 31,2003
    
    
    2002Cost:Land
    
    $
    58
    
    
    $
    53Buildings
    
    
    1,162
    
    
    
    1,168Machinery and equipment
    
    
    3,442
    
    
    
    3,4794,662
    
    
    
    4,700Less accumulated depreciation:Buildings
    
    
    (546
    )
    
    
    (488
    )Machinery and equipment
    
    
    (2,736
    )
    
    
    (2,745
    )(3,282
    )
    
    
    (3,233
    )Plant and equipment  net (a)
    
    $
    1,380
    
    
    $
    1,467
 (a)
    
    Included assets held for sale with a carrying value of $47 and $78 as
at June 30, 2003 and December 31, 2002, related to owned facilities that
were being actively marketed. These assets were written down to their
estimated fair values less costs to sell in previous periods. The write
down was included in special charges. We expect to dispose of all of
these facilities by mid-2005.




| |  | Intangible assets  net:
| |  | ------------------------



June 30,
    
    
    December 31,2003
    
    
    2002Acquired technology
    
    $
    391
    
    
    $
    391Less: accumulated amortization
    
    
    (358
    )
    
    
    (293
    )Acquired technology  net(a)
    
    $
    33
    
    
    $
    98
 (a)
    
    Acquired technology is expected to be fully amortized by September
30, 2003.


22



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



June 30,
    
    
    December 31,2003
    
    
    2002Outsourcing and selling, general and administrative related
    
    $
    541
    
    
    $
    623Customer deposits
    
    
    63
    
    
    
    59Product related
    
    
    319
    
    
    
    343Warranty
    
    
    248
    
    
    
    255Deferred income
    
    
    574
    
    
    
    586Advance billings in excess of revenues
    
    
    199
    
    
    
    365Miscellaneous taxes
    
    
    107
    
    
    
    131Income taxes payable
    
    
    71
    
    
    
    99Current liabilities of discontinued operations
    
    
    81
    
    
    
    81Interest payable
    
    
    69
    
    
    
    77Other
    
    
    232
    
    
    
    355Other accrued liabilities
    
    $
    2,504
    
    
    $
    2,974




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



| |  | Interest and income taxes paid (recovered):
| |  | -------------------------------------------



June 30,
    
    
    June 30,2003
    
    
    2002Interest paid
    
    $
    101
    
    
    $
    147Income taxes paid (recovered)
    
    $
    8
    
    
    $
    (1,236
    )




| |  | Goodwill
| |  | --------



| |  | Goodwill represents the excess of the purchase price of an acquired
enterprise over the fair values of the identifiable assets acquired and
liabilities assumed. Nortel Networks tests for impairment of goodwill on an
annual basis on October 1 and at any other time if events occur or
circumstances change that would more likely than not reduce the fair value of
the reporting unit below its carrying amount.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Circumstances that could trigger an impairment test include a significant
adverse change in the business climate or legal factors, an adverse action or
assessment by a regulator, unanticipated competition, loss of key personnel,
the likelihood that a reporting unit or significant portion of a reporting
unit will be sold or otherwise disposed, results of testing for
recoverability of a significant asset group within a reporting unit and
recognition of a goodwill impairment loss in the financial statements of a
subsidiary that is a component of a reporting unit.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The impairment test for goodwill is a two-step process. Step one consists of
a comparison of the fair value of a reporting unit with its carrying amount,
including the goodwill allocated to the reporting unit. Measurement of the
fair value of a reporting unit is based on one or more fair value measures
including: estimated amounts at which the unit as a whole could be bought or
sold in a current transaction between willing parties; present value
techniques of estimated future cash flows; and valuation techniques based on
multiples of earnings or revenue or a similar performance measure. Nortel
Networks also considers its market capitalization as of the date of the
impairment test. If the carrying amount of the reporting unit exceeds the
fair value, step two requires the fair value of the reporting unit to be
allocated to the underlying assets and liabilities of that reporting unit,
resulting in an implied fair value of goodwill. If the carrying amount of
the reporting unit goodwill exceeds the implied fair value of that goodwill,
an impairment loss equal to the excess is recorded in net earnings (loss).
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

23



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##### Table of Contents





|5. |  | Segment information
|-- |  | -------------------



| |  | General description
| |  | -------------------



| |  | Nortel Networks operations are organized around four reportable segments:
Wireless Networks, Enterprise Networks, Wireline Networks and Optical
Networks. Wireless Networks includes network access and core networking
products for voice and data communications that span second and third
generation wireless technologies and most major global standards for mobile
networks. Enterprise Networks includes circuit and packet voice solutions,
data networking and security solutions and the related professional services
used by our enterprise customers. Wireline Networks includes circuit and
packet voice solutions, data networking and security solutions and the
related professional services used by our service provider customers.
Optical Networks includes metropolitan, regional and long-haul photonic dense
wavelength division multiplexing transmission systems, synchronous optical
transmission systems, optical switching solutions, network management
software and intelligence solutions and Optical Ethernet solutions for both
service provider and enterprise customers.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other represents miscellaneous business activities and corporate functions.
None of these activities meet the quantitative criteria to be disclosed as
reportable segments.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks President and Chief Executive Officer (CEO) has been
identified as the chief operating decision maker in assessing the performance
of the segments and the allocation of resources to the segments. Each
reportable segment is managed separately with each segment manager reporting
directly to the CEO. The CEO relies on the information derived directly from
the Nortel Networks management reporting system. Contribution margin
represents the primary financial measure used by the CEO in assessing
performance and allocating resources and includes the cost of revenues and
selling, general and administrative expense for which the segment managers
are held accountable. Costs associated with shared services and other
corporate costs are allocated to the segments based on usage determined
generally by headcount. Costs not allocated to the segments are primarily
related to Nortel Networks corporate compliance and other non-operational
activities and are included in other. In addition, the CEO does not review
asset information on a segmented basis in order to assess performance and
allocate resources. Research and development expense represents planned
investment in next generation core products across all segments. The
accounting policies of the reportable segments are the same as those applied
to the consolidated financial statements.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002RevenuesWireless Networks
    
    $
    1,000
    
    
    $
    1,137
    
    
    $
    1,934
    
    
    $
    2,260Enterprise Networks
    
    
    546
    
    
    
    638
    
    
    
    1,158
    
    
    
    1,312Wireline Networks
    
    
    494
    
    
    
    588
    
    
    
    1,055
    
    
    
    1,273Optical Networks
    
    
    298
    
    
    
    407
    
    
    
    567
    
    
    
    815Other
    
    
    
    
    
    
    18
    
    
    
    1
    
    
    
    34Total
    
    $
    2,338
    
    
    $
    2,788
    
    
    $
    4,715
    
    
    $
    5,694Contribution marginWireless Networks
    
    $
    346
    
    
    $
    323
    
    
    $
    663
    
    
    $
    583Enterprise Networks
    
    
    87
    
    
    
    95
    
    
    
    237
    
    
    
    185Wireline Networks
    
    
    173
    
    
    
    103
    
    
    
    331
    
    
    
    230Optical Networks
    
    
    28
    
    
    
    (212
    )
    
    
    42
    
    
    
    (530
    )Other
    
    
    (19
    )
    
    
    (52
    )
    
    
    (128
    )
    
    
    (99
    )Total
    
    
    615
    
    
    
    257
    
    
    
    1,145
    
    
    
    369Research and development expense
    
    
    (481
    )
    
    
    (571
    )
    
    
    (985
    )
    
    
    (1,153
    )Amortization of acquired technology
    
    
    (33
    )
    
    
    (41
    )
    
    
    (66
    )
    
    
    (84
    )Deferred stock option compensation
    
    
    (17
    )
    
    
    (20
    )
    
    
    (35
    )
    
    
    (44
    )Special charges
    
    
    2
    
    
    
    (361
    )
    
    
    (110
    )
    
    
    (824
    )Gain on sale of businesses
    
    
    4
    
    
    
    2
    
    
    
    8
    
    
    
    18Other income (expense)  net
    
    
    23
    
    
    
    (23
    )
    
    
    27
    
    
    
    (32
    )Interest expense
    
    
    (46
    )
    
    
    (66
    )
    
    
    (99
    )
    
    
    (137
    )Earnings (loss) from continuing operations before income taxes,
minority interests and equity in net loss of associated companies
    
    $
    67
    
    
    $
    (823
    )
    
    $
    (115
    )
    
    $
    (1,887
    )


25



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##### Table of Contents





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



| |  | During the three months and six months ended June 30, 2003, Nortel Networks
continued to implement its restructuring work plan initiated in 2001.
Changes in the provision for special charges are shown below:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Contractsettlement
    
    
    Plant andWorkforce
    
    
    and lease
    
    
    equipmentreduction
    
    
    costs
    
    
    write downs
    
    
    Other
    
    
    TotalProvision balance as at December 31, 2002 (a)
    
    $
    244
    
    
    $
    629
    
    
    $
    
    
    
    $
    9
    
    
    $
    882Special charges:For the three months ended March 31, 2003
    
    
    68
    
    
    
    31
    
    
    
    21
    
    
    
    
    
    
    
    120For the three months ended June 30, 2003
    
    
    22
    
    
    
    15
    
    
    
    23
    
    
    
    
    
    
    
    60Revisions to prior accruals:For the three months ended March 31, 2003
    
    
    (22
    )
    
    
    46
    
    
    
    (32
    )
    
    
    
    
    
    
    (8
    )For the three months ended June 30, 2003
    
    
    (13
    )
    
    
    (44
    )
    
    
    (5
    )
    
    
    
    
    
    
    (62
    )Cumulative provision (drawdowns) and adjustments in 2003:Cash drawdowns
    
    
    (215
    )
    
    
    (119
    )
    
    
    
    
    
    
    (9
    )
    
    
    (343
    )Non-cash (drawdowns) and adjustments
    
    
    
    
    
    
    
    
    
    
    (7
    )
    
    
    
    
    
    
    (7
    )Foreign exchange and other adjustments
    
    
    24
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    34Provision balance as at June 30, 2003 (a)
    
    $
    108
    
    
    $
    568
    
    
    $
    
    
    
    $
    
    
    
    $
    676
 (a)
    
    At June 30, 2003 and December 31, 2002, the short-term provision
balances were $303 and $548 respectively, and the long-term provision
balances were $373 and $334, respectively (included in other
liabilities).




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



Employees (approximate)Direct (a)
    
    
    Indirect (b)
    
    
    TotalRFT employee notifications for the three months ended:March 31, 2003
    
    
    300
    
    
    
    500
    
    
    
    800June 30, 2003
    
    
    
    
    
    
    300
    
    
    
    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.




| |  | Three months and six months ended June 30, 2003
| |  | -----------------------------------------------



| |  | For the three months and six months ended June 30, 2003, Nortel Networks
recorded total special charges of $(2) and $110, respectively, which were net
of revisions of $(62) and $(70), respectively, related to prior accruals.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Workforce reduction charges of $90 for the six months ended June 30, 2003
were related to severance and benefit costs associated with approximately
1,100 employees notified of termination during the six months ended June 30,
2003 which extended across all segments. Offsetting these charges were net
revisions of $(35) which were primarily related to termination benefits where
actual costs were lower than the estimated amounts across all segments.
During the six months ended June 30, 2003, the workforce reduction provision
balance was drawn down by cash payments of $215. The remaining provision is
expected to be substantially drawn down by mid-2004.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Contract settlement and lease costs of $46 for the six months ended June 30,
2003 consisted of net lease charges related to leased facilities (comprised
of office, warehouse and manufacturing space) and leased furniture that were
newly identified as no longer required and which were valued using the
estimated fair value method prescribed under SFAS 146. These costs extended
across all segments. In addition to these charges were revisions of $2
resulting from changes in sublease revenue and cost to vacate estimates
associated with certain properties which extended across all segments.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents





| |  | During the six months ended June 30, 2003, the provision balance for contract
settlement and lease costs was drawn down by cash payments of $119. The
remaining provision, net of approximately $301 in estimated sublease revenue,
is expected to be substantially drawn down by the end of 2010.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Plant and equipment write downs of $44 for the six months ended June 30, 2003
were related to current period write downs to fair value less costs to sell
for various leasehold improvements and excess Optical Networks equipment.
Revisions of $(37) to prior write downs of assets held for sale resulted
primarily from adjustments to original plans or estimated amounts for certain
facility closures.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | At June 30, 2003, Nortel Networks net deferred tax assets, excluding
discontinued operations, were $3,341, reflecting temporary differences
between financial reporting and the tax treatment of certain assets and
liabilities, in addition to the tax benefit of net operating loss and tax
credit carryforwards. These carryforwards expire at various dates beginning
in 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For the six months ended June 30, 2003, Nortel Networks recorded a tax
benefit of $28 on the pre-tax loss of $115 from continuing operations before
minority interests and equity in net loss of associated companies. This tax
benefit resulted from the accounting for the tax expense on income generated
from discontinued operations and a tax refund for a previously unrecognized
loss carryback. This tax benefit was partially offset by various non-income
related taxes.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks reviews the valuation allowance on a quarterly basis. As a
result of the latest review, Nortel Networks determined that the valuation
allowance as at June 30, 2003 was appropriate. The valuation allowance was
recorded in accordance with SFAS No. 109, Accounting for Income Taxes,
which requires that tax valuation allowances be established when it is more
likely than not that some portion or all of a companys deferred tax assets
will not be realized.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|8. |  | Long-term debt, credit and support facilities
|-- |  | ---------------------------------------------



| |  | Long-term debt
| |  | --------------



| |  | During the three months ended March 31, 2003, Nortel Networks purchased a
portion of its 6.125 percent notes due February 15, 2006 with a face value of
$39. The transaction resulted in a gain of $4 which was included in the
consolidated statement of operations within other income (expense)  net for
the six months ended June 30, 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | At June 30, 2003 and December 31, 2002, Nortel Networks had total unused
committed credit facilities of $750.
| |  | -------------------------------------------------------------------------------------------------------------



| |  | Support facilities
| |  | ------------------



| |  | On February 14, 2003, Nortel Networks principal direct operating subsidiary,
Nortel Networks Limited (NNL), 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). The agreement was subsequently amended to extend
its expiry date to December 31, 2005 from June 30, 2004 (see note 18).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The EDC Support Facility provides for up to $750 in support including $300 of
committed revolving support for performance bonds or similar instruments, of
which $123 was utilized as at June 30, 2003. The remainder is uncommitted
support for performance bonds, receivables sales and/or securitizations, of
which $65 was utilized as at June 30, 2003. For additional information, see
Nortel Networks 2002 Annual Report and Nortel Networks Current Reports on
Form 8-K filed on February 14, 2003 and July 10, 2003 with the SEC.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On February 14, 2003, NNLs obligations under the EDC Support Facility became
secured on an equal and ratable basis under the existing security agreements
entered into by NNL and various of its subsidiaries that pledge substantially
all of the assets of NNL in favor of the banks under the NNL and Nortel
Networks Inc. (NNI) $750 April 2000 five year
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

27



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##### Table of Contents





| |  | credit facilities and the holders of Nortel Networks public debt securities.
This security became effective in favor of the banks and the public debt
holders on April 4, 2002 (see note 19).
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|9. |  | Financial instruments and hedging activities
|-- |  | --------------------------------------------



| |  | During the three months ended March 31, 2003, various cross currency coupon
swaps (notional amount of Canadian $350) were terminated. There was no
impact to net earnings (loss) on termination as these instruments were not
designated as hedges and changes in fair value were previously accounted for
in the statements of operations.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|10. |  | Guarantees
|--- |  | ----------



| |  | Nortel Networks has estimated the fair value relating to certain guarantees
issued or modified after December 31, 2002. The estimation resulted in an
immaterial accrual for the six months ended June 30, 2003. Unless specified
below, Nortel Networks is unable to make a reasonable estimate of the maximum
amount that could be payable under certain of its guarantee arrangements
since maximum amounts are generally not specified in the applicable contracts
and the amounts are dependent upon the outcome of future contingent events,
the nature and likelihood of which cannot be determined at this time. A
description of Nortel Networks guarantees as at June 30, 2003 is provided
below.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) | Business sale and business combination agreements
| | --- | -------------------------------------------------



| |  | In connection with agreements for the sale of portions of its business,
including certain discontinued operations, Nortel Networks has typically
retained the liabilities of a business which relate to events occurring
prior to its sale, such as tax, environmental, litigation and employment
matters. Nortel Networks generally indemnifies the purchaser of a Nortel
Networks business in the event that a third party asserts a claim against
the purchaser that relates to a liability retained by Nortel Networks.
These types of indemnification guarantees typically extend for a number of
years.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In the past, Nortel Networks has also entered into guarantees related to
the escrow of shares in business combinations. These types of agreements
generally include indemnities that require Nortel Networks to indemnify
counterparties for loss incurred from litigation that may be suffered by
counterparties arising under such agreements. These types of indemnities
apply over a specified period of time from the date of the business
combination and do not provide for any limit on the maximum potential
amount.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Nortel Networks has entered periodically into agreements with customers
and suppliers that include limited intellectual property indemnification
obligations that are customary in the industry. These guarantees
generally require Nortel Networks to compensate the other party for
certain damages and costs incurred as a result of third party intellectual
property claims arising from these transactions.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Lease agreements
| | --- | ----------------



| |  | Nortel Networks has entered into agreements with its lessors that
guarantee the lease payments of certain sub-lessees of its facilities to
lessors. Generally, these lease agreements relate to facilities Nortel
Networks vacated prior to the end of the term of its lease. These lease
agreements require Nortel Networks to make lease payments throughout the
lease term if the sub-lessee fails to make scheduled payments. These
lease agreements have expiration dates through June 2012. The maximum
amount that Nortel Networks may be required to pay under these types of
agreements is $38 as at June 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has also entered into an agreement to indemnify a certain
lessor against certain additional costs, including financing costs, costs
incurred relating to construction problems with the building and costs
incurred if the transaction becomes invalid, through the term of a lease
which expires in May 2013. The maximum indemnification amount that Nortel
Networks may be required to pay under this lease agreement is $90 as at
June 30, 2003.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (d) | Third party debt agreements
| | --- | ---------------------------



| |  | Nortel Networks has guaranteed the debt of certain customers. These third
party debt agreements require Nortel Networks to make debt payments
throughout the term of the related debt instrument if the customer fails
to make scheduled debt payments. These third party debt agreements have
expiration dates extending to May 2012. The maximum amount that Nortel
Networks may be required to pay under these types of debt agreements is $8
and has been provisioned.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | Indemnification of banks and agents under credit facilities, EDC
Support Facility and security agreements
| | --- | ---------------------------------------------------------------------------------------------------------



| |  | Nortel Networks has agreed to indemnify the banks and agents under its
credit facilities against costs or losses resulting from changes in laws
and regulations which would increase the banks costs 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 extend for the term
of the credit and support facilities, or for as long as the security
agreements remain in effect, and do not provide for any limit on the
maximum potential liability.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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, costs incurred by the counterparties as a
result of regulatory penalties that may be suffered by the counterparty as
a consequence of the transaction or the repurchase of the receivables if
the particular transaction becomes invalid. The indemnification
provisions normally expire upon collection of the receivable amount by the
counterparty. As at June 30, 2003, Nortel Networks had approximately $290
of securitized receivables which were subject to repurchase if the
securitization transaction becomes invalid.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | Other indemnification agreements
| | --- | --------------------------------



| |  | Nortel Networks has also entered into other agreements that provide
indemnifications to counterparties in certain transactions including
investment banking agreements, guarantees related to the administration of
capital trust accounts, guarantees related to the administration of
employee benefit plans, indentures for its outstanding public debt and
sales of assets (other than the business sale agreements noted above).
These indemnification agreements generally require Nortel Networks to
indemnify the counterparties for costs incurred as a result of changes in
laws and regulations (including tax legislation) or in the interpretations
of such laws and regulations and/or as a result of losses from litigation
that may be suffered by the counterparties arising from the transactions.
These types of indemnification agreements normally extend over an
unspecified period of time from the date of the transaction and do not
provide for any limit on the maximum potential amount.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Product warranties
| |  | ------------------



| |  | As part of the normal sale of product, Nortel Networks has provided its
customers with product warranties that extend for periods generally ranging
from one to five years from the date of sale. A liability for the expected
cost of warranty-related claims is established when products are sold and the
related revenue is recognized. In estimating the warranty liability,
historical material replacement costs and associated labor to correct the
product failure are considered. Revisions are made when actual experience
differs materially from historical experience. Known product defects were
not included in the warranty reconciliation below and were included as an
element within other accrued liabilities  product related. The following
summarizes the accrual of product warranties that was recorded as part of
other accrued liabilities in the accompanying consolidated balance sheets as
at June 30, 2003:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Balance as at December 31, 2002
    
    $
    255Payments
    
    
    (63
    )Warranties issued
    
    
    64Adjustments
    
    
    (8
    )Balance as at June 30, 2003
    
    $
    248




|11. |  | Commitments
|--- |  | -----------



| |  | Bid, performance related and other bonds
| |  | ----------------------------------------



| |  | Nortel Networks has entered into bid, performance related and other bonds
associated with various contracts. Bid bonds generally have a term less than
twelve months. Performance related bonds generally have a term of twelve
months. Other bonds generally have a term of twenty-four months. The
various contracts to which these bonds apply generally have terms ranging
from two to five years. Potential payments due under these bonds are related
to Nortel Networks non-performance under the applicable contract. The
following table sets forth the maximum potential amount of future payments
under bid, performance related and other bonds, net of restricted cash and
cash equivalents, as at:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



June 30,
    
    
    December 31,2003
    
    
    2002Bid and performance related bonds (a)
    
    $
    341
    
    
    $
    400Other bonds (b)
    
    
    38
    
    
    
    35Total bid, performance related and other bonds
    
    $
    379
    
    
    $
    435
 (a)
    
    Net of restricted cash and cash equivalent amounts of $63 and $195 as
at June 30, 2003 and December 31, 2002, respectively.(b)
    
    Net of restricted cash and cash equivalent amounts of $29 and $19 as
at June 30, 2003 and December 31, 2002, respectively.




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



| |  | Pursuant to certain financing agreements, Nortel Networks is committed to
provide future financing in connection with purchases of Nortel Networks
products and services. Commitments to extend future financing generally have
conditions for funding, fixed expiration or termination dates and specific
interest rates and purposes. Nortel Networks attempts to limit its financing
credit risk by utilizing an internal credit committee that actively monitors
the credit exposure of Nortel Networks. The following table sets forth
customer financing related information and commitments, excluding
discontinued operations, as at:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



June 30,
    
    
    December 31,2003
    
    
    2002Drawn and outstanding  gross (a)
    
    $
    471
    
    
    $
    1,091Provisions for doubtful accounts (a)
    
    
    (357
    )
    
    
    (799
    )Drawn and outstanding  net (a)
    
    
    114
    
    
    
    292Undrawn commitments (see note 18)
    
    
    667
    
    
    
    801Total customer financing
    
    $
    781
    
    
    $
    1,093
 (a)
    
    Included short-term and long-term amounts. Short-term and long-term
amounts were included in accounts receivable and other assets,
respectively, in the consolidated balance sheets.




| |  | During the three months ended June 30, 2003, Nortel Networks entered into
certain agreements to either sell or restructure various customer financing
and related receivables. As a result of these transactions, Nortel Networks
received cash consideration of approximately $199 to settle outstanding
receivables of approximately $503 (carrying value approximately $111).
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.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | During the three months ended June 30, 2003, Nortel Networks recorded net
customer financing bad debt recoveries of $48 primarily as a result of the
favorable settlements described above and adjustments to other existing
provisions. The $48 recovery was included in the consolidated statements of
operations within selling, general and administrative expense.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|12. |  | Restricted cash and cash equivalents
|--- |  | ------------------------------------



| |  | As at June 30, 2003 and December 31, 2002, approximately $115 and $249,
respectively, of cash and cash equivalents was restricted as collateral for
certain bid, performance related and other bonds. In addition to the payment
of fees, cash and cash equivalent collateral was also required in connection
with obtaining new bid, performance related and other bonds as a result of
the general economic and industry environment and NNLs current credit
ratings.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|13. |  | Capital stock
|--- |  | -------------



| |  | Common shares and prepaid forward purchase contracts
| |  | ----------------------------------------------------



| |  | Nortel Networks is authorized to issue an unlimited number of common shares
without nominal or par value. For the six months ended June 30, 2003, the
outstanding number of common shares included in shareholders equity
consisted of:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



June 30, 2003Number(Number of common shares in thousands)
    
    of shares
    
    
    $Common shares:Balance at beginning of period
    
    
    3,850,169
    
    
    $
    33,583Shares issued pursuant to:Stock option plans
    
    
    831
    
    
    
    26Acquisition and acquisition related (a)
    
    
    (220
    )
    
    
    (9
    )Prepaid forward purchase contracts (b)
    
    
    94,376
    
    
    
    122Balance at end of period
    
    
    3,945,156
    
    
    $
    33,722(Number of prepaid forward purchase contracts)Prepaid forward purchase contracts:(c)Balance at beginning of period
    
    
    28,722
    
    
    $
    622Settlement of prepaid forward purchase contracts (b)
    
    
    (5,589
    )
    
    
    (122
    )Balance at end of period
    
    
    23,133
    
    
    $
    500
 (a)
    
    Common shares issued as part of the purchase price consideration.
During the six months ended June 30, 2003, common shares were cancelled
as earn out provisions were forfeited pursuant to their applicable
agreements.(b)
    
    During the six months ended June 30, 2003, 94,376 common shares were
issued as a result of the early settlement of 5,589 prepaid forward purchase contracts.(c)
    
    Included in additional paid-in capital in the consolidated balance
sheets.




| |  | At the Nortel Networks annual and special shareholders meeting on April 24,
2003, shareholders gave authority to the Nortel Networks Board of Directors
to implement a consolidation of Nortel Networks outstanding common shares,
also known as a reverse stock split. As a result, the Board of Directors has
the authority in its sole discretion to implement a consolidation of Nortel
Networks common shares at any time, if at all, prior to April 15, 2004. If a
share consolidation is determined to be in the best interests of Nortel
Networks and its shareholders, the Board of Directors will select a
consolidation ratio within the range of one post-consolidation common share
for every five pre-consolidation common shares to one post-consolidation
common share for every ten pre-consolidation common shares.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Shareholder rights plan
| |  | -----------------------



| |  | At the Nortel Networks annual and special shareholders meeting on April 24,
2003, shareholders approved the reconfirmation and amendment of Nortel
Networks shareholder rights plan, which will expire at the annual meeting of
shareholders to be held in 2006 unless it is reconfirmed at that time. Under
the rights plan, Nortel Networks issues one right for each Nortel Networks
common share outstanding. These rights become exercisable upon the
occurrence of
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | certain events associated with an unsolicited takeover bid. For additional
information, see Shareholder rights plan in note 15 of Nortel Networks
financial statements in Nortel Networks 2002 Annual Report and the Nortel
Networks Registration Statement on Form 8-A/A filed with the SEC on April 25,
2003.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|14. |  | Earnings (loss) per common share
|--- |  | --------------------------------



| |  | The following table details the weighted average number of Nortel Networks
common shares outstanding for the following periods:
| |  | -------------------------------------------------------------------------------------------------------------------------------



Three months ended June 30,
    
    Six months ended June 30,(Number of common shares in millions)
    
    2003
    
    
    2002(a)
    
    
    2003(a)
    
    
    2002(a)Basic weighted average shares outstanding:Issued and outstanding
    
    
    3,871
    
    
    
    3,339
    
    
    
    3,858
    
    
    
    3,272Minimum shares to be issued as deferred consideration
    
    
    11
    
    
    
    11
    
    
    
    11
    
    
    
    11Prepaid forward purchase contracts (b)
    
    
    455
    
    
    
    101
    
    
    
    468
    
    
    
    51Other
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )Basic weighted average shares outstanding
    
    
    4,336
    
    
    
    3,450
    
    
    
    4,336
    
    
    
    3,333Weighted average shares dilution adjustments:Dilutive
stock options (c)(d)
    
    
    1
    
    
    
    2
    
    
    
    4
    
    
    
    34.25 percent
convertible senior notes (d)
    
    
    
    
    
    
    180
    
    
    
    180
    
    
    
    180Prepaid forward purchase contracts
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    9Diluted weighted average shares outstanding
    
    
    4,337
    
    
    
    3,649
    
    
    
    4,520
    
    
    
    3,525
 (a)
    
    As a result of the net loss from continuing operations for the six
months ended June 30, 2003 and the three months and six months ended
June 30, 2002, diluted earnings per share was calculated using the basic
weighted average shares outstanding because to do otherwise would have
been anti-dilutive.(b)
    
    The basic weighted average number of Nortel Networks common shares
outstanding included the minimum number of common shares to be issued
upon settlement of the prepaid forward purchase contracts of 391 and 485
as at June 30, 2003 and 2002, respectively. The impact of the minimum
number of common shares to be issued upon settlement of the prepaid
forward purchase contracts on a weighted basis, was 455 and 468 for the
three months and six months ended June 30, 2003, respectively, and 101
and 51 for the three months and six months ended June 30, 2002,
respectively.(c)
    
    Dilutive and anti-dilutive stock options were determined by using the
average Nortel Networks common share price for the period. For the
three months and six months ended June 30, 2003, the average share price
used was $2.77 per share and $2.51 per share, respectively. For the
three months and six months ended June 30, 2002, the average share price
used was $2.76 per share and $4.45 per share, respectively.(d)
    
    As a result of net earnings from
continuing operations for the three months ended June 30, 2003,
the calculation of dilution adjustments indicated that certain grants
of stock options were anti-dilutive as a result of the impact of fair
value accounting during the three months ended June 30, 2003 and
the 4.25 per cent convertible senior notes of 180 were
anti-dilutive for the three months ended June 30, 2003.




|15. |  | Comprehensive income (loss)
|--- |  | ---------------------------



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



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Net earnings (loss)
    
    $
    37
    
    
    $
    (629
    )
    
    $
    48
    
    
    $
    (1,365
    )Other comprehensive income (loss) adjustments:Change in foreign currency translation adjustment (a)
    
    
    192
    
    
    
    204
    
    
    
    289
    
    
    
    128Unrealized gain (loss) on investments  net (b)
    
    
    43
    
    
    
    (19
    )
    
    
    47
    
    
    
    (3
    )Unrealized derivative gain on cash flow hedges  net (c)
    
    
    9
    
    
    
    14
    
    
    
    20
    
    
    
    15Comprehensive income (loss)
    
    $
    281
    
    
    $
    (430
    )
    
    $
    404
    
    
    $
    (1,225
    )
 (a)
    
    The changes in the foreign currency translation adjustments were not
adjusted for income taxes since they related to indefinite term
investments in non-United States subsidiaries.(b)
    
    Certain securities deemed available-for-sale by Nortel Networks are
measured at fair value. Unrealized holding gains (losses) related to
these securities were excluded from net earnings (loss) and were
included in comprehensive income (loss) until realized. Unrealized gain
(loss) on investments was net of tax of $(5) and nil for the three
months and six months ended June 30, 2003, respectively, and net of tax
of $13 and $3 for the three months and six months ended June 30, 2002,
respectively.(c)
    
    During the three months and six months ended June 30, 2003, $9 and
$10 of net derivative gains were reclassified to net earnings (loss),
respectively. During the three months and six months ended June 30,
2002, $(6) and $(10), respectively, of net derivative losses were
reclassified to net earnings (loss). Nortel Networks estimates that $19
of net derivative gains included in accumulated other comprehensive
income (loss) will be reclassified into net earnings (loss) within the
next 12 months.


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|16. |  | Discontinued operations
|--- |  | -----------------------



| |  | During the six months ended June 30, 2003, Nortel Networks substantially
completed the wind-down of its access solutions operations. The initial
disposal strategy or intent to exit the business was approved by the Nortel
Networks Board of Directors on June 14, 2001. The continued deterioration in
industry and market conditions delayed certain disposal activities beyond the
original planned timeframe of one year. In particular, actions involving
negotiations with customers, who were also affected by industry conditions,
took longer than expected. Although disposal activities continued beyond a
one-year period, Nortel Networks has continued to present the access
solutions operations as discontinued operations in the accompanying unaudited
consolidated financial statements.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following unaudited consolidated financial results for discontinued
operations are presented for the three months and six months ended June 30,
2003 and 2002 for the consolidated statements of operations, as at June 30,
2003 and December 31, 2002 for the consolidated balance sheets, and for the
six months ended June 30, 2003 and 2002 for the consolidated statements of
cash flows:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Three months ended June 30,
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Revenues
    
    $
    4
    
    
    $
    70
    
    
    $
    7
    
    
    $
    138Net earnings (loss) from discontinued operations  net of tax (a)
    
    $
    (1
    )
    
    $
    3
    
    
    $
    189
    
    
    $
    19
 (a)
    
    Net earnings from discontinued operations were net of applicable
income tax of nil and $19 for the three months and six months ended June
30, 2003, respectively, and net of applicable income tax of nil for the
three months and six months ended June 30, 2002.




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



June 30,
    
    
    December 31,2003
    
    
    2002Accounts receivable  net (a)
    
    $
    
    
    
    $
    20Inventories  net
    
    
    4
    
    
    
    Deferred income taxes
    
    
    63
    
    
    
    158Other current assets
    
    
    
    
    
    
    45Total current assets of discontinued operations (b)
    
    
    67
    
    
    
    223Other long-term assets (a)(b)
    
    
    75
    
    
    
    48Total assets of discontinued operations
    
    $
    142
    
    
    $
    271Current liabilities (b)(c)
    
    $
    81
    
    
    $
    81Long-term liabilities (b)
    
    
    2
    
    
    
    2Total liabilities of discontinued operations
    
    $
    83
    
    
    $
    83
 (a)
    
    Included customer financing receivables of nil (net of provisions of
$81) and $56 (net of provisions of $486) as at June 30, 2003 and
December 31, 2002, respectively.(b)
    
    Current assets, other long-term assets, current liabilities and
long-term liabilities of discontinued operations were included in other
current assets, other assets, other accrued liabilities and other
liabilities, respectively, of the consolidated balance sheets.(c)
    
    Included accruals of $75 and $79 as at June 30, 2003 and December 31,
2002, respectively, related to the future contractual obligations and
estimated liabilities during the planned period of disposition.


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



Six months ended June 30,2003
    
    
    2002Cash flows from discontinued operationsOperating activities
    
    $
    30
    
    
    $
    209Investing activities
    
    
    241
    
    
    
    79Net cash from discontinued operations
    
    $
    271
    
    
    $
    288




| |  | Six months ended June 30, 2003
| |  | ------------------------------



| |  | On March 24, 2003, Nortel Networks sold 8 million common shares of Arris
Group Inc. (Arris) to Arris for cash consideration of $28 pursuant to a
March 11, 2003 agreement. This resulted in a gain of $12. Upon completion
of this transaction, Nortel Networks owned 14 million Arris common shares or
18.8 percent of the Arris outstanding common shares. Nortel Networks has
classified its remaining ownership interest in Arris as an available-for-sale
investment. In addition, on March 18, 2003, Nortel Networks assigned its
membership interest in Arris Interactive LLC to ANTEC Corporation, an Arris
company, for cash consideration of $89. This resulted in a gain for the full
amount.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On March 20, 2003, Nortel Networks entered into an agreement with a customer
to restructure approximately $465 of trade and customer financing receivables
owed to Nortel Networks, the majority of which was previously provisioned.
As a result of the restructuring agreement, Nortel Networks received
consideration including cash of $125, notes receivable and an ownership
interest which have been fully provided for and the mutual release of all
other claims between the parties. A gain of $95 was recorded as a result of
the transaction. In addition to the restructuring agreement, a five year
equipment and services supply agreement was entered into requiring customer
payment terms of either cash in advance or guarantee by letters of credit in
favor of Nortel Networks.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | Subsequent to the February 15, 2001 announcement in which Nortel Networks
provided revised guidance for financial performance for the 2001 fiscal year
and the first quarter of 2001, Nortel Networks and certain of its then
current officers and directors were named as defendants in more than
twenty-five purported class action lawsuits. These lawsuits in the United
States District Courts for the Eastern District of New York, for the Southern
District of New York and for the District of New Jersey and the provinces of
Ontario, Quebec and British Columbia in Canada, on behalf of shareholders who
acquired Nortel Networks securities as early as October 24, 2000 and as late
as February 15, 2001, allege, among other things, violations of United States
federal and Canadian provincial securities laws. These matters also have
been the subject of review by Canadian and U.S. securities regulatory
authorities. On May 11, 2001, Nortel Networks filed motions to dismiss
and/or stay in connection with the three proceedings in Quebec primarily
based on the factual allegations lacking substantial connection to Quebec and
the inclusion of shareholders resident in Quebec in the class claimed in the
Ontario lawsuit. The plaintiffs in two of these proceedings in Quebec
obtained court approval for discontinuances of their proceedings on January
17, 2002. The motion to dismiss and/or stay the third proceeding was heard
on November 6, 2001 and the court deferred any determination on the motion to
the judge who will hear the application for authorization to commence a class
proceeding. On December 6, 2001, Nortel Networks filed a motion seeking
leave to appeal that decision. The motion for leave to appeal was dismissed
on March 11, 2002. On October 16, 2001, an order in the Southern District of
New York was filed consolidating twenty-five of the related United States
class action lawsuits into a single case, appointing class plaintiffs and
counsel for such plaintiffs. The plaintiffs served a consolidated amended
complaint on January 18, 2002. On December 17, 2001, the defendants in the
British Columbia action served notice of a motion requesting the court to
decline jurisdiction and to stay all proceedings on the ground that British
Columbia is an inappropriate forum. The motion has been adjourned at the
plaintiffs request to a future date to be set by the parties.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

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



| |  | On July 17, 2002, a new purported class action lawsuit (the Ontario Claim)
was filed in the Ontario Superior Court of Justice, Commercial List, naming
Nortel Networks, certain of its current and former officers and directors and
its auditor as defendants. The factual allegations in the Ontario Claim are
substantially similar to the allegations in the consolidated amended
complaint filed in the United States District Court described above. The
Ontario Claim is on behalf of all Canadian residents who purchased Nortel
Networks securities (including options on Nortel Networks 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A purported class action lawsuit was filed in the United States District
Court for the Middle District of Tennessee on December 21, 2001, on behalf of
participants and beneficiaries of the Nortel Networks Long-Term Investment
Plan (the Plan) at any time during the period of March 7, 2000 through the
filing date and who made or maintained Plan investments in Nortel Networks
common shares, under the Employee Retirement Income Security Act for
Plan-wide relief and alleging, among other things, material
misrepresentations and omissions to induce Plan participants to continue to
invest in and maintain investments in Nortel Networks 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 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 common
shares, during the period of March 7, 2000 through December 21, 2000. On
September 24, 2002, plaintiffs in the consolidated action filed a motion to
consolidate all the actions and to transfer them to the United States
District Court for the Southern District of New York. The plaintiffs then
filed a motion to withdraw the pending motion to consolidate and transfer.
The withdrawal was granted by the District Court on December 30, 2002. A
fourth purported class action lawsuit, on behalf of the Plan and Plan
participants for whose individual accounts the Plan held Nortel Networks
common shares during the period from March 7, 2000 through March 31, 2001 and
making similar allegations, was filed in the United States District Court for
the Southern District of New York on March 12, 2003. On March 18, 2003,
plaintiffs in the fourth purported class action filed a motion with the
Judicial Panel on Multidistrict Litigation to transfer all the actions to the
Southern District of New York for coordinated or consolidated proceedings
pursuant to 28 U.S.C. section 1407. On June 24, 2003, the Judicial Panel on
Multidistrict Litigation issued a transfer order transferring the Southern
District of New York action to the Middle District of Tennessee.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On March 4, 1997, Bay Networks, Inc. (Bay Networks), a company acquired on
August 31, 1998, announced that shareholders had filed two separate lawsuits
in the United States District Court for the Northern District of California
(the Federal Court) and the California Superior Court, County of Santa
Clara (the California Court), against Bay Networks and ten of Bay Networks
then current and former officers and directors purportedly on behalf of a
class of shareholders who purchased Bay Networks common shares during the
period of May 1, 1995 through October 14, 1996. On August 17, 2000, the
Federal Court granted the defendants motion to dismiss the federal
complaint. On August 1, 2001, the United States Court of Appeals for the
Ninth Circuit denied the plaintiffs appeal of that decision. On April 18,
1997, a second lawsuit was filed in the California Court, purportedly on
behalf of a class of shareholders who acquired Bay Networks common shares
pursuant to the registration statement and prospectus that became effective
on November 15, 1995. The two actions in the California Court were
consolidated in April 1998; however, the California Court denied the
plaintiffs motion for class certification. In January 2000, the California
Court of Appeal rejected the plaintiffs appeal of the decision. A petition
for review was filed with the California Supreme Court by the plaintiffs and
was denied. In February 2000, new plaintiffs who allege to have been
shareholders of Bay Networks during the relevant
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

35



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##### Table of Contents





| |  | periods, filed a motion for intervention in the California Court seeking to
become the representatives of a class of shareholders. The motion was
granted on June 8, 2001 and the new plaintiffs filed their
complaint-in-intervention on an individual and purported class representative
basis alleging misrepresentations made in connection with the purchase and
sale of securities of Bay Networks in violation of California statutory and
common law. On March 11, 2002, the California Court granted the defendants
motion to strike the class allegations. The plaintiffs were permitted to
proceed on their individual claims. The intervenor-plaintiffs are appealing
the dismissal of their class allegations. On July 25, 2003, the California
Court of Appeal reversed the trial courts dismissal of the
intervenor-plaintiffs class allegations. The defendants intend to appeal
this decision to the California Supreme Court.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Except as otherwise described herein, in each of the matters described above,
plaintiffs are seeking an unspecified amount of monetary damages.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is also a defendant in various other suits, claims,
proceedings and investigations which arise in the normal course of business.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Nortel Networks is unable to ascertain the ultimate aggregate amount of
monetary liability or financial impact to Nortel Networks of the above
matters which, unless otherwise specified, seek damages from the defendants
of material or indeterminate amounts. Nortel Networks cannot determine
whether these actions, suits, claims and proceedings will, individually or
collectively, have a material adverse effect on the business, results of
operations and financial condition of Nortel Networks. Nortel Networks and
any named directors and officers of Nortel Networks intend to vigorously
defend these actions, suits, claims and proceedings.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | On August 10, 2003, Nortel Networks essentially finalized the realignment of
Optical Networks with the sale of certain assets related to its high speed
module business to BreconRidge Manufacturing Solutions Corporation. This
transaction is not expected to have a material impact on Nortel Networks
business, results of operations and financial condition.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On July 22, 2003, Nortel Networks renegotiated an agreement with a certain
customer and reduced undrawn customer financing commitments by approximately
$509, leaving approximately $158 in aggregate undrawn commitments.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On July 10, 2003, Nortel Networks and EDC amended the terms of the EDC
Support Facility by extending the termination date of the facility to
December 31, 2005 from June 30, 2004. All other material terms of the EDC
Support Facility remained unchanged.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 in three European joint ventures. On July 1,
2003, EADS exercised its put option to sell its minority interest of 45
percent in Nortel Networks France S.A.S. to Nortel Networks. On July 18,
2003, Nortel Networks exercised its call option and share exchange rights to
acquire the minority interest of EADS of 42 percent in Nortel Networks
Germany GmbH & Co. KG and dispose of Nortel Networks equity interest of 41
percent in EADS Telecom S.A.S. (formerly EADS Defence and Security Networks
S.A.S.). The closing of the transactions is subject to final regulatory
approval and involves net consideration payable by Nortel Networks of
approximately $130 (consisting of approximately $48 in cash and an in-kind
component of approximately $82, representing the return of a loan note
currently owed to Nortel Networks by EADS Telecom S.A.S., an affiliate of
EADS). The net consideration is payable by Nortel Networks in euro and the
approximation of net consideration is subject to fluctuations between the
euro and United States dollar. The acquisitions will be accounted for using
the purchase method of accounting. These transactions are expected to close
in the three months ending September 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|19. |  | Supplemental consolidating financial information
|--- |  | ------------------------------------------------



| |  | As a result of NNLs current credit ratings, various liens, pledges and
guarantees are effective under certain credit, support and security
agreements entered into by NNL and various of its subsidiaries.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The security agreements were originally entered into in connection with the
$1,510 December 2001 364-day credit facilities (which expired on December 13,
2002). The security became effective April 4, 2002 following Moodys
Investors Services Inc. (Moodys) downgrade of NNLs senior long-term debt
rating to below investment grade, in
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

36



---



##### Table of Contents





| |  | respect of the then existing credit facilities including the available $750
April 2000 five year credit facilities. Consequently on April 4, 2002, and
in accordance with the negative pledge covenants in the indentures for all
Nortel Networks 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 NNLs and NNIs then existing
credit facilities.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | NNLs obligations under the EDC Support Facility became secured on an equal
and ratable basis under the security agreements on February 14, 2003. As at
June 30, 2003, the security agreements pledge substantially all of the assets
of NNL in favor of the banks under the $750 April 2000 five year credit
facilities, EDC and the holders of Nortel Networks outstanding public debt
securities, which debt securities represent substantially all of Nortel
Networks consolidated long term debt.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The security provided under the security agreements is comprised of pledges
of substantially all of the assets of NNL and those of most of its United
States and Canadian subsidiaries and pledges of shares in certain of NNLs
other subsidiaries. In addition, certain of NNLs wholly owned subsidiaries
have guaranteed NNLs obligations under the credit and support facilities and
outstanding public debt securities (the Guarantor Subsidiaries).
Non-guarantor subsidiaries (the Non-Guarantor Subsidiaries) represent
either wholly owned subsidiaries of NNL whose shares have been pledged, or
are the remaining subsidiaries of NNL which are not providing liens, pledges
or guarantees.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | If NNLs senior long-term debt rating by Moodys returns to Baa2 (with a
stable outlook) and its rating by Standard & Poors returns to BBB (with a
stable outlook), the security and guarantees will be released in full in
respect of the banks, EDC, the public debt holders and any other parties
secured under the security agreements at that time. If both the $750 April
2000 five year credit facilities and the EDC Support Facility are terminated,
or expire, the security and guarantees will also be released in full in
respect of the banks, EDC, the public debt holders and any other parties
secured under the security agreements at that time. NNL may provide EDC with
cash collateral in an amount equal to the total amount of its outstanding
obligations and undrawn commitments and expenses under the EDC Support
Facility (or any other alternative collateral acceptable to EDC) in lieu of
the security provided under the security agreements (see note 8).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following supplemental consolidating financial data illustrates, in
separate columns, the composition of Nortel Networks Corporation, NNL, the
Guarantor Subsidiaries, the Non-Guarantor Subsidiaries, eliminations and the
consolidated total as at June 30, 2003 and December 31, 2002 and for the
three months and six months ended June 30, 2003 and 2002.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Investments in subsidiaries are accounted for by the equity method for
purposes of the supplemental consolidating financial data. Net earnings
(loss) of subsidiaries are therefore reflected in the investment account and
net loss. The principal elimination entries eliminate investments in
subsidiaries and intercompany balances and transactions. The financial data
may not necessarily be indicative of the results of operations or financial
position had the subsidiaries been operated as independent entities.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

37



---



##### Table of Contents



Supplemental Consolidating Statement of Operations for the three months ended June 30, 2003:

Nortel
    
    
    Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    
    
    
    $
    765
    
    
    $
    1,576
    
    
    $
    713
    
    
    $
    (716
    )
    
    $
    2,338Cost of revenues
    
    
    
    
    
    
    469
    
    
    
    1,070
    
    
    
    487
    
    
    
    (716
    )
    
    
    1,310Gross profit
    
    
    
    
    
    
    296
    
    
    
    506
    
    
    
    226
    
    
    
    
    
    
    
    1,028Selling, general and administrative expense
    
    
    
    
    
    
    90
    
    
    
    281
    
    
    
    42
    
    
    
    
    
    
    
    413Research and development expense
    
    
    
    
    
    
    201
    
    
    
    207
    
    
    
    73
    
    
    
    
    
    
    
    481Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33
    
    
    
    
    
    
    
    33Deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    17Special charges
    
    
    
    
    
    
    25
    
    
    
    11
    
    
    
    (38
    )
    
    
    
    
    
    
    (2
    )Gain on sale of businesses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )Operating earnings (loss)
    
    
    
    
    
    
    (20
    )
    
    
    7
    
    
    
    103
    
    
    
    
    
    
    
    90Other income (expense)  net
    
    
    
    
    
    
    8
    
    
    
    103
    
    
    
    (88
    )
    
    
    
    
    
    
    23Interest expenseLong-term debt
    
    
    (21
    )
    
    
    (17
    )
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    (44
    )Other
    
    
    
    
    
    
    
    
    
    
    (13
    )
    
    
    11
    
    
    
    
    
    
    
    (2
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net loss of associated companies
    
    
    (21
    )
    
    
    (29
    )
    
    
    97
    
    
    
    20
    
    
    
    
    
    
    
    67Income tax benefit (provision)
    
    
    
    
    
    
    3
    
    
    
    16
    
    
    
    (9
    )
    
    
    
    
    
    
    10(21
    )
    
    
    (26
    )
    
    
    113
    
    
    
    11
    
    
    
    
    
    
    
    77Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    (7
    )
    
    
    (19
    )Equity in net loss of associated companies net of tax
    
    
    59
    
    
    
    135
    
    
    
    546
    
    
    
    4
    
    
    
    (764
    )
    
    
    (20
    )Net earnings from continuing operations
    
    
    38
    
    
    
    109
    
    
    
    659
    
    
    
    3
    
    
    
    (771
    )
    
    
    38Net loss from discontinued operations net of tax
    
    
    (1
    )
    
    
    (2
    )
    
    
    (1
    )
    
    
    
    
    
    
    3
    
    
    
    (1
    )Net earnings
    
    $
    37
    
    
    $
    107
    
    
    $
    658
    
    
    $
    3
    
    
    $
    (768
    )
    
    $
    37


38



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##### Table of Contents



Supplemental Consolidating Statement of Operations for the three months ended June 30, 2002:

Nortel
    
    
    Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    
    
    
    $
    847
    
    
    $
    2,173
    
    
    $
    656
    
    
    $
    (888
    )
    
    $
    2,788Cost of revenues
    
    
    
    
    
    
    791
    
    
    
    1,360
    
    
    
    512
    
    
    
    (888
    )
    
    
    1,775Gross profit
    
    
    
    
    
    
    56
    
    
    
    813
    
    
    
    144
    
    
    
    
    
    
    
    1,013Selling, general and administrative expense
    
    
    
    
    
    
    97
    
    
    
    494
    
    
    
    165
    
    
    
    
    
    
    
    756Research and development expense
    
    
    
    
    
    
    241
    
    
    
    241
    
    
    
    89
    
    
    
    
    
    
    
    571Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    35
    
    
    
    
    
    
    
    41Deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    20Special charges
    
    
    
    
    
    
    182
    
    
    
    81
    
    
    
    98
    
    
    
    
    
    
    
    361Gain on sale of businesses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    (2
    )Operating loss
    
    
    
    
    
    
    (464
    )
    
    
    (9
    )
    
    
    (261
    )
    
    
    
    
    
    
    (734
    )Other income (expense)  net
    
    
    
    
    
    
    35
    
    
    
    (39
    )
    
    
    (19
    )
    
    
    
    
    
    
    (23
    )Interest expenseLong-term debt
    
    
    (21
    )
    
    
    (28
    )
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    (57
    )Other
    
    
    
    
    
    
    (3
    )
    
    
    (4
    )
    
    
    (2
    )
    
    
    
    
    
    
    (9
    )Loss from continuing operations before
income taxes, minority interests and equity in
net loss of associated companies
    
    
    (21
    )
    
    
    (460
    )
    
    
    (52
    )
    
    
    (290
    )
    
    
    
    
    
    
    (823
    )Income tax benefit
    
    
    2
    
    
    
    221
    
    
    
    (39
    )
    
    
    12
    
    
    
    
    
    
    
    196(19
    )
    
    
    (239
    )
    
    
    (91
    )
    
    
    (278
    )
    
    
    
    
    
    
    (627
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    (5
    )
    
    
    6Equity in net loss of associated companies net of tax
    
    
    (613
    )
    
    
    (261
    )
    
    
    (233
    )
    
    
    (7
    )
    
    
    1,103
    
    
    
    (11
    )Net loss from continuing operations
    
    
    (632
    )
    
    
    (500
    )
    
    
    (324
    )
    
    
    (274
    )
    
    
    1,098
    
    
    
    (632
    )Net earnings from discontinued operations net of tax
    
    
    3
    
    
    
    3
    
    
    
    2
    
    
    
    
    
    
    
    (5
    )
    
    
    3Net loss
    
    $
    (629
    )
    
    $
    (497
    )
    
    $
    (322
    )
    
    $
    (274
    )
    
    $
    1,093
    
    
    $
    (629
    )


39



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##### Table of Contents



Supplemental Consolidating Statement of Operations for the six months ended June 30, 2003:

Nortel
    
    
    Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    
    
    
    $
    1,638
    
    
    $
    3,284
    
    
    $
    1,381
    
    
    $
    (1,588
    )
    
    $
    4,715Cost of revenues
    
    
    
    
    
    
    910
    
    
    
    2,409
    
    
    
    912
    
    
    
    (1,588
    )
    
    
    2,643Gross profit
    
    
    
    
    
    
    728
    
    
    
    875
    
    
    
    469
    
    
    
    
    
    
    
    2,072Selling, general and administrative expense
    
    
    
    
    
    
    232
    
    
    
    599
    
    
    
    96
    
    
    
    
    
    
    
    927Research and development expense
    
    
    
    
    
    
    399
    
    
    
    441
    
    
    
    145
    
    
    
    
    
    
    
    985Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    66
    
    
    
    
    
    
    
    66Deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35
    
    
    
    
    
    
    
    35Special charges
    
    
    
    
    
    
    61
    
    
    
    72
    
    
    
    (23
    )
    
    
    
    
    
    
    110Gain on sale of businesses
    
    
    
    
    
    
    (2
    )
    
    
    2
    
    
    
    (8
    )
    
    
    
    
    
    
    (8
    )Operating earnings (loss)
    
    
    
    
    
    
    38
    
    
    
    (239
    )
    
    
    158
    
    
    
    
    
    
    
    (43
    )Other income (expense)  net
    
    
    
    
    
    
    50
    
    
    
    78
    
    
    
    (101
    )
    
    
    
    
    
    
    27Interest expenseLong-term debt
    
    
    (43
    )
    
    
    (34
    )
    
    
    1
    
    
    
    (13
    )
    
    
    
    
    
    
    (89
    )Other
    
    
    
    
    
    
    (2
    )
    
    
    (27
    )
    
    
    19
    
    
    
    
    
    
    
    (10
    )Earnings (loss) from continuing operations before
income taxes, minority interests and equity in
net loss of associated companies
    
    
    (43
    )
    
    
    52
    
    
    
    (187
    )
    
    
    63
    
    
    
    
    
    
    
    (115
    )Income tax benefit
    
    
    10
    
    
    
    155
    
    
    
    (280
    )
    
    
    143
    
    
    
    
    
    
    
    28(33
    )
    
    
    207
    
    
    
    (467
    )
    
    
    206
    
    
    
    
    
    
    
    (87
    )Minority interests  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    (12
    )
    
    
    (16
    )Equity in net loss of associated companies net of tax
    
    
    (108
    )
    
    
    (209
    )
    
    
    1,351
    
    
    
    9
    
    
    
    (1,073
    )
    
    
    (30
    )Net earnings (loss) from continuing operations
    
    
    (141
    )
    
    
    (2
    )
    
    
    884
    
    
    
    211
    
    
    
    (1,085
    )
    
    
    (133
    )Net earnings from discontinued operations net of tax
    
    
    189
    
    
    
    162
    
    
    
    106
    
    
    
    27
    
    
    
    (295
    )
    
    
    189Net earnings before cumulative effect of
accounting change
    
    
    48
    
    
    
    160
    
    
    
    990
    
    
    
    238
    
    
    
    (1,380
    )
    
    
    56Cumulative effect of accounting change  net of tax
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    (8
    )Net earnings
    
    $
    48
    
    
    $
    160
    
    
    $
    982
    
    
    $
    238
    
    
    $
    (1,380
    )
    
    $
    48


40



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##### Table of Contents



Supplemental Consolidating Statement of Operations for the six months ended June 30, 2002:

Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalRevenues
    
    $
    
    
    
    $
    1,598
    
    
    $
    4,207
    
    
    $
    1,457
    
    
    $
    (1,568
    )
    
    $
    5,694Cost of revenues
    
    
    
    
    
    
    1,470
    
    
    
    2,874
    
    
    
    1,086
    
    
    
    (1,568
    )
    
    
    3,862Gross profit
    
    
    
    
    
    
    128
    
    
    
    1,333
    
    
    
    371
    
    
    
    
    
    
    
    1,832Selling, general and administrative expense
    
    
    
    
    
    
    228
    
    
    
    1,002
    
    
    
    233
    
    
    
    
    
    
    
    1,463Research and development expense
    
    
    
    
    
    
    438
    
    
    
    533
    
    
    
    182
    
    
    
    
    
    
    
    1,153Amortization of acquired technology
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    73
    
    
    
    
    
    
    
    84Deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    
    
    
    
    44Special charges
    
    
    
    
    
    
    252
    
    
    
    297
    
    
    
    275
    
    
    
    
    
    
    
    824Gain on sale of businesses
    
    
    
    
    
    
    (1
    )
    
    
    (4
    )
    
    
    (13
    )
    
    
    
    
    
    
    (18
    )Operating loss
    
    
    
    
    
    
    (789
    )
    
    
    (506
    )
    
    
    (423
    )
    
    
    
    
    
    
    (1,718
    )Other income (expense)  net
    
    
    (9
    )
    
    
    33
    
    
    
    (51
    )
    
    
    (5
    )
    
    
    
    
    
    
    (32
    )Interest expenseLong-term debt
    
    
    (42
    )
    
    
    (58
    )
    
    
    
    
    
    
    (16
    )
    
    
    
    
    
    
    (116
    )Other
    
    
    
    
    
    
    (3
    )
    
    
    (17
    )
    
    
    (1
    )
    
    
    
    
    
    
    (21
    )Loss from continuing operations before
income taxes, minority interests and equity in
net loss of associated companies
    
    
    (51
    )
    
    
    (817
    )
    
    
    (574
    )
    
    
    (445
    )
    
    
    
    
    
    
    (1,887
    )Income tax benefit
    
    
    7
    
    
    
    327
    
    
    
    80
    
    
    
    110
    
    
    
    
    
    
    
    524(44
    )
    
    
    (490
    )
    
    
    (494
    )
    
    
    (335
    )
    
    
    
    
    
    
    (1,363
    )Minority interest  net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    (10
    )
    
    
    (2
    )Equity in net loss of associated companies net of tax
    
    
    (1,340
    )
    
    
    (712
    )
    
    
    (336
    )
    
    
    (7
    )
    
    
    2,376
    
    
    
    (19
    )Net loss from continuing operations
    
    
    (1,384
    )
    
    
    (1,202
    )
    
    
    (830
    )
    
    
    (334
    )
    
    
    2,366
    
    
    
    (1,384
    )Net earnings from discontinued operations net of tax
    
    
    19
    
    
    
    19
    
    
    
    12
    
    
    
    
    
    
    
    (31
    )
    
    
    19Net loss
    
    $
    (1,365
    )
    
    $
    (1,183
    )
    
    $
    (818
    )
    
    $
    (334
    )
    
    $
    2,335
    
    
    $
    (1,365
    )


41



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##### Table of Contents



Supplemental Consolidating Balance Sheet as at June 30, 2003:

Nortel
    
    
    Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    74
    
    
    $
    27
    
    
    $
    3,218
    
    
    $
    871
    
    
    $
    
    
    
    $
    4,190Restricted cash and cash equivalents
    
    
    
    
    
    
    20
    
    
    
    57
    
    
    
    38
    
    
    
    
    
    
    
    115Accounts receivable  net
    
    
    
    
    
    
    265
    
    
    
    1,154
    
    
    
    407
    
    
    
    
    
    
    
    1,826Intercompany/related party accounts receivable
    
    
    
    
    
    
    4,808
    
    
    
    4,134
    
    
    
    3,159
    
    
    
    (12,101
    )
    
    
    Inventories  net
    
    
    
    
    
    
    439
    
    
    
    263
    
    
    
    177
    
    
    
    
    
    
    
    879Income taxes recoverable
    
    
    
    
    
    
    8
    
    
    
    21
    
    
    
    28
    
    
    
    
    
    
    
    57Deferred income taxes  net
    
    
    6
    
    
    
    130
    
    
    
    267
    
    
    
    (4
    )
    
    
    
    
    
    
    399Other current assets
    
    
    
    
    
    
    71
    
    
    
    245
    
    
    
    113
    
    
    
    
    
    
    
    429Total current assets
    
    
    80
    
    
    
    5,768
    
    
    
    9,359
    
    
    
    4,789
    
    
    
    (12,101
    )
    
    
    7,895Investments
    
    
    4,918
    
    
    
    1,311
    
    
    
    (6,897
    )
    
    
    133
    
    
    
    734
    
    
    
    199Plant and equipment  net
    
    
    
    
    
    
    399
    
    
    
    708
    
    
    
    273
    
    
    
    
    
    
    
    1,380Goodwill
    
    
    
    
    
    
    
    
    
    
    1,956
    
    
    
    246
    
    
    
    
    
    
    
    2,202Intangible assets  net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33
    
    
    
    
    
    
    
    33Deferred income taxes  net
    
    
    25
    
    
    
    1,560
    
    
    
    1,613
    
    
    
    245
    
    
    
    
    
    
    
    3,443Other assets
    
    
    38
    
    
    
    586
    
    
    
    (286
    )
    
    
    1,466
    
    
    
    (1,117
    )
    
    
    687Total assets
    
    $
    5,061
    
    
    $
    9,624
    
    
    $
    6,453
    
    
    $
    7,185
    
    
    $
    (12,484
    )
    
    $
    15,839LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    
    
    
    $
    2
    
    
    $
    3
    
    
    $
    43
    
    
    $
    
    
    
    $
    48Trade and other accounts payable
    
    
    
    
    
    
    254
    
    
    
    463
    
    
    
    53
    
    
    
    
    
    
    
    770Intercompany/related party accounts payable
    
    
    47
    
    
    
    233
    
    
    
    5,505
    
    
    
    6,316
    
    
    
    (12,101
    )
    
    
    Payroll and benefit-related liabilities
    
    
    
    
    
    
    49
    
    
    
    453
    
    
    
    127
    
    
    
    
    
    
    
    629Contractual liabilities
    
    
    
    
    
    
    53
    
    
    
    619
    
    
    
    336
    
    
    
    
    
    
    
    1,008Restructuring
    
    
    
    
    
    
    90
    
    
    
    144
    
    
    
    69
    
    
    
    
    
    
    
    303Other accrued liabilities
    
    
    26
    
    
    
    604
    
    
    
    1,653
    
    
    
    221
    
    
    
    
    
    
    
    2,504Long-term debt due within one year
    
    
    
    
    
    
    174
    
    
    
    7
    
    
    
    3
    
    
    
    
    
    
    
    184Total current liabilities
    
    
    73
    
    
    
    1,459
    
    
    
    8,847
    
    
    
    7,168
    
    
    
    (12,101
    )
    
    
    5,446Long-term debt
    
    
    1,800
    
    
    
    1,567
    
    
    
    10
    
    
    
    323
    
    
    
    
    
    
    
    3,700Deferred income taxes  net
    
    
    84
    
    
    
    267
    
    
    
    122
    
    
    
    28
    
    
    
    
    
    
    
    501Other liabilities
    
    
    
    
    
    
    997
    
    
    
    1,665
    
    
    
    881
    
    
    
    (1,117
    )
    
    
    2,4261,957
    
    
    
    4,290
    
    
    
    10,644
    
    
    
    8,400
    
    
    
    (13,218
    )
    
    
    12,073Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    126
    
    
    
    536
    
    
    
    662SHAREHOLDERS EQUITYPreferred shares
    
    
    
    
    
    
    536
    
    
    
    342
    
    
    
    47
    
    
    
    (925
    )
    
    
    Common shares
    
    
    33,722
    
    
    
    1,211
    
    
    
    5,979
    
    
    
    1,059
    
    
    
    (8,249
    )
    
    
    33,722Additional paid-in capital
    
    
    3,625
    
    
    
    22,017
    
    
    
    1,523
    
    
    
    19,809
    
    
    
    (43,349
    )
    
    
    3,625Deferred stock option compensation
    
    
    (53
    )
    
    
    
    
    
    
    
    
    
    
    (62
    )
    
    
    62
    
    
    
    (53
    )Accumulated deficit
    
    
    (33,191
    )
    
    
    (17,459
    )
    
    
    (12,954
    )
    
    
    (22,135
    )
    
    
    52,548
    
    
    
    (33,191
    )Accumulated other comprehensive income (loss)
    
    
    (999
    )
    
    
    (971
    )
    
    
    919
    
    
    
    (59
    )
    
    
    111
    
    
    
    (999
    )Total shareholders equity
    
    
    3,104
    
    
    
    5,334
    
    
    
    (4,191
    )
    
    
    (1,341
    )
    
    
    198
    
    
    
    3,104Total liabilities and shareholders equity
    
    $
    5,061
    
    
    $
    9,624
    
    
    $
    6,453
    
    
    $
    7,185
    
    
    $
    (12,484
    )
    
    $
    15,839


42



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##### Table of Contents



Supplemental Consolidating Balance Sheet as at December 31, 2002:

Nortel
    
    
    Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalASSETSCurrent assetsCash and cash equivalents
    
    $
    35
    
    
    $
    251
    
    
    $
    2,382
    
    
    $
    1,123
    
    
    $
    
    
    
    $
    3,791Restricted cash and cash equivalents
    
    
    
    
    
    
    6
    
    
    
    176
    
    
    
    67
    
    
    
    
    
    
    
    249Accounts receivable  net
    
    
    
    
    
    
    270
    
    
    
    1,488
    
    
    
    405
    
    
    
    
    
    
    
    2,163Intercompany/related party accounts receivable
    
    
    
    
    
    
    4,200
    
    
    
    976
    
    
    
    722
    
    
    
    (5,898
    )
    
    
    Inventories  net
    
    
    
    
    
    
    524
    
    
    
    246
    
    
    
    216
    
    
    
    
    
    
    
    986Income taxes recoverable
    
    
    
    
    
    
    3
    
    
    
    46
    
    
    
    9
    
    
    
    
    
    
    
    58Deferred income taxes  net
    
    
    12
    
    
    
    178
    
    
    
    615
    
    
    
    (15
    )
    
    
    
    
    
    
    790Other current assets
    
    
    
    
    
    
    182
    
    
    
    427
    
    
    
    72
    
    
    
    
    
    
    
    681Total current assets
    
    
    47
    
    
    
    5,614
    
    
    
    6,356
    
    
    
    2,599
    
    
    
    (5,898
    )
    
    
    8,718Investments
    
    
    4,723
    
    
    
    1,338
    
    
    
    (8,037
    )
    
    
    118
    
    
    
    2,106
    
    
    
    248Plant and equipment  net
    
    
    
    
    
    
    409
    
    
    
    752
    
    
    
    306
    
    
    
    
    
    
    
    1,467Goodwill
    
    
    
    
    
    
    
    
    
    
    1,956
    
    
    
    245
    
    
    
    
    
    
    
    2,201Intangible assets  net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98
    
    
    
    
    
    
    
    98Deferred income taxes  net
    
    
    (26
    )
    
    
    1,062
    
    
    
    1,537
    
    
    
    6
    
    
    
    
    
    
    
    2,579Other assets
    
    
    36
    
    
    
    627
    
    
    
    1,279
    
    
    
    389
    
    
    
    (1,529
    )
    
    
    802Total assets
    
    $
    4,780
    
    
    $
    9,050
    
    
    $
    3,843
    
    
    $
    3,761
    
    
    $
    (5,321
    )
    
    $
    16,113LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesNotes payable
    
    $
    
    
    
    $
    2
    
    
    $
    3
    
    
    $
    25
    
    
    $
    
    
    
    $
    30Trade and other accounts payable
    
    
    
    
    
    
    356
    
    
    
    429
    
    
    
    87
    
    
    
    
    
    
    
    872Intercompany/related party accounts payable
    
    
    295
    
    
    
    153
    
    
    
    3,288
    
    
    
    2,162
    
    
    
    (5,898
    )
    
    
    Payroll and benefit-related liabilities
    
    
    
    
    
    
    32
    
    
    
    383
    
    
    
    92
    
    
    
    
    
    
    
    507Contractual liabilities
    
    
    
    
    
    
    78
    
    
    
    751
    
    
    
    386
    
    
    
    
    
    
    
    1,215Restructuring
    
    
    
    
    
    
    113
    
    
    
    308
    
    
    
    127
    
    
    
    
    
    
    
    548Other accrued liabilities
    
    
    39
    
    
    
    637
    
    
    
    1,969
    
    
    
    329
    
    
    
    
    
    
    
    2,974Long-term debt due within one year
    
    
    
    
    
    
    174
    
    
    
    8
    
    
    
    51
    
    
    
    
    
    
    
    233Total current liabilities
    
    
    334
    
    
    
    1,545
    
    
    
    7,139
    
    
    
    3,259
    
    
    
    (5,898
    )
    
    
    6,379Long-term debt
    
    
    1,800
    
    
    
    1,603
    
    
    
    34
    
    
    
    312
    
    
    
    
    
    
    
    3,749Deferred income taxes  net
    
    
    (6
    )
    
    
    263
    
    
    
    95
    
    
    
    (7
    )
    
    
    
    
    
    
    345Other liabilities
    
    
    
    
    
    
    813
    
    
    
    1,734
    
    
    
    1,305
    
    
    
    (1,529
    )
    
    
    2,3232,128
    
    
    
    4,224
    
    
    
    9,002
    
    
    
    4,869
    
    
    
    (7,427
    )
    
    
    12,796Minority interests in subsidiary companies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    129
    
    
    
    536
    
    
    
    665SHAREHOLDERS EQUITYPreferred shares
    
    
    
    
    
    
    536
    
    
    
    342
    
    
    
    46
    
    
    
    (924
    )
    
    
    Common shares
    
    
    33,583
    
    
    
    1,211
    
    
    
    6,061
    
    
    
    1,744
    
    
    
    (9,016
    )
    
    
    33,583Additional paid-in capital
    
    
    3,754
    
    
    
    22,004
    
    
    
    1,563
    
    
    
    20,009
    
    
    
    (43,576
    )
    
    
    3,754Deferred stock option compensation
    
    
    (91
    )
    
    
    
    
    
    
    
    
    
    
    (100
    )
    
    
    100
    
    
    
    (91
    )Accumulated deficit
    
    
    (33,239
    )
    
    
    (17,607
    )
    
    
    (13,897
    )
    
    
    (22,810
    )
    
    
    54,314
    
    
    
    (33,239
    )Accumulated other comprehensive income (loss)
    
    
    (1,355
    )
    
    
    (1,318
    )
    
    
    772
    
    
    
    (126
    )
    
    
    672
    
    
    
    (1,355
    )Total shareholders equity
    
    
    2,652
    
    
    
    4,826
    
    
    
    (5,159
    )
    
    
    (1,237
    )
    
    
    1,570
    
    
    
    2,652Total liabilities and shareholders equity
    
    $
    4,780
    
    
    $
    9,050
    
    
    $
    3,843
    
    
    $
    3,761
    
    
    $
    (5,321
    )
    
    $
    16,113


43



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##### Table of Contents



Supplemental Consolidating Statement of Cash Flows for the six months ended June 30, 2003:

Nortel
    
    
    Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet earnings (loss) from continuing operations
    
    $
    (141
    )
    
    $
    (2
    )
    
    $
    884
    
    
    $
    211
    
    
    $
    (1,085
    )
    
    $
    (133
    )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
    
    
    
    
    
    
    46
    
    
    
    122
    
    
    
    114
    
    
    
    
    
    
    
    282Non-cash portion of special charges
and related asset write downs
    
    
    
    
    
    
    51
    
    
    
    (41
    )
    
    
    (3
    )
    
    
    
    
    
    
    7Equity in net (earnings) loss of associated companies
    
    
    108
    
    
    
    209
    
    
    
    (1,351
    )
    
    
    (9
    )
    
    
    1,073
    
    
    
    30Current and deferred stock option compensation
    
    
    
    
    
    
    2
    
    
    
    8
    
    
    
    37
    
    
    
    
    
    
    
    47Deferred income taxes
    
    
    (10
    )
    
    
    10
    
    
    
    8
    
    
    
    (1
    )
    
    
    
    
    
    
    7Other liabilities
    
    
    
    
    
    
    45
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    65Gain on repurchases of outstanding debt securities
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )Loss on sale or write down of investments and businesses
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    
    
    
    
    
    
    
    
    28Other  net
    
    
    457
    
    
    
    180
    
    
    
    (187
    )
    
    
    (466
    )
    
    
    
    
    
    
    (16
    )Change in operating assets and liabilities:Accounts receivable
    
    
    8
    
    
    
    376
    
    
    
    72
    
    
    
    (122
    )
    
    
    
    
    
    
    334Inventories
    
    
    
    
    
    
    85
    
    
    
    9
    
    
    
    43
    
    
    
    
    
    
    
    137Income taxes
    
    
    
    
    
    
    
    
    
    
    (22
    )
    
    
    15
    
    
    
    
    
    
    
    (7
    )Restructuring
    
    
    
    
    
    
    (81
    )
    
    
    (207
    )
    
    
    (55
    )
    
    
    
    
    
    
    (343
    )Accounts payable and accrued liabilities
    
    
    (16
    )
    
    
    (99
    )
    
    
    (278
    )
    
    
    (111
    )
    
    
    
    
    
    
    (504
    )Other operating assets and liabilities
    
    
    
    
    
    
    (313
    )
    
    
    104
    
    
    
    138
    
    
    
    
    
    
    
    (71
    )Intercompany/related party activity
    
    
    (368
    )
    
    
    (955
    )
    
    
    1,317
    
    
    
    6
    
    
    
    
    
    
    
    Net cash from (used in) operating activities of continuing
operations
    
    
    38
    
    
    
    (450
    )
    
    
    486
    
    
    
    (203
    )
    
    
    (12
    )
    
    
    (141
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    
    
    
    
    (15
    )
    
    
    (28
    )
    
    
    (13
    )
    
    
    
    
    
    
    (56
    )Proceeds on disposals of plant and equipment
    
    
    
    
    
    
    6
    
    
    
    12
    
    
    
    3
    
    
    
    
    
    
    
    21Decrease (increase) restricted cash andcash equivalents
    
    
    
    
    
    
    (12
    )
    
    
    131
    
    
    
    25
    
    
    
    
    
    
    
    144Increase in long-term receivables
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    (1
    )
    
    
    
    
    
    
    (11
    )Decrease in long-term receivables
    
    
    
    
    
    
    195
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    197Acquisitions of investments and businesses
 net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Proceeds on sale of investments and businesses
    
    
    
    
    
    
    1
    
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    8Net cash from investing activities
    
    
    
    
    
    
    175
    
    
    
    112
    
    
    
    14
    
    
    
    
    
    
    
    301Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    Decrease in notes payable  net
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    (18
    )
    
    
    
    
    
    
    (14
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Repayments of long-term debt
    
    
    
    
    
    
    (34
    )
    
    
    
    
    
    
    (60
    )
    
    
    
    
    
    
    (94
    )Decrease in capital leases payable
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    (2
    )Net cash from (used in) financing activities of continuing
operations
    
    
    
    
    
    
    (46
    )
    
    
    3
    
    
    
    (79
    )
    
    
    12
    
    
    
    (110
    )Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    1
    
    
    
    1
    
    
    
    60
    
    
    
    16
    
    
    
    
    
    
    
    78Net cash from (used in) continuing operations
    
    
    39
    
    
    
    (320
    )
    
    
    661
    
    
    
    (252
    )
    
    
    
    
    
    
    128Net cash from discontinued operations
    
    
    
    
    
    
    96
    
    
    
    175
    
    
    
    
    
    
    
    
    
    
    
    271Net increase (decrease) in cash and
cash equivalents
    
    
    39
    
    
    
    (224
    )
    
    
    836
    
    
    
    (252
    )
    
    
    
    
    
    
    399Cash and cash equivalents at beginning of
period  net
    
    
    35
    
    
    
    251
    
    
    
    2,382
    
    
    
    1,123
    
    
    
    
    
    
    
    3,791Cash and cash equivalents at end of period
 net
    
    $
    74
    
    
    $
    27
    
    
    $
    3,218
    
    
    $
    871
    
    
    $
    
    
    
    $
    4,190


44



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##### Table of Contents



Supplemental Consolidating Statement of Cash Flows for the six months ended June 30, 2002:

Nortel
    
    
    Nortel
    
    
    
    
    
    
    Non-Networks
    
    
    Networks
    
    
    Guarantor
    
    
    Guarantor(millions of U.S. dollars)
    
    Corporation
    
    
    Limited
    
    
    subsidiaries
    
    
    subsidiaries
    
    
    Elimination
    
    
    TotalCash flows from (used in) operating activitiesNet loss from continuing operations
    
    $
    (1,384
    )
    
    $
    (1,202
    )
    
    $
    (830
    )
    
    $
    (334
    )
    
    $
    2,366
    
    
    $
    (1,384
    )Adjustments to reconcile net loss from continuing
operations to net cash from (used in) operating
activities, net of effects from acquisitions and
divestitures of businesses:Amortization and depreciation
    
    
    
    
    
    
    47
    
    
    
    238
    
    
    
    101
    
    
    
    
    
    
    
    386Non-cash portion of special charges
and related asset write downs
    
    
    
    
    
    
    156
    
    
    
    102
    
    
    
    124
    
    
    
    
    
    
    
    382Equity in net loss of associated companies
    
    
    1,340
    
    
    
    712
    
    
    
    336
    
    
    
    7
    
    
    
    (2,376
    )
    
    
    19Current and deferred stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    
    
    
    
    44Deferred income taxes
    
    
    3
    
    
    
    (142
    )
    
    
    (356
    )
    
    
    (41
    )
    
    
    
    
    
    
    (536
    )Other liabilities
    
    
    
    
    
    
    (14
    )
    
    
    (33
    )
    
    
    17
    
    
    
    
    
    
    
    (30
    )Gain on repurchase of outstanding debt securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gain on sale or write-down of investments and businesses
    
    
    
    
    
    
    (10
    )
    
    
    (5
    )
    
    
    (11
    )
    
    
    
    
    
    
    (26
    )Other  net
    
    
    1
    
    
    
    76
    
    
    
    167
    
    
    
    1
    
    
    
    
    
    
    
    245Change in operating assets and liabilities:Accounts receivable
    
    
    
    
    
    
    (101
    )
    
    
    664
    
    
    
    (1
    )
    
    
    
    
    
    
    562Inventories
    
    
    
    
    
    
    89
    
    
    
    55
    
    
    
    (9
    )
    
    
    
    
    
    
    135Income taxes
    
    
    
    
    
    
    219
    
    
    
    1,079
    
    
    
    (18
    )
    
    
    
    
    
    
    1,280Restructuring
    
    
    
    
    
    
    (113
    )
    
    
    (417
    )
    
    
    (125
    )
    
    
    
    
    
    
    (655
    )Accounts payable and accrued liabilities
    
    
    7
    
    
    
    (122
    )
    
    
    (407
    )
    
    
    57
    
    
    
    
    
    
    
    (465
    )Other operating assets and liabilities
    
    
    (12
    )
    
    
    (359
    )
    
    
    273
    
    
    
    (78
    )
    
    
    
    
    
    
    (176
    )Intercompany/related party activity
    
    
    49
    
    
    
    505
    
    
    
    (731
    )
    
    
    177
    
    
    
    
    
    
    
    Net cash from (used in) operating activities of continuing operations
    
    
    4
    
    
    
    (259
    )
    
    
    135
    
    
    
    (89
    )
    
    
    (10
    )
    
    
    (219
    )Cash flows from (used in) investing activitiesExpenditures for plant and equipment
    
    
    
    
    
    
    (15
    )
    
    
    (174
    )
    
    
    (19
    )
    
    
    
    
    
    
    (208
    )Proceeds on disposals of plant and equipment
    
    
    
    
    
    
    
    
    
    
    76
    
    
    
    
    
    
    
    
    
    
    
    76Decrease (increase) in restricted cash and cash equivalents
    
    
    
    
    
    
    (2
    )
    
    
    (18
    )
    
    
    (2
    )
    
    
    
    
    
    
    (22
    )(Increase)
decrease in long-term receivables
    
    
    
    
    
    
    65
    
    
    
    (152
    )
    
    
    (122
    )
    
    
    
    
    
    
    (209
    )Decrease in long-term receivables
    
    
    
    
    
    
    18
    
    
    
    83
    
    
    
    4
    
    
    
    
    
    
    
    105Acquisitions of investments and businesses net of cash acquired
    
    
    
    
    
    
    (3
    )
    
    
    (22
    )
    
    
    
    
    
    
    
    
    
    
    (25
    )Proceeds on sale of investments and businesses
    
    
    
    
    
    
    20
    
    
    
    18
    
    
    
    35
    
    
    
    
    
    
    
    73Investments in subsidiaries
    
    
    (800
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800
    
    
    
    Net cash from (used in) investing activities of continuing operations
    
    
    (800
    )
    
    
    83
    
    
    
    (189
    )
    
    
    (104
    )
    
    
    800
    
    
    
    (210
    )Cash flows from (used in) financing activitiesDividends on preferred shares
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    Decrease in notes payable  net
    
    
    
    
    
    
    
    
    
    
    (24
    )
    
    
    (78
    )
    
    
    
    
    
    
    (102
    )Proceeds from long-term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31
    
    
    
    
    
    
    
    31Repayments of long-term debt
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    (3
    )
    
    
    
    
    
    
    (6
    )Decrease in capital leases payable
    
    
    
    
    
    
    (1
    )
    
    
    (3
    )
    
    
    (1
    )
    
    
    
    
    
    
    (5
    )Issuance of common shares
    
    
    862
    
    
    
    800
    
    
    
    
    
    
    
    
    
    
    
    (800
    )
    
    
    862Issuance of prepaid forward purchase contracts
    
    
    623
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    623Net cash from (used in) financing activities of continuing operations
    
    
    1,485
    
    
    
    789
    
    
    
    (30
    )
    
    
    (51
    )
    
    
    (790
    )
    
    
    1,403Effect of foreign exchange rate changes
on cash and cash equivalents
    
    
    
    
    
    
    8
    
    
    
    28
    
    
    
    10
    
    
    
    
    
    
    
    46Net cash from (used in) continuing operations
    
    
    689
    
    
    
    621
    
    
    
    (56
    )
    
    
    (234
    )
    
    
    
    
    
    
    1,020Net cash from discontinued operations
    
    
    
    
    
    
    99
    
    
    
    187
    
    
    
    2
    
    
    
    
    
    
    
    288Net increase in cash and cash equivalents
    
    
    689
    
    
    
    720
    
    
    
    131
    
    
    
    (232
    )
    
    
    
    
    
    
    1,308Cash and cash equivalents at beginning of period  net
    
    
    18
    
    
    
    (41
    )
    
    
    2,285
    
    
    
    1,198
    
    
    
    
    
    
    
    3,460Cash and cash equivalents at end of period  net
    
    $
    707
    
    
    $
    679
    
    
    $
    2,416
    
    
    $
    966
    
    
    $
    
    
    
    $
    4,768


45



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##### Table of Contents






ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

The Managements Discussion and Analysis of Financial Condition and Results of
Operations, or MD&A, set forth in this Item 2 has been revised to reflect the
restatements and to update certain forward looking statements to reflect
current expectations, as well as to incorporate certain conforming changes.

You should read this section in combination with the accompanying unaudited
consolidated financial statements prepared in accordance with United States
generally accepted accounting principles. This section contains forward-looking
statements and should be read in conjunction with the factors described below
under Forward looking statements which risk factors have been updated to
reflect the restatements as well as for events and developments subsequent to
June 30, 2003. All dollar amounts in this Managements Discussion and Analysis
of Financial Condition and Results of Operations are in millions of United
States dollars unless otherwise stated.

Apart from the revisions described above, this MD&A does not reflect events and
developments subsequent to June 30, 2003.

Where we say we, us, our, or Nortel Networks, we mean Nortel Networks
Corporation or Nortel Networks Corporation and its subsidiaries, as
applicable. Where we refer to our 2002 Annual Report, we mean our Annual
Report onForm 10-Kfor the year ended December 31, 2002 filed with the
Securities and Exchange Commission, or SEC, on March 10, 2003, as subsequently
amended by our Amendment No. 1 to our Annual Report onForm 10-K/Afor the year
ended December 31, 2002 filed with the SEC on December 23, 2003. Where we refer
to the industry, we mean the telecommunications industry.

Business overview

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

Our operations are organized into four reportable segments: Wireless Networks,
Enterprise Networks, Wireline Networks and Optical Networks.

Nortel Networks Corporations common shares are publicly traded on the New York
and Toronto stock exchanges under the symbol NT. Nortel Networks Limited is
our principal direct operating subsidiary. Nortel Networks Corporation holds
all of Nortel Networks Limiteds outstanding common shares but none of its
outstanding preferred shares.

Recent developments

Restatements

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

46



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##### Table of Contents



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

Based on the completion of the comprehensive review and certain related reviews
(collectively, the comprehensive review), we determined that approximately
$952 and $935 of certain liabilities (primarily accruals and provisions)
carried on our previously reported consolidated balance sheets as at June 30,
2003 and December 31, 2002, respectively, needed to be released to income.
These provisions were either initially recorded incorrectly in prior periods or
not properly released or adjusted for changes in estimates in the appropriate
periods. In certain cases, costs were incorrectly charged to operations rather
than to the appropriate provisions. Following our determination to restate our
consolidated financial statements for the periods noted above, we also
determined that we would correct certain known errors that were previously not
recorded because the amount of the errors was not material to the consolidated
financial statements. Specifically, among other items, we made certain revenue
adjustments to reflect revenue which should have been deferred instead of
recognized in a particular period. Also, as part of the restatements, we made
adjustments to correct errors related to our deferred income tax assets and
foreign currency translation accounts. In addition, we made reclassification
adjustments within the consolidated balance sheets to better reflect the
underlying nature of certain items; these reclassifications did not impact the
net assets as at the end of any period. The net effect of all of these
adjustments was a reduction in accumulated deficit of $505 and $497 as at June
30, 2003 and December 31, 2002, respectively.

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

Three months ended
    
    
    December 31,June 30,
    
    
    March 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Prior2003
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    years(a)RevenuesAs previously reported
    
    $
    2,326
    
    
    $
    2,399
    
    
    $
    10,560
    
    
    $
    17,511
    
    
    $
    27,948Adjustments
    
    
    12
    
    
    
    (22
    )
    
    
    9
    
    
    
    (103
    )
    
    
    (17
    )
    
    $
    (1
    )As restated
    
    $
    2,338
    
    
    $
    2,377
    
    
    $
    10,569
    
    
    $
    17,408
    
    
    $
    27,931Earnings (loss)Earnings (loss) from
continuing operationsAs previously reported
    
    $
    (14
    )
    
    $
    (136
    )
    
    $
    (3,585
    )
    
    $
    (24,307
    )
    
    $
    (2,995
    )Adjustments
    
    
    52
    
    
    
    (35
    )
    
    
    299
    
    
    
    133
    
    
    
    27
    
    
    $
    4As restated
    
    $
    38
    
    
    $
    (171
    )
    
    $
    (3,286
    )
    
    $
    (24,174
    )
    
    $
    (2,968
    )Earnings (loss) from discontinued
operationsnet of taxAs previously reported
    
    $
    
    
    
    $
    190
    
    
    $
    
    
    
    $
    (3,010
    )
    
    $
    (475
    )Adjustments
    
    
    (1
    )
    
    
    
    
    
    
    20
    
    
    
    14
    
    
    
    
    
    
    $
    As restated
    
    $
    (1
    )
    
    $
    190
    
    
    $
    20
    
    
    $
    (2,996
    )
    
    $
    (475
    )Net lossAs previously reported
    
    $
    (14
    )
    
    $
    54
    
    
    $
    (3,585
    )
    
    $
    (27,302
    )
    
    $
    (3,470
    )Adjustments
    
    
    51
    
    
    
    (43
    )
    
    
    319
    
    
    
    147
    
    
    
    27
    
    
    $
    4As restated
    
    $
    37
    
    
    $
    11
    
    
    $
    (3,266
    )
    
    $
    (27,155
    )
    
    $
    (3,443
    )


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

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

The following presents details by category, aggregating to the net improvement
in the net earnings (loss) for the three months and six months ended June 30,
2003 and 2002, resulting from the restatement adjustments:

47



---



##### Table of Contents



Net decrease in net (loss)/Net increase in net earnings

Three months ended June 30,
    
    
    Six months ended June 30,2003
    
    
    2002
    
    
    2003
    
    
    2002Contract and customer-related accruals
    
    $
    (3
    )
    
    $
    85
    
    
    $
    27
    
    
    $
    144Special charges related to restructuring actions
    
    
    13
    
    
    
    47
    
    
    
    39
    
    
    
    75Other accruals and provisions
    
    
    
    
    
    
    (16
    )
    
    
    (96
    )
    
    
    54Total accruals and provisions adjustments
    
    
    10
    
    
    
    116
    
    
    
    (30
    )
    
    
    273Income tax adjustments
    
    
    3
    
    
    
    (33
    )
    
    
    19
    
    
    
    (79
    )Revenue adjustments
    
    
    12
    
    
    
    15
    
    
    
    (10
    )
    
    
    9Foreign currency translation adjustments  Brazilian operations
    
    
    26
    
    
    
    (30
    )
    
    
    29
    
    
    
    (30
    )Net decrease in net (loss)/Net increase in net earnings
    
    $
    51
    
    
    $
    68
    
    
    $
    8
    
    
    $
    173


Impacts of the restatements on the accompanying (unaudited) consolidated financial statements

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

Consolidated statement of operations for the three months ended June 30, 2003 as restated

Net loss for the three months ended June 30, 2003 was reduced by $51 from a net
loss of $14 to net earnings of $37. The major components of the reduction
included:

| 
|-
|

| |  | a $17 increase in other income which included $26 of foreign exchange
adjustments related to our Brazilian operations and $21 which resulted
from the release of accruals for inter-company out of balance amounts
partially offset by $30 of other items.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Consolidated statement of operations for the six months ended June 30, 2003 as restated

Net earnings for the six months ended June 30, 2003 increased by $8 from $40 to
$48. The major components of the increase included:

| 
|-
|

| |  | a $24 increase in selling, general and administrative expense which
resulted primarily from the reversal of previously recorded releases
of accruals and provisions, including $15 of accruals associated with
programs to upgrade certain financial information systems;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $17 increase in research and development expense which resulted
primarily from the reversal of previously recorded releases of
accruals and provisions;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $29 decrease which resulted from the release of special charges
related to costs associated with severance and fringe benefits for
terminated employees, plant and equipment and contract settlements,
partially offset by an increase in special charges related to certain
real estate facilities; and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $27 decrease in other income which included $29 from the reversal of
previously recorded releases of other accruals and provisions
(including $9 for accruals for inter-company out of balance amounts)
and $27 net of other items partially offset by $29 of foreign exchange
adjustments related to our Brazilian operations.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Consolidated statement of operations for the three months ended June 30, 2002 as restated

Net loss for the three months ended June 30, 2002 was reduced by $68 from $697
to $629. The major components of the reduction included:

| 
|-
|

| |  | a $11 decrease in selling, general and administrative expense and a $8 decrease in research and development expense, each
due to a net decrease in other accruals and provisions;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

48



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##### Table of Contents



| |  | a $42 decrease which resulted from the release of special charges primarily related to costs associated with severance and
fringe benefits for terminated employees; and
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $14 increase in other expense which resulted from adjustments related to other accruals and provisions.
|- |  | ---------------------------------------------------------------------------------------------------------

Consolidated statement of operations for the six months ended June 30, 2002 as restated

Net loss for the six months ended June 30, 2002 was reduced by $173 from $1,538
to $1,365. The major components of the reduction included:

| 
|-
|

| |  | a $48 decrease in selling, general and administrative expense which
resulted primarily from the release of accruals and provisions,
including $15 of accruals for discretionary bonuses in excess of
amounts reasonably expected to be paid and $10 of accruals associated
with programs to upgrade certain financial information systems;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $21 decrease in research and development expense which resulted
primarily from the release of other accruals and provisions;
|- |  | ------------------------------------------------------------------------------------------------------------------------------

| |  | a $66 decrease which resulted from the release of special charges
related to costs associated with severance and fringe benefits for
terminated employees; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a $19 adjustment to discontinued operations for items previously
recorded incorrectly as an expense in discontinued operations.
|- |  | -------------------------------------------------------------------------------------------------------------------------------

Consolidated balance sheets as at June 30, 2003 and December 31, 2002

Restatements

The consolidated balance sheets included in
Restatements in note 2 of the
accompanying (unaudited) consolidated financial statements present the
cumulative impact of the restatement adjustments classified by balance sheet
line item as at June 30, 2003 and December 31, 2002.

Reclassification adjustments

In addition to the restatement adjustments, reclassification adjustments were
made between line items which also impacted the consolidated balance sheets as
at June 30, 2003 and December 31, 2002. The principal reclassifications are
set forth below.

As at June 30, 2003

| 
|-
|

| |  | a $37 increase in net inventory with related reductions of $18 in other current assets and of $19 in other long-term
assets; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------

| |  | a $137 increase in other accrued liabilities related to accounts receivable-net (as noted above).
|- |  | -------------------------------------------------------------------------------------------------

As at December 31, 2002

| 
|-
|

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

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

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

49



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##### Table of Contents



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

The financial results of Nortel Networks Limited are fully consolidated into
our results. Nortel Networks Limited financial statements have also been
restated as a result of the comprehensive review and other related reviews.

For further information on the restatements, see Significant accounting
policies and Restatements in notes 1 and 2, respectively, of the
accompanying consolidated financial statements.

Customer financing commitments

During the first half of 2003, we reduced undrawn customer financing
commitments by $134 reflecting commitment expirations, cancellations and
changing customer business plans. As of June 30, 2003, approximately $482 of
the $667 in undrawn commitments was not available for funding under the terms
of our financing agreements. Subsequent to June 30, 2003, we renegotiated an
agreement with a certain customer and reduced our undrawn commitments by
approximately $509, leaving approximately $158 in aggregate undrawn commitments
of which $82 was not available for funding under the terms of our financing
agreements.

Ownership adjustment in our French and German operations

On July 18, 2003, we announced that we will realign our business activities in
France and Germany. As a result, we will increase our ownership in our core
businesses in these countries, consistent with our overall global business
strategy. Subject to final regulatory approval, we will acquire the 42%
ownership interest in Nortel Networks Germany GmbH & Co. KG and the 45%
ownership interest in Nortel Networks France S.A.S., currently held by European
Aeronautic Defence and Space Company EADS N.V., or EADS, our partner in three
European joint ventures. When completed, these transactions will bring our
ownership in each company to 100%. These companies are responsible for the
sales and marketing of our products in France and Germany. At the same time,
EADS will increase its ownership in EADS Telecom S.A.S. (formerly EADS Defence
and Security Networks S.A.S.) from 59% to 100% as a result of acquiring our
equity ownership in that company.

For additional information, see Joint ventures/minority interests.

EDC support facility

On February 14, 2003, Nortel Networks Limited entered into an agreement with
Export Development Canada, or EDC, regarding arrangements to provide for
support, on a secured basis, of certain of our performance related obligations
arising out of normal course business activities. This facility provides for
up to $750 in performance related support for our operations and has reduced
our need to utilize restricted cash as collateral for our performance related
obligations. Currently, $300 is committed support for performance bonds. On
July 10, 2003, we announced an amendment to the EDC support facility which
extended the termination date to December 31, 2005 from June 30, 2004. See
Available support facility for additional information.

Common shares

At our annual and special shareholders meeting on April 24, 2003, our
shareholders gave authority to our Board of Directors to implement a
consolidation of our outstanding common shares, also known as a reverse stock
split. As a result, our Board of Directors has the authority in its sole
discretion to implement a consolidation of our common shares at any time, if at
all, prior to April 15, 2004. If a share consolidation is determined to be in
the best interests of Nortel Networks and its shareholders, our Board of
Directors will select a consolidation ratio within the range of one
post-consolidation common share for every five pre-consolidation common shares
to one post-consolidation common share for every ten pre-consolidation common
shares.

50



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##### Table of Contents



Shareholder rights plan

At our annual and special shareholders meeting on April 24, 2003, our
shareholders approved the reconfirmation and amendment of our shareholder
rights plan which will expire at the annual meeting of shareholders to be held
in 2006 unless it is reconfirmed at that time. Under the rights plan, we issue
one right for each Nortel Networks common share outstanding. These rights
become exercisable upon the occurrence of certain events associated with an
unsolicited takeover bid. For additional information, you should refer to
Shareholder rights plan in note 15 of our financial statements in our 2002
Annual Report and to our Registration Statement on Form 8-A/A filed with the
SEC on April 25, 2003.

Discontinued operations

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

|
|
|

| |  | the restructuring of approximately $465 of trade and customer
financing receivables owed to us by a customer, the majority of which
was previously provisioned. As a result of the restructuring agreement,
we received consideration including cash of $125, notes receivable and
an ownership interest which have been fully provided for and the mutual
release of all other claims between the parties. The transaction closed
on March 20, 2003 and resulted in a gain of $95.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Stock options

We adopted fair value accounting for new grants or modifications of stock
options beginning January 1, 2003. As a result, all stock option grants or
modifications in 2003 and beyond will be expensed over the stock option vesting
period based on their fair value at the date the options are granted or
modified. The effect of the adoption of Statement of Financial Accounting
Standards, or SFAS, No. 148 was a stock option expense of $7 in the second
quarter of 2003 and $12 in the first half of 2003. If we continue to grant
options in 2003 at a similar level to 2002, the expected impact on net earnings
(loss) per share will be approximately ($0.01) per common share for 2003. For
additional information, you should refer to Significant accounting policies
in note 2(t) of our financial statements in our 2002 Annual Report.

Results of operations  continuing operations

Segment revenues

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    1,000
    
    
    $
    1,137
    
    
    $
    (137
    )
    
    
    (12
    )
    
    $
    1,934
    
    
    $
    2,260
    
    
    $
    (326
    )
    
    
    (14
    )Enterprise Networks
    
    
    546
    
    
    
    638
    
    
    
    (92
    )
    
    
    (14
    )
    
    
    1,158
    
    
    
    1,312
    
    
    
    (154
    )
    
    
    (12
    )Wireline Networks
    
    
    494
    
    
    
    588
    
    
    
    (94
    )
    
    
    (16
    )
    
    
    1,055
    
    
    
    1,273
    
    
    
    (218
    )
    
    
    (17
    )Optical Networks
    
    
    298
    
    
    
    407
    
    
    
    (109
    )
    
    
    (27
    )
    
    
    567
    
    
    
    815
    
    
    
    (248
    )
    
    
    (30
    )Other(a)
    
    
    
    
    
    
    18
    
    
    
    (18
    )
    
    
    (100
    )
    
    
    1
    
    
    
    34
    
    
    
    (33
    )
    
    
    (97
    )Consolidated
    
    $
    2,338
    
    
    $
    2,788
    
    
    $
    (450
    )
    
    
    (16
    )
    
    $
    4,715
    
    
    $
    5,694
    
    
    $
    (979
    )
    
    
    (17
    )


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

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##### Table of Contents



Geographic revenues

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

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeUnited States
    
    $
    1,148
    
    
    $
    1,517
    
    
    $
    (369
    )
    
    
    (24
    )
    
    $
    2,348
    
    
    $
    2,928
    
    
    $
    (580
    )
    
    
    (20
    )EMEA (a)
    
    
    582
    
    
    
    632
    
    
    
    (50
    )
    
    
    (8
    )
    
    
    1,222
    
    
    
    1,346
    
    
    
    (124
    )
    
    
    (9
    )Canada
    
    
    138
    
    
    
    196
    
    
    
    (58
    )
    
    
    (30
    )
    
    
    264
    
    
    
    413
    
    
    
    (149
    )
    
    
    (36
    )Other regions(b)
    
    
    470
    
    
    
    443
    
    
    
    27
    
    
    
    6
    
    
    
    881
    
    
    
    1,007
    
    
    
    (126
    )
    
    
    (13
    )Consolidated
    
    $
    2,338
    
    
    $
    2,788
    
    
    $
    (450
    )
    
    
    (16
    )
    
    $
    4,715
    
    
    $
    5,694
    
    
    $
    (979
    )
    
    
    (17
    )


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

Consolidated revenues

Q2 2003 vs. Q2 2002 and first half of 2003 vs. first half of 2002

Our consolidated revenues declined 16% in the second quarter of 2003 compared
to the second quarter of 2002 and declined 17% in the first half of 2003
compared to the first half of 2002. These declines were across all segments
and were primarily due to the continuing industry adjustment, tightened capital
markets and/or capital spending restrictions experienced by our service
provider and enterprise customers. Customer spending remained cautious, with
many of our customers realigning capital spending with their current levels of
revenues and profits in order to maximize their return on invested capital.
Also, excess network capacity continued to exist in the industry which has led
to continued pricing pressures on the sale of certain of our products. As a
result, our customers continued to focus on conserving capital, decreasing
their debt levels, reducing costs and/or increasing the capacity utilization
rates and efficiency of existing networks.

From a geographic perspective, the 16% decline in revenues in the second
quarter of 2003 compared to the same period in 2002 was primarily due to a:



| |  | 24% decline in revenues in the United States primarily due to
tightened capital markets and/or capital spending restrictions by our
service provider and enterprise customers and their focus on capital and
cash flow management and a one time shipment to a certain enterprise
customer in the second quarter of 2002 which was not repeated in the
second quarter of 2003;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 30% decline in revenues in Canada primarily due to tightened capital
markets, capital spending restrictions experienced by our service
provider customers and their focus on capital and cash flow management;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 8% decline in revenues in the Europe, Middle East and Africa region,
or EMEA, primarily due a substantial reduction in capital spending as a
result of the continuing industry adjustment, tightened capital markets
and/or customers continuing to focus on maximizing return on invested
capital; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 20% decline in revenues in the Caribbean and Latin America region,
or CALA, primarily due to continued capital spending restrictions by
service provider and enterprise customers; partially offset by
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 17% increase in revenues in the Asia Pacific region, or Asia
Pacific, primarily due to new contracts with certain customers and
continuing network expansions.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, the 17% decline in revenues in the first half of
2003 compared to the same period in 2002 was primarily due to a:



| |  | 20% decline in revenues in the United States primarily due to
tightened capital markets and/or capital spending restrictions by our
service provider and enterprise customers and their focus on capital and
cash flow management;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 36% decline in revenues in Canada primarily due to tightened capital
markets, capital spending restrictions experienced by our service
provider customers and their focus on capital and cash flow management;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents



| |  | 9% decline in revenues in EMEA primarily due to tightened capital
markets and/or capital spending restrictions by service provider and
enterprise customers which were partially offset by increases in revenue
related to new Global System for Mobile communications, or GSM,
contracts with certain service providers; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 33% 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Q2 2003 vs. Q1 2003

Our consolidated revenues declined $39 from $2,377 in the first quarter of 2003
to $2,338 in the second quarter of 2003. The decline was primarily due to
continuing capital spending restrictions experienced by our service provider
and enterprise customers. Also contributing to the decline in revenues were
some incremental one time shipments on new contracts in the first quarter of
2003 in the United States that were not repeated in the second quarter of 2003.

Geographic revenues for the second quarter of 2003 compared to the first
quarter of 2003 decreased 9% in EMEA, decreased 4% in the United States,
decreased 19% in CALA, increased 30% in Asia Pacific and increased 10% in
Canada.

Remainder of 2003

Given the ongoing economic and geopolitical uncertainty, customers continue to
spend cautiously. We expect to see continued restrictions on capital spending
by customers due to:



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

| |  | a longer, more stringent spending approval process by customers when making capital investment decisions;
| | - | ---------------------------------------------------------------------------------------------------------

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

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

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

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

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

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

Also, we expect that we will continue to experience pricing pressures on sales
of certain of our products as a result of increased competition. Further,
customer spending is expected to remain cautious while customers assess the
impact of the recent Federal Communications Commission, or FCC, decision
regarding unbundled network elements, or UNEs. It is difficult to predict the
duration of the current industry adjustment, as growth in industry spending is
not expected to occur until the economic and financial concerns and the
geopolitical uncertainty have subsided. Market visibility remains limited and
we do not expect that our results of operations for any quarter will
necessarily be consistent with our historical quarterly profile or indicative
of our expected results in future quarters. See Forward looking statements
for factors that may affect our revenues.

53



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##### Table of Contents



Wireless Networks revenues

The following chart summarizes recent quarterly revenues for Wireless Networks:

(WIRELESS NETWORKS REVENUES BAR GRAPH)

Q2 2003 vs. Q2 2002

Wireless Networks revenues declined 12% in the second quarter of 2003 compared
to the second quarter of 2002 primarily due to an ongoing focus by wireless
service providers on capital and cash flow management and increased competition
for customers by wireless service providers. Many customers continued to
heavily scrutinize capital expenditure requirements and postponed or reduced
their capital spending.

Code Division Multiple Access, or CDMA, revenues declined in the second quarter
of 2003 compared to the second quarter of 2002 primarily due to customers,
particularly in the United States, continuing to implement capital spending
restrictions driven by their continued focus on capital and cash flow
management. CDMA revenues also declined substantially in CALA primarily due to
many of our customers completing their initial network deployments in 2002 and,
as a result, having sufficient capacity to currently meet additional subscriber
demand. CDMA revenues in Asia Pacific increased substantially in the second
quarter of 2003 compared to the second quarter of 2002 and partially offset the
declines in the United States and CALA. This substantial increase was
primarily due to new contracts with certain service providers and other
customers expanding their existing networks to meet increased subscriber
demand.

Time Division Multiple Access, or TDMA, revenues declined substantially in the
second quarter of 2003 compared to the second quarter of 2002 primarily due to
the continued transition to newer wireless technologies. The substantial
decline was primarily due to United States customers continuing to migrate from
the mature TDMA technology to GSM and CDMA technologies. TDMA revenues
continued to be a smaller portion of Wireless Networks revenues in the second
quarter of 2003 compared to the second quarter of 2002.

Overall GSM revenues, which includes General Packet Radio Standard, or GPRS,
and Enhanced Data Rates for Global Evolution, or EDGE, declined slightly in the
second quarter of 2003 compared to the second quarter of 2002 due to a
significant decline in the United States and a substantial decline in Asia
Pacific. The significant decrease in revenues in the United States was
primarily due to a continued decline in the overall growth rate of GSM
technology deployments by wireless service providers as a result of sufficient
network capacity. In Asia Pacific, the substantial decline in GSM revenues was
primarily due to the completion of network deployments by many of our customers
as of the beginning of the first quarter of 2003 and as a result, they have
sufficient capacity to currently meet additional subscriber demand. GSM
revenues increased substantially in EMEA and CALA in the second quarter of 2003
compared to the same period in 2002 and partially offset the declines in the
United States and Asia Pacific. The substantial increases were primarily due
to new contracts with certain service providers.

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

54



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From a geographic perspective, the 12% decrease in Wireless Networks revenues
in the second quarter of 2003 compared to the same period in 2002 was primarily
due to a:



| |  | 26% decline in revenues in the United States and a 41% decline in
Canada primarily due to customers focus on capital and cash flow
management; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 8% decline in revenues in CALA primarily due to many customers
completing their initial network deployments in 2002, and as a result,
having sufficient capacity to currently meet additional subscriber
demand; partially offset by
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 58% increase in revenues in Asia Pacific primarily due to new CDMA
contracts with certain customers and continuing CDMA network expansion;
and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------

| |  | 15% increase in revenues in EMEA primarily due to new GSM contracts
with certain service provider customers.
| | - | ------------------------------------------------------------------------------------------------------------

First half 2003 vs. first half 2002

In the first half of 2003, Wireless Networks revenues declined 14% compared to
the same period in 2002 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
continued to heavily scrutinize their capital expenditure requirements and
postponed or reduced their capital spending.

CDMA revenues decreased in the first half of 2003 compared to the first half of
2002 primarily due to a substantial decline in the United States and Canada as
customers continued to experience capital spending restrictions driven by 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.

TDMA revenues declined substantially in the first half of 2003 compared to the
first half of 2002 primarily due to the continued transition to newer wireless
technologies. The substantial decline was primarily due to United States and
Canada customers continuing to migrate from the mature TDMA technology to GSM
and CDMA technologies. In the first half of 2003, TDMA revenues accounted for
less than 10% of total Wireless Networks revenues.

GSM revenues decreased in the first half of 2003 compared to the first half of
2002 due to a substantial decline in Asia Pacific and a significant decline in
the United States. The substantial decline in Asia Pacific was primarily 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 have completed their current network deployments, and
as a result, they have sufficient capacity to currently meet additional
subscriber demand. In the United States, the significant decline was primarily
due to the completion of some network deployments by certain service providers.
In EMEA and CALA, GSM revenues increased substantially in the first half of
2003 primarily due to new contracts with certain service providers.

UMTS revenues were essentially flat in the first half of 2003 compared to the
first half of 2002. In the first half of 2003, operators continued to
scrutinize and delay deployment plans.

From a geographic perspective, the 14% decrease in Wireless Networks revenues
in the first half of 2003 compared to the first half of 2002 was primarily due
to a:



| |  | 21% decline in revenues in the United States and a 58% decline in
Canada primarily due to customers focus on capital and cash flow
management, technology migration and a slower subscriber growth; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 9% decline in revenues in Asia Pacific primarily due to capital
spending restrictions, network completion and a slower subscriber
growth; partially offset by
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 21% increase in revenues in EMEA and a 8% increase in CALA primarily
due to new GSM contracts with certain service providers.
| | - | -----------------------------------------------------------------------------------------------------------------------------

55



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##### Table of Contents



Q2 2003 vs. Q1 2003

Compared to the first quarter of 2003, Wireless Networks revenues increased 7%
in the second quarter of 2003, primarily due to a:



| |  | substantial increase in GSM revenues primarily due to increases in
the United States, Canada, EMEA and Asia Pacific as a result of new
contracts and network expansions; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | increase in CDMA revenues, primarily in Asia Pacific, as a result of
existing network expansions to meet increased subscriber demand;
partially offset by
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | substantial decline in UMTS revenues in EMEA primarily due to the
resolution of contractual issues, including collectibility, with a
certain customer in the first quarter of 2003 not repeated in the second
quarter of 2003; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | substantial decline in TDMA revenues, primarily in the United States
and Canada, as a result of customers continuing to migrate to CDMA and
GSM technologies.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, Wireless Networks revenues increased 7% in the
second quarter of 2003 compared to the first quarter of 2003 as a result of a
102% increase in revenues in Asia Pacific and a 68% increase in revenues in
Canada. These increases were partially offset by a 24% decline in revenues in
CALA and an 11% decline in revenues in EMEA. United States revenues were
essentially flat in the second quarter of 2003 compared to the first quarter of
2003.

Remainder of 2003

In the first half of 2003, Wireless Networks revenues continued to be primarily
generated by sales of CDMA and GSM technologies. We continue to expect that
revenues associated with our TDMA technologies will decline in 2003 compared to
2002. In 2003, our UMTS technology sales are expected to grow, compared to
2002, and represent a larger proportion of Wireless Networks revenues as 3G
technologies are expected to gain a greater foothold in the market due to
increased wireless data traffic and requirements for greater wireless spectrum
efficiency.

As at December 23, 2003, we expect that revenues from UMTS technologies will
reach a small portion of overall Wireless Networks revenues in 2003.

As with the rest of the industry, our wireless customers are experiencing
significant pressure and are adapting to a new, more stringent spending
environment due to overall slower economic conditions. We anticipate a
reduction in global capital expenditures for wireless operators in 2003
compared to 2002. In addition, the timing of the anticipated change in revenue
mix from the different wireless technologies has become increasingly difficult
to predict as a result of the complexities and potential for delays in the
implementation of UMTS network deployments. All of these factors could
adversely affect our Wireless Networks revenues in the future.

Enterprise Networks revenues

The following chart summarizes recent quarterly revenues for Enterprise
Networks:

(ENTERPRISE NETWORKS REVENUES BAR GRAPH)

56



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Q2 2003 vs. Q2 2002

Enterprise Networks revenues declined 14% in the second quarter of 2003
compared to the second quarter of 2002 and was primarily a result of:



| |  | a substantial decline in the data networking and security portion of
this segment due to pricing pressures driven by increased competition, a
decline in our legacy routing portfolio and a corresponding reduction in
the number of service contract renewals;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a decline in demand in our traditional circuit switching products as
a result of delays with the establishment of new channel relationships
to address demand from small and medium sized enterprise customers and
the redirection of sales efforts by existing channel partners towards
larger enterprise customers; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | enterprise customers having implemented a longer, more stringent
spending approval process when making capital expenditure decisions
which resulted in continued capital spending delays.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues from the circuit and packet voice portion of this segment decreased in
the second quarter of 2003 compared to the second quarter of 2002 primarily due
to a decrease in the United States and a significant decline in EMEA. The
decline in the United States was primarily due to a decrease in demand for our
traditional circuit switching products as our enterprise customers networks
had sufficient capacity to meet demand. In EMEA, the significant decline was
primarily due to the transition of certain service contracts to our channel
partners during the first half of 2003. These declines were partially offset
by a substantial increase in revenues associated with our packet voice
solutions in the second quarter of 2003 compared to the same period in 2002 as
a result of the continuing evolution of traditional circuit switching
technology towards converged internet protocol, or IP, telephony solutions.

Revenues in the data networking and security portion of this segment declined
substantially in the second quarter of 2003 compared to the second quarter of
2002. This substantial decline was primarily due to a reduction in the number
of service contract renewals associated with our legacy routing portfolio,
primarily in the United States. Further, revenues associated with certain of
our Layer 2 products declined substantially as a result of pricing pressures
driven by increased competition for enterprise customers. In Asia Pacific,
revenues decreased substantially primarily due to one time incremental
shipments of certain products in the second quarter of 2002 which were not
repeated in the second quarter of 2003.

From a geographic perspective, the 14% decline in Enterprise Networks revenues
in the second quarter of 2003 compared to the second quarter of 2002 was
primarily due to a:



| |  | 19% decline in revenues in the United States primarily due to our
enterprise customers traditional circuit switching networks having
sufficient capacity to meet current demand and a reduction in service
contract renewals;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 11% decline in revenues in Asia Pacific primarily due to one time
incremental shipments of certain products in the second quarter of 2002
which were not repeated in the second quarter of 2003;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 7% decline in revenues in EMEA primarily due to continuing economic
uncertainty in the region, a delay associated with the transition of a
portion of our business from direct to indirect channels and the
transition of certain service contracts to our channel partners during
the first half of 2003. 2003; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 35% decline in revenues in CALA primarily due to the deterioration
of the economic situation in certain countries and associated spending
restrictions implemented by certain of our distributors.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

First half 2003 vs. first half 2002

Enterprise Networks revenues declined 12% in the first half of 2003 compared to
the first half of 2002 and was primarily due to:



| |  | a decline in our traditional circuit switching products as a result
of delays associated with the establishment of new channel relationships
to address demand from small and medium sized enterprise customers and
the redirection of sales efforts by existing channel partners towards
larger enterprise customers;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a substantial decline in our legacy routing portfolio and an
associated decline in service revenues related to this portfolio as the
number of service contract renewals decreased; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | enterprise customers having implemented a longer, more stringent
spending approval process when making capital investment decisions which
resulted in continued capital spending delays.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Revenues from the circuit and packet voice portion of this segment decreased in
the first half of 2003 compared to the first half of 2002. We experienced a
reduction in revenues associated with our traditional circuit switching and
interactive voice response products primarily due to continuing capital
spending restrictions as a result of the economic uncertainty in the industry.
These declines were partially offset by a substantial increase in revenues
associated with our IP telephony solutions as customers continued to migrate
towards converged packet voice solutions.

Revenues associated with the data networking and security portion of this
segment decreased significantly in the first half of 2003 compared to the first
half of 2002. The significant decrease in revenues was primarily due to a
decline in revenues associated with our legacy routing portfolio and a
reduction in the number of service contract renewals associated with these
products. Also, we experienced a decline in revenue in certain of our other
data networking and security products primarily due to pricing pressures driven
by increased competition.

From a geographic perspective, the 12% decline in Enterprise Networks revenues
in the first half of 2003 compared to the first half of 2002 was primarily due
to a:



| |  | 16% decline in revenues in the United States primarily due to
customer spending restrictions, a reduction in revenues associated with
our legacy routing portfolio and a corresponding reduction in the number
of service contract renewals;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 7% decline in revenues in EMEA primarily due to continuing economic
uncertainty in the region, a delay associated with the transition of a
portion of our business from direct to indirect channels and the
transition of certain service contracts to our channel partners during
the first half of 2003;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 30% decline in revenues in CALA primarily due to the continued
deterioration of the economic situation in certain countries and
associated spending restrictions implemented by certain of our
distributors; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 5% decline in Asia Pacific primarily due to one time incremental
shipments of certain products in the second quarter of 2002 which were
not repeated in the first half of 2003.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Q2 2003 vs. Q1 2003

Enterprise Networks revenues decreased 11% in the second quarter of 2003
compared to the first quarter of 2003 primarily due to:



| |  | a significant decline in revenues associated with our traditional
circuit switching products primarily due to incentive programs and other
pricing discounts offered to certain enterprise customers during the
first quarter of 2003 and not repeated in the second quarter of 2003;
and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a decrease in the data network and security portion of this segment
primarily due to enterprise customers having implemented a longer, more
stringent spending approval process when making capital investment
decisions which resulted in continued capital spending delays and
increased competition for enterprise customers.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, the 11% decline in the second quarter of 2003
compared to the first quarter of 2003 was primarily due to a 14% decline in
revenues in EMEA, an 8% decline in revenues in the United States, a 24% decline
in revenues in Canada and a 32% decline in CALA.

Remainder of 2003

We anticipate that enterprise customers will continue to increase the use of
voice over packet technologies in their communications networks. We expect
that data, voice and multimedia communications technologies will continue to
converge, and enterprises will look for ways to maximize the effectiveness of
their existing networks while reducing ongoing capital expenditures and
operating costs. However, the timing of this progression is unclear. Although
we anticipate that demand will continue for our traditional circuit switching
products, it is difficult to determine the extent to which the decline in these
revenues will continue as a result of the migration to voice over packet
technologies. We are also working to complete the realignment of our channel
strategy to address the demand of the small and medium sized enterprise
customers. Overall, we expect that the continuing industry adjustment will
have a negative impact on the level of spending by our enterprise customers.

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

Wireline Networks revenues

The following chart summarizes recent quarterly revenues for Wireline Networks:

(WIRELINE NETWORKS REVENUES BAR GRAPH)

Q2 2003 vs. Q2 2002

Wireline Networks revenues declined 16% in the second quarter of 2003 compared
to the second quarter of 2002 primarily due to a substantial reduction in
capital spending by our service provider customers as a result of the
continuing industry adjustment and continued cautious customer spending.

Revenues from the circuit and packet voice portion of this segment decreased
significantly in the second quarter of 2003 compared to the second quarter of
2002 primarily due to a substantial decrease in our traditional circuit
switching product revenues in the United States and also uncertainty regarding
the recent FCC decision regarding UNEs. The decline in our circuit switching
product revenues was primarily due to the continuing impact of tightened
capital markets and capital spending restrictions experienced by our service
provider customers. Revenues from our packet voice solutions increased
substantially in the United States and Canada in the second quarter of 2003
compared to the second quarter of 2002 and continued to represent a small, but
growing, portion of overall Wireline Networks revenues. The increase was
primarily due to new service provider contracts.

Revenues from the data networking and security portion of this segment
decreased in the second quarter of 2003 compared to the second quarter of 2002
and was primarily due to substantial declines in Asia Pacific and CALA. In
these regions, we experienced a decline in demand for our mature products
compounded by the ongoing industry adjustment as service providers continued to
reduce their capital expenditures.

From a geographic perspective, the 16% decline in Wireline Networks revenues in
the second quarter of 2003 compared to the second quarter of 2002 was primarily
due to a:



| |  | 20% decline in revenues in the United States primarily due to the
continuing impact of tightened capital markets and capital spending
restrictions experienced by our service provider customers and also
uncertainty regarding the recent FCC decision regarding UNEs;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 35% decline in revenues in Asia Pacific primarily due to service
provider capital spending restrictions; and
| | - | ------------------------------------------------------------------------------------------------------------

| |  | 48% decline in revenues in CALA primarily due to service provider
capital spending restrictions and tightened capital markets; partially
offset by
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 30% increase in revenues in Canada primarily due to an increase in
packet voice revenues as certain customers upgraded their existing
networks.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

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First half 2003 vs. first half 2002

Wireline Networks revenues declined 17% in the first half of 2003 compared to
the first half of 2002. These declines were primarily due to a substantial
reduction in capital spending by our service provider customers as a result of
the continuing industry adjustment.

Revenues from the circuit and packet voice portion of this segment decreased
significantly in the first half of 2003 compared to the first half of 2002
primarily due to a substantial decrease in our traditional circuit switching
product revenues and also uncertainty regarding the recent FCC decision with
respect to UNEs. The decline in our circuit switching revenues was primarily
due to the continuing impact of tightened capital markets and capital spending
restrictions experienced by our service provider customers. Revenues from our
packet voice solutions increased substantially in the United States and Canada
in the first half of 2003 compared to the first half of 2002 primarily due to
some incremental one time shipments in the first quarter of 2003 relating to
new contracts awarded in the second half of 2002 and the first quarter of 2003.

Revenues from the data networking and security portion of this segment
decreased significantly in the first half of 2003 compared to the first half of
2002 primarily due to substantial declines in Asia Pacific and CALA regions and
a significant decline in the United States. In these regions, we experienced a
decline in demand for our mature products primarily due to the ongoing industry
adjustment as service providers continued to reduce their capital expenditures.

From a geographic perspective, the 17% decline in Wireline Networks revenues in
the first half of 2003 compared to the first half of 2002 was primarily due to
a:



| |  | 76% 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;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 10% decline in revenues in the United States primarily due to the
continuing impact of tightened capital markets, capital spending
restrictions experienced by our service provider customers and also
uncertainty regarding the recent FCC decision regarding UNEs;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 10% decline in revenues in EMEA primarily due to a reduction in
capital spending by service provider customers and tightened capital
markets; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 22% decline in revenues in Asia Pacific primarily due to service
provider capital spending restrictions.
| | - | --------------------------------------------------------------------------------------------------------

Q2 2003 vs. Q1 2003

Our Wireline Networks revenues decreased 12% in the second quarter of 2003
compared to the first quarter of 2003 primarily due to:



| |  | a significant decline in the circuit and packet voice portion of this
segment, primarily in the United States, due to a substantial decrease
in revenues associated with our packet-based technologies caused by
incremental one time shipments on new contracts in the first quarter of
2003 that were not repeated in the second quarter of 2003; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a decrease in the data networking and security portion of this
segment primarily due to continued customer spending restrictions in
EMEA associated with our more mature products.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

From a geographic perspective, Wireline Networks revenues decreased 12% in the
second quarter of 2003 compared to the first quarter of 2003 primarily as a
result of a 25% decrease in the United States partially offset by a 10%
increase in EMEA. The remaining geographic regions were essentially flat
compared to the first quarter of 2003.

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Remainder of 2003

We anticipate that service providers will continue to increase the use of
packet-based technologies in their communications networks as they look for
ways to optimize their existing networks and offer new revenue generating
services while controlling capital expenditures and operating costs. Although
we experienced an increase in revenues in our packet-based technologies in the
first half of 2003 compared to the same period in 2002, the timing of when
service providers will deploy packed based technologies on a wider scale is
unclear. Further, it is difficult to determine the effect the recent FCC
ruling regarding UNEs will have on our business as our customers assess its
impact. We expect that the continuing industry adjustment and reduction in
capital spending by our customers will have a negative impact on the level of
spending by our service provider customers and could adversely affect Wireline
Networks revenues in the future.

Optical Networks revenues

The following chart summarizes recent quarterly revenues for Optical Networks:

(OPTICAL NETWORKS REVENUES BAR GRAPH)

Q2 2003 vs. Q2 2002

Optical Networks revenues declined 27% in the second quarter of 2003 compared
to the second quarter of 2002. This decline was primarily due to the
continuing industry adjustment, tightened capital markets and substantial
reductions in capital spending by our United States, Canada and EMEA customers
in both the long-haul and metro optical portions of this segment. These
declines were partially offset by a substantial increase in Asia Pacific due to
new contracts with customers in the second quarter of 2003.

Revenues in the long-haul portion of this segment decreased substantially in
the second quarter of 2003 compared to the second quarter of 2002. The
substantial decline was primarily due to the continuing industry adjustment,
tightened capital markets and continued capital spending restrictions in the
United States, Canada and EMEA as our service provider customers continued to
focus on maximizing return on invested capital by increasing the capacity
utilization rates and efficiency of existing networks. Also contributing to
the decline in the United States were revenues associated with a one time
shipment to a certain enterprise customer in the second quarter of 2002 which
was not repeated in the second quarter of 2003. In addition, significant
excess inventories continued to exist in this portion of the segment which
resulted in ongoing pricing pressures.

In the fourth quarter of 2002, we sold certain optical components assets to
Bookham Technology plc, or Bookham. As a result, our second quarter results in
2003 in the long-haul portion of this segment do not reflect revenues generated
from these assets. In the second quarter of 2002, revenues generated from the
optical components assets sold to Bookham were approximately 5% of the total
revenues of $407. For additional information relating to the sale of these
assets to Bookham, you should refer to information contained in our 2002 Annual
Report.

Revenues in the metro optical portion of this segment decreased significantly
in the second quarter of 2003 compared to the second quarter of 2002. The
significant decrease was primarily due to a substantial decrease in EMEA as a
result of the continuing industry adjustment, tightened capital markets and
capital spending restrictions by customers.

From a geographic perspective, the 27% decline in Optical Networks revenues in
the second quarter of 2003 compared to the second quarter of 2002 was primarily
due to a:

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| |  | 46% decline in revenues in EMEA primarily related to a substantial
reduction in capital spending as a result of the continuing industry
adjustment, tightened capital markets and customers continuing to focus
on maximizing return on invested capital;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 29% decline in revenues in the United States primarily related to a
substantial reduction in capital spending as a result of the continuing
industry adjustment, tightened capital markets and customers continuing
to focus on maximizing return on invested capital and a one time
shipment to a certain enterprise customer in the second quarter of 2002
which was not repeated in the second quarter of 2003; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 61% decrease in revenues in Canada primarily related to a
substantial reduction in capital spending as a result of the continuing
industry adjustment, tightened capital markets and customers continuing
to focus on maximizing return on invested capital; partially offset by
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 30% increase in revenues in Asia Pacific primarily due to new
customer contracts for expansions of existing networks to meet increased
customer demand.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

First half 2003 vs. first half 2002

Optical Networks revenues declined 30% in the first half of 2003 compared to
the first half of 2002. These declines were primarily the result of the
continuing industry adjustment, tightened capital markets and substantial
reductions in capital spending by our United States, Canada and EMEA customers
in the long-haul portion of this segment.

Revenues in the long-haul portion of this segment declined substantially in the
first half of 2003 compared to the first half of 2002. The substantial decline
was primarily due to the continuing industry adjustment, tightened capital
markets and
continued capital spending restrictions in the United States, Canada and EMEA
as customers continued to focus on maximizing return on invested capital by
increasing the capacity utilization rates and efficiency of existing networks.
In addition, significant excess inventories continued to exist in this portion
of the segment which resulted in ongoing pricing pressures.

As mentioned above, our long-haul revenues in the first half of 2003 do not
reflect revenues generated from the optical component assets sold to Bookham.
In the first half of 2002, revenues associated with these assets were
approximately 5% of the total Optical Networks revenues of $815.

Revenues in the metro optical portion of this segment decreased significantly
in the first half of 2003 compared to the first half of 2002. The significant
decrease was primarily due to a substantial decrease in revenues in EMEA and
the United States and was partially offset by a substantial increase in
revenues in Asia Pacific. The declines in EMEA and the United States were
primarily the result of the continuing industry adjustment, tightened capital
markets and customer spending restrictions. The substantial increase in
revenues in Asia Pacific was primarily due to new customer contracts in 2003
for expansions of existing networks to meet increased customer demand.

From a geographic perspective, the 30% decline in Optical Networks revenues in
the first half of 2003 compared to the first half of 2002 was primarily due to
a:



| |  | 47% decline in revenues in EMEA, 37% decline in the United States
and a 53% decline in Canada primarily related to a substantial reduction
in capital spending as a result of the continuing industry adjustment,
tightened capital markets and customers continuing to focus on
maximizing return on invested capital; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 38% decline in revenues in CALA primarily related to a reduction in
capital spending and excess network capacity and assets; partially
offset by
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 34% increase in revenues in Asia Pacific primarily due to new
customer contracts for expansions of existing networks to meet increased
customer demand.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

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Q2 2003 vs. Q1 2003

Optical Networks revenues increased 11% in the second quarter of 2003 compared
to the first quarter of 2003 primarily due to increased customer spending in
the United States on both our long-haul and metro optical products. The
increased spending in the United States was mainly due to customers expanding
existing networks and the resolution of contractual issues with certain
customers in the first quarter of 2003. The substantial increase in revenues
in the United States was partially offset by a substantial decline in revenues
in EMEA which was mainly due to some incremental one time shipments of products
in the first quarter of 2003 which were not repeated in the second quarter of
2003.

From a geographic perspective, Optical Networks revenues increased 11% in the
second quarter of 2003 compared to the first quarter of 2003 primarily as a
result of a 77% increase in revenues in the United States partially offset by a
26% decrease in revenues in EMEA. The remaining geographic regions were
essentially flat.

Remainder of 2003

On August 10, 2003, we essentially finalized the realignment of Optical
Networks with the sale of certain assets of our high speed module business. We
do not expect that the sale of this business will have a material impact on our
business, results of operations and financial condition. Going forward, our
efforts will focus on providing next generation optical networking systems,
including the evolution of next generation SONET/SDH systems, metro Dense
Wavelength Division Multiplexing, or metro DWDM, systems and optical long-haul
line and terminal solutions. Also, we will continue to invest in core
technologies, such as efficient service adaptation, aggregation, switching and
management that will enable our customers to deploy optical networking services
which we believe will lead the networking transformation towards packet-based
networks.

Our major customers in the optical long-haul portion of this segment remain
focused on maximizing return on their invested capital by increasing the
capacity utilization rates and efficiency of existing networks. We expect that
any additional capital spending by those customers will be increasingly
directed to opportunities that enhance customer performance, revenues
generation and cost reduction in the near term. We expect that customers in
this portion of the segment will continue to focus on route by route
activities, adding channels to existing networks, interconnectivity and
bandwidth as it is required in the short term. Further, we believe that
building out networks for increased bandwidth will remain long term projects.

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

Due to the severe reduction, in number and size, of new optical long-haul
network build-outs and due to the nature of the relationship between the
products within the optical long-haul portion of this segment, it is difficult
to predict when a meaningful recovery in the optical long-haul market will
occur. Also, we anticipate that pricing pressures on optical system vendors
will continue due to intense competition, large inventories and a diminished
market. As a result, we expect that our Optical Networks revenues will decline
in 2003 compared to 2002 and will be one of our last segments to recover from
the significant industry adjustment.

Gross profit and gross margin

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    Change
    
    
    % ChangeGross profit
    
    $
    1,028
    
    
    $
    1,013
    
    
    $
    15
    
    
    
    1
    
    
    $
    2,072
    
    
    $
    1,832
    
    
    $
    240
    
    
    
    13Gross margin
    
    
    44.0
    %
    
    
    36.3
    %
    
    
    7.7
    
    
    
    21.2
    
    
    
    43.9
    %
    
    
    32.2
    %
    
    
    11.7
    
    
    
    36


Gross margin improved 7.7 percentage points in the second quarter of 2003
compared to the second quarter of 2002 primarily due to:



| |  | an increase of approximately 6 percentage points related to
reductions in inventory provisioning and other operations related costs,
primarily in the United States and EMEA; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | a favorable gross margin impact of approximately 1.5 percentage
points in the second quarter of 2002 for purchase discounts recognized
in connection with the JDS Uniphase Corporation purchase arrangement
that was not repeated in the second quarter of 2003.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Gross margin also improved 11.7 percentage points in the first half of 2003
compared to the first half of 2002 primarily due to:



| |  | an increase of approximately 8 percentage points related to a decline
in inventory provisioning, contract and customer settlement costs and
other operations related costs; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an increase of approximately 5 percentage points related to continued
improvements in our cost structure primarily as a result of more
favorable supplier pricing which was partially offset by continued
pricing pressures on the sale of certain of our products; partially
offset by
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | a favorable gross margin impact of approximately 1.5 percentage
points in the first half of 2002 for purchase discounts recognized in
connection with the JDS Uniphase Corporation purchase arrangement that
was not repeated in the first half of 2003.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

While we cannot predict the extent to which changes in product mix and pricing
pressures will impact our gross margin, we continue to see the effects of our
restructuring work plan which we began implementing in 2001 to create a cost
structure that is more reflective of the current industry and economic
environment. As a result, we expect that gross margin will continue to trend
in the low 40% range for the remainder of 2003. See Forward looking
statements for factors that may affect our gross margins.

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

Segment gross profit and gross margin

Wireless Networks

Wireless Networks gross margin improved by approximately 2 percentage points in
the second quarter of 2003 compared to the second quarter of 2002. The
improvement was primarily due to changes in product mix and ongoing product
cost improvements.

Wireless Networks gross margin improved by approximately 6 percentage points in
the first half of 2003 compared to the first half of 2002. The improvement was
primarily due to changes in product mix and ongoing product cost improvements.

Enterprise Networks

Enterprise Networks gross margin improved approximately 1 percentage point in
the second quarter of 2003 compared to the second quarter of 2002. The
improvement in gross margin was primarily due to:



| |  | improvements in our cost structure as a result of more favorable
supplier pricing which was partially offset by reductions in the selling
price of certain of our products as a result of increased competition
for enterprise customers;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reductions in other operations related costs including product defects, customer service and warranty costs; and
| | - | ----------------------------------------------------------------------------------------------------------------

| |  | changes in customer and product mix.
| | - | ------------------------------------

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



| |  | improvements in our cost structure as a result of more favorable
supplier pricing which was partially offset by reductions in the selling
price of certain of our products as a result of increased competition
for enterprise customers;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reductions in other operations related costs including product
defects, customer service and warranty costs; and
| | - | ----------------------------------------------------------------------------------------------------------------

| |  | a decrease in inventory provisioning and contract and customer
settlement costs in the first half of 2003 compared to the first half of
2002.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

Wireline Networks

Wireline Networks gross margin increased by approximately 7 percentage points
in the second quarter of 2003 compared to the second quarter of 2002. The
increase in gross margin was primarily due to:



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

| |  | a decrease in inventory provisioning; and
| | - | -----------------------------------------

| |  | reductions in other operations related costs including customer service and warranty costs.
| | - | -------------------------------------------------------------------------------------------

Wireline Networks gross margin increased by approximately 6 percentage points
in the first half of 2003 compared to the same period in 2002. The increase in
gross margin was primarily due to:



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

| |  | a decrease in inventory provisioning and contract and customer
settlement costs in the first half of 2003 compared to the first half of
2002; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reductions in other operations related costs including customer
service and warranty costs.
| | - | -------------------------------------------------------------------------------------------

Optical Networks

Optical Networks gross margin improved by approximately 32 percentage points in
the second quarter of 2003 compared to the second quarter of 2002. The
improvement in gross margin was primarily due to:



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

| |  | a decrease in inventory provisioning in the first half of 2003 compared to the first half of 2002;
| | - | --------------------------------------------------------------------------------------------------

| |  | the sale of certain optical components assets to Bookham in the
fourth quarter of 2002 and, as a result, our gross margin in the second
quarter of 2003 in the long-haul portion of this segment excluded the
impact of excess capacity of those optical components assets; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | improvements in our cost structure primarily as a result of more
favorable supplier pricing which was partially offset by continued
pricing pressures on the sale of certain products; partially offset by
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a favorable gross margin impact in the second quarter of 2002 for
purchase discounts recognized in connection with the JDS Uniphase
Corporation purchase arrangement that was not repeated in the second
quarter of 2003.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Optical Networks gross margin improved by approximately 48 percentage points in
the first half of 2003 compared to the same period in 2002. The improvement in
gross margin was primarily due to:



| |  | a decrease in inventory provisioning and contract and customer
settlement costs in the first half of 2003 compared to the first half of
2002;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | the sale of certain optical components assets to Bookham and, as a
result, our gross margin in the first half of 2003 excluded the impact
of excess capacity of those optical components assets; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | improvements in our cost structure primarily as a result of more
favorable supplier pricing which were partially offset by continued
pricing pressures on the sale of certain products; partially offset by
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a favorable gross margin impact in the first half of 2002 for
purchase discounts recognized in connection with the JDS Uniphase
Corporation purchase arrangement that was not repeated in the first half
of 2003.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Operating expenses

Selling, general and administrative expense

3 months ended June 30,
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeSG&A expense
    
    $
    413
    
    
    $
    756
    
    
    $
    (343
    )
    
    
    (45
    )
    
    $
    927
    
    
    $
    1,463
    
    
    $
    (536
    )
    
    
    (37
    )As % of revenues
    
    
    17.7
    %
    
    
    27.1
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    19.7
    %
    
    
    25.7
    %
    
    
    N/A
    
    
    
    N/A


Selling, general and administrative, or SG&A, expense declined $343 in the
second quarter of 2003 compared to the second quarter of 2002 primarily due to:



| |  | the continued impact of our workforce reductions and associated
reductions in other related costs such as information services and real
estate; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |  | net customer financing bad debt recoveries of $48 primarily as a
result of favorable settlements related to our customer financing
activities and adjustments to other existing provisions.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In the first half of 2003, SG&A expense declined $536 compared to the first
half of 2002. These declines were primarily due to:



| |  | the continued impact of our workforce reductions and associated
reductions in other related costs such as information services and real
estate;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | net customer financing bad debt recoveries of $48 primarily as a
result of favorable settlements related to our customer financing
activities and adjustments to other existing provisions; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | accruals in the first half of 2003 for the employee return to
profitability bonus plan for which no similar accrual was made in the
first half of 2002.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

We will continue to manage SG&A expense according to the requirements of our
business, allocating resources and investment where customer demand dictates,
and reducing resources and investment where opportunities for improved
efficiencies present themselves. For the year 2003, we expect that our annual
SG&A expense will continue to decline compared to 2002 although not to the same
extent as was experienced in 2002 compared to 2001.

Segment selling, general and administrative expense

Wireless Networks

Wireless Networks SG&A expense decreased substantially in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the first half of 2002. These declines were primarily due to:



| |  | the continued impact of our workforce reductions and organizational
realignment across all regions and associated reductions in other
related costs such as information services and real estate; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Enterprise Networks

Enterprise Networks SG&A expense decreased significantly in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the same period in 2002. These decreases were primarily due
to:



| |  | the continued impact of our workforce reductions, primarily in the
United States and Canada, and associated reductions in other related
costs such as information services and real estate; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a decrease in provisioning for trade receivables.
| | - | -------------------------------------------------

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Wireline Networks

Wireline Networks SG&A expense decreased substantially in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the same period in 2002. These decreases were primarily due
to:



| |  | the continued impact of our workforce reductions, primarily in the
United States and Canada, and associated reductions in other related
costs such as information services and real estate; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Optical Networks

Optical Networks SG&A expense decreased substantially in both the second
quarter of 2003 compared to the second quarter of 2002 and the first half of
2003 compared to the same period in 2002. These reductions were primarily due
to:



| |  | the continued impact of our workforce reductions across all regions
and associated reductions in other related costs such as information
services and real estate; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Segment contribution margin

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeWireless Networks
    
    $
    346
    
    
    $
    323
    
    
    $
    23
    
    
    
    7
    
    
    $
    663
    
    
    $
    583
    
    
    $
    80
    
    
    
    14Enterprise Networks
    
    
    87
    
    
    
    95
    
    
    
    (8
    )
    
    
    (8
    )
    
    
    237
    
    
    
    185
    
    
    
    52
    
    
    
    28Wireline Networks
    
    
    173
    
    
    
    103
    
    
    
    70
    
    
    
    68
    
    
    
    331
    
    
    
    230
    
    
    
    101
    
    
    
    44Optical Networks
    
    
    28
    
    
    
    (212
    )
    
    
    240
    
    
    
    113
    
    
    
    42
    
    
    
    (530
    )
    
    
    572
    
    
    
    108Other
    
    
    (19
    )
    
    
    (52
    )
    
    
    33
    
    
    
    63
    
    
    
    (128
    )
    
    
    (99
    )
    
    
    (29
    )
    
    
    (29
    )Consolidated
    
    $
    615
    
    
    $
    257
    
    
    $
    358
    
    
    
    139
    
    
    $
    1,145
    
    
    $
    369
    
    
    $
    776
    
    
    
    210


As a result of the gross margin and SG&A expense changes discussed above, our
consolidated contribution margin improved by $358 in the second quarter of 2003
compared to the second quarter of 2002 and by $776 in the first half of 2003
compared to the first half of 2002. All of our four reportable segments
contributed positive contribution margin in the second quarter and first half
of 2003.

Research and development expense

3 months ended June 30,
    
    
    6 months ended June 30,2003
    
    
    2002
    
    
    $ Change
    
    
    % Change
    
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeR&D expense
    
    $
    481
    
    
    $
    571
    
    
    $
    (90
    )
    
    
    (16
    )
    
    $
    985
    
    
    $
    1,153
    
    
    $
    (168
    )
    
    
    (15
    )As % of revenues
    
    
    20.6
    %
    
    
    20.5
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    20.9
    %
    
    
    20.2
    %
    
    
    N/A
    
    
    
    N/A


Research and development, or R&D, expense represents our planned investment in
our next generation core products across all segments. R&D expense decreased
$90 in the second quarter of 2003 compared to the second quarter of 2002. The
decline was primarily due to workforce reductions and focused investment
decisions to drive market leadership across our product portfolios.

R&D expense also decreased $168 in the first half of 2003 compared to the first
half of 2002 primarily due to our workforce reductions and focused investments
to drive market leadership across our product portfolios. The decline was
partially offset by an accrual in the first quarter of 2003 for the employee
return to profitability bonus plan for which no similar accrual was made in the
first half of 2002.

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Our continuing strategic investments in R&D are aligned with technology
leadership in anticipated growth areas, while targeting a level of R&D expense
that is more representative of our overall cost structure. We will continue to
manage R&D expense according to the requirements of our business, allocating
resources and investment where customer demand dictates, and reducing resources
and investment where opportunities for improved efficiencies present
themselves. Our research and development efforts are currently focused on key
next generation networking solutions including:



| |  | key areas of wireless networking solutions;
| | - | -------------------------------------------

| |  | voice over packet solutions to drive operating efficiencies, cost
savings and in some cases new revenues for our customers;
| | - | ---------------------------------------------------------------------------------------------------------------------------

| |  | multimedia services and applications to drive business and revenue
growth; and
| | - | ------------------------------------------------------------------------------

| |  | broadband networking solutions including optical networking solutions
to support storage area network connectivity services and business
continuity.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------

For the year 2003, we expect that our annual R&D expense will continue to
decline compared to 2002 although not to the same extent as was experienced in
2002 compared to 2001.

Amortization of acquired technology

The amortization of acquired technology in the first half of 2003 and the same
period in 2002 primarily reflected the charge related to the acquisition of
Alteon WebSystems, Inc. The remaining net carrying value of acquired
technology will be fully amortized in the third quarter of 2003 and was $33 on
June 30, 2003 and $98 on December 31, 2002.

Deferred stock option compensation

For acquisitions completed subsequent to July 1, 2000, we were required to
allocate a portion of the purchase price to deferred compensation related to
unvested stock options held by employees of the companies acquired. This
deferred compensation is amortized to net income (loss) based on the graded
vesting schedule of the stock option awards. Deferred stock option
compensation was $17 in the second quarter of 2003 compared to $20 in the
second quarter of 2002 and was primarily due to the completion of the deferred
compensation amortization associated with certain employees vesting periods.
Deferred stock option compensation was $35 in the first half of 2003 compared
to $44 in the first half of 2002. This decline was primarily due to the
completion of the deferred compensation amortization associated with certain
employees vesting periods and the cancellation of unvested stock options that
were held by employees whose employment was terminated in 2002. Currently, we
expect that the amount of deferred stock option compensation for the next two
quarters will decline slightly compared to the expense recorded in the second
quarter of 2003.

Special charges

In the second quarter of 2003, we recorded a net reduction in special charges
of $2 associated with our continued restructuring work plan. Included in this
net reduction were total reductions of $62 related to revisions to prior
accruals. Workforce reduction charges of $22 related to the cost of severance
and benefits across all segments associated with approximately 300 employees
notified of termination during the second quarter of 2003. Net revisions of
$13 to reduce prior accruals primarily related to termination benefits where
actual costs were lower than our original estimates across all segments.
Contract settlement and lease costs were $15 and related to leased facilities
and furniture that were no longer being used across all segments. Net
revisions of $44 reduced prior accruals and related to changes in estimates
associated with the cost of vacating previously identified properties and
changes in sublease revenue assumptions across all segments. Also, we recorded
a charge of $23 related to current period write downs for various leasehold
improvements and excess equipment. Net revisions of $5 to reduce prior
accruals related to adjustments in our original plans or estimates for the
closure of certain facilities.

In the first half of 2003, we recorded special charges of $110 related to our
continued restructuring work plan. Included in this charge was a reduction of
$70 related to revisions to prior accruals. Workforce reduction charges of $90
related to the cost of severance and benefits associated with approximately
1,100 employees notified of termination during the first half of 2003 which
extended across all segments. Net revisions of $35 to reduce prior accruals
primarily related to termination benefits where actual costs were lower than
our original estimates across all segments. Contract settlement and lease
costs were $46 and related to newly identified leased facilities and furniture
that we determined were no longer being used across all segments. Net
revisions of $2 increased prior accruals and related to changes in estimates
associated with the cost of

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vacating previously identified properties and
changes in sublease revenues across all segments. Also, we recorded charges of
$44 related to current period write downs for various leasehold improvements
and excess Optical Networks equipment. Net
revisions of $37 to reduce prior accruals related to adjustments in our
original plans or estimates for the closure of certain facilities.

In the second quarter of 2002, we recorded special charges of $361 related to
our restructuring work plan. Workforce reduction charges of $90 related to the
cost of severance and benefits associated with approximately 1,900 employees
notified of termination which extended across all segments. Contract
settlement and lease costs included net revisions of approximately $14 which
reduced prior accruals and related to change in estimates associated with the
cost of vacating previously identified properties and changes in sublease
revenue assumptions across all segments. We recorded approximately $270 in
plant and equipment write downs within Optical Networks. Also in the second
quarter of 2002, we recorded $15 related to the write down of certain acquired
technology in Optical Networks due to our reassessment of market conditions.

In the first half of 2002, we recorded special charges of $824 related to our
restructuring work plan. Workforce reduction charges of $398 were related to
the cost of severance and benefits associated with the approximately 6,300
employees notified of termination which extended across all segments. Contract
settlement and lease costs included negotiated settlements of approximately $44
to either cancel contracts or renegotiate existing contracts across all of our
segments. Also, we recorded approximately $355 in plant and equipment write
downs within global operations, a function that supports all of our segments,
and within Optical Networks. Also in the first half of 2002, we recorded $27
related to the write downs of acquired technology in Optical Networks due to
our reassessment of market conditions.

Currently, we expect that approximately $30 to $40 of special charges related
to our restructuring work plan will be incurred in the second half of 2003.

In the third quarter of 2003, we recorded special charges of $70 relating to
our continued restructuring work plan. As at December 23, 2003, we expect that
approximately $40 of special charges relating to our restructuring work plan
will be incurred in the fourth quarter of 2003.

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

Other income (expense)  net

In the first half of 2003, other income  net was $27, which primarily
included:



| |  | interest income on our short term investments; and
| | - | --------------------------------------------------

| |  | a payment received from a settlement related to intellectual property use; partially offset by
| | - | ----------------------------------------------------------------------------------------------

| |  | foreign exchange losses; and
| | - | ----------------------------

| |  | losses on the sale or write down of certain of our investments.
| | - | ---------------------------------------------------------------

Interest expense

Interest expense decreased $20 in the second quarter of 2003 compared to the
second quarter of 2002 and declined $38 in the first half of 2003 compared to
the first half of 2002. These declines were primarily due to a reduction in
the outstanding balances of our notes payable and long-term debt.

In the third quarter of 2003, we expect that our quarterly interest expense
will remain at a level similar to that of the second quarter of 2003.

Income tax benefit

In the first half of 2003, we recorded a tax benefit of $28 on the pre-tax loss
from continuing operations before minority interests and equity earnings in net
loss of associated companies. This tax benefit resulted from the tax expense
on income generated from discontinued operations and a tax refund for a
previously unrecognized loss carryback. This tax benefit was partially offset
by various non-income related taxes.

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We will continue to record a full valuation allowance on the tax benefit of
losses generated from continuing operations to the extent that such benefits
exceed the tax effect of income generated from similar transactions discussed
above. These valuation allowances are in accordance with SFAS No. 109,
Accounting for Income Taxes, which requires that tax valuation allowances be
established when it is more likely than not that some portion or all of a
companys deferred tax assets will not be realized. Our valuation allowances
are primarily attributed to continued uncertainty in the industry. If market
conditions deteriorate further or future results of operations are less than
expected, additional tax valuation allowances may be required for all or a
portion of our deferred tax assets. For additional information, see Tax asset
valuation.

Net loss from continuing operations

As a result of the items discussed under our results of operations, our
reported net loss from continuing operations improved by $670 and $1,251 in the
second quarter and first half of 2003, respectively, compared to the same
periods in 2002.

Results of operations  discontinued operations

During the first quarter of 2003, we substantially completed the wind-down of
our access solutions operations and recorded net earnings of $190 (net of tax)
related to the sale of certain components of this business. The $190 in net
earnings was primarily related to a $101 gain from the disposition of certain
shares and a membership interest in certain Arris Group Inc. companies and a
gain of $95 from the settlement of certain trade and customer financing
receivables. Our intent to exit this business was originally approved by our
Board of Directors on June 14, 2001. The continued deterioration in industry
and market conditions delayed certain disposal activities beyond the originally
planned timeframe of one year. In particular, actions involving negotiations
with customers, who have also been affected by industry conditions, took longer
than expected. Although disposal activities continued beyond the one-year
period, we have continued to present the access solutions operations as
discontinued operations in the accompanying unaudited consolidated financial
statements.

For additional information, see Discontinued operations in note 16 of the
accompanying unaudited consolidated financial statements.

Application of critical accounting policies

Our unaudited consolidated financial statements are based on the selection and
application of accounting policies, generally accepted in the United States,
which require us to make significant estimates and assumptions. We believe that
the following accounting policies may involve a higher degree of judgment and
complexity in their application and represent our critical accounting policies.
The application of these policies requires us to make subjective and objective
judgments. These accounting policies include estimates and assumptions
associated with revenue recognition, provisions for receivables, provisions for
inventory, tax asset valuation, goodwill valuation, pension and post retirement
benefits and other contingencies.

There have been no changes to our critical accounting policies since December
31, 2002, other than the material changes in the recorded balances and other
updates noted below. For further information relating to our critical
accounting policies, see our 2002 Annual Report.

Revenue recognition

In November 2002, the Financial Accounting Standards Board, or FASB, Emerging
Issues Task Force reached a consensus on Issue 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. We will be applying this guidance
prospectively for all revenue arrangements entered into after June 30, 2003 and
expect that the adoption of this pronouncement will not have a material impact
on our business, results of operations and financial condition. For additional
information, see Significant accounting policies in note 1(d) of the
accompanying unaudited consolidated financial statements.

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Provisions for receivables

We recorded receivable (recoveries) provisions, relating to continuing
operations, of $(49) in the first half of 2003 compared to $116 in the first
half of 2002. The receivable recoveries in the first half of 2003 primarily
related to net customer financing bad debt recoveries of $48 primarily as a
result of favorable settlements related to our sale or restructuring of various
customer financing related receivables and adjustments to other existing
provisions. The following table summarizes our accounts receivable and
long-term receivable balances and related reserves of our continuing
operations, as at:

June 30,
    
    
    December 31,2003
    
    
    2002Gross accounts receivable
    
    $
    2,196
    
    
    $
    2,680Related reserves
    
    
    (370
    )
    
    
    (517
    )Net accounts receivable
    
    $
    1,826
    
    
    $
    2,163Accounts receivable reserves as a percentage of gross accounts receivable
    
    
    17
    %
    
    
    19
    %Gross long-term receivables
    
    $
    409
    
    
    $
    1,001Related reserves
    
    
    (301
    )
    
    
    (736
    )Net long-term receivables
    
    $
    108
    
    
    $
    265Long-term receivable reserves as a percentage of long-term receivables
    
    
    74
    %
    
    
    74
    %


Throughout 2002, we recorded significant provisions related to receivables from
our continuing operations. In the first half of 2003, we recorded net
recoveries primarily due to our subsequent collections of certain customer
financing receivables for amounts exceeding our original estimates of net
recovery. Given the current market conditions and creditworthiness of some of
our customers, it is difficult to determine the extent to which this trend will
continue in the future.

Provisions for inventory

We recorded inventory provisions and other provisions related to our contract
manufacturers and suppliers, relating to continuing operations, of $100 in the
first half of 2003 compared to $370 in the first half of 2002. The following
table summarizes our inventory balances and related reserves of our continuing
operations, as at:

June 30,
    
    
    December 31,2003
    
    
    2002Gross inventory
    
    $
    1,876
    
    
    $
    2,056Related reserves
    
    
    (997
    )
    
    
    (1,070
    )Net inventory
    
    $
    879
    
    
    $
    986Inventory reserves as a percentage of gross inventory
    
    
    53
    %
    
    
    52
    %Other reserves for claims related to our contract manufacturers and suppliers(a)
    
    
    (146
    )
    
    
    (167
    )


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

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

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Tax asset valuation

We currently have deferred tax assets resulting from net operating loss
carryforwards, tax credit carryforwards and deductible temporary differences,
all of which will reduce taxable income in the future. We assess the
realization of these deferred tax assets quarterly to determine whether an
income tax valuation allowance is required. Based on available evidence, both
positive and negative, we determine whether it is more likely than not that all
or a portion of the remaining net deferred tax assets will be realized. In
evaluating the positive and negative evidence, the weight given to each type of
evidence must be proportionate to the extent to which it can be objectively
verified.

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

Liquidity and capital resources

Cash flows

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

6 months ended June 30,2003
    
    
    2002Net cash used in operating activities of continuing operations
    
    $
    (141
    )
    
    $
    (219
    )Net cash from (used in) investing activities of continuing operations
    
    
    301
    
    
    
    (210
    )Net cash from (used in) financing activities of continuing operations
    
    
    (110
    )
    
    
    1,403Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    78
    
    
    
    46Net cash from continuing operations
    
    
    128
    
    
    
    1,020Net cash from discontinued operations
    
    
    271
    
    
    
    288Net increase in cash and cash equivalents
    
    
    399
    
    
    
    1,308Cash and cash equivalents at beginning of period  net
    
    
    3,791
    
    
    
    3,460Cash and cash equivalents at end of period  net
    
    $
    4,190
    
    
    $
    4,768


As of June 30, 2003, our primary source of liquidity was our current cash and
cash equivalents, or cash. At June 30, 2003, we had cash of $4,190 excluding
$115 of restricted cash and cash equivalents. We believe this cash will be
sufficient to fund our current business model, manage our investments and meet
our customer commitments for at least the next 12 months. However, if capital
spending by service providers and other customers declines more significantly
than we currently expect, we may be required to adjust our current business
model. As a result, our revenues and cash flows may be materially lower than
we expect and we may be required to further reduce our investments or take
other measures in order to meet our cash requirements. We may seek additional
funds from liquidity generating transactions and other conventional sources of
external financing. We cannot provide any assurance that our net cash
requirements will be as we currently expect, that we will continue to have
access to our credit facilities and support facility when and as needed or that
liquidity generating transactions or financings will be available to us on
acceptable terms or at all.

Cash flows used in operating activities were $141 due to a net loss from
continuing operations of $133, less an adjustment of $446 for non-cash and
other items, plus a net cash outflow of $454 from operating assets and
liabilities. We generated cash inflows of $334 from accounts receivables due
to increased cash collections. Cash inflows of $137 from inventories were
primarily due to product shipments exceeding additions to inventories during
the first half of 2003. Net cash outflows from income taxes were $7. As a
result of previously incurred tax losses, we do not expect that we will have to
make significant cash income tax payments for the foreseeable future. The net
cash outflows of $938 from the remaining operating assets and liabilities were
primarily due to:

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| |  | $343 relating to restructuring payments; and
| | - | --------------------------------------------

| |  | the proportionate decrease in our assets and liabilities as a result
of the decline in sales volumes and the associated size of the business.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

Cash flows from investing activities were $301 and were primarily due to a net
decrease of $186 in long-term receivables primarily due to cash inflows of
outstanding customer financing amounts associated with two customers, a
decrease of $144 in restricted cash and cash equivalents held as cash
collateral for certain bid, performance related and other bonds, proceeds of
$21 from the sale of plant and equipment and proceeds of $8 from the sale of
certain investments and businesses. These amounts were partially offset by $56
in plant and equipment expenditures. For the year 2003, we now expect that our
plant and equipment purchases will decline substantially from the $335 in
purchases we made in 2002.

Cash flows used in financing activities were $110 and were primarily due to $94
used to reduce our long-term debt and a reduction of our notes payable by a net
of $14.

Uses of liquidity

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



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

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

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

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

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

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

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

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

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

Obligations under special charges

We expect to incur approximately $300 to $400 in restructuring work plan
related cash outflows during the remainder of 2003. For the entire year 2003,
we currently expect to incur approximately $650 to $750 in restructuring work
plan related cash outflows.

The remaining balance sheet reserve of $108 relating to workforce reduction
initiatives is expected to be substantially drawn down by mid 2004. The
remaining balance sheet reserve of $568 related to contract settlement and
lease costs is expected to be substantially drawn down by the end of 2010.

As of September 30, 2003, the remaining balance sheet reserve of $95 related to
workforce reduction initiatives is expected to be substantially drawn down by
mid-2004. The remaining balance sheet reserve of $492, net of approximately
$353 in estimated sublease revenues, related to contract settlement and lease
costs is expected to be substantially drawn down by the end of 2010. As at
December 23, 2003, for the entire year 2003, we currently expect to incur
approximately $550 to $600 in restructuring work plan related cash outflows.

Contractual cash obligations

Our contractual cash obligations for long-term debt, outsourcing contracts,
operating leases and unconditional purchase obligations remained substantially
unchanged from the amounts disclosed as at December 31, 2002 in our 2002 Annual
Report.

In the second quarter of 2003, we repaid $51 related to an outstanding loan.
In the first quarter of 2003, we purchased $39 of our 6.125% Notes due February
15, 2006. Also, we plan to repay the remaining $164 of our 6.00% Notes due
September 1, 2003 in the third quarter of 2003.

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Commitments and guarantees

Bid, performance related and other bonds

We enter into bid, performance related and other bonds in connection with
various contracts. Bid bonds generally have a term of less than twelve months,
depending on the length of the bid period for the applicable contract.
Performance related bonds generally have a term of twelve months and are
typically renewed, as required, over the term of the applicable contract.
Other bonds generally have a term of twenty-four months. The various contracts
to which these bonds apply generally have terms ranging from two to five years.
Any potential payments that we would be required to make are related to our
performance under the applicable contract.

The following table provides information related to these types of bonds, as
at:

June 30,
    
    
    December 31,2003
    
    
    2002Bid and performance related bonds(a)
    
    $
    341
    
    
    $
    400Other bonds(b)
    
    
    38
    
    
    
    35Total bid, performance related and other bonds
    
    $
    379
    
    
    $
    435


|(a) |  | Net of restricted cash and cash equivalents of $63 as at June 30, 2003
and $195 as at December 31, 2002.
|--- |  | --------------------------------------------------------------------------------------------------------
|(b) |  | Net of restricted cash and cash equivalents of $29 as at June 30, 2003
and $19 as at December 31, 2002. 

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

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

Our support facility with EDC provides support for certain obligations under
bid and performance related bonds and may reduce the requirement to provide
cash collateral to support these obligations. On July 10, 2003, Nortel
Networks Limited and EDC entered into an amendment to the support facility
which extended the termination date to December 31, 2005 from June 30, 2004.
All other material terms of the support facility remained unchanged. This
facility provides for up to $750 in support, of which $300 is committed support
for these bonds. In addition, any bid or performance related bonds with terms
that extend beyond December 31, 2005 are currently not eligible for the support
provided by this facility. In addition to the support facility with EDC, our
existing security agreements permit us to secure additional obligations under
bid and performance related bonds with the assets pledged under the security
agreements and to provide cash collateral as security for these types of bonds.
See Available support facility for additional information on this support
facility and the security agreements.

Third party debt agreements

In the normal course of business, we have guaranteed the debt of certain
customers. These third party debt agreements require us to make debt payments
throughout the term of the related debt instrument if the customer fails to
make a scheduled payment. Historically, we have not had to make material
payments and currently we do not anticipate that we will be required to make
material payments under these debt instruments. Our third party debt
agreements remain substantially unchanged from the amounts disclosed as at
December 31, 2002 in our 2002 Annual Report.

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Supply and network outsourcing contracts

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



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

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

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

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

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

Customer financing

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

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

June 30,
    
    
    December 31,2003
    
    
    2002Drawn and outstanding  gross(a)
    
    $
    471
    
    
    $
    1,091Provisions for doubtful accounts(a)
    
    
    (357
    )
    
    
    (799
    )Drawn and outstanding  net(a)
    
    
    114
    
    
    
    292Undrawn commitments (see note 18)
    
    
    667
    
    
    
    801Total customer financing
    
    $
    781
    
    
    $
    1,093


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

In the second quarter of 2003, we entered into certain agreements to either
sell or restructure various customer financing and related receivables. As a
result of these transactions, we received cash consideration of approximately
$199 to settle outstanding receivables of approximately $503 with a carrying
value of approximately $111. 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.

Also in the second quarter of 2003, we recorded net customer financing bad debt
recoveries of $48 primarily as a result of the favorable settlements described
above and adjustments to other existing provisions.

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In the first quarter of 2003, our gross customer financing receivables and
related provisions each decreased by approximately $100 as a result of the
securitization of outstanding balances associated with two of our customers and
the write down of a third customer balance as a result of the customers
bankruptcy restructuring.

We currently have customer financing commitments and/or balances outstanding in
connection with the construction of new networks, including 3G wireless
networks. Although we may commit to provide customer financing to customers in
areas that are strategic to our core businesses, we remain focused on reducing
our overall customer financing exposures in accordance with any obligations
under our financing agreements. During the first half of 2003, we reduced
undrawn commitments by $134 reflecting commitment expiration, cancellations and
changing customer business plans. As of June 30, 2003, approximately $482 of
the $667 in undrawn commitments was not available for funding under the terms
of our financing agreements. In addition to being highly selective in
providing customer financing, we have programs in place to monitor and mitigate
customer credit risk, including performance milestones and other conditions of
funding. Management is focused on the strategic use of our customer financing
capacity and on reducing the amount of our existing and future customer
financing exposure.

Subsequent to June 30, 2003, we renegotiated an agreement with a certain
customer and reduced our undrawn commitments by approximately $509, leaving
approximately $158 in aggregate undrawn commitments of which $82 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 they reflect current market
conditions. We review the ability of our customers to meet their repayment
obligations and determine our provisions accordingly. Any misinterpretation or
misunderstanding of these factors by us may result in losses in excess of our
provisions. These losses could have a material adverse effect on our business,
results of operations, financial condition and customer relationships.

Our ability to place customer financing with third party lenders has been
significantly reduced primarily due to:



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

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

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

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

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

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

Joint ventures/minority interests

As was previously discussed in our Recent developments, 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 in three European joint
ventures. During July 2003, the options and share exchange were exercised
which will require us to deliver, subject to final regulatory approval, net
consideration of approximately $130 consisting of approximately $48 in cash and
an in-kind component of approximately $82 representing the return of a loan
note currently owed to us by an affiliate of EADS. The net consideration is
payable in euro and is subject to fluctuations between the euro and United
States dollar. These transactions are expected to close prior to the end of
the third quarter of 2003 and are not expected to have a material impact on our
business, results of operations and financial condition.

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Discontinued operations

As of June 30, 2003, accruals relating to our discontinued access solutions
operations totaled $78 and were related to future contractual obligations and
estimated liabilities during the planned period of disposition. The remaining
accruals are expected to be substantially drawn down by cash payments over the
period of disposition. During the first half of 2003, we generated cash of
approximately $271 on the disposition of various assets from the access
solutions operations and associated wind-down activities.

For additional information related to our discontinued operations, see
Discontinued operations in note 16 of the accompanying unaudited consolidated
financial statements.

Sources of liquidity

Available credit facilities

We currently have $750 in available and undrawn credit facilities which expire
in April 2005. These credit facilities were entered into on April 12, 2000 by
Nortel Networks Limited and Nortel Networks Inc. and permit borrowings for
general corporate purposes. As of June 30, 2003, there were no balances drawn
under our available credit facilities.

The $750 April 2000 five year credit facilities contain a financial covenant
requiring that Nortel Networks Limiteds consolidated tangible net worth at any
time be not less than $1,888. As of June 30, 2003, we were in compliance with
this covenant. We continue to monitor the financial position of Nortel
Networks Limited in light of this covenant and if we incur net losses or record
additional charges relating to our restructuring work plan, the accounting of
our registered pension plans, the valuation of deferred income tax assets or
for other events, Nortel Networks Limiteds consolidated tangible net worth may
be reduced below the $1,888 threshold. If Nortel Networks Limited is unable to
comply with the consolidated tangible net worth covenant, we will be unable to
access the $750 April 2000 five year credit facilities.

Available support facility

On February 14, 2003, Nortel Networks Limited entered into an agreement with
EDC regarding arrangements to provide support, on a secured basis, of certain
of its performance related obligations arising out of normal course business
activities. This facility, which, following an amendment on July 10, 2003,
expires on December 31, 2005, provides for up to $750 in support including $300
of committed revolving support for performance bonds or similar instruments of
which $123 was utilized as at June 30, 2003. The remainder is uncommitted
support for performance bonds, receivables sales and/or securitizations of
which $65 was utilized as at June 30, 2003.

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

Nortel Networks Limiteds obligations under the support facility with EDC are
secured on an equal and ratable basis under the existing security agreements
entered into by Nortel Networks Limited and various of our subsidiaries that
pledge substantially all of Nortel Networks Limited and its subsidiaries assets
in favor of the banks under the $750 April 2000 five year credit facilities,
the holders of Nortel Networks Limiteds public debt securities and the holders
of our 4.25% convertible senior notes. The security provided under the
security agreements is comprised of:



| |  | pledges of substantially all of the assets Nortel Networks Limited
and those of most of its United States and Canadian subsidiaries;
| | - | ------------------------------------------------------------------------------------------------------------------------------------

| |  | share pledges in certain of Nortel Networks Limiteds other subsidiaries; and
| | - | -----------------------------------------------------------------------------

| |  | guarantees by certain of Nortel Networks Limiteds wholly owned subsidiaries.
| | - | -----------------------------------------------------------------------------

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If Nortel Networks Limiteds senior long-term debt rating by Moodys returns to
Baa2 (with a stable outlook) and its rating by Standard & Poors returns to BBB
(with a stable outlook), the security and guarantees will be released in full
in respect of the banks, EDC, the public debtholders and any other party
secured under the security agreements at that time. If both the $750 April
2000 five year credit facilities and the support facility with EDC are
terminated, or expire, the security and
guarantees will also be released in full in respect of the banks, EDC, the
public debtholders and any other party secured under the security agreements at
that time. Nortel Networks Limited 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 acceptable to EDC) in lieu of the security provided under the
security agreements.

For additional information relating to our outstanding public debt, the $750
April 2000 five year credit facilities and the support facility with EDC, see
Long-term debt, credit and support facilities and Supplemental consolidating
financial information in notes 8 and 19, respectively, of the accompanying
unaudited consolidated financial statements. For additional financial
information related to those subsidiaries providing guarantees, see
Supplemental consolidating financial information in note 19 of the
accompanying unaudited consolidated financial statements. For information
relating to our debt ratings, see Credit ratings below. See Forward looking
statements for factors that may affect our ability to comply with covenants
and conditions in our credit and support facilities in the future.

Shelf registration statement and base shelf prospectus

In the second quarter of 2002, we filed a shelf registration statement with the
SEC and a base shelf prospectus with the applicable securities regulatory
authorities in Canada, to qualify for the potential sale of up to $2,500 of
various types of securities in the United States and/or Canada. The qualifying
securities include common shares, preferred shares, debt securities, warrants
to purchase equity or debt securities, share purchase contracts and share
purchase or equity units (subject to certain approvals). As of June 30, 2003,
approximately $1,700 of the $2,500 available under the shelf registration
statement and base shelf prospectus has been utilized. Approximately $800
remains available for use.

Credit ratings

Rating on long-term debtissued or guaranteed byNortel Networks
    
    
    Rating on preferred sharesLimited/Nortel Networks
    
    
    issued by Nortel NetworksRating agency
    
    Corporation
    
    
    Limited
    
    
    Last updateStandard & Poors Ratings Service
    
    
    B
    
    
    CCC
    
    
    September 18, 2002Moodys Investors Services, Inc.
    
    
    B3
    
    
    Caa3
    
    
    November 1, 2002


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

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

Off-balance sheet arrangements

We have conducted certain receivable sales and lease financing transactions
through special purpose entities.

Our receivable sales transactions are generally conducted either directly with
financial institutions or with multi-seller conduits. Under the criteria set
out in FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, or FIN 46, we do not expect that we will be required to consolidate
any of these entities or provide any of the additional disclosures set out in
FIN 46.

Certain lease financing transactions are structured through single transaction
special purpose entities that currently do not have sufficient equity at risk
as defined in FIN 46. In addition, we retain certain risks associated with
guaranteeing recovery of the unamortized principal balance of debt which is
expected to represent the majority of the risks associated with the special
purpose entities activities. The amount of the guarantee will be adjusted
over time as the underlying debt matures. Therefore, we will be required to consolidate the assets, liabilities and any
non-controlling interests of these special purpose entities effective July 1,
2003. The total assets and total liabilities held by these entities at June 30,
2003 were each approximately $181 and represented the collateral and maximum
exposure to loss, respectively, as a result of our involvement with these
entities.

For additional information, see Significant accounting policies in note 1(c)
of the accompanying unaudited consolidated financial statements.

Contractual obligations

Our contractual cash obligations for long-term debt, outsourcing contracts,
operating leases and unconditional purchase obligations remained substantially
unchanged from the amounts disclosed as at December 31, 2002 in our 2002 Annual
Report. See Contractual cash obligations for additional information.

Contingent liabilities and commitments

Customer financing commitments

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

Purchase commitments

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

Commitment relating to joint ventures/minority interests

See Joint ventures/minority interests for additional information relating to
the acquisition of the minority interest in two of our joint ventures and the
disposition of our equity interest in a third joint venture.

Other contingent liabilities and commitments

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



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

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

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

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

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

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

Historically, we have not made any significant payments under any of these
indemnifications or guarantees. In certain cases, due to the nature of the
agreement, we have not been able to estimate our maximum potential loss or the
maximum potential loss has not been specified. For additional information, see
Guarantees in note 10 of the accompanying unaudited consolidated financial
statements.

Market risk

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

For additional information relating to our derivative financial instruments,
you should refer to Significant accounting policies in note 2(s) and
Financial instruments and hedging activities in note 12 of the consolidated
financial statements contained in our 2002 Annual Report.

We manage foreign exchange exposures using forward and option contracts to
hedge firm sale and purchase commitments. Our most significant foreign
exchange exposures are in the Canadian dollar, the United Kingdom pound and the
euro. We enter into United States to Canadian dollar forward and option
contracts intended to hedge the United States to Canadian dollar exposure on
future revenues and expenditure streams. In accordance with SFAS 133,
Accounting for Derivative Instruments and Hedging Activities, we recognize
the gains and losses on the effective portion of these contracts in income when
the hedged transaction occurs. Any ineffective portion of these contracts is
recognized in income immediately.

We expect to continue to expand our business globally and, as such, expect that
an increasing proportion of our business will be denominated in currencies
other than United States dollars. As a result, fluctuations in foreign
currencies may have a material impact on our business, results of operations
and financial condition. We try to minimize the impact of such currency
fluctuations through our ongoing commercial practices and by attempting to
hedge our exposures to major currencies. In attempting to manage this foreign
exchange risk, we identify operations and transactions that may have exposure
based upon the excess or deficiency of foreign currency receipts over foreign
currency expenditures. Given our exposure to international markets, we
regularly monitor all of our foreign currency exposures. We cannot predict
whether we will incur foreign exchange losses in the future. However, if
significant foreign exchange losses are experienced, they could have a material
adverse effect on our business, results of operations and financial condition.

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

For additional information on our exposure to foreign currency and interest
rate risk, you should refer to our Market Risk discussion
in our 2002 Annual
Report.

Legal proceedings

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 and financial condition. We, and any of our named
directors or officers, intend to vigorously defend these actions, suits,
claims, proceedings and investigations.

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For additional information related to our legal proceedings, see
Contingencies in note 17 of the accompanying unaudited consolidated financial
statements.

Forward looking statements

Certain statements in this Quarterly Report, contain words such as could,
expects, may, anticipates, believes, intends, estimates, plans,
envisions and other similar language and are considered forward looking
statements. These statements are based on our current expectations, estimates,
forecasts and projections about the operating environment, economies and
markets in which we operate. In addition, other written or oral statements
which are considered forward looking may be made by us or others on our behalf.
These statements are subject to important risks, uncertainties and
assumptions, which are difficult to predict and the actual outcome may be
materially different. Some of the factors which could cause results or events
to differ from current expectations include, but are not limited to, the risk
factors described below. Unless required by applicable securities laws, we do
not have any intention or obligation to publicly update or revise any forward
looking statements, whether as a result of new information, future events or
otherwise. The risk factors have been updated to reflect the restatements as
well as for events and developments subsequent to June 30, 2003.

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

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

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

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



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

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

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

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

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

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business from one or more of these customers, or a failure to achieve
a significant market share with these customers, could have a material adverse
effect on our business, results of operations and financial condition.

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Significant fluctuations in our operating results could contribute to
volatility in the market price of our common shares.

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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



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

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

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

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

Our gross margins may be negatively affected, which in turn would negatively
affect our operating results and could contribute to volatility in the market
price of our common shares.

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



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

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

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

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

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

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

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

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

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

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

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

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

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

Lower than expected gross margins would negatively affect our operating results
and could contribute to volatility in the market price of our common shares.

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

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

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

Our working capital requirements and cash flows historically have been, and are
expected to continue to be, subject to quarterly and yearly fluctuations,
depending on such factors as timing and size of capital expenditures, levels of
sales, timing of deliveries and collection of receivables, inventory levels,
customer payment terms, customer financing obligations and supplier terms and
conditions. In addition, due to the current general economic and industry
environment, and our current credit condition, an increased portion of our cash
and cash equivalents may be restricted as cash collateral for customer

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

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

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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We have risks related to our defined benefit plans.

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

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

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

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

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

We cannot be sure what the rate of such convergence of voice and data networks
will be, due to the dynamic and rapidly evolving nature of the communications
business, the technology involved and the availability of capital.
Consequently, market discontinuities and the resulting demand for IP-optimized
networking solutions or 3G wireless networks may not materialize.
Alternatively, the pace of that development may be slower than currently
anticipated. It may also be the case that the market may develop in an
unforeseen direction. Certain events, including the commercial availability
and actual implementation of new technologies, including 3G networks, or the
evolution of other technologies, may occur which would

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affect the extent or
timing of anticipated market demand, or increase demand for products based on
other technologies, or reduce the demand for IP-optimized networking solutions
or 3G wireless networks, which in turn may reduce purchases of
our networking solutions by our customers, require increased expenditures to
develop and market different technologies, or provide market opportunities for
our competitors. Our performance may also be materially and adversely affected
by a lack of growth in the rate of data traffic, a reduction in the use of the
Internet or a reduction in the demand for IP-optimized networking solutions or
3G wireless networks in the future.

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

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



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

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

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

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

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

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

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

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

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

| |  | potential issuance of common stock that would dilute our shareholders percentage ownership; and
| | - | ------------------------------------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

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We face certain barriers in our efforts to expand internationally.

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



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

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

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

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

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

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

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

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

| |  | taxation;
| | - | ---------

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

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

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

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

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

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

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

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

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

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intellectual property rights, we may not be able to successfully contest
such challenges.

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

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

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

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

Our stock price has historically been volatile and further declines in the
market price of our common shares or our other securities may negatively impact
our ability to make future strategic acquisitions, raise capital, issue debt or
retain employees.

Our common shares have experienced, and may continue to experience, substantial
price volatility, including considerable decreases, particularly as a result of
variations between our actual or anticipated financial results and the
published expectations of analysts and as a result of announcements by our
competitors and us. Also, we are no longer listed on the S&P 500 or S&P 100
indices which may also affect the price volatility of our common shares. Our
credit quality, any equity or equity related offerings, operating results and
prospects, restatements of previously issued financial statements, among other
factors, including any exclusion of our common shares from any other widely
followed stock market indices, will also affect the market price of our common
shares.

The stock markets have experienced extreme price fluctuations that have
affected the market price and trading volumes of many technology and
telecommunications companies in particular, with potential consequential
negative effects on the trading of securities of such companies. A major
decline in the capital markets generally, or an adjustment in the market price
or trading volumes of our common shares or our other securities, may negatively
impact our ability to raise capital, issue debt, secure customer business,
retain employees or make future strategic acquisitions. These factors, as well
as general economic and geopolitical conditions, and continued negative events
within the technology sector, may in turn have a

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material adverse effect on the market price of our common shares.

Substantial price volatility may result in our failure to meet the minimum
listing requirements of the New York Stock
Exchange which include a minimum share price condition.

There are risks associated with a share consolidation.

By special resolution approved by our shareholders at the annual and special
meeting of shareholders held on April 24, 2003, the board of directors has the
authority, in its sole discretion, to consolidate our issued and outstanding
common shares (also known as a reverse stock split) at any time prior to April
15, 2004 at a consolidation ratio selected by the board of directors, provided
that (i) the ratio may be no smaller than one post-consolidation common share
for every five pre-consolidation common shares, and no larger than one
post-consolidation common share for every ten pre-consolidation common shares,
and (ii) the number of pre-consolidation shares in the ratio must be a whole
number of common shares (that is, either five, six, seven, eight, nine or ten).
In addition, notwithstanding approval of the proposed consolidation by the
shareholders, the board of directors, in its sole discretion, may revoke the
special resolution, and abandon the consolidation without further approval or
action by or prior notice to the shareholders.

There can be no assurance that our board of directors will implement the
proposed share consolidation. Failure to implement the proposed share
consolidation may increase the probability that our common shares would be
delisted from the New York Stock Exchange in the future due to failure to
satisfy the minimum share price listing condition. In addition, in the event
that the trading price or trading volume of our common shares on the New York
Stock Exchange were to fall to an abnormally low level, the New York Stock
Exchange would have discretionary authority to begin delisting proceedings
prior to any action by our board of directors to implement the proposal.

There can be no assurance that any increase in the market price for each of our
common shares resulting from a share consolidation will be sustainable or that
it will equal or exceed the direct arithmetical result of the consolidation
(that is, from five to ten times the pre-consolidation price, depending on the
ratio selected by our board of directors) since there are numerous factors and
contingencies that would affect such price, including the status of the market
for the common shares at the time, our reported results of operations in future
periods and general economic, geopolitical, stock market and industry
conditions. Accordingly, the total market capitalization of our common shares
after a possible share consolidation may be lower than the total market
capitalization before such consolidation and, in the future, the market price
of the common shares may not exceed or remain higher than the market price
prior to such consolidation. Further, there can be no assurance that, post
consolidation, Nortel Networks will continue to meet the minimum listing
requirements of the New York Stock Exchange. If such minimum listing
requirements are not met, the New York Stock Exchange would have discretionary
authority to begin delisting proceedings. The delisting of Nortel Networks
common shares from the New York Stock Exchange could have a material adverse
effect on the market price and liquidity of the common shares.

While a higher share price may help generate investor interest in our common
shares, there can be no assurance that a share consolidation will result in a
per share market price that will attract institutional investors or investment
funds or that such price will satisfy the investing guidelines of institutional
investors or investment funds. As a result, the trading liquidity of the
common shares may not necessarily improve as a result of a share consolidation.

If the share consolidation is implemented and the market price of our common
shares declines, the percentage decline may be greater than would occur in the
absence of the share consolidation. The market price of the common shares
will, however, also be based on our performance and other factors, which are
unrelated to the number of common shares outstanding. Furthermore, the
liquidity of our common shares could be adversely affected by the reduced
number of common shares that would be outstanding after the share
consolidation.

Acceleration of the settlement date on early settlement of our purchase
contracts could contribute to volatility in the market price of our common
shares.

On June 12, 2002, concurrent with the offering of our common shares, 28,750
equity units were offered, each initially evidencing ownership of a prepaid
forward purchase contract, or purchase contract, entitling the holder to
receive our common shares, and specified zero-coupon U.S. treasury strips.
The aggregate number of our common shares issuable on the settlement date of
the remaining purchase contracts will be between approximately 333 million and
400 million shares, subject to some anti-dilution adjustments (which include
adjustments for a possible consolidation of our common shares), depending on
the applicable market value of Nortel Networks common shares. As at October
31, 2003, 9,793 purchase

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contracts were outstanding. The settlement date for
each purchase contract is August 15, 2005, subject to acceleration or early
settlement in certain cases. If we are involved in a merger, amalgamation,
arrangement, consolidation or other reorganization event (other than with or
into Nortel Networks Limited or certain other subsidiaries) in which all of our
common shares are exchanged for consideration of at least 30 percent of the
value of which consists of cash or cash equivalents, then a holder of purchase
contracts may elect to accelerate and settle some or all of its purchase
contracts, for our
common shares. The settlement date under each purchase contract will
automatically accelerate upon the occurrence of specified events of bankruptcy,
insolvency or reorganization with respect to us. Upon acceleration of the
settlement date, holders will be entitled to receive 20,263.12 common shares
per purchase contract (regardless of the market price of our common shares at
that time), subject to some anti-dilution adjustments. A holder of purchase
contracts may also elect to accelerate the settlement date in respect of some
or all of its purchase contracts. Upon an early settlement, the holder will
receive 16,885.93 common shares per purchase contract (regardless of the market
price of Nortel Networks common shares at that time), subject to some
anti-dilution adjustments. An acceleration of the settlement date or early
settlement of our purchase contracts could contribute to volatility in the
market price of our common shares.

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

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

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

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

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

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

Our ability to meet customer demand is, in part, dependent on us obtaining
timely and adequate component parts and products from suppliers, contract
manufacturers, and internal manufacturing capacity. As part of the
transformation of our supply chain from a vertically integrated manufacturing
model to a virtually integrated model, we have outsourced a substantial portion
of our manufacturing capacity to contract manufacturers. We work closely with
our suppliers and contract

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manufacturers to address quality issues and to meet
increases in customer demand, when needed, and we also manage our internal
manufacturing capacity, quality, and inventory levels as required. However, we
may encounter shortages of quality components and/or products in the future.
In addition, our component suppliers and contract manufacturers have
experienced, and may continue to experience, a consolidation in the industry
and financial difficulties, both of which may result in fewer sources of
components or products and greater exposure to the financial stability of our
suppliers. A reduction or interruption in component supply or external
manufacturing capacity, a significant increase in the price of one or more
components, or excessive inventory levels could materially and negatively
affect our gross margins and our operating results
and could materially damage customer relationships.

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

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

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

We are currently a defendant in numerous class actions and other lawsuits,
including lawsuits initiated on behalf of holders of our common shares, which
seek damages of material and indeterminate amounts, as well as lawsuits in the
normal course of business. We are and may in the future be subject to other
litigation arising in the normal course of our business.

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

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

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Recent accounting pronouncements

For a discussion of recent pronouncements, see Significant accounting
policies in note 1 of the accompanying unaudited consolidated financial
statements.




ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact the consolidated
financial statements of Nortel Networks due to adverse changes in financial
market prices and rates. Nortel Networks market risk exposure is primarily a
result of fluctuations in interest rates and foreign exchange rates. Disclosure
of market risk is contained in our 2002 Annual Report.




ITEM 4. Controls and Procedures

This Item 4 has been updated to reflect the restatements as well as for events
and developments subsequent to June 30, 2003.



|(a) |  | Evaluation of Disclosure Controls and Procedures
|--- |  | ------------------------------------------------

Subsequent to the evaluation referenced in Nortel Networks Quarterly Report on
Form 10-Q for the period ended June 30, 2003 filed with the Securities and
Exchange Commission (the SEC) on August 12, 2003, Nortel Networks has
re-evaluated the effectiveness of the design and operation of Nortel Networks
disclosure controls and procedures as of the end of the period covered by this
report under the supervision and with the participation of management,
including the President and Chief Executive Officer and the Chief Financial
Officer, pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as
amended (the Exchange Act), in light of the restatements and the
identification of certain material weaknesses discussed below.

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



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

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

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

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

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that the design and
operation of Nortel Networks disclosure controls and procedures were effective,
in all material respects, to ensure that information required to be disclosed
in the reports Nortel Networks files and
submits under the Exchange Act is recorded, processed, summarized and reported
as and when required, except for the material weaknesses identified above.



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

Nortel Networks initiated, and disclosed in its Quarterly Report on Form 10-Q
for the period ended June 30, 2003, a comprehensive review and analysis of its
assets and liabilities. On October 23, 2003, Nortel Networks announced it would
restate its consolidated financial statements for the years ended December 31,
2002, 2001 and 2000 and the fiscal quarters ended March 31, 2003 and June 30,
2003. The restatements primarily relate to the determination by Nortel
Networks that $952 and $935 of liabilities (primarily accruals and provisions)
carried on its previously reported balance sheet as at June 30, 2003 and
December 31, 2002, respectively, needed to be released to income. These
provisions were either initially recorded incorrectly in prior periods or not
properly released or adjusted for changes in estimates in the appropriate
periods. In certain cases, costs were incorrectly charged to operations rather
than to the appropriate provisions. Following its determination to restate its
financial statements, Nortel Networks also determined that it would correct
certain known errors that were previously not recorded because the amount of
the errors was not material to the consolidated financial statements.
Specifically, among other items, Nortel Networks has made certain revenue
adjustments to reflect revenue which should have been deferred instead of
recognized in a particular period. Also, as part of the restatements, Nortel
Networks made adjustments to correct errors relating to its deferred income tax
assets and foreign currency translation accounts. The net effect of the
restatement adjustments to Nortel Networks accumulated deficit as at June 30,
2003 was $505. Please see note 2 to the accompanying (unaudited) consolidated
financial statements and Recent developmentsRestatements in the MD&A for
further information concerning the restatements and their impact on Nortel
Networks financials statements.

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



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

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

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

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

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

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

There has been no change in Nortel
Networks internal control over financial reporting during the period covered by
this report or, with the exception of the items noted above, in the period ended September 30, 2003 covered by Nortel
Networks Quarterly Report on Form 10-Q filed with the SEC on November 19, 2003
that has materially affected or is reasonably likely to materially affect Nortel Networks
internal control over financial reporting.

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PART II




ITEM 6. Exhibits And Reports On Form 8-K

The information set forth in this Item 6 has not been revised to reflect events
and developments subsequent to June 30, 2003 except for Exhibits 31.1, 31.2 and 32.

a)
    
    Exhibits:10.1
    
    Amended general description of special cash bonus for
employees and executives of Nortel Networks Corporation
and Nortel Networks Limited.*10.2
    
    Nortel Networks Corporation Directors Deferred Share
Compensation Plan as amended and restated, effective May
29, 2003.*10.3
    
    Nortel Networks Limited Directors Deferred Share Compensation Plan
as amended and restated, effective May 29, 2003.10.4
    
    Letter dated June 23, 2003 from Frank A. Dunn, 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 granted to and held by Frank A.
Dunn.31.1
    
    Certification of the President and Chief
Executive Officer pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    Certification of the Chief Financial
Officer pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32
    
    Certification of the President and Chief
Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.b)
    
    Reports on Form 8-K:Nortel Networks Corporation furnished a Current Report on Form 8-K
dated April 24, 2003 related to its financial results for the first
quarter 2003.Nortel Networks Corporation filed a Current Report on Form 8-K dated
April 24, 2003 related to its financial results for the first quarter
of 2003.Nortel Networks Corporation filed a Current Report on Form 8-K dated
April 24, 2003 related to the approval by the shareholders of Nortel
Networks Corporation at the annual and special meeting held on April
24, 2003 granting the Board of Directors of Nortel Networks
Corporation the authority to implement a consolidation of its
outstanding common shares, in its sole discretion and the
reconfirmation and amendment of Nortel Networks Corporations
shareholder rights plan.Nortel Networks Corporation filed a Current Report on Form 8-K dated
July 10, 2003 related to Amending Agreement No. 1 dated as of July
10, 2003 to the Master Facility Agreement dated as of February 14,
2003 between Nortel Networks Limited and Export Development Canada.


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Nortel Networks Corporation furnished a Current Report on Form 8-K
dated July 25, 2003 related to its financial results for the second
quarter of 2003.Nortel Networks Corporation filed a Current Report on Form 8-K dated
July 25, 2003 related to its financial results for the second quarter
of 2003.


| | 
| | 

| | * |  | Previously filed as an exhibit to the Originally Filed 10-Q, which
was filed with the Securities and Exchange Commission on August 11,
2003.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

NORTEL NETWORKS CORPORATION
(Registrant)

Chief Financial Officer  
D.C.
BEATTY
D.C. BEATTY
Chief Financial Officer
    
    Chief Accounting Officer  
M.J.
GOLLOGLY
M.J. GOLLOGLY
Controller


Date:  December 23, 2003

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