Reliant Nortel Networks Form 10 K Users Manual December 31, 2003

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2003

For the transition period from to

Commission file number 001-07260

Nortel Networks Corporation

(Exact name of registrant as specified in its charter)

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

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

The common shares are also listed on the Toronto Stock Exchange in Canada

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act

of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been

subject to filing requirements for the past 90 days. Yes No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be

contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form

10-K or any amendment to this Form 10-K.

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

On December 31, 2004, 4,268,236,086 common shares of Nortel Networks Corporation were issued and outstanding. Non-affiliates of

the registrant held 4,261,699,641 common shares having an aggregate market value of $14,788,097,754 based upon the last sale price

on the New York Stock Exchange on December 31, 2004, of $3.47 per share; for purposes of this calculation, shares held by directors

and executive officers have been excluded.

Annual report pursuant to Section 13 or 15(d) of

the Securities Exchan

e Act of 1934

Transition report pursuant to Section 13 or 15(d) of

the Securities Exchan

e Act of 1934

Canada Not A

licable

(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

8200 Dixie Road, Suite 100, Bram

ton, Ontario, Canada L6T 5P6

(Address of principal executive offices) (Zip Code)

Title of each class Name of each exchan

e on which re

istered

Common Shares without nominal or par value New York Stock Exchange

4.25% Convertible Senior Notes Due 2008 New York Stock Exchange

EXPLANATORY NOTE

Nortel Networks Corporation previously announced the need to restate its consolidated financial statements for the years ended December 31,

2002 and 2001 and each of its first three quarterly periods for 2003.

The consolidated statements of operations, changes in equity and comprehensive income (loss) and cash flows for the years ended

December 31, 2002 and 2001 and the consolidated balance sheet as of December 31, 2002, including the applicable notes, contained in this

Annual Report on Form 10-K have been restated.

A number of Nortel Networks past filings with the United States Securities and Exchange Commission remain subject to ongoing review by

the United States Securities and Exchange Commission’s Division of Corporation Finance. In addition, the Second Restatement involved the

restatement of Nortel Networks consolidated financial statements for 2001 and 2002 and the first, second and third quarters of 2003.

Amendments to Nortel Networks prior filings with the United States Securities and Exchange Commission would be required in order for

Nortel Networks to be in full compliance with Nortel Networks reporting obligations under the Securities Exchange Act of 1934. However,

Nortel Networks does not believe that it will be feasible to amend Nortel Networks Annual Report on Form 10-K/A for the year ended

December 31, 2002, or 2002 Form 10-K/A and our 2003 Quarterly Reports due to, among other factors, identified material weaknesses in

Nortel Networks internal control over financial reporting, the significant turnover in Nortel Networks finance personnel, changes in accounting

systems, documentation weaknesses, a likely inability to obtain third party corroboration in certain cases due to the substantial industry

adjustment in recent years and the passage of time generally. In addition, disclosure in the 2002 Form 10-K/A and 2003 Form 10-Qs would in

large part repeat the disclosure expected to be contained in this report and the 2004 Form 10-Qs. Accordingly, Nortel Networks does not plan

to amend our 2002 Form 10-K/A and 2003 Form 10-Qs. Nortel Networks believes that it has included in this report all information needed for

current investor understanding. Ongoing United States Securities and Exchange Commission review may require Nortel Networks to amend

this Annual Report on Form 10-K or Nortel Networks other public filings.

For a description of the restatements, see “Restatement” in note 3 of the accompanying audited consolidated financial statements and “Item 7

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Developments in 2003 and 2004 — Nortel

Networks Audit Committee Independent Review; restatements; related matters” contained in this Annual Report on Form 10-K.

TABLE OF CONTENTS

PART I

ITEM 1. Business 1

Overview 1

Developments in 2003 and 2004 2

Networking solutions 5

Wireless Networks 6

Enterprise Networks 9

Wireline Networks 11

Optical Networks 14

Sales and distribution 17

Backlog 17

Product standards, certification and regulation 18

Sources and availability of materials 18

Seasonality 19

Strategic alliances, acquisitions and minority investments 19

Research and development 20

Intellectual property 20

Employee relations 21

Environmental matters 22

Financial information by operating segment and product category 22

Financial information by geographic area 22

Working capital 23

Risk factors 23

ITEM 2. Properties 24

ITEM 3. Legal Proceedings 25

ITEM 4. Submission of Matters to a Vote of Security Holders 29

PART II

ITEM 5. Market for the Registrant’s Common Equity and Related Stockholder Matters 29

Securities authorized for issuance under equity compensation plans 29

Dividends 30

Canadian tax matters 30

Sales of unregistered securities 30

ITEM 6. Selected Financial Data (Unaudited) 31

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 35

Business overview 37

Developments in 2003 and 2004 41

Results of operations —continuing operations 54

Results of operations —discontinued operations 72

Liquidity and capital resources 73

Off-balance sheet arrangements, contractual obligations and contingent liabilities and commitments 80

Application of critical accounting estimates 82

Accounting change and recent accounting pronouncements 89

Market risk 91

Equity price risk 92

Environmental matters 92

Legal proceedings 93

Risk factors/forward looking statements 93

ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 111

ITEM 8. Consolidated Financial Statements and Supplementary Data 112

ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 113

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

NORTEL NETWORKS, NORTEL NETWORKS LOGO, NT, the GLOBEMARK, BUSINESS WITHOUT BOUNDARIES, DMS, OPTERA

and UNIVERSAL EDGE are trademarks of Nortel Networks.

ACCESSNODE is a trademark of Zhone Technologies Inc.

CDMA2000 is a trademark of the Telecommunications Industry Association.

CDMAONE — design mark is a trademark of the CDMA Development Group, Inc.

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

MOODY’S is a trademark of Moody’s Investors Service, Inc.

RCMP is a trademark of the Royal Canadian Mounted Police.

S&P and STANDARD & POOR’S are trademarks of The McGraw-Hill Companies, Inc.

ITEM 9A. Controls and Procedures 113

PART III

ITEM 10. Directors and Executive Officers of the Registrant 138

Executive officers and certain other non-executive board appointed officers of the Registrant 142

Section 16(a) beneficial ownership reporting compliance 144

ITEM 11. Executive Compensation 145

Summary compensation table 145

Option grants in 2003 151

Aggregate option exercises in 2004 and 2003 and year-end option values 151

Long-term incentive plans —awards in last fiscal year 154

Retirement plans 155

Certain employment arrangements 158

Compensation of directors 160

Compensation committee interlocks and insider participation 161

ITEM 12. Security Ownership of Certain Beneficial Owners and Management 161

Equity compensation plan information 164

ITEM 13. Certain Relationships and Related Transactions 165

Indebtedness of managemen

165

ITEM 14. Principal Accountant Fees and Services 166

PART IV

ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 168

SIGNATURES 223

PART I

Overview

Nortel Networks Corporation is a recognized leader in delivering communications capabilities that enhance the human experience, ignite and

power global commerce, and secure and protect the world’s most critical information. We offer converged multimedia networks that use

innovative packet, wireless, voice and optical technologies and are underpinned by high standards of security and reliability. For both service

providers and enterprises, these networks help to drive increased profitability and productivity by reducing costs and enabling new business

and consumer services opportunities. We refer to the communications technology, infrastructure and related professional services that we

supply as “networking solutions”. Our business consists of the design, development, manufacture, assembly, marketing, sale, licensing,

installation, servicing and support of these networking solutions. A substantial portion of our business has a technology focus and is dedicated

to research and development. This focus forms a core strength and is a factor that we believe differentiates us from many of our competitors.

We envision a network society where people will be able to connect and interact with information and with each other instantly, simply and

reliably, accessing data, voice and multimedia communications services and sharing experiences anywhere, anytime.

Our networking solutions enable our service provider and enterprise customers to provide their own customers or employees with services to

communicate locally, regionally or globally through the use of data, voice and multimedia communications. Our service provider customers

include local and long-distance communications companies, wireless service providers and cable operators. Our networking solutions enable

our service provider customers to deploy reliable, robust networks that create opportunities to provide revenue-generating services and cost

savings. Our enterprise customers include large and small businesses, governments and institutions. Our networking solutions enable our

enterprise customers to deploy secure networks with seamless connectivity that provide opportunities for cost efficiency and increased

productivity.

During 2003 and up to September 30, 2004, we conducted our business through the following four reportable segments: Wireless Networks;

Enterprise Networks; Wireline Networks; and Optical Networks. We refer you to the descriptions of each of these segments below. Effective

October 1, 2004, we established a new organizational structure that included, among other things, combining the businesses of our four

segments into two business organizations: (i) Carrier Networks and Global Operations; and (ii) Enterprise Networks. We are reviewing the

impact of these changes to our reportable segments under applicable accounting standards. The new structure reflects the evolution of the

network transformation to converged networks. For financial information by reporting segment and product category, see “Segment

information” in note 6 of the accompanying consolidated financial statements and “Results of operations — continuing operations — Segment

revenues” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A.

The Company’s principal executive offices are located at 8200 Dixie Road, Suite 100, Brampton, Ontario, Canada, L6T 5P6, telephone number

(905) 863-0000. The Company was incorporated in Canada on March 7, 2000 under the name New Nortel Inc. On May 1, 2000, the Company

participated in a Canadian court-approved plan of arrangement under which, among other things, the Company exchanged its common shares

for all of the outstanding common shares of Nortel Networks Limited (previously known as Nortel Networks Corporation); Nortel Networks

Limited, or NNL, became the principal operating subsidiary of the Company; and the Company changed its name to Nortel Networks

Corporation.

Where we say “we”, “us”, “our” or “Nortel Networks”, we mean Nortel Networks Corporation or Nortel Networks Corporation and its

subsidiaries, as applicable. References to “the Company” mean Nortel Networks Corporation without its subsidiaries. Where we refer to the

“industry”, we mean the telecommunications industry.

The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to

those reports available free of charge under “Investor Relations” on our website at www.nortel.com as soon as reasonably practicable after we

electronically file this material with, or furnish this material to, the United States Securities and Exchange Commission, or SEC. We have

adopted a Code of Ethics known as “Living the Values: A Guide to Ethical Business Practices at Nortel Networks”. We make our Code of

Ethics, and all amendments to and waivers of (in accordance with applicable laws) our Code of Ethics, available free of charge under

“Corporate Information” on our website at www.nortel.com or by writing to our corporate secretary at Nortel Networks Corporation, 8200

Dixie Road, Suite 100,

ITEM 1. Business

Brampton, Ontario L6T 5P6. Information contained on our website is not incorporated by reference into our annual report on Form 10-K.

Developments in 2003 and 2004

usiness environment

In 2003, customer spending remained cautious as a result of tightened capital markets, mainly in the first half of 2003, and customers

realigning capital spending with their current levels of revenues and profits in order to maximize their return on invested capital. We

experienced continued industry adjustment and capital spending restrictions by our service provider customers. In 2003, many of our customers

continued to focus on conserving capital, decreasing their debt levels, reducing costs and/or increasing the capacity utilization rates and

efficiency of their existing networks. Also, excess network capacity and competition continued to exist in the industry, which led to continued

pricing pressures on the sale of certain of our products.

During the second half of 2003 and into 2004, we began to experience a period of relative industry stability following an unprecedented period

of business realignment that commenced in 2001 in response to a significant industry adjustment. Throughout the second half of 2003 and into

2004, we announced several new contracts across all of our reportable segments, but primarily in our Wireless Networks segment, as certain

service provider customers began to expand and upgrade their existing networks.

The period of relative industry stability that had characterized the second half of 2003 continued into 2004. The moderate growth in 2004 has

primarily been a result of customers increasing their investments in:

In 2004, spending in these areas of our business has been partially offset by customers limiting their investments in mature technologies as they

focus on maximizing return on investment capital. In addition, we have continued to experience pricing pressures on sales of certain of our

products as a result of increased competition, particularly from low cost competitors. Further, while customer support generally remains strong,

the ongoing restatement activities and the internal restructuring and realignment programs initiated in August 2004 have adversely impacted

business performance in 2004.

ortel Networks Audit Committee Independent Review; restatements; related matters

In May 2003, we commenced certain balance sheet reviews at the direction of certain members of former management that led to a

comprehensive review and analysis of our assets and liabilities, or the Comprehensive Review, which resulted in the restatement (effected in

December 2003) of our consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the quarters ended

March 31, 2003 and June 30, 2003, or the First Restatement.

In late October 2003, the Audit Committees of the Boards of Directors of Nortel Networks and NNL, or the Audit Committee, initiated an

independent review of the facts and circumstances leading to the First Restatement, or the Independent Review, and engaged the law firm now

known as Wilmer Cutler Pickering Hale & Dorr LLP, or WCPHD, to advise it in connection with the Independent Review. The Audit

Committee sought to gain a full understanding of the events that caused significant excess liabilities to be maintained on the balance sheet that

needed to be restated, and to recommend that our Board of Directors adopt, and direct management to implement, necessary remedial measures

to address personnel, controls, compliance and discipline. In January 2005, the Audit Committee reported the findings of the Independent

Review, together with its recommendations for governing principles for remedial measures that were developed for the Audit Committee by

WCPHD. Each of our and NNL’s Boards of Directors has adopted these recommendations in their entirety and directed our management to

develop a detailed plan and timetable for their implementation, and will monitor their implementation.

As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns identified

by WCPHD regarding provisioning activity and to review certain provision releases. That examination, and other errors identified by

management, led to the restatement (effected today) of our financial statements for the years ended December 31, 2002 and 2001 and the

quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003 and 2002, or the Second Restatement, and our

revision of previously announced unaudited results for the year ended December 31, 2003.

• voice over packet technologies;

• third generation wireless technologies; and

• expansion and enhancement of existing networks due to subscriber growth and competitive pressures.

The need for the Second Restatement resulted in delays in filing our and NNL’s 2003 Annual Reports on Form 10-K, or the 2003 Annual

Reports, and Quarterly Reports on Form 10-Q for the first, second and third quarters of 2004, or the 2004 Quarterly Reports, beyond the SEC’s

required filing dates in 2004. We refer to the 2003 Annual Reports and the 2004 Quarterly Reports together as the Reports.

Over the course of the Second Restatement process, management identified certain accounting practices that it determined should be adjusted

for as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and undertook a

process of focused revenue reviews. As described in more detail in the “Controls and Procedures” section of this report, in light of the resulting

adjustments to revenues previously reported in relevant periods, the Audit Committee has determined to review the facts and circumstances

leading to the restatement of these revenues for specific transactions identified in the Second Restatement. This review will have a particular

emphasis on the underlying conduct that led to the initial recognition of these revenues. The Audit Committee will seek a full understanding of

the historic events that required the revenues for these specific transactions to be restated and will consider any appropriate additional remedial

measures, including those involving internal controls and processes. The Audit Committee has engaged WCPHD to advise it in connection

with this review. See “Risk factors/forward looking statements.”

The key developments in 2004 with respect to the foregoing matters are the following:

• In connection with the Independent Review, we terminated for cause (i) our former president and chief executive officer, former chief

financial officer and former controller in April 2004 and (ii) seven additional senior finance employees with significant responsibilities

for our financial reporting as a whole or for their respective business units and geographic regions in August 2004.

• We are under investigation by the SEC and the Ontario Securities Commission, or OSC, Enforcement Staff and have received a U.S.

federal grand jury subpoena for the production of certain documents sought in connection with an ongoing criminal investigation being

conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division. Further, the Integrated Market Enforcement

Team of the Royal Canadian Mounted Police, or RCMP, has advised us that it would be commencing a criminal investigation into Nortel

Networks financial accounting situation. In addition, numerous class action complaints have been filed against Nortel Networks,

including class action complaints under the Employee Retirement Income Security Act, or ERISA. In addition, a derivative action

complaint has been filed against Nortel Networks. See “Contingencies” in note 22 in the accompanying consolidated financial

statements.

• As a result of the delay in filing the Reports, we and NNL were not in compliance with our obligations to deliver the Reports under our

and NNL’s public debt indentures and were required to seek waivers from Export Development Corporation, or EDC, under the EDC

Support Facility. If we and NNL fail to file all of the Reports by January 15, 2005, EDC will have the right, on such date (absent a further

waiver in relation to the delayed filings and certain additional breaches under the EDC Support Facility, or the Related Breaches), to

(i) terminate the EDC Support Facility and (ii) exercise certain rights against collateral or require NNL to cash collateralize all existing

support. In addition, the Related Breaches will continue beyond the filing of the Reports. These delays have also resulted in our inability

to use, in its current form, the remaining approximately $800 million of capacity under our shelf registration statement filed with the SEC

for various types of securities. In addition, these delays resulted in our termination of our $750 million April 2000 five year credit

facilities. See “Liquidity and capital resources” in the MD&A section of this repor

• The OSC issued an order prohibiting all trading by directors, officers and certain current and former employees in the securities of Nortel

Networks Corporation and NNL. The order remains in effect until two full business days following the receipt by the OSC of all filings

required to be made by us and NNL pursuant to Ontario securities laws.

• We postponed our Annual Shareholders’ Meeting for 2003 due to the delay in filing our 2003 financial statements.

• As a result of the delayed filing of certain of our Reports, we are in breach of the continued listing requirements of the Toronto Stock

Exchange, or TSX, and the New York Stock Exchange, or NYSE. Although each of the TSX and NYSE has verbally confirmed that it

has not commenced, nor has any intention of commencing, any suspension or delisting procedures in respect of the Company’s and

NNL’s listed securities, the commencement of any suspension or delisting procedures by either exchange remains, at all times, at the

discretion of such exchange and would be publicly announced by the exchange. The NYSE granted us and NNL an extension of up to

March 31, 2005 to file our 2003 Annual Reports, during which time the Nortel Networks Corporation common shares and our and NNL’s

other securities will remain listed on the NYSE. The extension is subject to review by the NYSE on an ongoing basis.

• We suspended as of March 10, 2004: the purchase of Nortel Networks Corporation common shares under the stock purchase plans for

eligible employees in eligible countries that facilitate the acquisition of Nortel Networks

Strategic plan

On August 19, 2004, we first announced a new strategic plan, which contains the following principal components:

Our strategic plan also includes a work plan involving focused workforce reductions of approximately 3,250 employees, a voluntary retirement

program, real estate optimization and other cost containment actions such as reductions in information services costs, outsourced services and

other discretionary spending. Approximately 64% of employee actions related to the focused workforce reduction were completed by the end

of 2004, including approximately 55% that were notified of termination or acceptance of voluntary retirement, with the remainder comprising

voluntary attrition of employees that were not replaced. The remainder of employee actions are expected to be completed by June 30, 2005. In

addition, however, the Company continues to hire in certain strategic areas such as investments in the finance organization. Our intention is

that our strategic plan will enable us to build on our market leadership in developing the converged networks of the future and improve

business efficiency and operating cost performance in an increasingly competitive market. It is our intention to be optimally positioned to

maximize strategic opportunities as they arise and leverage our acknowledged strengths in high reliability networks and strong customer

loyalty. We continue to drive the business forward with a focus on costs, cash and revenues as strategic goals. We remain committed to our

business strategy of technology and solutions evolution in helping our customers transform their networks and implement new applications and

services to drive improved productivity.

Other business developments

We engaged in a number of activities in 2003 and 2004, in part to respond to the industry environment and in part to address various business

matters that arose during those periods. Some of our activities and other business developments included:

Corporation common shares; the exercise of outstanding options granted under Nortel Networks Corporation 2000 Stock Option Plan, or

the 2000 Plan, and the Nortel Networks Corporation 1986 Stock Option Plan as amended and restated, or the 1986 Plan, or the grant of

any additional options under those plans, or the exercise of outstanding options granted under employee stock option plans previously

assumed by us in connection with mergers and acquisitions; and the purchase of units in a Nortel Networks stock fund or purchase of

Nortel Networks Corporation common shares under our defined contribution and investment plans, until such time as, at the earliest, we

are in compliance with U.S. and Canadian regulatory securities filing requirements.

• On April 28, 2004, Standard and Poor’s, or S&P, downgraded its ratings on NNL, including its long-term corporate credit ratings from

“B” to “B-” and its preferred shares ratings from “CCC” to “CCC-”. At the same time, it revised its outlook to developing from negative.

On April 28, 2004, Moody’s Investor’s Service, Inc. changed its outlook to potential downgrade from uncertain. See “Liquidity and

capital resources — Credit ratings” in the MD&A section of this report.

• a renewed commitment to best corporate practices and ethical conduct, including the establishment of the office of a chief ethics

and compliance officer which has been filled on an interim basis pending the permanent appointment of Susan E. Shepard, as now

announced;

• a streamlined organizational structure to reflect alignment with carrier converged networks;

• an increased focus on the enterprise market and customers;

• optimized research and development programs for highly secure, available and reliable converged networks;

• the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;

• the establishment of a chief marketing officer to drive overall marketing strategy;

• the strategic review of embedded services to assess opportunities in the professional services business; an

• a distinct focus on government and defense customers.

2003

• realigning our business activities in France and Germany;

• reducing undrawn customer financing commitments;

• entering into an agreement with EDC regarding arrangements to provide support for certain of our performance-related obligations;

and

• substantially completing the wind-down of our discontinued access solutions operations.

For information on these and other developments in 2003, see “Special charges” in note 7, “Acquisitions, divestitures and closures” in note 10,

“Long-term debt, credit and support facilities” in note 11 and “Subsequent events” in note 23 of the accompanying consolidated financial

statements and “Developments in 2003 and 2004” in the MD&A section of this report.

Networking solutions

Networking

In our industry, networking refers to:

Network components

A telecommunications network generally consists of equipment and software that enable network access, core networking and network

services. Network access equipment and software enables information to enter or exit a network, and resides with or near an end-user of the

network. Network access can be obtained through the use of either wireline cable (such as fiber optic, copper wire or coaxial) or wireless radio

signals.

Core networking equipment and software direct, route or “switch” the data, voice and multimedia communications signals from one part of the

network to another. Core network equipment and software also transport communications signals to and from network access equipment and

other core networking equipment located in another location. These functions are carried out primarily through the use of routers, circuit and

packet switches, and fiber optic technologies.

Network services consist of various user capabilities that are enabled through the use of software elements in a network. User capabilities may

be configured to extend throughout the network and include features such as location-based services, security services, calling features and

multimedia services. Network services can be personalized to suit the user’s needs and to support various applications.

Networking solutions

Our networking solutions include network equipment, software and other technologies that enable communications between two or more

points defining a network through the use of data, voice and multimedia networking. Our networking solutions may consist of a combination of

products and services provided by our four reportable segments consisting of Wireless Networks, Enterprise Networks, Wireline Networks and

Optical Networks. For a discussion of our recent establishment of a new organizational structure that includes, among other things, combining

the businesses of our four segments into two business organizations, see “Business — Overview”.

Networking solutions can be circuit-based or packet-based. Our circuit-based networking solutions consist of technologies that require a

separate network circuit to be maintained for each communications signal for the duration of the transmission. Our packet-based networking

solutions consist of technologies which involve the conversion of a data, voice or multimedia communications signal into pieces, or “packets”,

that are directed or routed through the network independently and then re-

2004

• the announcement of our planned divestiture of substantially all of our remaining manufacturing operations to Flextronics

International Ltd., or Flextronics;

• the contribution of certain assets and liabilities of our directory and operator services business in return for a 24% interest in

VoltDelta, Resources LLC;

• the entering into an agreement with Foundry Networks, Inc., or Foundry, to settle outstanding patent infringement claims and

counterclaims by us and Foundry; and

• a strategic arrangement with Bharat Sanchar Nigram Limited to establish a wireless network in India.

• the connecting of two or more communications devices, such as telephones and personal computers, across short or long distances

to create a “network”;

• the connecting of two or more networks; or

• the connecting of equipment used in a network.

assembled at the destination. This enables large numbers of communications signals to be directed or routed simultaneously and more

efficiently than in circuit networking. Our data networking solutions consist of products and services designed to enable the transportation of

data information across a network. Our security solutions consist of products and services designed to ensure that information can be securely

transported across a network and to prevent unauthorized users from being able to disrupt the network.

Wireless Networks includes network access and core networking solutions for voice and data communications that span second and third

generation wireless technologies and most major global standards for mobile networks. Enterprise Networks includes circuit and packet voice

solutions, and data networking and security solutions used by our enterprise customers. Wireline Networks includes circuit and packet voice

solutions, and data networking and security solutions used by our service provider customers. Optical Networks includes metropolitan, regional

and long-haul optical transport and switching solutions and managed broadband services. Within each of our reportable segments, our

networking solutions also consist of related professional services which may include: strategic planning, network design and engineering;

network optimization; network operations planning and consulting; and installation and ongoing technical support.

For more information about our networking solutions, please refer to our segment descriptions below.

Wireless Networks

Products

Wireless networking, also known as mobility networking, refers to communications networks that enable end-users to be mobile while they

send and receive voice and data communications using wireless devices, such as cellular telephones, personal digital assistants and other

computing and communications devices. These networks use specialized network access equipment and specialized core networking

equipment that enable an end-user to be connected and identified when not in a fixed location. The technology for wireless communications

networks has evolved and continues to evolve, through various technology “generations”.

Our existing wireless solutions span second and third generation wireless technologies and most major global digital standards for mobile

networks. The majority of wireless communications networks existing today are still based on second generation, or 2G, wireless technologies,

which consist of circuit switching technology with modest data transmission capabilities. However, third generation, or 3G, networks have

been launched in several regions. 3G wireless technologies consist of packet networking technology with high-speed data, voice and

multimedia transmission capabilities.

We support all of the following primary international standards for wireless communications networks:

We also offer a range of related professional services to our customers.

• Time Division Multiple Access, or TDMA, is a 2G wireless standard supported mainly in the United States, Canada and the

Caribbean and Latin America region, or CALA.

• Code Division Multiple Access, or CDMA, is a 2G wireless standard, also known as IS-95 or cdmaOne, and is supported globally.

CDMA networks are evolving to 3G according to the CDMA 3G 1xRTT (single channel (1x) Radio Transmission Technology)

standard, also known as CDMA2000, for voice and high-speed data mobility. CDMA 3G 1xEV-DO, or Evolution Data Optimized,

and CDMA 3G 1xEV-DV, or Evolution Data and Voice, are extensions of CDMA 3G standards for high speed wireless networks

for data, voice and multimedia communications.

• Global System for Mobile communications, or GSM, is a 2G wireless standard supported globally. GSM networks are evolving to

carry data, as well as voice, with the introduction of General Packet Radio Standard, or GPRS. GPRS is viewed as a “2.5G”

technology that provides faster and therefore increased data transmission capabilities. Enhanced Data Rates for Global Evolution,

or EDGE, is a further evolution of GSM systems to support higher data speeds. In addition to higher data speeds, EDGE provides

increased voice capacity for existing GSM operators. An additional variant of this standard, called GSM-R, focuses on the delivery

of communications and control services for railway systems.

• Universal Mobile Telecommunications System, or UMTS, is now a commercial standard for 3G networks based on Wideband

CDMA, or WCDMA, technology. UMTS combines WCDMA-based radio access with packet switching technology to yield high

capacity, high speed wireless networks for data, voice and multimedia communications.

etwork access

Radio network access equipment uses radio waves to provide wireless access to the subscriber’s device, enabling the wireless subscriber to

connect to the network to send and receive data, voice and multimedia communications. The key network elements in radio access are base

station transceivers or access points and base station/radio network controllers. We offer our customers a wide range of base station

transceivers and base station controllers for all of the standards that we support.

Core networking

Core networking equipment directs, routes or “switches” communications signals within a service provider’s wireless communications

network. The key network elements in the core part of a wireless communications network are mobile switching centers, home location

registers and packet data serving nodes.

Our mobile switching centers, home location registers and packet data serving nodes support all of the primary international standards for

wireless communications networks.

Product development

Our wireless networking products in development include the next evolution of our CDMA 3G, GSM/GPRS/EDGE, wireless local area

network, or WLAN, and UMTS products.

• Mobile switching centers direct or “switch” data, voice and multimedia communications signals from one network circuit to

another and also support advanced voice services like 3-way calling, calling party number/name delivery, call holding and call

redirection.

• A home location register is a database that contains subscriber data, such as provisioning and service information, and dynamic

information, such as the wireless handset’s current location.

• Packet data serving nodes are hardware and software network equipment elements that aggregate and manage data communications

between wireless subscriber devices and public/private data networks, such as the Internet. Packet data serving nodes deliver

valuable network services including conten

-based billing, security, virtual private networks and quality of service.

• Our CDMA 3G 1xRTT products are generally available and have been deployed in several commercial networks in all our

geographic regions. Our CDMA 3G 1xEV-DO product is currently being deployed by several large operators in the United States

and Brazil and is generally available for commercial deployment. We are currently working with the various standards bodies to

finalize the specifications for CDMA 3G 1xEV-DV.

• There are several GSM/GPRS/EDGE products that are being developed to allow GSM operators to offer higher data rates on

existing GSM spectrum allocations. We have successfully completed customer trials of Adaptive MultiRate, or AMR, base station

transceivers. AMR allows service providers to use the radio spectrum allocated to them more efficiently to support more customers

onthesamenetwork.

• The enhanced version of our GSM base station controller, the GSM BSC 3000 (formerly, the BSCe3), became generally available

for commercial deployment in 2003. Our EDGE base station transceivers, including both hardware and software, are currently in

customer trials and are being deployed by several customers in the United States.

• Our UMTS radio network access and core networking products are generally available and have been launched by several operators

in the Europe, Middle East and Africa region, or EMEA, and in the United States. Our UMTS networking products have been

deployed in the initial launch of the first commercial UMTS network to be deployed in the United States. We are continuing to

develop our UMTS solutions for use in the Asia Pacific (including Greater China) region.

• We are working at establishing strategic relationships with other companies for research, development and manufacture of

equipment that conforms to the Chinese 3G TD-SCDMA standard.

• We continue to work on developing access technologies such as UMTS-HSDPA, or High Speed Downlink Packet Access, 1x-EV,

or single channel Evolution, OFDM, or Orthogonal Frequency Division Multiplexing, and MIMO, or Multiple Input Multiple

Output, antenna technologies to increase the speed and efficiency of broadband wireless access from 3G networks deployed today.

Markets

We anticipate that demand for wireless networking equipment will be driven by continued subscriber and traffic growth, and the effectiveness

of 2.5G and 3G wireless networking systems. There are two key aspects to the migration from 2G wireless communications technologies to

2.5G and 3G wireless communications technologies. The first is that all current 3G technologies, including CDMA 3G and UMTS, are based

on spread spectrum technology. The second is that the migration from 2G to 2.5G and 3G technologies is largely based on a transition from

circuit switching technologies in 2G core networks to packet-based networking technologies in 3G core networks. We believe that our

extensive experience in deploying CDMA wireless communications networks, combined with our expertise in packet-based networking for

wireline networks, will be a competitive strength during the migration from 2G wireless communications networks to 2.5G and 3G wireless

communications networks.

Commercial CDMA 3G networks have been launched in the United States, Canada, CALA and the Asia Pacific region. CDMA networks

operating in the 450 MHz radio spectrum are also expanding into Central and Eastern Europe. GPRS and UMTS networks have already been

launched in EMEA, the Asia Pacific region and the United States. In addition, EDGE has been launched to support higher speed transmission

of data in the United States and also by several operators in Western Europe and the Asia Pacific region. GSM-R has already been deployed by

many countries across the world, including member states of the European Union, China and India. The GSM-R market is one of the fastest

growing segments of the overall wireless market.

In the United States, Canada and CALA, usage rates of wireless communications services continue to increase, and we anticipate that capital

spending decisions by wireless service providers will be driven by capacity requirements, new wireless subscribers, increased use of wireless

devices for Internet access and technology migration from 2G wireless technologies to 2.5G and 3G wireless technologies. We also anticipate

that the migration from 2G to 2.5G and 3G wireless will initially be driven by CDMA 3G 1xRTT and 1xEV-DO deployment for CDMA-based

networks, and by GPRS, EDGE and UMTS deployment for GSM- and TDMA-based networks.

Within EMEA, wireless subscriber growth remains slower in many Western European countries, largely due to relatively high wireless

subscriber penetration levels. However, other parts of EMEA continue to grow their subscriber base due to the lower market penetration for

wireless services. Investment decisions by wireless service providers in Western Europe are being driven by anticipated growth in wireless data

communications services. As a result, infrastructure spending in Western Europe is currently primarily driven by the migration from GSM to

GPRS and UMTS technologies, and the associated migration from circuit switching technologies to packet-based networking technologies.

In the Asia Pacific region, we anticipate that capital spending by wireless service providers will be driven by the migration to 3G technologies

in Japan and Korea, and by continued growth in wireless subscribers in the People’s Republic of China, or China. Growth in China may be

further driven by anticipated new national licenses for 3G. However, the timing of the issuance of new national licenses for 3G in China is

uncertain. The issuance of new national licenses for 3G in China is also expected to impact the entire 3G market. Many countries in South and

South East Asia have very low wireless subscriber penetration levels, and are expected to experience increased wireless subscriber growth over

the next five years. India is also anticipated to be a major wireless infrastructure market in the next five years.

Customers

Our Wireless Networks customers are wireless service providers, and their customers are the subscribers for wireless communications services.

The top 20 global wireless service providers collectively account for a majority of all wireless subscribers around the world. We are currently

focused on increasing our market presence among the top global wireless service providers. None of our Wireless Networks customers

represented more than 10% of Nortel Networks consolidated revenues in 2003.

• Our Wireless Mesh Network solution, designed to allow our customers to reduce the costs of high-speed wireless data transport

from wireless access networks to wired broadband networks, is now generally available and has been deployed in the United States

and Asia Pacific.

• Our enterprise grade WLAN access products are generally available for commercial deployment by our wireless service provider

customers.

Competition

Our major competitors in the global wireless infrastructure business have traditionally included Telefonaktiebolaget LM Ericsson, Nokia

Corporation, Siemens Aktiengesellschaft, Motorola, Inc. and Lucent Technologies Inc. Nokia and Siemens compete in the sale of GSM and

UMTS equipment, whereas Lucent competes in the sale of CDMA and UMTS equipment. Motorola is a competitor in the sale of GSM, UMTS

and CDMA equipment. Ericsson competes in the sale of equipment for all of the major wireless communications technologies. More recently,

Samsung Electronics Co., Ltd. has emerged as a competitor in the sale of CDMA systems, and Huawei Technologies Co., Ltd. and ZTE

Corporation have emerged as competitors for GSM, CDMA and UMTS systems in China and many other developing countries. NEC

Corporation and Fujitsu Limited have emerged as competitors for UMTS equipment.

The primary global factors of competition for our Wireless Networks products include:

We intend to compete with our traditional and emerging competitors as the global market for wireless networking equipment migrates to 3G

technologies.

Enterprise Networks

Products

Our Enterprise Networks solutions portfolio provides data, voice and multimedia communications solutions for our enterprise customers. We

also provide our enterprise customers with related professional services.

Circuit and packet voice solutions

Our voice portfolio includes a broad range of circuit and packet voice communications solutions.

• technology leadership, product features and availability;

• product quality and reliability;

• conformity to existing and emerging regulatory and industry standards;

• warranty and customer support;

• price and cost of ownership;

• interoperability with other networking products;

• network management capabilities;

• traditional supplier relationships, particularly in EMEA and the Asia Pacific region;

• regulatory certification; and

• provision of customer financing.

• Our communications servers and remote gateway products provide converged data, voice and multimedia communications systems,

using voice over internet protocol, or IP, or session initiation protocol, or SIP, for service providers and enterprises. SIP is a

standard protocol for initiating an interactive user session that involves multimedia elements such as video, voice, chat, gaming and

virtual reality. Our enterprise solutions can be used by customers building new networks and customers who want to transform their

existing communications network into a more cost effective, packet-based network supporting data, voice and multimedia

communications.

• Our customer premises-based circuit and packet telephone switching systems are designed for small, medium and large commercial

enterprises and government agencies. These systems provide or can be configured with multiple applications, including voice

communications features, such as voice messaging, call waiting and call forwarding, as well as advanced voice services, converged

multimedia applications and other networking capabilities.

• Our customer contact center, messaging and interactive voice and web service solutions are advanced communications tools

designed to work with our customer premises-based solutions. These tools enable employees to efficiently and productively

communicate with business contacts and other employees regardless of where they are located, the applicable time zone or whether

they choose to interact over the telephone or the Internet.

ata networking and security solutions

We offer a broad range of data networking (packet switching and routing) and security solutions for our enterprise customers. Our packet

switching and routing systems include data switching systems, aggregation products, virtual private network gateways and routers, including:

Product development

We are currently focused on developing products that support the continuing evolution of voice and data communications systems toward

converged or combined data, voice and multimedia networks, including:

Markets

We offer Enterprise Networks products to enterprises around the world. With the growth of data, voice and multimedia communications over

the public telephone network, the public Internet and private voice and data communications networks, there is an increasing opportunity to

converge disparate networks towards a single, high performance network that can support various types of communications traffic and

applications.

We believe that in order to meet the growing demand for increased capacity at lower per-minute rates, enterprises will transition their circuit-

based voice communications to more cost effective packet-based technologies. As a result, we anticipate growth in demand for packet-based

networking equipment that supports the convergence of data, voice and multimedia communications over a single communications network

and that provides greater network capacity, reliability, speed, quality and performance. However, the rate of growth of this progression is

unclear.

• Our data switches, secure routers and associated security products provide data switching designed to allow our customers to

provide Internet data security and IP services including IP routing, virtual private networks, deep packet inspection, firewall

applications, policy management and data traffic flow management. These products also enable our customers to manage and

prioritize the Internet content that is provided to end-users and balance the amount of communications traffic on multiple Internet

servers.

• Our Ethernet switch portfolio is a series of high performance packet switches for our enterprise customers’ small to large local area

networks that use the Ethernet, a standard computer networking protocol for local area networks.

• Our multi-protocol routers offer high-speed, high-capacity and medium-capacity data switching to support a wide range of data

communications technologies, including multi-protocol label switching, asynchronous transfer mode, IP and frame relay services.

Our Ethernet routing switches deliver IP routing and switching.

• Our portfolio of WLAN service switching products is designed to provide secure and efficient transmission of WLAN data and

voice traffic for mobile users. Our WLAN voice products integrate with our communications servers and gateway products to

provide a wireless voice over IP solution for our customers.

• Our portfolio of optical network switching products is designed to extend the range of storage area networks to enable our

customers to consolidate their data servers. Our products enable enterprises to deploy these storage area networks in alternate

locations, providing geographic redundancy as part of their business continuity strategy.

• The continued development of our multimedia communication server for enterprise, a product that provides the capability to deliver

converged data, voice and multimedia applications and enhanced networking capabilities.

• Additions to the applications in our communications server products to allow integration of voice over IP, voice extensible markup

language, new operating systems and servers, and voice recognition speech products.

• New developments in data networking products that will deliver resiliency, enable increased data network traffic and provide

suitable service levels and network connectivity and power to devices over the same line.

• The development of the next generation web platform, which will feature higher performance, scalability (that is, the ability to

grow a service or capability with incremental cost) and integrated applications.

• Enhancements to our security portfolio including the new secure sockets layer, or SSL, and switching products and a new high-end

secure router product. In addition, we have entered into and continue to pursue strategic relationships that enhance our end-to-end

security solutions.

• Updates to our customer premises-based telephone systems to support our software that enables those systems to function entirely

as a packe

-based system or as a hybrid packet and circuit switching system.

Globally, enterprise customers continue to invest in equipment for their communications networks, primarily for network security and

resiliency, for voice over IP, WLANs and for virtual private networks. In the United States and Canada, enterprise customers are investing in

voice over IP as they transition from legacy voice products to our enterprise line of communication servers and remote gateway products that

enable conversion from voice communication networks to packet-based networks supporting data, voice and multimedia communications. In

EMEA, our customers are beginning to invest in new technologies, such as voice over IP. In the Asia Pacific region, Enterprise Networks

customers are investing in networking equipment to improve the connections among their regional sites and branch offices. In CALA,

enterprises are continuing to drive demand for networking equipment that supports the growing use of the Internet in the region.

Customers

We offer our products and services to a broad range of enterprise customers around the world, including large businesses and their branch

offices, small businesses and home offices, as well as government agencies, educational and other institutions and utility organizations. Key

industry sectors for our business customers include the telecommunications, high-technology manufacturing, government (including the

defense sector) and financial services sectors. We also serve customers in the healthcare, retail, education, hospitality, services, transportation

and other industry sectors. We are currently focused on increasing our market presence with enterprise customers. In particular, we intend to

focus on leading enterprise customers with high performance networking needs. Certain of our service provider customers also act as a

distribution channel for our Enterprise Networks sales and include incumbent local telephone companies, competitive local telephone

companies and system integrators. None of our Enterprise Networks customers represented more than 10% of Nortel Networks consolidated

revenues in 2003.

Competition

Our principal competitors in the sale of our Enterprise Networks solutions are Cisco Systems, Inc., Avaya Inc., Siemens, Alcatel S.A., and

NEC Corporation. Avaya is our largest competitor in the sale of voice equipment while Cisco is our largest competitor in the sale of data

networking equipment to enterprises. We also compete with smaller companies that address specific niches, such as Juniper Networks, Inc.,

3Com Corporation, Foundry Networks, Inc., Extreme Networks, Inc. and Enterasys Networks, Inc. in data networking; and Mitel Networks

Corporation in Internet-based voice communications solutions. We expect competition to remain intense as enterprises look for ways to

maximize the effectiveness of their existing networks while reducing ongoing capital expenditures and operating costs.

The principal global factors of competition in the sale of our Enterprise Networks solutions include:

Wireline Networks

Products

Our Wireline Networks portfolio addresses the demand by our service provider customers for cost efficient data, voice and multimedia

communications solutions. Our wireline solutions, including related professional services, simplify network architectures by bringing data,

voice, multimedia and emerging broadband applications for revenue generating services together on one packet network.

• technology leadership, product features and availability;

• product quality and reliability;

• conformity to existing and emerging regulatory and industry standards;

• sales distribution and channel marketing strategy;

• warranty and customer support;

• price and cost of ownership;

• interoperability with other networking products;

• installed base of product;

• alternative solutions offered to enterprises by service providers;

• the leveraging of existing customer-supplier relationships; and

• the availability of distribution channels.

Circuit and packet voice solutions

We are a leader in the development and deployment of highly scalable circuit switched and secure voice over packet solutions such as voice

over IP for wireline and wireless service providers around the world. Our voice over packet solutions offer service providers opportunities for

new revenue sources and sustainable operating and capital cost reduction, as well as high levels of reliability and network resiliency. Our

solutions include the following:

These solutions work alone or in combination with each other to provide traditional voice services, advanced packet voice services and

enhanced multimedia services to service providers around the world.

ata networking and security solutions

We offer a wide range of data networking (packet switching and routing) solutions to our service provider customers. Our wide area network,

or WAN, solutions and IP service routers enable our service provider customers to offer connectivity solutions and high value services to both

enterprises and residential customers. Connectivity solutions include packet services such as: frame relay; Asynchronous Transfer Mode, or

ATM; Ethernet; and IP access for digital subscriber line and cable users. High-value services, such as IP virtual private networks, enable an

enterprise to connect with other enterprise sites and remote users and to securely connect with business partners. These high-value services also

provide enhanced network capabilities, such as network security, network address translation and class of service, that enable service providers

to offer a wide range of networking services beyond basic connection to the network. In 2004, we announced a new multiservice provider edge

networking device that allows service providers to converge multiple networks at the network edge to enable the delivery of voice, data,

multimedia and wireless services over a single, converged network. When we refer to the network edge, we are referring to the point at which

access networks meet the core network.

Product development

Research and development investments are focused on creating new and improving existing, packet-based residential and business services for

wireline and wireless service providers. Also, we continue to develop products that support the evolution of data, voice and multimedia

communications systems toward converged or combined voice and data networks, including:

• Our wireline voice over packet network solutions for service providers, which include softswitches and media gateways. The

portfolio provides the complete range of voice over packet solutions, including local, toll, long-distance and international gateway

capabilities, and enables voice applications to run on the new multi-services packet network. These solutions leverage more

efficient packet-based, as opposed to circuit-based, technologies that drive reduced capital and operational costs for service

providers and provide a platform for the delivery of new revenue-generating services, such as Centrex IP and voice over IP virtual

private networks.

• Our multimedia communications services portfolio allows our customers to deploy new, enhanced multimedia services, including

video, collaboration and personal agent services. The portfolio includes a session initiation protocol-based application server that

can enable an interactive user session involving multimedia elements. For example, personal agent services allow users to

customize their communications by selecting the medium over which they wish to receive a particular message (such as wireline or

wireless telephony, e-mail and instant messaging) by setting screening criteria such as time of day and day of week, month or year.

• Our DMS portfolio is a family of digital, circuit-based telephone switches that provides local, toll, long-distance and international

gateway capabilities for service providers. Our DMS systems enable service providers to connect end-users making local and long-

distance telephone calls. The DMS family of products can evolve to voice over packet solutions.

• Our Nortel Networks Developers Partner Program helps to drive the interoperability of our voice over IP multimedia

communications and DMS portfolios with third party vendors including infrastructure and application companies.

• Enhancements to our voice over packet solutions that will allow service providers to connect any business telephone system, using

standard voice over IP protocols, into a common dialing plan with connectivity to the public switched telephone network.

Additional enhancements to our packet voice solutions will continue to focus on interoperability with other manufacturers’

equipment, including gateway and integrated access device manufacturers, as well as on meeting the needs of the Asian and

European markets. We continue to make improvements to our softswitch portfolio by utilizing the latest commercial technology to

provide our customers with converged wireline and wireless service support, superior application choices, integrated network

management and linear scalable capacity.

Markets

With the growth of data, voice and multimedia communications over the public telephone network, the public Internet and private voice and

data communications networks, there is an increasing opportunity to converge disparate networks towards a single, high performance packet

network that can support most types of communications traffic and applications. Converged voice and data networks also provide an

opportunity for service providers to offer new revenue-generating services while reducing their ongoing operational costs year over year as

they incorporate packet-based technology in their networks. We believe our advantage lies in our ability to transition and upgrade our

customers’ installed base of voice and data network solutions to a multimedia IP network.

To meet the growing demand for new revenue generating services and network efficiency, we anticipate growth in demand for packet-based

networking equipment that supports the convergence of data, voice and multimedia communications over a single communications network

and that provides greater network capacity, reliability, speed, quality and performance. We anticipate a continued increase in deployments of

service provider voice over IP networks worldwide. While we anticipate growth in voice over IP networks, we also anticipate a decline in

legacy voice networks.

Cable operators and new Internet telephone service providers are entering the voice and data markets and are increasing the competitive

pressure on established service providers. For example, cable operators provide high speed data services as well as voice services by using

voice over IP technology. Similarly, established service providers are using existing broadband networks and expanding those broadband

networks to offer bundled services such as telephone, high speed Internet and television services across those broadband networks.

The market for our Wireline Networks products is global. Service providers are expected over the long term to continue to modernize with

packet-based networks and converge voice and data communications networks in order to deploy new revenue-generating service offerings.

We anticipate an increased emphasis by service providers towards end-user networks in addition to their efforts to modernize the inter-

connection of those networks. In EMEA, we also continue to see market demand for certain networking products, including equipment for

voice over IP and equipment for virtual private networking. In EMEA, we anticipate continued opportunities with alternate operators, cable

operators and wireless operators and anticipate new opportunities in emerging markets.

In the Asia Pacific region, we continue to see market demand for certain networking products, including equipment for voice over IP and

multimedia services and equipment for virtual private networking. Deregulation in China has created opportunities for new entrants who are

building out their networks with packet-based technologies. In CALA, service

• Enhancements to the MCS 5200, part of our multimedia communications portfolio, that will allow a service provider to offer

intelligent multimedia services across any manufacturer’s circuit switches. Additionally, development will focus on increasing the

breadth and usability of the MCS 5200 applications.

• Additions to the DMS portfolio that will allow service providers to offer and manage IP voice and multimedia (Centrex IP) services

to those businesses that use traditional business telephones as well as businesses that use next generation telephones designed for

use in IP networks.

• Enhancements to our IP services router that enable an increase in the number of residential subscribers and virtual private network

sites that can be supported, and the amount of bandwidth that can be applied to an enterprise site. Development will also focus on

enhancing the ability of our service provider customers to provide additional revenue-generating services.

• A focus on cable standards compliance to enhance our solutions for the cable operator markets in the United States, Canada and

EMEA, including support for the open cable standard protocol for cable media gateways.

• Enhancements to our WAN switch portfolio to improve interoperability with other vendors’ products. In addition, development will

focus on enhancing the migration to converged networks which simultaneously support data, voice and multimedia.

• Continued development of a multiservice provider edge networking device designed to converge multiple communications services

operating at the IP or multi-protocol label switching network edge. This device is currently undergoing customer trials and is not

yet generally available. As well, we continue to develop enhancements to our existing line of WAN switch and IP service router

products that are intended to efficiently aggregate different types of data traffic at the network edge.

• Continued integration of a service provider core network router into our voice over packet portfolio to enable us to provide a

complete end-to-end solution.

providers are also focused on implementing voice over IP technology to enable opportunities for additional growth, network efficiency and

revenue-generating services. There is also a growing demand for voice over IP technology among cable operators in CALA.

Customers

We offer our Wireline Networks products and services to a wide range of wireline and wireless service providers around the world. We are

focused on increasing our market presence with key global service providers which we currently expect to account for a substantial proportion

of service provider capital spending in 2004 and beyond. Our service provider customers include local and long distance telephone companies,

wireless service providers, cable operators and other communications service providers.

We also offer applicable data networking and security solutions from our Wireline Networks to enterprises for private networking, as well as to

service providers and system integrators that in turn build, operate and manage networks for their customers such as businesses, government

agencies and utility organizations. None of our Wireline Networks customers represented more than 10% of Nortel Networks consolidated

revenues in 2003.

Competition

Our principal competitors in the Wireline Networks business are large communications companies such as Siemens, Alcatel, Cisco and Lucent.

In addition, we compete with smaller companies that address specific niches within this market, such as Sonus Systems Limited, BroadSoft,

Inc. and Taqua Inc. in packet and Internet-based voice communications solutions; Juniper and Laurel Networks, Inc. in multiservice provider

edge solutions; and Ciena Corporation (which acquired Wavesmith Networks, Inc. in 2003) in multiservice WAN solutions; and Redback

Networks Inc. in aggregation products. Certain competitors are also strong on a regional basis, such as ZTE Corporation and Huawei in the

Asia Pacific region. Some niche competitors are partnering with larger companies to enhance their product offerings and large communications

competitors are also looking for these partnerships or alliances to complete their product offerings. No one competitor is dominant in the

Wireline Networks market.

The primary global factors of competition for our wireline products include:

Competition remains intense as a result of reduced investment in existing legacy networks by service providers, the continued consolidation in

the service provider industry, and the continued focus by suppliers on selling to large service providers with financial resources.

Optical Networks

Products

Our Optical Networks solutions portfolio addresses the varying optical communication needs of service providers and enterprises. Optical

networks transport data, voice and multimedia communications within and between cities, countries or continents by transmitting

communications signals in the form of light waves through fiber optic cables. Optical networking is the most common method for transporting

communications signals between the various locations within a service provider’s network and is unmatched for delivering vast amounts of

data reliably and cost-effectively with service and bandwidth flexibility and scalability.

• technology leadership, product features and availability;

• price and total cost of ownership;

• ability to create new revenue-generating services for service providers and cable operators;

• conformity to existing and emerging regulatory and industry standards;

• installed base of products and customer relationships;

• network management capabilities;

• product quality and reliability; and

• warranty and customer support.

Our optical networking solutions are designed to provide metropolitan, regional and long-haul, high-capacity transport and switching of data,

voice and multimedia communications signals. These solutions include photonic Dense Wavelength Division Multiplexing, or DWDM,

transmission solutions, synchronous optical transmission solutions, optical switching solutions and network management and intelligence

software. We also offer our customers a variety of related professional services. Our solutions include the following:

Our Optical Networks solutions enable customers to enhance and transform their networks towards a scalable and reliable network for

delivering diverse high speed data and voice communication services. Such network transformation is expected to increase deployment of

managed broadband services, such as:

In addition, in February 2004, we announced strategic alliances with Calix Networks, Inc., ECI Telecom Ltd. and KEYMILE AG that will

expand our broadband networking solutions portfolio and enable our service provider customers to deliver a new set of emerging broadband

services to their enterprise and residential end-users.

Product development

We are focused on developing next generation optical networking systems, including the evolution of our next generation SONET/SDH

systems, our metro DWDM systems and our optical long-haul line and terminal solutions. In 2003, we:

• Our photonic networking DWDM solutions allow multiple light wave signals to be transmitted on the same fiber optic strand

simultaneously by using different wavelengths of light to distinguish specific signals, thereby increasing the capacity and flexibility

of a network. Our long-haul DWDM line systems span distances up to 2,000 kilometers and our metro DWDM series provides

networking solutions within a city or region for up to 350 kilometres.

• Our synchronous optical transmission systems use traditional optical standards, including the Synchronous Optical Network, or

SONET, standard, which is the most common standard in the United States and Canada and some countries in the Asia Pacific

region, and the Synchronous Digital Hierarchy, or SDH, standard, which is the most common standard in EMEA and many other

countries. Our synchronous next-generation SONET/SDH solutions comprise multi-service optical platforms that integrate diverse

protocols and technologies to deliver services over a cost effective, scalable and reliable converged services network.

• Our optical switching solutions enable communication signals in optical fibers to be selectively directed or “switched” from one

network circuit to another.

• Our network management software and intelligence solutions are designed to give our customers the ability to monitor and improve

the performance of their networks.

• Optical Ethernet solutions that combine the strengths of the Ethernet network computing protocol with those of optical

communications. Optical Ethernet solutions transport communications signals carrying Ethernet packets in the form of light waves

through fiber optic cables between locations within a city or between cities.

• Optical storage connectivity solutions, which allow the interconnection of data centers for the efficient preservation and sharing of

business-critical data to ensure business continuity and disaster recovery.

• Managed wavelength solutions, which offer multiple protocol and transmission speed networking capability to reliably interconnect

business sites.

• introduced an advanced metro optical network product, our Optical Multiservice Edge 6500, that enables the convergence of

multiple platforms onto a single platform, enabling reduced network costs and enhanced functionality;

• enhanced the capabilities of our existing metro optical network products to enable new storage area solutions that address emerging

enterprise business continuity requirements; and

• introduced a new long-haul product that utilizes photonic networking DWDM technology, which assists customers in lowering their

network costs by providing improved optical performance.

We continue to develop and enhance our Optical Networks portfolio, including by:

We also continue to invest in core technologies, such as efficient service adaptation, aggregation, switching and management, that enable our

customers worldwide to deploy innovative optical networking services which we believe will lead the networking transformation towards high

performance packet-based networks.

Markets

We are a leading provider of optical networking products to service providers and enterprises around the world. Compared to the last few

years, the global optical market has stabilized. Service providers remain focused on maximizing return on invested capital by increasing their

capacity utilization rates and the efficiency of their existing networks. Some service providers have delayed the deployment of next generation

products. However, there remain opportunities to deliver new technologies and services that enable service providers to offer additional

revenue-generating services. We also expect that enterprises will continue to generate demand for optical networking solutions that enable

them to operate their networks more efficiently.

The outlook for optical equipment sales may be further impacted by service providers preferring to lease excess network capacity from others

or purchase assets from other operators rather than making capital investments in their own networks. We expect that any additional capital

spending by our customers will continue to be directed toward opportunities that enhance customer performance, generate revenue and reduce

costs in the near term. However, as service providers begin to more effectively utilize and eventually exceed their network capacity, we expect

that they may incrementally enhance that capacity. The timing and impact of these developments remain difficult to predict.

The market for our Optical Networks solutions is global. In the United States and Canada, new networks are not currently being built by

service providers in anticipation of market demand, but are instead being built to more closely align with actual end-user demand. Several

service providers in the United States have announced plans to deploy optical fiber networks to allow access to these networks by residential

end-users. Within EMEA, the building of pan-European optical networks by service providers is now mature and many service providers have

begun to focus on building their metropolitan and regional optical networks. We expect that the increased usage of broadband wireless data

provided by 3G networks may eventually drive the increased deployment of optical networks. The demand for additional and enhanced

services by enterprises is increasing in Europe and may also encourage service providers to invest in the creation of networks that offer

services such as optical Ethernet and storage connectivity. In EMEA, European government-sponsored service providers and networking

equipment suppliers enjoy favorable positions within many European countries.

In the Asia Pacific region, the industry is continuing to develop and may provide a significant market for new optical networking equipment

over the next several years. As a result, there has been an increased focus on the Asia Pacific region by virtually all suppliers of optical

networking equipment. Similar to what is occurring in Europe within the EMEA region, the Asia Pacific region may experience increased

demand for additional and enhanced services by enterprises which may encourage service providers to invest in the creation of networks that

offer services such as optical Ethernet and storage connectivity. In CALA, where a few service providers account for a significant percentage

of the industry, the building of national optical network infrastructures is largely complete.

Customers

Our Optical Networks business is primarily focused on offering our optical networking solutions to service providers around the world. The

service provider customers for our optical networking products include local and long-distance telephone companies, cable operators, Internet

service providers and other communications service providers. We are currently focused on increasing our market presence with key service

provider customers worldwide, which we expect to account for a substantial proportion of service provider optical capital spending.

• enhancing our optical Ethernet portfolio by introducing new Ethernet switching and transport capabilities designed to improve the

productivity of our enterprise customers and the services offered by our service provider customers;

• introducing in 2004, a new common photonic layer product that simplifies and automates the deployment and operation of medium

and long-haul optical links;

• introducing the second release of our high density optical switching system to provide additional customer applications; and

• investing in improving the density, capacity and flexibility of our optical long-haul transmission systems.

We are also focused on enterprises and we continue to provide optical solutions for private enterprise networking and also for service providers

to build and operate custom dedicated networks for enterprises. We leverage numerous channels for delivering optical networking solutions to

enterprises from our own direct sales force for large enterprises and governments and through distributors, resellers and partners to offer our

solution to medium-sized enterprises and smaller enterprises. None of our Optical Networks customers represented more than 10% of Nortel

Networks consolidated revenues in 2003.

Competition

Our major competitors in the sale of optical networking equipment include Alcatel, Lucent, Siemens, Fujitsu Limited, Marconi plc, Cisco,

Huawei, NEC, Ciena and ADVA International Inc. Market position in the global market for optical networking equipment can fluctuate

significantly on a quarter-by-quarter basis. However, we continue to be a leading global provider of optical networking equipment. No one

competitor is dominant in the optical networking equipment market.

The primary global factors of competition for our Optical Networks products include:

Our focus is on increasing market share relative to our competitors.

Sales and distribution

All of our reportable segments use the Nortel Networks direct sales force to market and sell to customers around the world. The Nortel

Networks global sales force operates on a regional basis and markets and sells our products and services to customers located in the following

regional areas: Canada; United States; CALA; EMEA; and Asia Pacific. Our sales office bases for our direct sales force are aligned with our

customers on a country and regional basis.

We have dedicated sales account teams for certain major service provider customers. These dedicated teams are located close to the customers’

main purchasing locations. In addition, teams within the regional sales groups are dedicated to our enterprise customers. Our Enterprise

Networks sales teams work directly with the top regional enterprises, and are also responsible for managing regional distribution channels. We

also have centralized marketing, product management and technical support teams dedicated to individual product lines that support the global

sales and support teams.

In the Asia Pacific region, particularly in China, we also use agents to interface with our customers. In addition, we have some small non-

exclusive distribution agreements with distributors in EMEA, CALA and the Asia Pacific region. In Enterprise Networks, certain service

providers, system integrators, value-added resellers and stocking distributors act as non-exclusive distribution channels for our products.

Backlog

Our backlog was approximately $3.3 billion and $3.3 billion as of September 30, 2004 and September 30, 2003, respectively. A majority of

backlog consists of orders confirmed with a binding purchase order or contract for our network solutions typically scheduled for delivery to our

customers within the next twelve months. A significant portion of backlog may also include orders that relate to revenue that has been deferred

for periods longer than twelve months. However, orders are subject to possible rescheduling by customers. Although we believe that the orders

included in the backlog are firm, we may elect to permit cancellation of orders without penalty where management believes that it is in our best

interest to do so. Prior

• technology leadership, product features and availability;

• product quality and reliability;

• conformity to existing and emerging regulatory and industry standards;

• warranty and customer support;

• price and cost of ownership;

• interoperability with other networking products;

• network management capabilities;

• traditional supplier relationships, particularly in EMEA and the Asia Pacific region; and

• regulatory certification, particularly for incumbent local and long-distance telephone companies.

to including orders in backlog, customers must have approved credit status. However, from time to time, some customers may become unable

to pay for or finance their purchases in which case the order is removed from our backlog.

Product standards, certification and regulations

Our products are subject to equipment standards, registration and certification in Canada, the United States, the European Union and other

countries. We design and manufacture our products to satisfy a variety of regulatory requirements and protocols established to, for instance,

avoid interference among users of radio frequencies and to permit interconnection of equipment. For example, our equipment must satisfy the

United States Federal Communications Commission’s, or FCC, emissions testing requirements, and must be certified to safety, electrical noise

and communications standards compliance. Different regulations and regulatory processes exist in each country.

In order for our products to be used in some jurisdictions, regulatory approval and, in some cases, specific country compliance testing and re-

testing may be required. The delays inherent in this regulatory approval process may force us to reschedule, postpone or cancel introduction of

products or new capabilities in certain geographic areas, and may result in reductions in our sales. The failure to comply with current or future

regulations or changes in the interpretation of existing regulations in a particular country could result in the suspension or cessation of sales in

that country or require us to incur substantial costs to modify our products to comply with the regulations of that country. To support our

compliance efforts, we work with consultants and testing laboratories as necessary to ensure that our products comply with the requirements of

Industry Canada in Canada, the FCC in the United States and the European Telecommunications Standards Institute in Western Europe, as well

as with the various regulations of other countries. For additional information, see “Environmental Matters.”

The operations of our service provider customers are subject to extensive country-specific telecommunications regulations. In the United

States, on February 20, 2003, the FCC announced a decision in its triennial review proceeding of the agency’s rules regarding unbundled

network elements. The text of the FCC’s order and reasons for the decision were released on August 21, 2003. The FCC decision, subsequent

udicial review of the decision and the FCC’s reconsideration of its decision and subsequent adoption on December 15, 2004 of new

unbundling rules in response to the remand by the U.S. Court of Appeals for the D.C. Circuit are affecting, and may continue to affect, the

decisions of certain of our United States-based service provider customers regarding investment in their telecommunications infrastructure.

These unbundled network elements rules and/or material changes in other country-specific telecommunications regulations at any time or from

time to time may affect capital spending by service providers in the United States and/or around the world, and this may in turn affect the

United States and/or global markets for networking solutions.

Sources and availability of materials

Since 1999, our manufacturing and supply chain strategy has evolved and has resulted in the gradual transformation of our traditional

manufacturing model, in which our products were primarily manufactured and assembled in-house, to primarily an outsourced model which

relies on electronic manufacturing services, or EMS, suppliers. By the end of 2003, most of our manufacturing activities had been divested to

leading EMS suppliers. We have continued to pursue an outsourced manufacturing model and in January 2004 announced our intention to

divest substantially all of our remaining manufacturing activities. On June 29, 2004, we announced that we had reached an agreement with

Flextronics to divest substantially all of Nortel Networks remaining manufacturing operations, located in Canada and Brazil, with the

anticipation that Flextronics will also acquire similar operations in France and Northern Ireland, subject to the completion of the required

information and consultation processes. For recent developments in the evolution of our supply chain strategy, see “Developments in 2003 and

2004” in the MD&A section of this report.

We believe that the use of an outsourced manufacturing model has enabled us to benefit from leading manufacturing technologies, leverage

existing resources from around the world, lower our cost of sales, adjust to fluctuations in market demand and decrease our investment in plant,

equipment and inventories. We continue to retain in-house all strategic management and overall control responsibilities associated with our

various supply chains, including all customer interfaces, customer service, order management, quality assurance, product cost-management,

new product introduction, and network solutions integration, testing and fulfillment.

Through our existing manufacturing model, we are generally able to obtain sufficient materials and components from global sources to meet

the needs of our four reportable segments. In each of our reportable segments, we:

Comparing 2003 to 2002, we observed fewer instances of supply surpluses because of adjustments to eliminate excess capacity. In 2003, we

continued our focus on inventory management and component cost reduction. In 2004, we continued to purchase, manufacture, or otherwise

obtain sufficient components and materials to supply our products, systems and networks within customary delivery periods.

For more information on our supply arrangements, see “Commitments” in note 14 of the accompanying consolidated financial statements and

“Developments in 2003 and 2004” and “Liquidity and capital resources — Contractual cash obligations — Outsourcing contracts” in the

MD&A section of this report.

Seasonality

Prior to 2001, our business results in all of our reportable segments were generally strongest in our fourth quarter, second strongest in our

second quarter, third strongest in our third quarter and the weakest in our first quarter, primarily due to the networking industry purchasing

cycles exhibited by our customers. The industry adjustment and economic downturn in the United States and elsewhere in 2001 and 2002

affected our customers’ traditional purchasing patterns, the demand for our products and services and the traditional seasonality of our

business. In 2003, we began to experience a period of relative industry stability. While our customers increased their purchasing levels in the

fourth quarter of 2003, our customers continued to spend cautiously. We experienced a seasonal decline in revenues in the first quarter of 2004

compared to the fourth quarter of 2003, followed by growth in the second quarter of 2004 compared to the first quarter of 2004 in all of our

four reportable segments. There will be a sequential decline in revenue in the third quarter of 2004 compared to the second quarter of 2004 and

that we expect the fourth quarter of 2004 will be the strongest quarter in 2004. The quarterly profile of our business results in 2004 is not

expected to be consistent across all of our reportable segments and there is no assurance that our results of operations for any quarter will

necessarily be consistent with our historical quarterly profile or indicative of our expected results in future quarters. See “Results of operations

— continuing operations — 2004 and 2005” and “Risk factors/forward looking statements” in the MD&A section of this report.

Strategic alliances, acquisitions and minority investments

We use strategic alliances to deliver certain solutions to our customers. These alliances are typically formed to fill product or service gaps in

areas that support our core businesses. We believe strategic alliances also augment our access to potential new customers. We intend to

continue to pursue strategic alliances with businesses that offer technology and/or resources that would enhance our ability to compete in

existing markets or exploit new market opportunities.

In 2003, we increased our then existing majority positions in certain companies to 100% ownership. See “Developments in 2003 and 2004 —

Ownership adjustment in our French and German operations” in the MD&A section of this report. However, we did not make any material

acquisitions in 2003 or in 2004. In the future, we may consider selective opportunistic acquisitions of companies with resources and product or

service offerings capable of providing us with additional enhancements to our networking solutions or access to new markets. For information

regarding the risks associated with strategic alliances and acquisitions, see “Risk factors/forward looking statements” in the MD&A section of

this report.

We continue to hold minority investments in certain “start-up” businesses with technology, products or services that, at the time of investment,

had the potential to fulfill key existing or emerging market opportunities. When minority investments are no longer required to maintain our

strategic relationship, or the relationship is no longer strategic to our core businesses, we intend to exit such investments at an opportune time.

• make significant purchases of electronic components and assemblies, optical components, original equipment manufacturer, or

OEM, products, software products, outsourced assemblies and other materials and components from many domestic and foreign

sources;

• develop and maintain alternative sources for certain essential materials and components; and

• occasionally maintain special inventories of components internally or request that they be maintained by suppliers to satisfy

customer demand or to minimize effects of possible market shortages.

Our investment activity remained at a low level in 2003 and in 2004. We may make selective minority investments in start-up ventures and

certain other companies where we believe the relationship could lay the foundation for future alliances that would support our customer

solutions. In certain circumstances, we may also acquire an equity position in a company as consideration for a divested business. See

“Developments in 2003 and 2004 — Directory and operator services business” in the MD&A section of this report.

Research and development

In order to remain among the technology leaders in anticipated growth areas, we intend to continue to make strategic investments in our

research and development activities. Our research and development activities — specifically, research, design and development, systems

engineering and other product development activities — represent focused investments to drive market leadership across our product

portfolios. We refer you to the four “Product development” discussions contained in the descriptions of Wireless Networks, Enterprise

Networks, Wireline Networks and Optical Networks above.

Our research and development investments are focused on network transformation and next generation products and solutions including

wireless voice and data, voice over packet, multimedia services and applications, broadband networking and network security. We also conduct

network planning and systems engineering on behalf of, or in conjunction with, major customers. Although we derive many of our products

from substantial internal research and development activities, we supplement this with technology acquired or licensed from third parties.

Our research and development forms a core strength and is a factor differentiating us from many of our competitors. As at December 31, 2003,

we employed approximately 13,600 regular full-time research and development employees (excluding employees on notice of termination)

including approximately:

In August and September 2004, we announced a new strategic plan that includes a focused workforce reduction of approximately 3,250

employees, or about 10% of our workforce. It is expected that approximately 1,400 regular full-time research and development employees will

be affected by the workforce reduction, which is expected to principally affect employees in Wireline Networks and Optical Networks. See

“Employee relations”.

We also conduct research and development activities through affiliated laboratories in other countries.

The following table sets forth our consolidated expenses for research and development for each of the three fiscal years ended December 31:

Intellectual property

Our intellectual property is fundamental to Nortel Networks and the business of each of our four reportable segments. In particular, our success

is dependent upon our proprietary technology. We generate, maintain, utilize and enforce a substantial portfolio of intellectual property rights,

including trademarks, and an extensive portfolio of patents covering significant innovations arising from research and development activities.

In all of our reportable segments, we use our intellectual property rights to protect our investments in research and development activities, to

strengthen our leadership positions, to protect our good name, to promote our brand name recognition, to enhance our competitiveness and to

otherwise support our business goals and objectives. However, our intellectual property rights may be challenged, invalidated or circumvented,

• 5,310 regular full-time research and development employees in Canada;

• 5,010 regular full-time research and development employees in the United States;

• 2,400 regular full-time research and development employees in EMEA; and

• 880 regular full-time research and development employees in other countries.

(millions of dollars) 2003 2002 2001

R&D expense $1,960 $2,083 $3,116

R&D costs incurred on behalf of others (a) 72 49 68

Total $2,032 $2,132 $3,184

(a) These costs included research and development charged to our customers pursuant to contracts that provided for full recovery of the estimated cost of development,

material, engineering, installation and all other applicable costs, which were accounted for as contract costs.

fail to provide us with significant competitive advantages. See “Risk factors/forward looking statements” in the MD&A section of this report.

The duration and level of protection of our intellectual property rights are dependent upon the laws and requirements of the jurisdictions

providing or controlling those rights.

As of December 31, 2003, we had, on a consolidated basis, approximately:

We were granted 464 United States patents in 2003.

Our patents outside of the United States are primarily counterparts to our United States patents. We have entered into some mutual patent

cross-license agreements with several major corporations to enable each party to operate without risk of a patent infringement claim from the

other. In addition, we are actively licensing certain of our patents and/or technology to third parties. We also occasionally license single patents

or groups of patents from third parties.

Our trademark and trade name, Nortel Networks, is one of our most valuable assets. We sell our products primarily under the Nortel Networks

brand name. We have registered the Nortel Networks trademark, and many of our other trademarks, in countries around the world. On a

consolidated basis as of December 31, 2003, we owned approximately 120 registered trademarks in the United States, and approximately 2,040

registered trademarks in other countries. In addition, as of December 31, 2003, we had approximately 160 pending trademark registrations

worldwide.

Employee relations

At December 31, 2003, we employed approximately 35,160 regular full-time employees (excluding employees on notice of termination),

including approximately:

We also employ individuals on a regular part-time basis and on a temporary full-time basis. In addition, we engage the services of contractors

as required.

As part of our resizing activities to further reduce our cost structure and streamline operations, we notified for termination and provisioned for

the exit of approximately 1,800 regular full-time employees during 2003. As well, divestitures and outsourcing affecting non-core businesses

completed or entered into in 2003 resulted in additional reductions. On June 29, 2004, we announced that we had reached an agreement with

Flextronics to divest certain manufacturing operations in Canada and Brazil, with the anticipation that Flextronics will also acquire similar

operations in France and Northern Ireland, subject to the completion of the required information and consultation process. Under the terms of

the agreement, it is intended that approximately 2,500 Nortel Networks employees would transfer to Flextronics by the end of June 2005. In

addition, in August and September 2004 we announced a new strategic plan, including a new streamlined organizational structure which will

lead to an anticipated reduction in employees of approximately 3,250, or about 10% of the workforce. Approximately 64% of employee actions

related to the focused workforce reduction were completed by the end of 2004, including approximately 55% that were notified of termination

or acceptance of voluntary retirement, with the remainder comprising voluntary attrition of employees that were not replaced. The remainder of

employee actions are expected to be completed by June 30, 2005. In addition, however, the Company continues to hire in certain strategic areas

such as investments in the finance organization. The workforce reduction will be subject to completion of the appropriate information and

consultation processes with the relevant employee representatives in certain jurisdictions, as required by law. For additional information, see

“Sources and availability of materials”, “Special charges” in note 7 of the accompanying consolidated financial statements and “Results of

operations — continuing operations — Operating expenses — Special charges” in the MD&A section of this report.

• 3,200 United States patents;

• 2,800 patents in other countries; and

• 6,200 pending patent applications worldwide.

• 12,990 regular full-time employees in the United States;

• 9,430 regular full-time employees in Canada;

• 7,840 regular full-time employees in EMEA; and

• 4,900 regular full-time employees in other countries.

At December 31, 2003, labor contracts covered approximately five percent of our employees worldwide. At the same date, five labor contracts

covered approximately ten percent of our employees in Canada including:

At December 31, 2003, labor contracts covered approximately four percent of our employees in EMEA and all of our employees in Brazil.

These labor contracts generally have a one-year term, and primarily relate to remuneration. We have no labor contracts in the United States.

We believe our employee relations are generally positive. Employee morale continues to be an area of focus as a result of ongoing workforce

reductions associated with our restructuring activities occurring since 2001, the recent reductions resulting from our strategic plan announced

in August and September 2004, and the restatement of our financial results and related matters. Although the recruitment and retention of

technically skilled employees in recent years was highly competitive in the global networking industry, the economic conditions during the

past few years have lessened the competition for skilled employees in our industry. We do, however, believe that our ability to recruit and

retain skilled employees will continue to be critical to our future success. During 2003, approximately 1,200 regular full-time employees were

hired globally. From the beginning of 2004 until November 30, 2004, approximately 2,300 regular full-time employees were hired. See “Risk

factors/forward looking statements” in the MD&A section of this report.

Environmental matters

Our operations are subject to a wide range of environmental laws in various jurisdictions around the world. We seek to operate our business in

compliance with such laws. In Europe, we expect to become subject to new product content laws and product takeback and recycling

requirements that will require full compliance by 2006. We expect that these laws will require us to incur additional compliance costs.

Although costs relating to environmental matters have not resulted in a material adverse effect on our business, results of operations, financial

condition and liquidity in the past, there can be no assurance that we will not be required to incur such costs in the future. We have a corporate

environmental management system standard and an environmental program to promote compliance. We also have a periodic, risk-based,

integrated environment, health and safety audit program. As part of our environmental program, we attempt to evaluate and assume

responsibility for the environmental impacts of our products throughout their life cycles. Our environmental program focuses on design for the

environment, supply chain and packaging reduction issues. We work with our suppliers and other external groups to encourage the sharing of

non-proprietary information on environmental research. For additional information on environmental matters, see “Contingencies —

Environmental matters” in note 22 of the accompanying consolidated financial statements.

Financial information by operating segment and product category

For financial information by operating segment and product category, see “Segment information” in note 6 of the accompanying consolidated

financial statements and “Results of operations — continuing operations — Segment revenues” in the MD&A section of this report.

Financial information by geographic area

For financial information by geographic area, see “Segment information” in note 6 of the accompanying consolidated financial statements and

“Results of operations — continuing operations — Geographic revenues” in the MD&A section of this report.

• one labor contract covering approximately eight percent of Canadian unionized employees which was renewed, ratified and became

effective February 26, 2003;

• one labor contract covering less than one percent of Canadian unionized employees which was renewed, ratified and became

effective August 16, 2003;

• one labor contract covering approximately ten percent of Canadian unionized employees which was renewed, ratified and became

effective June 19, 2003;

• one labor contract covering approximately 64% of Canadian unionized employees which was renewed, ratified and became

effective April 13, 2004; and

• one labor contract covering approximately 18% of Canadian unionized employees which expires in 2008.

Working capital

For a discussion of our working capital practices, see “Long-term debt, credit and support facilities” in note 11 of the accompanying

consolidated financial statements and “Liquidity and capital resources” in the MD&A section of this report.

Risk factors

THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD LOOKING INFORMATION THAT IS SUBJECT TO

IMPORTANT RISKS AND UNCERTAINTIES. THE RESULTS OR EVENTS PREDICTED IN THESE STATEMENTS MAY

DIFFER MATERIALLY FROM ACTUAL RESULTS OR EVENTS. RESULTS OR EVENTS COULD DIFFER FROM CURRENT

EXPECTATIONS AS A RESULT OF A WIDE RANGE OF RISK FACTORS. FOR INFORMATION REGARDING SOME OF THE

RISK FACTORS INVOLVED IN OUR BUSINESS AND OPERATIONS, SEE “RISK FACTORS/FORWARD LOOKING

STATEMENTS” IN THE MD&A SECTION OF THIS REPORT.

At December 31, 2003, we operated 208 sites around the world occupying approximately 13.7 million square feet. The following table sets

forth additional information regarding these sites:

At December 31, 2003, our facilities were primarily used, on a consolidated basis, approximately as follows:

In 2003, we continued to reduce the number of sites and square footage of our global facilities to better align ourselves with current market

conditions. We believe our facilities are suitable and adequate, and have sufficient capacity to meet our current needs. We continue to evaluate

our future real estate needs based on the current industry environment and taking into account our business requirements. In 2004, we

purchased land and two buildings that were previously leased by Nortel Networks. Our strategic plan announced in August and

September 2004 includes the reduction of approximately 2 million square feet of occupied space as a result of workforce reductions and

improved space utilization through the consolidation of locations. We expect the square footage reduction to be completed by the end of 2005.

For additional details, see “Special charges” in note 7 and “Long-term debt, credit and support facilities” in note 11 of the accompanying

consolidated financial statements, and “Liquidity and capital resources — Sources of liquidity” in the MD&A section of this report.

Security over substantially all of Nortel Networks Limited’s assets, including certain real estate assets in North America, became effective in

April 2002 under certain credit and security agreements entered into by Nortel Networks Limited and several of its subsidiaries. For additional

details regarding these agreements and the security, see “Long-term debt, credit and support facilities” in note 11, “Subsequent events” in note

23 and “Supplemental consolidating financial information” in note 24 of the accompanying consolidated financial statements and

“Developments in 2003 and 2004 — Credit facilities and security agreements” and “Liquidity and capital resources — Sources of liquidity —

Available support facility” in the MD&A section of this report.

ITEM 2. Pro

erties

Number of Sites

eofSite* Owned Leased Geo

hic Locations

Manufacturing and repair 8

–

All geographic regions

Distribution centers – 6 United States, Canada, EMEA and the Asia Pacific region

Offices (administration, sales and field service) 3174 All geographic regions

Research and developmen

314 United States, Canada, EMEA and the Asia Pacific region

TOTAL** 14 194

* Indicates the primary use of the site. A number of our sites are mixed-use facilities.

** Excludes approximately 8.7 million square feet, consisting primarily of leased and/or vacant property designated as part of a planned square footage reduction in

connection with our restructuring activities commenced in 2001. At December 31, 2003 approximately 2.8 million square feet of such property was sub-leased.

• 21% by Wireless Networks;

• 12% by Enterprise Networks;

• 10% by Wireline Networks;

• 6% by Optical Networks;

• 29% by global operations; and

• 22% by one or more of our reporting segments and/or corporate facilities.

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 U.S. District Courts for the Eastern District of New York, for

the Southern District of New York and for the District of New Jersey and the provinces of Ontario, Quebec and British Columbia in Canada,

on behalf of shareholders who acquired Nortel Networks Corporation securities as early as October 24, 2000 and as late as February 15, 2001,

allege, among other things, violations of U.S. federal and Canadian provincial securities laws. These matters also have been the subject of

review by Canadian and U.S. securities regulatory authorities. On May 11, 2001, the defendants filed motions to dismiss and/or stay in

connection with the three proceedings in Quebec primarily based on the factual allegations lacking substantial connection to Quebec and the

inclusion of shareholders resident in Quebec in the class claimed in the Ontario lawsuit. The plaintiffs in two of these proceedings in Quebec

obtained court approval for discontinuances of their proceedings on January 17, 2002. The motion to dismiss and/or stay the third proceeding

was heard on November 6, 2001 and the court deferred any determination on the motion to the judge who will hear the application for

authorization to commence a class proceeding. On December 6, 2001, the defendants filed a motion seeking leave to appeal that decision. The

motion for leave to appeal was dismissed on March 11, 2002. On October 16, 2001, an order in the Southern District of New York was filed

consolidating twenty-five of the related U.S. class action lawsuits into a single case, appointing class plaintiffs and counsel for such plaintiffs.

The plaintiffs served a consolidated amended complaint on January 18, 2002. On December 17, 2001, the defendants in the British Columbia

action served notice of a motion requesting the court to decline jurisdiction and to stay all proceedings on the grounds that British Columbia is

an inappropriate forum. The motion has been adjourned at the plaintiffs’ request to a future date to be set by the parties.

A class action lawsuit against Nortel Networks was also filed in the U.S. District Court for the Southern District of New York on behalf of

shareholders who acquired the securities of JDS between January 18, 2001 and February 15, 2001, alleging violations of the same U.S. federal

securities laws as the above-noted lawsuits.

On April 1, 2002, Nortel Networks filed a motion to dismiss both the above consolidated U.S. shareholder class action and the above JDS

shareholder class action complaints on the grounds that they failed to state a cause of action under U.S. federal securities laws. With respect to

the JDS shareholder class action complaint, 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 U.S. class action complaint. Plaintiffs appealed the dismissal of the JDS shareholder class action

complaint. On November 19, 2003, oral argument was held before the Second Circuit on the JDS shareholders’ appeal of the dismissal of their

complaint. On May 19, 2004, the Second Circuit issued an opinion affirming the dismissal of the JDS shareholder class action complaint and

on July 14, 2004 the Second Circuit denied plaintiffs’ motion for rehearing. On October 12, 2004, the plaintiffs filed a petition for writ of

certiorari in the U.S. Supreme Court. On November 12, 2004, the defendants filed Brief for the Respondents in Opposition, and on

November 22, 2004, the plaintiffs filed Reply to Brief in Opposition. With respect to the consolidated U.S. shareholder class action, the

plaintiffs served a motion for class certification on March 21, 2003. On May 30, 2003, the defendants served an opposition to the motion for

class certification. Plaintiffs’ reply was served on August 1, 2003. The District Court held oral arguments on September 3, 2003 and issued an

order granting class certification on September 5, 2003. On September 23, 2003, the defendants filed a motion in the Second Circuit for

permission to appeal the class certification decision. The plaintiffs’ opposition to the motion was filed on October 2, 2003. On November 24,

2003, the Second Circuit denied the motion. On March 10, 2004, the District Court approved the form of notice to the class which was

published and mailed.

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 auditors as defendants. The factual allegations in

the Ontario Claim are substantially similar to the allegations in the consolidated amended complaint filed in the U.S. District Court described

above. The Ontario Claim is on behalf of all Canadian residents who purchased Nortel Networks Corporation securities (including options on

Nortel Networks Corporation securities) between October 24, 2000 and February 15, 2001. The plaintiffs claim damages of Canadian $5,000,

plus punitive damages in the amount of Canadian $1,000, prejudgment and postjudgment interest and costs of the action. On September 23,

2003, the Court issued an order allowing the plaintiffs to proceed to amend the Ontario Claim and requiring that the plaintiffs serve class

certification materials by December 15, 2003. On September 24, 2003, the plaintiffs filed a notice of discontinuance of the original action filed

in Ontario. On December 12, 2003, plaintiffs’ counsel requested an extension of time to January 21, 2004 to deliver class certification

materials. On January 21, 2004, plaintiffs’ counsel advised the Court that the two representative plaintiffs in the action no longer wished to

proceed, but counsel was prepared to deliver draft certification

ITEM 3. Le

al Proceedin

materials pending the replacement of the representative plaintiffs. On February 19, 2004, the plaintiffs’ counsel advised the Court of a potential

new representative plaintiff. On February 26, 2004, the defendants requested the Court to direct the plaintiffs’ counsel to bring a motion to

permit the withdrawal of the current representative plaintiffs and to substitute the proposed representative plaintiff. On June 8, 2004, the Court

signed an order allowing a Second Fresh as Amended Statement of Claim that substituted one new representative plaintiff, but did not change

the substance of the prior claim.

A purported class action lawsuit was filed in the U.S. District Court for the Middle District of Tennessee on December 21, 2001, on behalf of

participants and beneficiaries of the Nortel Networks Long-Term Investment Plan (the “Plan”) at any time during the period of March 7, 2000

through the filing date and who made or maintained Plan investments in Nortel Networks Corporation common shares, under the Employee

Retirement Income Security Act (“ERISA”) for Plan-wide relief and alleging, among other things, material misrepresentations and omissions

to induce Plan participants to continue to invest in and maintain investments in Nortel Networks Corporation common shares in the Plan. A

second purported class action lawsuit, on behalf of the Plan and Plan participants for whose individual accounts the Plan purchased Nortel

Networks Corporation common shares during the period from October 27, 2000 to February 15, 2001 and making similar allegations was filed

in the same court on March 12, 2002. A third purported class action lawsuit, on behalf of persons who are or were Plan participants or

beneficiaries at any time since March 1, 1999 to the filing date and making similar allegations, was filed in the same court on March 21, 2002.

The first and second purported class action lawsuits were consolidated by a new purported class action complaint, filed on May 15, 2002 in the

same court and making similar allegations, on behalf of Plan participants and beneficiaries who directed the Plan to purchase or hold shares of

certain funds, which held primarily Nortel Networks Corporation common shares, during the period from March 7, 2000 through December 21,

2001. On September 24, 2002, plaintiffs in the consolidated action filed a motion to consolidate all the actions and to transfer them to the U.S.

District Court for the Southern District of New York. The plaintiffs then filed a motion to withdraw the pending motion to consolidate and

transfer. The withdrawal was granted by the District Court on December 30, 2002. A fourth purported class action lawsuit, on behalf of the

Plan and Plan participants for whose individual accounts the Plan held Nortel Networks Corporation common shares during the period from

March 7, 2000 through March 31, 2001 and making similar allegations, was filed in the U.S. District Court for the Southern District of New

York on March 12, 2003. On March 18, 2003, plaintiffs in the fourth purported class action filed a motion with the Judicial Panel on

Multidistrict Litigation to transfer all the actions to the Southern District of New York for coordinated or consolidated proceedings pursuant to

28 U.S.C. section 1407. On June 24, 2003, the Judicial Panel on Multidistrict Litigation issued a transfer order transferring the Southern

District of New York action to the Middle District of Tennessee (the “Consolidated ERISA Action”). On September 12, 2003, the plaintiffs in

all the actions filed a consolidated class action complaint. On October 28, 2003, the defendants filed a motion to dismiss the complaint and a

motion to stay discovery pending disposition of the motion to dismiss. On March 30, 2004, the plaintiffs filed a motion for certification of a

class consisting of participants in, or beneficiaries of, the Plan who held shares of the Nortel Networks Stock Fund during the period from

March 7, 2000 through March 31, 2001. On April 27, 2004, the Court granted the defendants’ motion to stay discovery pending resolution of

defendants’ motion to dismiss. On June 15, 2004, the plaintiffs filed a First Amended Consolidated Class Action Complaint that added

additional current and former officers and employees as defendants and expanded the purported class period to extend from March 7, 2000

through to June 15, 2004.

On March 4, 1997, Bay Networks, Inc. (“Bay Networks”), a company acquired on August 31, 1998, announced that shareholders had filed two

separate lawsuits in the U.S. District Court for the Northern District of California (the “Federal Court”) and the California Superior Court,

County of Santa Clara (the “California Court”), against Bay Networks and ten of Bay Networks’ then current and former officers and directors

purportedly on behalf of a class of shareholders who purchased Bay Networks’ common shares during the period of May 1, 1995 through

October 14, 1996. On August 17, 2000, the Federal Court granted the defendants’ motion to dismiss the federal complaint. On August 1, 2001,

the U.S. Court of Appeals for the Ninth Circuit denied the plaintiffs’ appeal of that decision. On April 18, 1997, a second lawsuit was filed in

the California Court, purportedly on behalf of a class of shareholders who acquired Bay Networks’ common shares pursuant to the registration

statement and prospectus that became effective on November 15, 1995. The two actions in the California Court were consolidated in

April 1998; however, the California Court denied the plaintiffs’ motion for class certification. In January 2000, the California Court of Appeal

rejected the plaintiffs’ appeal of the decision. A petition for review was filed with the California Supreme Court by the plaintiffs and was

denied. In February 2000, new plaintiffs who allege to have been shareholders of Bay Networks during the relevant periods, filed a motion for

intervention in the California Court seeking to become the representatives of a class of shareholders. The motion was granted on June 8, 2001

and the new plaintiffs filed their complaint-in-intervention on an individual and purported class representative basis alleging misrepresentations

made in connection with the purchase and sale of securities of Bay Networks in violation of California statutory and common law. On

March 11, 2002, the California Court granted the defendants’ motion to strike the class allegations. The plaintiffs were permitted to proceed on

their individual claims. The intervenor-plaintiffs appealed the dismissal of their class allegations. On July 25, 2003, the California Court of

Appeal reversed the trial court’s dismissal of the intervenor-plaintiffs’ class allegations. On September 3, 2003, the defendants filed a petition

for review with the

California Supreme Court seeking permission to appeal the Court of Appeal decision. On October 22, 2003, the California Supreme Court

denied, without opinion, the defendants’ petition for review. On December 22, 2003, the plaintiffs served their motion for certification of a

class of purchasers of Bay Networks’ common shares from July 25, 1995 through to October 14, 1996. Hearing of the plaintiffs’ motion for

class certification was held on May 4, 2004. On July 27, 2004, the Court entered an Amended Order Denying Motion of Intervenor Plaintiffs

for Class Certification and Setting Further Hearing. On August 9, 2004, the intervenor-plaintiffs obtained Court approval to dismiss their

claims and this action and, on September 30, 2004, the Court entered dismissal with prejudice of the entire action of all parties and all causes of

action.

Subsequent to the March 10, 2004 announcement in which Nortel Networks indicated it was likely that it would need to revise its previously

announced unaudited results for the year ended December 31, 2003, and the results reported in certain of its quarterly reports for 2003, and to

restate its previously filed financial results for one or more earlier periods, Nortel Networks and certain of its then current and former officers

and directors were named as defendants in 27 purported class action lawsuits. These lawsuits in the U.S. District Court for the Southern District

of New York on behalf of shareholders who acquired Nortel Networks Corporation securities as early as February 16, 2001 and as late as

May 15, 2004, allege, among other things, violations of U.S. federal securities laws. These matters are also the subject of investigations by

Canadian and U.S. securities regulatory and criminal investigative authorities (see note 23). On June 30, 2004, the Court signed Orders

consolidating the 27 class actions and appointing lead plaintiffs and lead counsel. The plaintiffs filed a consolidated class action complaint on

September 10, 2004, alleging a class period of April 24, 2003, through and including April 27, 2004. On November 5, 2004, Nortel Networks

Corporation and the Audit Committee Defendants filed a motion to dismiss the consolidated class action complaint.

On May 18, 2004, a purported class action lawsuit was filed in the U.S. District Court for the Middle District of Tennessee on behalf of

participants and beneficiaries of the Plan at any time during the period of December 23, 2003 through the filing date and who made or

maintained Plan investments in Nortel Networks Corporation common shares, under the ERISA for Plan-wide relief and alleging, among other

things, breaches of fiduciary duty. On September 3, 2004, the Court signed a stipulated order consolidating this action with the Consolidated

ERISA Action described above. On June 16, 2004, a second purported class action lawsuit, on behalf of the Plan and Plan participants for

whose individual accounts the Plan purchased Nortel Networks Corporation common shares during the period from October 24, 2000 to

June 16, 2004, and making similar allegations, was filed in the U.S. District Court for the Southern District of New York. On August 6, 2004,

the Judicial Panel on Multidistrict Litigation issued a conditional transfer order to transfer this action to the U.S. District Court for the Middle

District of Tennessee for coordinated or consolidated proceedings pursuant to 28 U.S.C. section 1407 with the Consolidated ERISA Action

described above. On August 20, 2004, plaintiffs filed a notice of opposition to the conditional transfer order with the Judicial Panel. On

December 6, 2004, the Judicial Panel denied the opposition and ordered the action transferred to the U.S. District Court for the Middle District

of Tennessee for coordinated or consolidated proceedings with the Consolidated ERISA Action described above.

On July 28, 2004, Nortel Networks and NNL, and certain directors and officers, and certain former directors and officers, of Nortel Networks

and NNL, were named as defendants in a purported class proceeding in the Ontario Superior Court of Justice on behalf of shareholders who

acquired Nortel Networks Corporation securities as early as November 12, 2002 and as late as July 28, 2004. This lawsuit alleges, among other

things, breaches of trust and fiduciary duty, oppressive conduct and misappropriation of corporate assets and trust property in respect of the

payment of cash bonuses to executives, officers and employees in 2003 and 2004 under the Nortel Networks Return to Profitability bonus

program and seeks damages of Canadian $250 and an order under the Canada Business Corporations Act directing that an investigation be

made respecting these bonus payments.

On July 30, 2004, a shareholders’ derivative complaint was filed in the U.S. District Court for the Southern District of New York against

certain directors and officers, and certain former directors and officers, of Nortel Networks alleging, among other things, breach of fiduciary

duties owed to Nortel Networks during the period from 2000 to 2003 including by causing Nortel Networks to engage in unlawful conduct or

failing to prevent such conduct; causing Nortel Networks to issue false statements; and violating the law.

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

damages.

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

Nortel Networks is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to Nortel Networks of the above

matters which, unless otherwise specified, seek damages from the defendants of material or

indeterminate amounts or could result in fines and penalties. Nortel Networks cannot determine whether these actions, suits, claims and

proceedings will, individually or collectively, have a material adverse effect on the business, results of operations, financial condition and

liquidity of Nortel Networks. Nortel Networks and any named directors and officers of Nortel Networks intend to vigorously defend these

actions, suits, claims and proceedings.

On April 5, 2004, Nortel Networks announced that the SEC had issued a formal order of investigation in connection with Nortel Networks

previous restatement of its financial results for certain periods, as announced in October 2003, and Nortel Networks announcements in

March 2004 regarding the likely need to revise certain previously announced results and restate previously filed financial results for one or

more earlier periods. The matter had been the subject of an informal SEC inquiry. On April 13, 2004, Nortel Networks announced that it had

received a letter from the staff of the Ontario Securities Commission (“OSC”) advising that there is an OSC Enforcement Staff investigation

into the same matters that are the subject of the SEC investigation.

On May 14, 2004, Nortel Networks announced that it had received a Federal Grand Jury Subpoena for the production of certain documents,

including financial statements and corporate, personnel and accounting records, prepared during the period from January 1, 2000 to the date of

the subpoena. The materials sought are pertinent to an ongoing criminal investigation being conducted by the U.S. Attorney’s Office for the

Northern District of Texas, Dallas Division.

On August 16, 2004, Nortel Networks received a letter from the Integrated Market Enforcement Team of the Royal Canadian Mounted Police

(“RCMP”) advising Nortel Networks that the RCMP would be commencing a criminal investigation into Nortel Networks financial accounting

situation.

Environmental matters

Nortel Networks operations are subject to a wide range of environmental laws in various jurisdictions around the world. Nortel Networks seeks

to operate its business in compliance with such laws. In 2004, Nortel Networks expects to become subject to new European product content

laws and product takeback and recycling requirements that will require full compliance by 2006. It is expected that these laws will require

Nortel Networks to incur additional compliance costs. Although costs relating to environmental matters have not resulted in a material adverse

effect on the business, results of operations, financial condition and liquidity in the past, there can be no assurance that Nortel Networks will

not be required to incur such costs in the future. Nortel Networks has a corporate environmental management system standard and an

environmental program to promote such compliance. Moreover, Nortel Networks has a periodic, risk-based, integrated environment, health and

safety audit program.

Nortel Networks environmental program focuses its activities on design for the environment, supply chain and packaging reduction issues.

Nortel Networks works with its suppliers and other external groups to encourage the sharing of non-proprietary information on environmental

research.

Nortel Networks is exposed to liabilities and compliance costs arising from its past and current generation, management and disposal of

hazardous substances and wastes. As of December 31, 2003, the accruals on the consolidated balance sheet for environmental matters were

$33. Based on information available as of December 31, 2003, management believes that the existing accruals are sufficient to satisfy probable

and reasonably estimable environmental liabilities related to known environmental matters. Any additional liability that may result from these

matters, and any additional liabilities that may result in connection with other locations currently under investigation, are not expected to have

a material adverse effect on the business, results of operations, financial condition and liquidity of Nortel Networks.

Nortel Networks has remedial activities under way at 12 sites which are either currently or previously owned or occupied facilities. An

estimate of Nortel Networks anticipated remediation costs associated with all such sites, to the extent probable and reasonably estimable, is

included in the environmental accruals referred to above in an approximate amount of $33.

Nortel Networks is also listed as a potentially responsible party (“PRP”) under the U.S. Comprehensive Environmental Response,

Compensation and Liability Act (“CERCLA”) at six Superfund sites in the U.S. An estimate of Nortel Networks share of the anticipated

remediation costs associated with such Superfund sites is expected to be de minimis and is included in the environmental accruals of $33

referred to above.

Liability under CERCLA may be imposed on a joint and several basis, without regard to the extent of Nortel Networks involvement. In

addition, the accuracy of Nortel Networks estimate of environmental liability is affected by several uncertainties such as additional

requirements which may be identified in connection with remedial activities, the complexity

and evolution of environmental laws and regulations, and the identification of presently unknown remediation requirements. Consequently,

Nortel Networks liability could be greater than its current estimate.

Not applicable.

PART II

The common shares of Nortel Networks Corporation are listed and posted for trading on the New York Stock Exchange in the United States

and on the Toronto Stock Exchange in Canada. The following table sets forth the high and low sale prices of the common shares as reported on

the New York Stock Exchange composite tape and on the Toronto Stock Exchange.

On December 31, 2004, the last sale price on the New York Stock Exchange was $3.47 and on the Toronto Stock Exchange was Canadian

$4.16.

On December 31, 2004, approximately 196,852 registered shareholders held 100% of the outstanding common shares of Nortel Networks

Corporation. This included the Canadian Depository for Securities and the Depository Trust Company, two clearing corporations, which held a

total of approximately 97% of the common shares of Nortel Networks Corporation on behalf of other shareholders.

Securities authorized for issuance under equity compensation plans

For a discussion of Nortel Networks equity compensation plans, please see “Equity compensation plan information” in Item 12, “Security

Ownership of Certain Beneficial Owners and Management”.

ITEM 4. Submission of Matters to a Vote of Securit

Holders

ITEM 5. Market for the Re

istrant’s Common E

uit

and Related Stockholder Matters

New York Toronto

Stock Exchange Stock Exchange

composite tape (Canadian $)

High Low High Low

2004 Fourth Quarter $3.91 $2.92 $4.80 $3.49

Third Quarter 5.05 3.16 6.40 4.11

Second Quarter 6.33 3.01 8.35 4.16

First Quarter 8.50 4.30 11.94 5.53

2003 Fourth Quarter 4.80 3.98 6.37 5.17

Third Quarte

4.73 2.68 6.50 3.84

Second Quarter 3.55 2.06 4.81 3.04

First Quarter 2.72 1.68 4.13 2.59

2002 Fourth Quarter 2.75 0.43 3.61 0.67

Third Quarter 1.70 0.45 2.60 0.70

Second Quarter 4.73 1.31 7.54 2.01

First Quarter 8.77 4.22 13.99 6.75

Dividends

On June 15, 2001, Nortel Networks Corporation announced that its Board of Directors decided to discontinue the declaration and payment of

common share dividends. As a result, dividends have not been declared and paid on Nortel Networks Corporation common shares since

June 29, 2001, and future dividends will not be declared unless and until the Board of Directors decides otherwise. On July 26, 2001, the Board

of Directors of Nortel Networks Corporation suspended the operation of the Nortel Networks Corporation Dividend Reinvestment and Stock

Purchase Plan.

In the first and second quarters of 2001, Nortel Networks Corporation declared and paid a cash dividend of $0.01875 per common share. This

represents a total dividend of $0.0375 per common share for 2001 and aggregate dividend payments of $123 million.

Canadian tax matters

Dividends

Under the United States-Canada Income Tax Convention (1980), or the Convention, Canadian withholding tax of 15% generally applies to the

gross amount of dividends (including stock dividends) paid or credited to beneficial owners of Nortel Networks Corporation common shares:

The Convention provides an exemption from withholding tax on dividends paid or credited to certain tax-exempt organizations that are resident

in the United States for purposes of the Convention. Persons who are subject to the United States federal income tax on dividends may be

entitled, subject to certain limitations, to either a credit or deduction with respect to Canadian income taxes withheld with respect to dividends

paid or credited on Nortel Networks Corporation common shares.

Sales or other dispositions of shares

Gains on sales or other dispositions of Nortel Networks Corporation common shares by a non-resident of Canada are generally not subject to

Canadian income tax, unless the holder realizes the gains in connection with a business carried on in Canada. A gain realized upon the

disposition of Nortel Networks Corporation common shares by a resident of the United States that is otherwise subject to Canadian tax may be

exempt from Canadian tax under the Convention. Where Nortel Networks Corporation common shares are disposed of by way of an

acquisition of such common shares by Nortel Networks Corporation, other than a purchase in the open market in the manner in which common

shares would normally be purchased by any member of the public in the open market, the amount paid by Nortel Networks Corporation in

excess of the paid-up capital of such common shares will be treated as a dividend, and will be subject to non-resident withholding tax as

described above under the heading “Dividends”.

Sales of unregistered securities

During the fourth quarter of 2003, Nortel Networks Corporation did not issue any common shares under the Nortel Networks/BCE 1985 Stock

Option Plan or the Nortel Networks/BCE 1999 Stock Option Plan. Any common shares issued under these plans are deemed to be exempt from

registration under the United States Securities Act of 1933, as amended, pursuant to Regulation S. All funds received by Nortel Networks

Corporation in connection with the exercise of stock options granted under the two Nortel Networks/BCE stock option plans are transferred in

full to BCE pursuant to the terms of the May 1, 2000 plan of arrangement, except for nominal amounts paid to Nortel Networks Corporation to

round up fractional entitlements into whole shares. Nortel Networks Corporation keeps these nominal amounts and uses them for general

corporate purposes.

• who are resident in the United States for the purposes of the Convention; and

• who do not hold the shares in connection with a business carried on through a permanent establishment or a fixed base in Canada.

The selected financial data presented below was derived from Nortel Networks Corporation’s audited consolidated financial statements and

related notes thereto included elsewhere in this Annual Report on Form 10-K except for the summarized balance sheet data as of December 31,

2001 and 2000. Readers should note the following information regarding the selected financial data presented below.

Nortel Networks Corporation has restated its previously reported consolidated financial statements for the fiscal years ended December 31,

2002 and 2001 and the quarters ended March 31, June 30 and September 30, 2003. The selected financial data presented below includes all

such restatements and covers the years ended December 31, 2003, 2002 and 2001 as well as selected balance sheet data as of December 31,

2003, 2002, 2001 and 2000. In connection with the restatement of the fiscal years ended December 31, 2002 and 2001, and the quarters ended

March 31, June 30 and September 30, 2003, Nortel Networks identified certain adjustments to its previously reported consolidated financial

statements for periods prior to fiscal 2001. The net effect of the adjustments relating to periods prior to fiscal 2001 have been reflected in the

selected financial data presented below as adjustments to accumulated deficit as of December 31, 2000. The disclosure presented below

addresses the adjustments identified in the Second Restatement that related to the periods prior to 2001.

Except for selected balance sheet data as of December 31, 2000, financial data for the years ended December 31, 2000 and 1999 has not been

restated or presented in the selected financial data presented below. Due to the identified material weaknesses in our internal controls over

financial reporting, significant turnover in Nortel Networks finance personnel, changes in accounting systems, documentation weaknesses, a

likely inability to obtain third party corroboration in certain cases due to the substantial industry adjustment in recent years and the passage of

time generally, Nortel Networks has determined that extensive additional efforts over an extended period of time would be required to restate

its 2000 and 1999 selected financial data. Nortel Networks also believes that selected financial data for these periods would not be meaningful

to investors due to the significant industry adjustment in the telecommunications industry beginning in 2001, which significantly impacted

Nortel Networks financial results in 2001 and subsequent periods and limits the relevance of financial results in periods prior to 2001 for

purposes of analysis of trends in subsequent periods. Previously reported financial information for 2000 and 1999 should not be relied upon.

See the “Controls and Procedures — Additional Background — Second Restatement — Estimates; Omissions of 1999 and 2000 Selected

Financial Data; Decision Not to Amend Certain Previous Filings” section of this report.

ITEM 6. Selected Financial Data (Unaudited)

See notes 4, 7 and 10 to the accompanying consolidated financial statements for the impact of accounting changes, special charges and acquisitions, divestitures and closures,

respectively, that affect the comparability of the above selected financial data.

(millions of U.S. dollars, except per share amounts) 2003 2002 2001

As restated* As restated*

Results of Operations

Revenues $ 10,193 $ 11,008 $ 18,900

Research and development expense 1,960 2,083 3,116

Special charges

Goodwill im

airmen

–595 11,426

Other special charges 284 1,500 3,390

Operating earnings (loss) 45 (3,072)(25,020)

Other income (expense) — net 445 (5) (506)

Income tax benefit (expense) 80 468 2,751

Net earnings (loss) from continuing operations 262 (2,893) (23,270)

Net earnings (loss) from discontinued operations — net of tax 184 (101)(2,467)

Cumulative effect of accounting changes — net of tax (12) – 15

Net earnings (loss) 434 (2,994)(25,722)

Basic earnings (loss) per common share

— from continuing operations 0.06 (0.75)(7.30)

— from discontinued operations 0.04 (0.03) (0.78)

Basic earnings (loss) per common share 0.10 (0.78)(8.08)

Diluted earnings (loss) per common share

— from continuing operations 0.06 (0.75)(7.30)

— from discontinued operations 0.04 (0.03) (0.78)

Diluted earnings (loss) per common share 0.10 (0.78)(8.08)

Dividends declared per common share – – 0.0375

(millions of U.S. dollars) 2003 2002 2001 2000**

As restated* As restated* As restated*

Financial Position as of December 31

Total assets $ 16,591 $ 16,961 $ 21,971 $ 44,337

Total debt 4,027 4,233 5,212 2,454

Minority interests in subsidiary companies 617 631 654 758

Total shareholders’ e

uit

3,945 3,053 4,808 27,862

* See note 3 to the accompanying consolidated financial statements.

** Total assets as of December 31, 2000 increased by $1,744 as a result of the Second Restatement, primarily due to increases in inventories — net and deferred income taxes-

net. Accumulated deficit as of December 31, 2000, increased by $1,432 as a result of the Second Restatement, as further described below.

The following information provides detailed disclosure in respect of each material component of the Second Restatement adjustments to the

accumulated deficit as of December 31, 2000:

Summary of Second Restatement Adjustments on Accumulated Deficit as of December 31, 2000:

Revenues and cost of revenues adjustments

Revenues were impacted by various errors related to revenue recognition resulting in a cumulative decrease of $3,379 for the years prior to

2001. The net impact to cost of revenues related to these revenue adjustments and other items was a cumulative decrease of $1,214 for the

years prior to 2001.

Revenues were recognized on certain sales for which it was subsequently determined that the criteria for revenue recognition under SAB 101

or SOP 97-2, as applicable, had not been met, including arrangements in which legal title or risk of loss on products did not transfer to the

buyer until full payment was received, and arrangements where delivery had not occurred. Revenues and related cost of revenues for these

arrangements should have been deferred to later periods when title or risk of loss had passed and all criteria for revenue recognition had been

met. Therefore, adjustments were made to defer revenues and related cost of revenues from the periods in which they were originally recorded

and to recognize them in the periods in which all revenue recognition criteria were met.

Revenues were recognized on certain sales for which it was subsequently determined that the criteria for revenue recognition under SOP 97-2

had not been met, including arrangements in which the criteria for fixed or determinable fees was not met. Revenues and related cost of

revenues for these agreements were deferred to later periods when payments became due and all criteria for revenue recognition had been met.

In certain multiple element arrangements, total arrangement fees were recognized as revenue at the time of delivery of software or hardware,

but prior to the delivery of future contractual or implicit PCS or other services. Revenues should have been allocated to these future

deliverables based on their fair value and recognized ratably over the PCS period or as the future obligations were performed. Adjustments

were made to appropriately allocate revenue among the accounting units and recognize the allocated revenue in accordance with the applicable

revenue recognition guidance. In certain circumstances where the criteria to treat delivered software and hardware elements and undelivered

PCS services as separate accounting units were not met, the entire arrangement fee was deferred and recognized over the PCS period.

Revenues were also recognized for certain contracts that involved undelivered elements as a result of product development delays. The lack of

relative fair value for the undelivered element meant that revenues and cost of revenues for all products delivered should have been deferred

until the undelivered element was delivered. As originally recorded, revenues were recognized upon delivery of an alternative product and

costs were accrued for the

(millions of U.S. dollars) Total

Adjustments

Revenues $(3,379)

Cost of revenues (1,214)

Gross profit (2,165)

Income tax benefit 623

Foreign exchange (186)

Other adjustments 296

Net increase to accumulated deficit $(1,432)

undelivered element. To correct for these items, related cost provisions were reversed and revenues and associated cost of revenues were

recognized in the appropriate periods when all elements had been delivered.

Revenues were recognized upon product delivery to a certain reseller who lacked economic substance apart from Nortel Networks. Revenue

should have been deferred and only recognized by Nortel Networks upon sale by the reseller to an end customer. Correction of this resulted in

revenues and cost of revenues being deferred with ultimate recognition in 2001.

Other adjustments included corrections related to errors in the application of percentage-of-completion accounting for certain contracts,

specific contracts with reciprocal arrangements that should have been treated as a reduction of revenues, and other errors related to non-cash

incentives and concessions provided to customers and other calculation errors.

Other adjustments

The income tax benefit as a result of the restatement decreased the accumulated deficit by $623. The determination of the functional currency

for certain entities was re-examined, and as a result Nortel Networks determined that the accounting for certain global headquarter functions

needed to be restated back to 1986 to reflect a U.S. dollar functional currency designation. This resulted in an increase of $186 to accumulated

deficit and a decrease to accumulated other comprehensive loss as of December 31, 2000. Other adjustments of $296 included the corrections

of errors in respect to each of intercompany related items, the accounting associated with sales of receivables, the calculation of the valuation

of deferred compensation on certain acquisitions and various other adjustments. Reflected in these adjustments were reclassifications of certain

items to or from cost of revenues.

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

erations — Table of Contents

Business overview 37

Our business 37

Our segments 37

Our business environmen

How we measure

ormance 39

Our strate

lan and outlook 40

Develo

ments in 2003 and 2004 41

2003 consolidated results summar

Nortel Networks Audit Committee Inde

endent Review; restatements; related matters 41

Comprehensive Review and First Restatement 41

Independent Review 42

Second Restatement 42

Material weaknesses in internal control over financial reporting identified in Second Restatement 48

Revenue Independent Review 49

Personnel actions 49

EDC Support Facility 49

Credit facilities and security agreements 50

Debt securities 50

Shelf registration statement 51

Credit ratings 51

Regulatory actions and pending litigation 51

Stoc

-based compensation plans 51

Evolution o

our su

chain strate

Other business developments 52

Shareholder rights plan 52

Ownership adjustment in our French and German operations 53

Customer financing commitments 53

Sale of Entrust shares 53

Real estate 53

Customer contract settlement 53

Directory and operator services business 53

Bharat Sanchar Nigram Limited contract 53

Patent infringement settlement 53

Customer financing arrangements 54

Results of o

erations —continuin

erations 54

ment revenues 54

Geo

hic revenues 54

Consolidated revenues 54

Wireless Networks revenues 56

Enterprise Networks revenues 58

Wireline Networks revenues 60

Optical Networks revenues 61

Gross

it and

ross mar

in 63

Segment gross profit and gross margin 63

Operating expenses 65

Selling, general and administrative expense 65

Segment selling, general and administrative expense 65

Research and development expense 66

Segment research and development expense 67

Segment contribution margin 68

Segment Management EBT 68

Amortization of intangibles 68

Deferred stock option compensation 68

Special charges 69

Gain (loss) on sale o

businesses and assets 71

Other income (ex

ense) —ne

Interest ex

ense 72

Income tax benefit (expense) 72

Net earnin

s(loss)

rom continuin

erations 72

Results of o

erations —discontinued o

erations 72

uidit

and ca

ital resources 73

Cash

lows 73

Uses o

uidit

Contractual cash obligations 76

JDS purchase arrangement 77

Customer financing 77

Joint ventures/minorit

interests 78

Discontinued o

erations 78

Sources o

uidit

Credit facilities 78

Available support facility 78

Shelf registration statement and base shelf prospectus 79

Credit ratin

s80

Off-balance sheet arran

ements 80

Bid,

ormance related and other bonds 80

Receivables securitization and certain lease

inancin

transactions 81

Other indemni

ications or

uarantees 81

lication of critical accountin

estimates 82

Revenue recognition 82

Provisions

or doubt

ul accounts 83

Provisions

or inventor

Income taxes 85

Tax asset valuation 85

Tax contingencies 86

Goodwill valuation 86

Pension and pos

-retirement benefits 87

ecial char

es 88

Other contin

encies 89

Accountin

chan

es and recent accountin

ronouncements 89

Accountin

chan

es 89

Recent accountin

ronouncements 90

Market risk 91

Equity price risk 92

Environmental matters 92

roceedin

s93

Risk factors/forward lookin

statements 93

Risks relatin

to our restatements and related matters 93

Risks relatin

to our business 99

Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operation, or MD&A, in combination with

the accompanying audited consolidated financial statements prepared in accordance with accounting principles generally accepted in the

United States, or U.S. GAAP. As discussed herein, this MD&A gives effect to the Second Restatement as described below in “Developments in

2003 and 2004 — Nortel Networks Audit Committee Independent Review; restatements; related matters” and in “Restatement” in note 3 of the

accompanying audited consolidated financial statements. A number of our and Nortel Networks Limited’s past filings with the United States

Securities and Exchange Commission, or SEC, remain subject to ongoing review by the SEC’s Division of Corporation Finance. In addition,

the Second Restatement involved the restatement of our consolidated financial statements for 2001 and 2002 and the first, second and third

quarters of 2003. Amendments to our prior filings with the SEC would be required in order for us to be in full compliance with our reporting

obligations under the Exchange Act. However, we do not believe that it will be feasible to amend our Annual Report on Form 10-K/A for the

ear ended December 31, 2002, or 2002 Form 10-K/A, and our 2003 Form 10-Qs due to, among other factors, identified material weaknesses

in our internal control over financial reporting, the significant turnover in our finance personnel, changes in accounting systems,

documentation weaknesses, a likely inability to obtain third party corroboration in certain cases due to the substantial industry adjustment in

recent years and the passage of time generally. In addition, disclosure in the 2002 Form 10-K/A and 2003 Form 10-Qs would in large part

repeat the disclosure expected to be contained in this report and the 2004 Form 10-Qs. Accordingly, we do not plan to amend our 2002 Form

10-K/A and 2003 Form 10-Qs. We believe that we have included in this report all information needed for current investor understanding.

Ongoing SEC review may require us to amend this Annual Report on Form 10-K or our other public filings further. See “Risk factors/forward

looking statements”.

This section contains forward looking statements and should be read in conjunction with the risk factors described below under “Risk

actors/forward looking statements”. All dollar amounts in this MD&A are in millions of United States, or U.S., dollars unless otherwise

stated.

Where we say “we”, “us”, “our” or “Nortel Networks”, we mean Nortel Networks Corporation or Nortel Networks Corporation and its

subsidiaries, as applicable, and where we refer to the “industry”, we mean the telecommunications industry.

Business overview

Our business

Nortel Networks is a recognized leader in delivering communications capabilities that enhance the human experience, ignite and power global

commerce, and secure and protect the world’s most critical information. Serving both service provider and enterprise customers, we deliver

innovative technology solutions encompassing end-to-end broadband, Voice over IP, multimedia services and applications, and wireless

broadband solutions designed to help people solve the world’s greatest challenges. Our business consists of the design, development,

manufacture, assembly, marketing, sale, licensing, installation, servicing and support of these networking solutions. A substantial portion of

our business has a technology focus and is dedicated to research and development, or R&D. This focus forms a core strength and is a factor

that we believe differentiates us from many of our competitors. We envision a networked society where people are able to connect and interact

with information and with each other instantly, simply and reliably, accessing data, voice and multimedia communications services and sharing

experiences anywhere, anytime.

The common shares of Nortel Networks Corporation are publicly traded on the New York Stock Exchange, or NYSE, and Toronto Stock

Exchange, or TSX, under the symbol “NT”. Nortel Networks Limited, or NNL is our principal direct operating subsidiary and its results are

consolidated into our results. Nortel Networks holds all of NNL’s outstanding common shares but none of its outstanding preferred shares.

NNL’s preferred shares are reported in minority interests in subsidiary companies in the consolidated balance sheets and dividends and the

related taxes on preferred shares are reported in minority interests — net of tax in the consolidated statements of operations.

Our segments

During 2003 and up to September 30, 2004, our operations were organized into four reportable segments as follows:

Effective October 1, 2004, we established a new streamlined organizational structure that included, among other things, combining the

businesses of our four segments into two business organizations: (i) Carrier Networks and Global Operations, and (ii) Enterprise Networks. We

are reviewing the impact of these changes on our reportable segments under Statement of Financial Accounting Standards, or SFAS, No. 131,

“Disclosures about segments of an enterprise and related information”.

Ourbusinessenvironment

In 2001, we entered into an unprecedented period of business realignment in response to a significant adjustment in the industry. Industry

demand for networking equipment dramatically declined in response to the industry adjustment, severe economic downturns in various regions

around the world and a tightening in global capital markets. We implemented a company-wide restructuring plan to streamline our operations

and activities around core markets and operations, which included significant workforce reductions, global real estate closures and dispositions,

substantial write-downs of our capital assets, goodwill and other intangible assets and extensive contract settlements with customers and

suppliers around the world. As a result of these actions, our workforce declined significantly from January 1, 2001 to December 31, 2003 and

over the same time period, we significantly reduced our facilities. In 2003, customer spending remained cautious as a result of tightened capital

markets mainly in the first half of 2003 and customers realigning capital spending with their current levels of revenues and profits in order to

maximize their return on invested capital. We experienced continued industry adjustment and capital spending restrictions by our service

provider customers. Also, excess network capacity and competition continued to exist in the industry which led to continued pricing pressures

on the sale of certain of our products.

During the second half of 2003 and in 2004, we began to experience a period of relative industry stability. Throughout the second half of 2003

and in 2004, we announced several new contracts across all of our reportable segments, but primarily in our Wireless Networks segment, as

certain service provider customers began to expand and upgrade their existing networks. In 2004, however, we continued to experience pricing

pressures on sales of certain products across all of our reportable segments primarily as a result of increased competition.

As first announced on August 19, 2004, we have put in place a new strategic plan that recognizes these industry dynamics and the evolution of

the converged network (see “Our strategic plan and outlook”). In an increasingly cost-competitive environment, we are taking steps that we

believe will better position us to grow market share and improve our results and cash generation. As part of our strategic plan, we also

announced a focused workforce reduction of approximately 3,250 employees.

In May 2003, we commenced certain balance sheet reviews at the direction of certain members of former management that led to a

comprehensive review and analysis of our assets and liabilities, or the Comprehensive Review, which resulted in the

• Wireless Networks — Our Wireless Networks segment provides communications networks that enable end-users to be mobile

while they send and receive voice and data communications using wireless devices, such as cellular telephones, personal digital

assistants and other computing and communications devices. Our Wireless Networks customers are wireless service providers, and

their customers are the subscribers for wireless communications services.

• Enterprise Networks — Our Enterprise Networks segment provides data, voice and multimedia communications solutions for our

enterprise customers. Our Enterprise Networks customers consist of a broad range of enterprise customers around the world,

including large businesses and their branch offices, small businesses and home offices, as well as government agencies, educational

and other institutions and utility organizations.

• Wireline Networks — Our Wireline Networks segment addresses the demand by our service provider customers for cost efficient

data, voice and multimedia communications solutions. We offer our Wireline Networks products and services to a wide range of

wireline and wireless service providers around the world. Our service provider customers include local and long distance telephone

companies, wireless service providers, cable operators and other communication service providers. We also provide services to our

data networking and security customers which consist of system integrators that in turn build, operate and manage networks for

their customers, such as businesses, government agencies and utility organizations.

• Optical Networks — Our Optical Networks segment solutions transport data, voice and multimedia communications within and

between cities, countries or continents by transmitting communications signals in the form of light waves through fiber optic cables.

Our Optical Networks business is primarily focused on offering our optical networking solutions to service providers around the

world. The service provider customers for our optical networking products include local and long-distance telephone companies,

cable operators, Internet service providers and other communications service providers.

restatement (effected in December 2003) of our consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and

for the quarters ended March 31, 2003 and June 30, 2003, or the First Restatement. In late October 2003, the Audit Committees of our and

NNL’s Boards of Directors, or the Audit Committee, initiated an independent review of the facts and circumstances leading to the First

Restatement, or the Independent Review, and engaged the law firm now known as Wilmer Cutler Pickering Hale & Dorr LLP, or WCPHD, to

advise it in connection with the Independent Review. The Audit Committee sought to gain a full understanding of the events that caused

significant excess liabilities to be maintained on the balance sheet that needed to be restated, and to recommend that our Board of Directors

adopt, and direct management to implement, necessary remedial measures to address personnel, controls, compliance and discipline. In

January 2005, the Audit Committee reported the findings of the Independent Review, together with its recommendations for governing

principles for remedial measures that were developed for the Audit Committee by WCPHD. Each of our and NNL’s Boards of Directors has

adopted these recommendations in their entirety and directed our management to develop a detailed plan and timetable for their

implementation, and will monitor their implementation.

As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns identified

by WCPHD regarding provisioning activity and to review certain provision releases. That examination, and other errors identified by

management, led to the restatement (effected today) of our financial statements for the years ended December 31, 2002 and 2001 and the

quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003 and 2002, or the Second Restatement, and our

revision of previously announced unaudited results for the year ended December 31, 2003. The need for the Second Restatement resulted in

delays in filing our and NNL’s 2003 Annual Reports on Form 10-K, or the 2003 Annual Reports, and Quarterly Reports on Form 10-Q for the

first, second and third quarters of 2004, or the 2004 Quarterly Reports, beyond the SEC’s required filing dates in 2004. We refer to the 2003

Annual Reports and the 2004 Quarterly Reports together as the Reports.

Over the course of the Second Restatement process, management identified certain accounting practices that it determined should be adjusted

as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and undertook a process of

revenue reviews. As described in more detail in the “Controls and Procedures” section of this report, in light of the resulting adjustments to

revenues previously reported in relevant periods, the Audit Committee has determined to review the facts and circumstances leading to the

restatement of these revenues for specific transactions identified in the Second Restatement. This review will have a particular emphasis on the

underlying conduct that led to the initial recognition of these revenues. The Audit Committee will seek a full understanding of the historic

events that required the revenues for these specific transactions to be restated and will consider any appropriate additional remedial measures,

including those involving internal controls and processes. The Audit Committee has engaged WCPHD to advise it in connection with this

review. See “Risk factors/forward looking statements.”

Over the course of the Second Restatement, we and our independent auditors identified a number of material weaknesses in our internal control

over financial reporting. Further, in connection with the Independent Review, we terminated for cause our former president and chief executive

officer, former chief financial officer and former controller in April 2004 and seven additional senior finance employees with significant

responsibilities for our financial reporting as a whole or for their respective business units and geographic areas in August 2004. We are subject

to significant pending civil litigation and ongoing regulatory and criminal investigations in the U.S. and Canada, which could require us to pay

substantial judgments, settlements, fines or other penalties.

We are currently in a challenging transitional period in connection with the completion of our restatement activity and as we implement the

new strategic plan. We believe that our strategic plan will enable us to build on our market leadership in developing the converged networks of

the future and improve business efficiency and operating cost performance in an increasingly competitive market.

ow we measure performance

Each reportable segment is allocated resources and assets based on whether projected customer demand would support additional investment.

We make adjustments to reduce resources and assets within a reportable segment in response to market conditions or where opportunities for

improved efficiencies present themselves.

Our president and chief executive officer, or CEO, has been identified as the chief operating decision maker in assessing the performance of

the segments and the allocation of resources to the segments. Each reportable segment is managed separately with each segment manager

reporting directly to the CEO. The CEO relies on the information derived directly from our management reporting system. In 2003, we

reported that the primary financial measure used by the former chief operating decision maker in assessing performance and allocating

resources to the segments was contribution margin, a measure that was comprised of gross profit less selling, general and administrative

expense, or SG&A. In April 2004, our and NNL’s boards of directors appointed a new CEO. Commencing in the second quarter of 2004, the

primary financial measure used by our CEO in assessing performance and allocating resources to the segments is management earnings

(loss) before income taxes, or Management EBT, a measure that includes contribution margin, R&D expense, interest expense, other income

(expense) — net, minority interest — net of tax and equity in net loss of associated companies — net of tax. As a result of the change in the

primary financial measure used to assess the performance of our segments during the period in which the

Reports have been delayed, and because both contribution margin and Management EBT were available to the former chief operating decision

maker during 2003, we have determined that it is appropriate to disclose both contribution margin and Management EBT for the periods

presented. See “Segment information — General description” in note 6 of the accompanying consolidated financial statements.

From a liquidity perspective, we maintain strict controls over our sources and uses of cash. We also focus on the liquidity and cash flows of our

customers in an effort to minimize our credit risk. We closely monitor our inventory levels, both in our manufacturing facilities as well as at

our contract manufacturers, in an effort to minimize our exposure to excess supply and subsequent cash costs incurred as a result of excess

capacity.

Our strategic plan and outlook

On August 19, 2004, we announced a new strategic plan intended to enable us to build on our market leadership in developing the converged

networks of the future and improve business efficiency and operating cost performance in an increasingly competitive market. We provided

further details concerning the strategic plan on September 30, 2004 and December 14, 2004. It is our intention to be optimally positioned to

maximize strategic opportunities as they arise and leverage our acknowledged strengths in high reliability networks and strong customer

loyalty. We continue to drive our business forward with a focus on costs, cash and revenues as strategic goals. We remain committed to our

business strategy of technology and solutions evolution in helping our customers transform their networks and implement new applications and

services to drive improved productivity, reduced costs and revenue growth.

The principal components of the strategic plan are:

Our strategic plan also includes a work plan involving focused workforce reductions of approximately 3,250 employees, a voluntary retirement

program, real estate optimization and other cost containment actions such as reductions in information services costs, outsourced services and

other discretionary spending. Our workforce actions are focused to disproportionately protect customer and sales facing roles as well as

continue our focus on new innovative solutions. Approximately 64% of employee actions related to the focused workforce reduction were

completed by the end of 2004, including approximately 55% that were notified of termination or acceptance of voluntary retirement, with the

remainder comprised of voluntary attrition of employees that were not replaced. The remainder of employee actions are expected to be

completed by June 30, 2005. In addition, however, the Company continues to hire in certain strategic areas such as investments in the finance

organization. These focused headcount reductions are intended to result in ongoing cost reductions in R&D and SG&A expenses and cost of

sales. These actions are subject to the completion of required jurisdictional consultation and regulatory approvals. This workforce reduction is

in addition to the workforce reduction that will result from our agreement with Flextronics International Ltd., or Flextronics (for more

information, see “Evolution of our supply chain strategy”). We expect the real estate actions to be completed by the end of 2005.

We estimate charges to the income statement associated with our overall work plan in the aggregate of approximately $450 comprised of

approximately $220 with respect to the workforce reductions and approximately $230 with respect to the real estate actions. No charges are

expected to be recorded with respect to the other cost containment actions. Approximately 25% of the aggregate income statement charges

were incurred in 2004 with the remainder expected to be incurred in 2005.

The associated cash costs of the work plan of approximately $430 are expected to be split approximately equally between the workforce

reductions and real estate actions. Approximately 10% of these cash costs were incurred in 2004 and approximately 40% are expected to be

incurred in 2005. The remaining 50% of the cash costs relates to the real estate actions and are expected be incurred in 2006 through to 2022

for ongoing lease costs related to impacted real estate facilities.

• a renewed commitment to best corporate practices and ethical conduct, including the establishment of the office of a chief ethics and

compliance officer, which has been filled on an interim basis pending the permanent appointment of Susan E. Shepard, as now

announced;

• a streamlined organizational structure to reflect alignment with carrier converged networks;

• an increased focus on the enterprise market and customers;

• optimized R&D programs for highly secure, available and reliable converged networks;

• the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;

• the establishment of a chief marketing officer to drive overall marketing strategy;

• the strategic review of embedded services to assess opportunities in the professional services business; an

• a distinct focus on government and defense customers.

In addition to the above, we also expect to incur capital cash costs of approximately $50 in 2005 for facility improvements related to the real

estate actions.

We anticipate cost savings from the implementation of the work plan of approximately $500 in 2005, which is expected to increase on an

annualized basis beyond 2005 as the full impact of the work plan is realized. We expect that this work plan will primarily be funded with cash

from operations.

We expect that our consolidated revenues in 2004 will be slightly lower compared with 2003. The 2003 consolidated revenues included

revenues that were deferred from prior periods. We see growth opportunities in emerging markets such as China and India. Further, we believe

security and reliability for service provider networks are increasingly important to governments, defense interests and enterprises around the

world.

Developments in 2003 and 2004

2003 consolidated results summary

During 2003, we began to experience a period of relative industry stability following an unprecedented period of business realignment that

commenced in 2001 in response to a significant industry adjustment. In 2003, our consolidated revenues were $3,266 in the fourth quarter,

$2,344 in the third quarter, $2,285 in the second quarter and $2,298 in the first quarter. Although our revenues declined 7% in 2003 ($10,193 in

2003 compared to $11,008 in 2002), this decline represented a substantial improvement from the revenue decline of 42% experienced in 2002

compared to 2001 ($11,008 in 2002 compared to $18,900 in 2001). As well, throughout the second half of 2003, we announced several new

contracts across all of our reportable segments, but primarily in our Wireless Networks segment, as certain service provider customers began to

expand and upgrade their existing networks.

Our gross margin increased to 42.6% in 2003 compared to 35.5% in 2002, an improvement of approximately 7 percentage points. SG&A

expense declined 24% in 2003 compared to 2002 and R&D expense declined 6% in 2003 compared to 2002. The percentage declines in SG&A

and R&D expense were primarily due to actions taken to better align our expenses with the volume of business in 2003. Our R&D expense did

not decline to the same extent as our SG&A expense on a percentage basis due to our technology focus and commitment to invest in next

generation solutions. Special charges substantially declined in 2003 compared to 2002, primarily as a result of a substantial reduction in

charges associated with workforce reductions and goodwill impairment related to our restructuring work plan initiated in 2001.

Our discontinued operations contributed $184 of net earnings in 2003 compared to a net loss of $101 in 2002. The $184 of net earnings was

primarily the result of the completion of a number of transactions in 2003 associated with the wind-down activities of our discontinued

operations.

As a result of these improvements, we reported net earnings before cumulative effect of accounting changes of $446 in 2003 compared to a net

loss before cumulative effect of accounting changes of $2,994 in 2002.

Throughout 2003, we maintained our strong liquidity position. In 2003, our cash and cash equivalents, or cash, increased $207 from $3,790 at

December 31, 2002 to $3,997 at December 31, 2003. The improvement was primarily due to an increase in cash of $390 from our discontinued

operations, an increase in cash of $85 from our operating activities and favorable foreign exchange impacts of $176. These increases in cash

were partially offset by $359 of cash used in our financing activities and $85 used in our investing activities. As of December 31, 2003, our

long term debt totaled $4,010.

ortel Networks Audit Committee Independent Review; restatements; related matters

In May 2003, we commenced certain balance sheet reviews at the direction of certain members of former management that led to the

Comprehensive Review, which resulted in the First Restatement. See notes 3 and 23 of the accompanying consolidated financial statements

and the “Controls and Procedures” section of this report.

In connection with the Comprehensive Review, Deloitte & Touche LLP, or D&T, our independent auditors, informed the Audit Committee on

July 24, 2003 of a “reportable condition” that did not constitute a “material weakness” in our internal

Com

rehensive Review and First Restatement

control over financial reporting (throughout this report, unless otherwise indicated, “reportable condition” and “material weakness” have the

meanings as formerly set forth under standards established by the American Institute of Certified Public Accountants, or AICPA). Later, on

November 18, 2003, as part of the communications by D&T to the Audit Committee with respect to D&T’s interim audit procedures for the

year ended December 31, 2003, D&T informed the Audit Committee that it had identified certain reportable conditions, each of which

constituted a material weakness in our internal control over financial reporting. These material weaknesses identified in the First Restatement

were also later identified in connection with the Second Restatement together with certain additional material weaknesses in our internal

control over financial reporting, as described in greater detail in the “Controls and Procedures” section of this report.

In late October 2003, the Audit Committee initiated the Independent Review and engaged WCPHD to advise it in connection with the

Independent Review in order to gain a full understanding of the events that caused significant excess liabilities to be maintained on the balance

sheet that needed to be restated, and to recommend that our Board of Directors adopt, and direct management to implement, necessary remedial

measures to address personnel, controls, compliance and discipline. The Independent Review focused initially on events relating to the

establishment and release of contractual liability and other related provisions (also called accruals reserves, or accrued liabilities) in the second

half of 2002 and the first half of 2003, including the involvement of senior corporate leadership. As the Independent Review evolved, its focus

broadened to include specific provisioning activities in each of the business units and geographic regions. In light of concerns raised in the

initial phase of the Independent Review, the Audit Committee expanded the review to include provisioning activities in the third and fourth

quarters of 2003.

As discussed more fully in the “Controls and Procedures” section of this report, the Independent Review concluded that “[i]n summary, former

corporate management (now terminated for cause) and former finance management (now terminated for cause) in the Company’s finance

organization endorsed, and employees carried out, accounting practices relating to the recording and release of provisions that were not in

compliance with [U.S. GAAP] in at least four quarters, including the third and fourth quarters of 2002 and the first and second quarters of

2003. In three of those four quarters — when Nortel was at, or close to break even — these practices were undertaken to meet internally

imposed... targets. While the dollar value of most of the individual provisions was relatively small, the aggregate value of the provisions made

the difference between a profit and a reported loss, on a pro forma basis, in the fourth quarter of 2002 and the difference between a loss and a

reported profit, on a pro forma basis, in the first and second quarters of 2003.”

As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns identified

by WCPHD regarding provisioning activity and to review provision releases, down to a low threshold. That examination, and other errors

identified by management, led to the Second Restatement.

Over the course of the Second Restatement process, management identified certain accounting practices that it determined should be adjusted

as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and undertook a process of

revenue reviews, resulting in adjustments to previously reported revenues during the periods 1999 through 2003. Other accounting practices

that management examined and adjusted as part of the Second Restatement included, among other things the following:

The following tables present the impact of the Second Restatement adjustments on our previously reported consolidated statements of

operations data for the years ended December 31, 2002 and 2001. The Second Restatement adjustments related primarily to the following

items, each of which reflect a number of related adjustments that have been aggregated for disclosure purposes, and are described in the

paragraphs following the tables below. See “Restatement” in note 3 of the accompanying consolidated financial statements.

Inde

endent Review

Second Restatement

• intercompany balances that did not eliminate upon consolidation and related provisions;

• our foreign exchange accounting, as part of the plan to address our identified material weakness related to foreign currency

translation;

• the accounting treatment of the February 2001 acquisition of the 980 NPLC business from JDS Uniphase Corporation, or JDS, and

the related OEM Purchase and Sale Agreement;

• special charges relating to goodwill, inventory impairment, contract settlement costs and other charges; and

• the accounting treatment of certain elements of discontinued operations.

Years ended December 31, 2002 and 2001

• revenues and cost of revenues;

• foreign exchange;

• intercompany balances;

• special charges;

•other;

• reclassifications; and

• discontinued operations.

Revenues and cost of revenues were impacted by various errors related to revenue recognition, corrections to foreign exchange accounting,

intercompany related items, special charges and other adjustments, including financial statement reclassifications. The net impact to revenues

of the adjustments was an increase of $439 and $1,492 for the years ended December 31, 2002 and 2001, respectively. The net impact to cost

of revenues related to these revenue adjustments, and the other corrections, was an increase of $305 and $598 for the years ended

December 31, 2002 and 2001, respectively. The Second Restatement adjustments to revenues and cost of revenues related primarily to the

following items:

Consolidated Statement of O

erations data for the

ear ended December 31, 2002

As previously

reported Adjustments As restated

Revenues $ 10,569 $ 439 $ 11,008

Gross profit 3,771 134 3,905

eratin

earnin

s (loss) (3,435) 363 (3,072)

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of

associated companies (3,721) 372 (3,349)

Net earnings (loss) from continuing operations (3,286) 393 (2,893)

Net earnings (loss) from discontinued operations — net of tax 20 (121) (101)

Net earnings (loss) (3,266) 272 (2,994)

Basic and diluted earnin

s (loss)

er common share

— from continuing operations $ (0.86) $ 0.11 $ (0.75)

— from discontinued operations 0.01 (0.04) (0.03)

Basic and diluted earnings (loss) per common share $ (0.85) $ 0.07 $ (0.78)

Consolidated Statement of O

erations data for the

ear ended December 31, 2001

As previously

reported Adjustments As restated

Revenues $ 17,408 $ 1,492 $ 18,900

Gross profit 3,394 894 4,288

Operating earnings (loss) (26,469) 1,449 (25,020)

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of

associated companies (27,176) 1,339 (25,837)

Net earnings (loss) from continuing operations (24,174) 904 (23,270)

Net earnings (loss) from discontinued operations — net of tax (2,996) 529 (2,467)

Net earnings (loss) (27,155) 1,433 (25,722)

Basic and diluted earnings (loss) per common share

— from continuing operations $ (7.58) $ 0.28 $ (7.30)

— from discontinued operations (0.94) 0.16 (0.78)

Basic and diluted earnings (loss) per common share $ (8.52) $ 0.44 $ (8.08)

evenues and cost o

revenues

• incorrect application of SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition (preceded by SAB 101), or SAB

104, or AICPA Statement of Position, or SOP, 97-2, Software Revenue Recognition, or SOP 97-2, the most significant of which

related to revenue that should have been deferred until title or risk of loss had passed, or products had been delivered;

• incorrect recognition of revenue upon product delivery to a certain reseller; and

• various other adjustments, primarily related to specific contracts and transactions and errors related to non-cash incentives and

concessions provided to customers.

As part of the plan to address a material weakness reported in our Quarterly Report on Form 10-Q for the period ended September 30, 2003, a

review of foreign exchange accounting was undertaken. The net impact was a decrease to pre-tax loss of $63 and $132 for the years ended

December 31, 2002 and 2001, respectively. The significant items were as follows:

Historically, we had certain intercompany balances that did not eliminate upon consolidation , or out-of-balance positions, and had recorded

provisions accordingly. As part of the Second Restatement, we reviewed these provisions and determined that they should not have been

recorded. We recorded adjustments in the appropriate periods to reverse these provisions and to correct the significant out-of-balance positions.

The net impact of the adjustments to correct the significant out-of-balance positions was a decrease of $36 and an increase of $42 to the

previously reported pre-tax loss for the years ended December 31, 2002 and 2001, respectively.

As part of the Second Restatement, we re-examined the components of special charges, and recorded decreases to special charges of $78 and

$845 for the years ended December 31, 2002 and 2001, respectively. The adjustments are discussed below.

The accounting for the deferred consideration associated with the acquisition of the 980 NPLC business from JDS and the related OEM

Purchase and Sale Agreement in February 2001 was re-examined. Upon re-examination, it was determined that adjustments were required to

reflect the appropriate purchase price and amount allocated to goodwill. The impact of the adjustments was a $473 decrease to special charges

to reduce the goodwill impairment for the year ended December 31, 2001. Other impacts included a decrease to goodwill amortization of $52

for the year ended December 31, 2001 and an increase to cost of revenues of $148 and $152 for the years ended December 31, 2002 and 2001,

respectively, with corresponding reversals of these amounts which were previously recorded against common shares.

As part of the Second Restatement, we determined that adjustments were required for various other acquisitions to the amounts allocated to

goodwill as a result of corrections to purchase accounting allocations, and to correct valuations of consideration paid. The impact of the

adjustments to goodwill was a decrease to special charges of $222 to reduce the impairment of goodwill for the year ended December 31, 2001.

Other impacts included an increase to deferred stock option compensation expense of $24 and $123 for the years ended December 31, 2002

and 2001, respectively, and a decrease to goodwill amortization of $39 for the year ended December 31, 2001.

Also as part of the Second Restatement, we reclassified inventory impairments of $89 to cost of revenues, previously incorrectly classified as

special charges. We also determined that certain items were either recorded in special charges in error or, although correctly recorded when

originally recognized, were not adjusted in the appropriate subsequent periods for changes in estimates and/or assumptions. The adjustments to

special charges for these other items were an increase of $11 and a decrease of $150 for the years ended December 31, 2002 and 2001,

respectively.

We recorded other adjustments primarily to correct certain accruals, provisions and other transactions, which were either initially recorded

incorrectly in prior periods, or not properly released or adjusted for changes in estimates and/or assumptions in the appropriate subsequent

periods. These adjustments decreased the net loss for the year ended December 31, 2002 by $314 and increased the net loss for the year ended

December 31, 2001 by $59, and included tax and minority interests impacts of all Second Restatement adjustments.

orei

nexchan

• we re-examined the determination of the functional currency for certain entities based on the guidance under SFAS No. 52,

“Foreign Currency Translation”, or SFAS No. 52. As a result, we identified four instances in which the functional currency

designation of an entity was incorrect. These revisions resulted in increases or decreases to other income (expense)

—

net; and

• we identified two instances of incorrect treatment of foreign currency translation gains and losses arising from significant

intercompany positions. The net impact of the adjustments was an increase or decrease to other income (expense) — net, with an

offset to accumulated other comprehensive loss.

ntercom

balances

ecial char

Other

The adjustment to income tax benefit, substantially all as a result of the Second Restatement adjustments, was an increase of $15 and a

decrease of $401 for the years ended December 31, 2002 and 2001, respectively. The adjustment to minority interests as a result of the Second

Restatement adjustments was an increase of $26 and a decrease of $12 for the years ended December 31, 2002 and 2001, respectively.

As a result of the restatement process, various presentation inconsistencies were identified. Adjustments were made to appropriately reflect

certain items in the statement of operations. The reclassifications were made for royalty expense, gain (loss) on sale of businesses and assets,

minority interests — net of tax (now reported separately), and other items including certain functional spending and specific expenses.

As a result of the restatement process, the initial provision for loss on disposal of the access solutions discontinued operations recorded in

June 2001, and the subsequent activity during 2001 through 2004 were re-examined. We concluded that the net loss on disposal of operations

recognized in the second quarter of 2001 was overstated by $738, of which $520 comprised items that should have been charged to continuing

operations. In addition, other adjustments were necessary to correct certain items that were either initially recorded incorrectly, or not properly

released or adjusted for changes in estimates in the appropriate periods subsequent to the second quarter of 2001. The net impact of all of these

changes on net loss from discontinued operations — net of tax was an increase of $121 and a decrease of $529 for the years ended

December 31, 2002 and 2001, respectively, and an increase to net loss of $121 and $7 for the years ended December 31, 2002 and 2001,

respectively.

The following tables present the impact of the Second Restatement adjustments on our previously reported consolidated statements of

operations data for the first, second and third quarters of 2003 (the fourth quarter of 2003 had not been previously reported). The Second

Restatement adjustments are described in the paragraphs following the tables below.

Consolidated Statement of Operations data for the three months ended March 31, 2003

eclassi

ications

iscontinued o

erations

irst, second and third

uarters o

2003

As previously

reported Adjustments As restated

Revenues $ 2,377 $ (79) $ 2,298

Gross profit 1,044 (149) 895

Operating earnings (loss) (133) (120) (253)

Earnin

s (loss) from continuin

erations before income taxes, minorit

interests and e

uit

in net loss of associated com

anies (182) (31) (213)

Net earnings (loss) from continuing operations (171) (63) (234)

Net earnings (loss) from discontinued operations — net of tax 190 (68) 122

Net earnings (loss) 11 (135) (124)

Basic and diluted earnings (loss) per common share

— from continuing operations $ (0.04) $ (0.02) $ (0.06)

— from discontinued o

erations 0.04 (0.01) 0.03

Basic and diluted earnings (loss) per common share $ 0.00 $ (0.03) $ (0.03)

Consolidated Statement of Operations data for the three months ended June 30, 2003

Consolidated Statement of Operations data for the three months ended September 30, 2003

As previously

reported Adjustments As restated

Revenues $ 2,338 $ (53) $ 2,285

Gross profit 1,028 (146) 882

eratin

earnin

s (loss) 90 (186) (96)

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of associated companies 67 (154) (87)

Net earnings (loss) from continuing operations 38 (131) (93)

Net earnings (loss) from discontinued operations — net of tax (1) (7) (8)

Net earnings (loss) 37 (138) (101)

Basic and diluted earnings (loss) per common share

— from continuin

erations $ 0.01 $ (0.03) $ (0.02)

— from discontinued operations 0.00 0.00 0.00

Basic and diluted earnin

s (loss)

er common share $ 0.01 $ (0.03) $ (0.02)

As previously

reported Adjustments As restated

Revenues $ 2,266 $ 78 $ 2,344

Gross profit 1,192 (62) 1,130

Operating earnings (loss) 124 (72) 52

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of associated companies 179 (32) 147

Net earnings (loss) from continuing operations 130 (42) 88

Net earnings (loss) from discontinued operations — net of tax 55 (12) 43

Net earnings (loss) 185 (54) 131

Basic and diluted earnings (loss) per common share

— from continuing operations $ 0.03 $ (0.01) $ 0.02

— from discontinued operations 0.01 0.00 0.01

Basic and diluted earnings (loss) per common share $ 0.04 $ (0.01) $ 0.03

Consolidated Statement of Operations data for the nine months ended September 30, 2003

Revenues and cost of revenues were impacted by various errors related to revenue recognition, corrections to foreign exchange accounting,

intercompany related items, special charges and other adjustments, including financial statement reclassifications. The net impact to revenues

of the adjustments was a decrease of $79, a decrease of $53 and an increase of $78 for the first, second and third quarters of 2003, respectively.

The net impact to cost of revenues related to these revenue adjustments, and the other corrections, was an increase of $70, $93 and $140 for the

first, second, and third quarters of 2003, respectively. The Second Restatement adjustments to revenues and cost of revenues in each of these

periods related primarily to the following items:

As part of the plan to address a material weakness reported in our Quarterly Report on Form 10-Q for the period ended September 30, 2003, a

review of foreign exchange accounting was undertaken. The net impact to pre-tax loss was a decrease of $91 and $15, and an increase of $8 for

the first, second, and third quarters of 2003, respectively. The significant items were as follows:

previously

orted Ad

ustments As restate

Revenues $ 6,981 $ (54) $ 6,927

Gross

rofit 3,264 (357) 2,907

Operating earnings (loss) 81 (378) (297)

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of associated companies 64 (217) (153)

Net earnings (loss) from continuing operations (3) (236) (239)

Net earnings (loss) from discontinued operations — net of tax 244 (87) 157

Net earnings (loss) 233 (327) (94)

Basic and diluted earnin

s (loss)

er common share

— from continuing operations $ 0.00 $ (0.06) $ (0.06)

— from discontinued operations 0.05 (0.01) 0.04

Basic and diluted earnings (loss) per common share $ 0.05 $ (0.07) $ (0.02)

evenues and cost o

revenues

• incorrect application of SAB 104 or SOP 97-2, the most significant of which related to revenue that should have been deferred until

title or risk of loss had passed, or products had been delivered;

• incorrect application of AICPA SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type

Contracts, or SOP 81-1, with respect to percentage-of-completion accounting for certain long-term constructions contracts; an

• various other adjustments, primarily related to specific contracts and transactions, including two transactions recorded in the first

quarter of 2003 which should have been recorded in 2002.

orei

nexchan

• we re-examined the determination of the functional currency for certain entities based on the guidance under SFAS No. 52. As a

result, we identified four instances in which the functional currency designation of an entity was incorrect. These revisions resulted

in increases or decreases to other income (expense)

—

net;

• we identified two instances of incorrect treatment of significant intercompany positions. The net impact of the adjustments was an

increase or decrease to other income (expense)

—

net, with an offset to accumulated other comprehensive loss; and

• we identified errors in the revaluation of certain foreign denominated customer financing provisions within discontinued operations,

which increased other income and decreased net earnings from discontinued operations.

Historically, we had certain intercompany balances that did not eliminate upon consolidation, or out-of-balance positions, and had recorded

provisions accordingly. As part of the Second Restatement, we reviewed these provisions and determined that they should not have been

recorded. We recorded adjustments in the appropriate periods to reverse these provisions and to correct the significant out-of-balance positions.

The net impact of these adjustments was an increase of $6, $14 and $3 to pre-tax loss for the first, second, and third quarters of 2003,

respectively.

As part of the Second Restatement, we reviewed the components of special charges and recorded an increase to special charges of $28, a

decrease of $20 and an increase of $10 for the first, second and third quarters of 2003, respectively. We determined that certain items were

either recorded in special charges in error or, although correctly recorded when originally recognized, were not adjusted in the appropriate

subsequent periods for changes in estimates and/or assumptions. These items related to contract settlement costs, plant and equipment

impairment costs, and severance and fringe benefit related costs.

We recorded other adjustments primarily to correct certain accruals, provisions and other transactions, which were either initially recorded

incorrectly in prior periods, or not properly released or adjusted for changes in estimates and/or assumptions in the appropriate subsequent

periods. The impact of these adjustments was an increase of $7, $94 and $10 to the pre-tax loss for the first, second, and third quarters of 2003,

respectively, primarily due to increased cost of revenues for customer and contract related accruals, warranty costs, and other accruals.

As a result of the restatement process, various presentation inconsistencies were identified. Adjustments were made to appropriately reflect

certain items in the statement of operations. The reclassifications were made for royalty expense, gain (loss) on sale of businesses and assets,

and other items including certain functional spending and specific expenses.

As a result of the restatement process, the initial provision for loss on disposal of the access solutions discontinued operations recorded in

June 2001, and the subsequent activity during 2001 through 2004 were re-examined. We concluded that the net loss on disposal of operations

recognized in the second quarter of 2001 was overstated by $738, of which $520 comprised items that should have been charged to continuing

operations. In addition, other adjustments were necessary to correct certain items that were either initially recorded incorrectly, or not properly

released or adjusted for changes in estimates in the appropriate periods subsequent to the second quarter of 2001. The net impact of all of these

changes on net earnings from discontinued operations — net of tax was a decrease of $68, $7 and $12 for the first, second, and third quarters of

2003, respectively. This was primarily due to the elimination of a gain in the first quarter of 2003 of $90 on redemption of an investment

interest due to the reversal in an earlier period of a full valuation allowance that had been recorded against the investment interest when

acquired.

As described above and in the “Controls and Procedures” section of this report, two material weaknesses in our internal control over financial

reporting were identified at the time of the First Restatement. Over the course of the Second Restatement, we and D&T identified a number of

additional material weaknesses in our internal control over financial reporting, as further described in the “Controls and Procedures” section of

this report. D&T confirmed to the Audit Committee these material weaknesses, listed below, on January 10, 2005:

ntercom

balances

ecial char

Other

eclassi

ications

iscontinued o

erations

Material weaknesses in internal control over financial re

ortin

identified in Second Restatement

• lack of compliance with written Nortel Networks procedures for monitoring and adjusting balances related to certain accruals and

provisions, including restructuring charges and contract and customer accruals;

• lack of compliance with Nortel Networks procedures for appropriately applying applicable GAAP to the initial recording of certain

liabilities including those described in SFAS No. 5, “Accounting for Contingencies”, or SFAS No. 5, and to foreign currency

translation as described in SFAS No. 52;

Upon completion of management’s assessment of our internal control over financial reporting as at December 31, 2004 pursuant to SOX 404,

we currently expect to conclude that the first five of these six Material Weaknesses continue to exist at December 31, 2004. We continue to

identify, develop and begin to implement remedial measures to address them, as described in the ”Controls and Procedures“ section of this

report. See also notes 3 and 23 to the accompanying consolidated financial statements.

Over the course of the Second Restatement process, management identified certain accounting practices that it determined should be adjusted

as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and undertook a process of

revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit Committee has determined to review the facts

and circumstances leading to the restatement of these revenues for specific transactions identified in the Second Restatement. The review will

have a particular emphasis on the underlying conduct that led to the initial recognition of these revenues. The Audit Committee will seek a full

understanding of the historic events that required the revenues for these specific transactions to be restated and will consider any appropriate

additional remedial measures, including those involving internal controls and processes. The Audit Committee has engaged WCPHD to advise

it in connection with this review.

In connection with the Independent Review, we have, among other actions, terminated for cause:

Each of these former members of management had responsibility for their respective positions at the time of the Comprehensive Review and

First Restatement. The Board of Directors determined that each of these individuals had significant responsibilities for our financial reporting

as a whole, or for their respective business units and geographic regions, and that each was aware, or ought to have been aware, that our

provisioning activity, described above, did not comply with U.S. GAAP.

The delayed filing of the Reports with the SEC, the trustees under our and NNL’s public debt indentures and Export Development Canada, or

EDC, gave EDC the right to (i) terminate its commitments under the $750 EDC support facility, or the EDC Support Facility, relating to

certain of our performance related obligations arising out of normal course business activities and (ii) exercise certain rights against the

collateral pledged under related security agreements or require NNL to cash collateralize all existing support. NNL has obtained waivers from

EDC with respect to these and related matters to permit continued access to the EDC Support Facility in accordance with its terms while we

complete our filing obligations with respect to the Reports. The waivers have also applied to certain additional breaches under the EDC

Support Facility relating to the delayed filings and the restatements and revisions to our and NNL’s prior financial results, or the Related

Breaches. In connection with such waivers, EDC reclassified the previously committed $300 revolving small bond sub-facility of the EDC

Support Facility as uncommitted support during the waiver period. The $300 revolving small bond facility will not become committed support

until all of the Reports have been filed with the SEC and NNL obtains a permanent waiver of the Related Breaches.

• lack of sufficient personnel with appropriate knowledge, experience and training in U.S. GAAP and lack of sufficient analysis and

documentation of the application of U.S. GAAP to transactions, including but not limited to revenue transactions;

• lack of a clear organization and accountability structure within the accounting function, including insufficient review and

supervision, combined with financial reporting systems that are not integrated and which require extensive manual interventions;

• lack of sufficient awareness of, and timely and appropriate remediation of, internal control issues by Nortel Networks personnel;

and

• an inappropriate ‘tone at the top’, which contributed to the lack of a strong control environment; as reported in the Independent

Review Summary set forth in the “Controls and Procedures” section of this report, there was a Management ‘tone at the top’ that

conveyed the strong leadership message that earnings targets could be met through application of accounting practices that finance

managers knew or ought to have known were not in compliance with U.S. GAAP and that questioning these practices was not

acceptable”.

Revenue Inde

endent Review

Personnel actions

• our former president and chief executive officer, former chief financial officer and former controller in April 2004 (the former chief

financial officer and former controller having been placed on paid leaves of absence in March 2004) and

• seven additional senior finance employees with significant responsibilities for our financial reporting as a whole or for their

respective business units and geographic regions in August 2004.

EDC Su

ort Facilit

As we and NNL will not have filed all of the Reports by January 15, 2005, EDC will have the right, on such date, (absent a further waiver in

relation to the delayed filings and the Related Breaches), to (i) terminate the EDC Support Facility (ii) exercise certain rights against collateral

or require NNL to cash collaterize all existing support, or (iii) require NNL to cash collaterize all existing support.

In addition, the Related Breaches will continue beyond the filing of the Reports. Accordingly, EDC will have the right (absent a further waiver

of the Related Breaches) beginning on January 15, 2005 to terminate or suspend the EDC Support Facility or exercise certain rights against

collateral notwithstanding the filing of the Reports. While NNL is seeking a permanent waiver from EDC in connection with the Related

Breaches, there can be no assurance that NNL will receive any waiver or as to the terms of any such waiver.

As of December 31, 2004, approximately $296 of outstanding support under the EDC Support Facility was outstanding, $212 of which was

outstanding under the revolving small bond sub-facility. See “Available support facility” and “Risk factors/forward looking statements”.

On April 28, 2004, NNL terminated the NNL and Nortel Networks Inc., or NNI, $750 April 2000 five year credit facilities, or the Five Year

Facilities. Absent such termination, the banks would have been permitted, upon 30 days’ notice, to terminate their commitments under the Five

Year Facilities as a result of NNL’s failure to file the NNL 2003 Annual Report on Form 10-K by April 29, 2004. Upon termination, the Five

Year Facilities were undrawn.

As a result of the termination of the Five Year Facilities, certain foreign security agreements entered into by NNL and various of its

subsidiaries, under which shares of certain subsidiaries of NNL incorporated outside of the U.S. and Canada were pledged in favor of the banks

under the Five Year Facilities, EDC and the holders of our and NNL’s outstanding public debt securities, also terminated in accordance with

their terms (see note 23 of the accompanying consolidated financial statements). In addition, the guarantees by certain subsidiaries of NNL

incorporated outside of the U.S. and Canada terminated in accordance with their terms. Because certain of the foreign security agreements,

including those relating to Nortel Networks S.A., were in place as of December 31, 2003, we have included Nortel Networks S.A. financial

statements in this report notwithstanding the subsequent termination of these agreements. Security agreements remain in place under which

substantially all of the assets of NNL located in the U.S. and Canada and those of most of its U.S. and Canadian subsidiaries, including the

shares of certain of NNL’s U.S. and Canadian subsidiaries, are pledged in favor of EDC and the holders of our and NNL’s outstanding public

debt securities. In addition, the guarantees by certain of NNL’s wholly owned subsidiaries, including NNI, most of NNL’s Canadian

subsidiaries, Nortel Networks (Asia) Limited, Nortel Networks (Ireland) Limited and Nortel Networks U.K. Limited, of NNL’s obligations

under the EDC Support Facility and our and NNL’s outstanding public debt securities, remain in place. See “Liquidity and capital resources”.

As a result of the delay in filing the Reports, we and NNL have not been in compliance with our obligations to deliver the Reports to the

trustees under our and NNL’s public debt indentures. As of December 31, 2004, approximately $1,800 of notes of NNL (or its subsidiaries)

and $1,800 of our convertible debt securities were outstanding.

These delays have not resulted in an automatic event of default and acceleration of the outstanding long-term debt and such default and

acceleration cannot occur unless notice by holders of at least 25% of the outstanding principal amount of any relevant series of debt securities

of such non-compliance is provided to us or NNL, as applicable, and we or NNL, as applicable, fail to file and deliver the relevant Report

within 90 days after such notice is provided, all in accordance with the terms of the indentures. While such notice could have been given at any

time after March 30, 2004, neither we nor NNL has received a notice to the date of this report. As a result of the continuing delay in filing

certain of our Reports, we and NNL continue to be in breach of our obligations under our and NNL’s public debt indentures, as described

above. If notice were given and acceleration of our debt securities were to occur, we may be unable to meet our payment obligations.

Based on publicly available information, we have reason to believe that more than 25% of the outstanding principal amount of the $150 of

7.875% notes due June 2026 issued by a subsidiary of NNL and guaranteed by us are held by one holder, or a group of related holders. Other

than with respect to that series of debt securities, based on such publicly available information, neither we nor NNL are aware of any holder, or

group of related holders, that holds at least 25% of the outstanding principal amount of any relevant series of debt securities. However, based

on such publicly available information, we have reason to believe that there is sufficient concentration among holders of the $150 of 7.40%

notes due June 2006 issued by NNL that the acquisition of a relatively small additional amount of these notes by certain holders could

Credit facilities and securit

reements

Debt securities

result in a holder or a group of related holders holding 25% or more of the outstanding principal amount of these notes. See “Liquidity and

capital resources” and “Risk factors/forward looking statements”.

Owing to the delayed filing of the Reports, we are currently unable to use, in its current form, the remaining approximately $800 of capacity

under our shelf registration statement filed with the SEC for various types of securities. See “Liquidity and capital resources” and “Risk

factors/forward looking statements”.

On April 28, 2004, Standard and Poor’s, or S&P, downgraded its ratings on NNL, including its long-term corporate credit ratings from “B” to

“B-” and its preferred shares rating from “CCC” to “CCC-”. At the same time, it revised its outlook to developing from negative. On April 28,

2004, Moody’s Investors Service, Inc., or Moody’s, changed its outlook to potential downgrade from uncertain. See “Credit ratings” and “Risk

factors/forward looking statements”.

We are under investigation by the SEC and the Ontario Securities Commission, or OSC, Enforcement Staff. In addition, Nortel Networks has

received a U.S. federal grand jury subpoena for the production of certain documents sought in connection with an ongoing criminal

investigation being conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division. Further, the Integrated Market

Enforcement Team of the Royal Canadian Mounted Police, or RCMP, has advised us that it would be commencing a criminal investigation

into our financial accounting situation. We will continue to cooperate fully with all authorities in connection with these investigations and

reviews. See “Legal proceedings” and “Risk factors/forward looking statements”.

In addition, numerous class action complaints have been filed against Nortel Networks, including class action complaints under the Employee

Retirement Income Security Act, or ERISA. In addition, a derivative action complaint has been filed against Nortel Networks. These pending

civil litigation actions and regulatory and criminal investigations are significant and if decided against us, could materially adversely affect our

financial condition and liquidity by requiring us to pay substantial judgments, settlements, fines or other penalties. See “Liquidity and capital

resources”, “Legal proceedings” and “Risk factors/forward looking statements”.

On May 31, 2004, the OSC issued a final order prohibiting all trading by our directors, officers and certain current and former employees in the

securities of Nortel Networks Corporation and NNL. This order will remain in effect until two full business days following the receipt by the

OSC of all filings required to be made by us and NNL pursuant to Ontario securities laws.

We and NNL continue to provide periodic updates to the NYSE and the TSX concerning our and NNL’s delay in filing certain of the Reports.

The NYSE granted us and NNL an extension of up to March 31, 2005 to file our 2003 Annual Reports, during which the Nortel Networks

Corporation common shares and our and NNL’s other securities remain listed on the NYSE. To the date of this report, neither the NYSE nor

the TSX has commenced any suspension or delisting procedures in respect of Nortel Networks Corporation common shares or other of our or

NNL’s listed securities. The commencement of any suspension or delisting procedure by either exchange remains, at all times, at the discretion

of such exchange, and would be publicly announced by the exchange. See “Risk factors/forward looking statements”.

As a result of our March 10, 2004 announcement that we and NNL would need to delay the filing of our 2003 Annual Reports, we suspended

as of March 10, 2004: the purchase of Nortel Networks Corporation common shares under the stock purchase plans for eligible employees in

eligible countries that facilitate the acquisition of Nortel Networks Corporation common shares; the exercise of outstanding options granted

under the Nortel Networks Corporation 2000 Stock Option Plan, or the 2000 Plan, or Nortel Networks Corporation 1986 Stock Option Plan as

amended and restated, or the 1986 Plan, or the grant of any additional options under those plans, or the exercise of outstanding options granted

under employee stock option plans previously assumed by us in connection with mergers and acquisitions; and the purchase of units in a Nortel

Networks stock fund or purchase of Nortel Networks Corporation common shares under our defined contribution and investments plans, until

such time as, at the earliest, that we are in compliance with U.S. and Canadian regulatory securities filing requirements.

Shelf re

istration statement

Credit ratin

ulator

actions and

endin

liti

ation

Stock-based com

ensation

lans

volution of our supply chain strategy

Over the last five years, we have divested most of our manufacturing activities to Electronic Manufacturing Services, or EMS, suppliers. On

June 29, 2004, we announced an agreement with Flextronics regarding the divestiture of substantially all of our remaining manufacturing

operations, including product integration, testing and repair operations carried out in our Systems Houses in Calgary and Montreal, Canada and

Campinas, Brazil, as well as certain activities related to these locations, including the management of the supply chain, related suppliers, and

third-party logistics. In Europe, Flextronics has made an offer to purchase similar operations at our Monkstown, Northern Ireland and

Chateaudun, France Systems Houses, subject to the completion of the required information and consultation process.

Under the terms of the agreement and offer, Flextronics will also acquire our global repair services, as well as certain design assets in Ottawa,

Canada and Monkstown related to hardware and embedded software design, and related product verification for certain established optical

products.

We have entered into a four year supply agreement with Flextronics for manufacturing services (whereby Flextronics will manage

approximately $2,500 of our annual cost of sales) and a three year supply agreement for design services. The transfer of the optical design

operations and related assets in Ottawa and Monkstown closed in the fourth quarter of 2004. The portions of the transaction related to the

manufacturing activities in Montreal and Calgary are expected to close in the first and second quarters of 2005, respectively. The balance of the

transaction is expected to close on separate dates occurring during the first half of 2005. These transactions are subject to customary conditions

and regulatory approvals.

The successful completion of the agreement and offer with Flextronics will result in the transfer of approximately 2,500 of our employees to

Flextronics. We expect to receive cash proceeds ranging from approximately $675 to $725, which will be allocated to each separate closing

and, with respect to each closing, will be paid on an installment basis up to nine months thereafter. Such payments will be subject to a number

of adjustments, including from potential post-closing date asset valuations and potential post-closing indemnity payments. Flextronics also has

the ability in certain cases to exercise rights to sell back to us certain inventory and equipment after the expiration of a specified period (of up

to fifteen months) following each respective closing date. We do not expect such rights to be exercised with respect to any material amount of

inventory and/or equipment. The cash proceeds estimate is comprised of approximately $475 to $525 for inventory and equipment and $200

for intangible assets. The cash proceeds would be partially offset by related estimated transaction costs (including transition, potential

severance, and information technology implementation and real estate costs) of approximately $200.

We also announced that we plan to create Solutions Operations Centers in Calgary and Montreal and, pending the completion of information

and consultation processes in Europe, in Monkstown and Chateaudun. These centers are expected to have overall responsibility for the strategic

management and control of our various supply chains, including all customer interfaces, customer service, order management, quality

assurance, product cost management, new product introduction, and network solutions integration, testing and fulfillment.

We believe that the use of an outsourced manufacturing model has enabled us to benefit from leading manufacturing technologies, leverage

existing resources from around the world, lower our cost of sales, quickly adjust to fluctuations in market demand and decrease our investment

in plant, equipment and inventories. We continue to retain in-house all strategic management and overall control responsibilities associated

with our various supply chains, including all customer interfaces, customer service, order management, quality assurance, product cost-

management, new product introduction, and network solutions integration, testing and fulfillment.

Other business developments

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 shareholder rights plan, one right for each Nortel Networks Corporation common share outstanding may be issued. These rights become

exercisable upon the occurrence of certain events associated with an unsolicited takeover bid.

Shareholder ri

hts

lan

On September 18, 2003, consistent with our overall global business strategy, we realigned our business activities in France and Germany by

increasing our ownership in our core businesses in these countries. As a result of this realignment, we acquired the 42% minority interest in

Nortel Networks Germany GmbH & Co. KG and the 45% minority interest in Nortel Networks France S.A.S., or NNF, previously held by

European Aeronautic Defence and Space Company EADS N.V., or EADS, our former partner in three European joint ventures. At the

completion of these transactions, our ownership in each company increased to 100%. These companies are responsible for the sales and

marketing of our products in Germany and France. At the same time, EADS increased its ownership in EADS Telecom S.A.S. (formerly

EADS Defence and Security Networks S.A.S.), or EADS Telecom, from 59% to 100% as a result of acquiring our equity ownership in that

company. For additional information, see “Nortel Networks Germany and Nortel Networks France” in note 10 of the accompanying

consolidated financial statements.

During 2003, we reduced our undrawn customer financing commitments by $651 primarily as a result of the expiration or cancellation of

commitments and changing customer business plans. As of December 31, 2003, approximately $108 of the $177 in undrawn commitments was

not available for funding under the terms of our financing agreements. For additional information, see “Customer financing”.

On February 3, 2004, we sold approximately 7 million common shares of Entrust Inc., or Entrust, for cash consideration of $33, resulting in a

gain of $18. In connection with this transaction, we no longer hold any equity interest in Entrust.

On March 1, 2004, we purchased land and two buildings for $87 that were previously leased by us, which leases expired on February 28, 2004.

As a result, we extinguished a debt of $87.

On May 7, 2004, we received $80 in proceeds from the sale of certain assets in connection with a customer contract settlement in Latin

America. This resulted in a gain of $78, which will be included in (gain) loss on sale of businesses and assets for the three months ended

June 30, 2004.

On August 2, 2004, we completed the contribution of certain assets and liabilities of our directory and operator services, or DOS, business to

VoltDelta, Resources LLC, or VoltDelta, a wholly owned subsidiary of Volt Information Sciences, Inc., or VIS, in return for a 24% interest in

VoltDelta. After a period of two years, we and VIS each have an option to cause us to sell our VoltDelta shares to VIS for proceeds ranging

from $25 to $70. As a result of this transaction, approximately 160 of our DOS employees in North America and Mexico joined VoltDelta. We

recorded a gain on sale of businesses and assets of approximately $50 in the third quarter of 2004.

In August 2004, we entered into a contract with Bharat Sanchar Nigram Limited to establish a wireless network in India. Our commitments to

date for orders received under this contract have resulted in an estimated project loss of approximately $130, which has been recorded in the

third quarter of 2004.

On October 26, 2004, we entered into an agreement with Foundry Networks, Inc., or Foundry, to settle outstanding patent infringement claims

and counterclaims by us and Foundry. As part of the settlement, we granted Foundry a four year license under certain patents and Foundry paid

$35tous.

Ownershi

ustment in our French and German o

erations

Customer financin

commitments

Sale of Entrust shares

Real estate

Customer contract settlement

Director

and o

erator services business

Bharat Sanchar Ni

ram Limited contract

Patent infrin

ement settlement

On December 15 and 16, 2004, we sold certain notes receivable and convertible notes receivable that had been received as a result of the

restructuring of a customer financing arrangement for cash proceeds of $116. The net carrying amount of the notes receivable and convertible

notes receivable was $56.

On December 23, 2004, a customer financing arrangement was restructured. The notes receivable that were restructured had a net carrying

amount as of December 31, 2003 of $13, net of provisions for doubtful accounts of $147 ($55 of the provision is included in discontinued

operations). We are currently assessing the value of the restructured notes receivable and expect that an increase in value from the net carrying

amount has occurred.

Results of operations — continuing operations

Segment revenues

The following table summarizes our revenues for 2003, 2002 and 2001 by segment:

“Other” represented miscellaneous business activities and corporate functions.

Geographic revenues

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

Consolidated revenues

The following chart summarizes our quarterly revenues during 2003 and 2002:

Customer financin

arran

ements

For the years ended December 31, 2003 vs 2002 2002 vs 2001

2003 2002 2001 $ Change % Change $ Change % Change

Wireless Networks $ 4,389 $ 4,161 $ 5,699 $ 228 5 $ (1,538) (27)

Enterprise Networks 2,589 2,422 3,222 167 7 (800) (25)

Wireline Networks 2,005 2,572 4,328 (567) (22) (1,756) (41)

Optical Networks 1,179 1,820 5,050 (641) (35) (3,230) (64)

Other (a) 31 33 601 (2) (6) (568) (95)

Consolidated $ 10,193 $ 11,008 $ 18,900 $ (815) (7) $ (7,892) (42)

For the years ended December 31, 2003 vs 2002 2002 vs 2001

2003 2002 2001 $ Change % Change $ Change % Change

United States $ 5,424 $ 5,823 $ 10,136 $ (399) (7) $ (4,313) (43)

EMEA (a) 2,366 2,500 4,380 (134) (5) (1,880) (43)

Canada 587 648 1,076 (61) (9) (428) (40)

Asia Pacific 1,307 1,483 2,289 (176) (12) (806) (35)

CALA (b) 509 554 1,019 (45) (8) (465) (46)

Consolidated $ 10,193 $ 11,008 $ 18,900 $ (815) (7) $ (7,892) (42)

(a) The Europe, Middle East and Africa region, or EMEA.

(b) The Caribbean and Latin America region, or CALA.

Our consolidated revenues declined 7% in 2003 compared to 2002. There were substantial declines in Wireline Networks and Optical

Networks while Wireless Networks increased 5% and Enterprise Networks increased 7%. The decline was primarily due to the continued

industry adjustment and capital spending restrictions experienced by our service provider customers. As well, the decline in 2003 was

attributable to tightened capital markets mainly experienced in the first half of 2003 as customer spending remained cautious, with many of our

customers realigning capital spending with their current levels of revenues and profits in order to maximize their return on invested capital.

Many of our customers continued to focus on conserving capital, decreasing their debt levels, reducing costs and/or increasing the capacity

utilization rates and efficiency of existing networks. Also, excess network capacity and competition continued to exist in the industry which led

to continued pricing pressures on the sale of certain of our products.

From a geographic perspective, the 7% decline in revenues in 2003 compared to 2002 was due to a:

Our consolidated revenues declined 42% in 2002 compared to 2001. Following a period of rapid infrastructure build-out and strong economic

growth in 1999 and 2000, we saw severe economic downturns in various regions around the world and a continued tightening in the global

capital markets and slowdown in the industry throughout 2001. Our revenues declined sequentially in 2001 due to lower capital spending by

industry participants and substantially less demand for our products and services as customers focused on maximizing their return on invested

capital. During 2002, we continued to see these constraints on capital expenditures by our customers. Also, excess network capacity continued

to exist in the industry. In addition, we saw continuing consolidation of service providers within the industry. This environment created a

change in our customers’ focus from building new networks to conserving capital, decreasing their debt levels, reducing costs and/or increasing

the capacity utilization rates and efficiency of existing networks.

From a geographic perspective, the 42% decline in revenues in 2002 compared to 2001 was primarily due to a 43% decline in the U.S., a 43%

decline in EMEA, a 35% decline in Asia Pacific, a 46% decline in CALA and a 40% decline in Canada. All regional declines in 2002

compared to 2001 were primarily the result of the factors mentioned above.

We expect that our consolidated revenues in 2004 will be slightly lower compared with 2003. The 2003 consolidated revenues included

revenues that were deferred from prior periods. Although we expect a slight decline of consolidated revenues in 2004 as compared to 2003, we

saw growth in several areas in 2004 primarily as a result of customers increasing their investments in:

2003 vs. 2002

• 7% decline in revenues in the U.S. primarily due to capital spending restrictions experienced by our service provider customers and

their focus on capital and cash flow management in 2003 as well as tightened capital markets mainly during the first half of 2003.

This was partially offset by the release of certain software including the general availability of Succession 3.0 in the fourth quarter

of 2003 which triggered the recognition of associated revenues deferred from prior periods. In addition, revenues increased due to

the recognition of deferred revenues associated with certain data switch upgrades. Further, Global System for Mobile

communications, or GSM, and Code Division Multiple Access, or CDMA, customers upgraded and expanded their existing

networks in the second half of 2003;

• 12% decline in revenues in Asia Pacific due to capital spending restrictions by our service provider customers;

• 5% decline in revenues in EMEA primarily due to capital spending restrictions by service provider and enterprise customers and

tightened capital markets mainly during the first half of 2003 which was partially offset by increases in revenue related to new

GSM contracts with certain service providers and the impact of favorable foreign exchange effects associated with the euro;

• 9% decline in revenues in Canada primarily due to capital spending restrictions experienced by our service provider customers and

their focus on capital and cash flow management, the completion of certain customer deployments as well as tightened capital

markets mainly during the first half of 2003, which was partially offset by the impact of favorable foreign exchange effects

associated with the Canadian dollar; and

• 8% decline in revenues in CALA primarily due to the completion of a major contract in the first quarter of 2002 and continued

capital spending restrictions experienced by our service provider customers, which was partially offset by increases in revenue

related to new GSM contracts with certain service providers.

2002 vs. 2001

2004 and 2005

The period of relative industry stability that had characterized the second half of 2003 continued into 2004. For 2005, we expect revenue

growth over 2004 primarily due to continued growth in the above areas.

Spending in these areas of our business has been partially offset by customers limiting their investment in mature technologies as they focus on

maximizing return on investment capital. In addition, we have continued to experience pricing pressures on sales of certain of our products as a

result of increased competition particularly from low cost suppliers. Further, while customer support generally remains strong, we believe the

ongoing restatement activities and the internal restructuring and realignment programs initiated in August 2004 have adversely impacted

business performance in 2004.

Consolidated revenues for the third and fourth quarters of 2004 reflect certain of these trends, with third quarter 2004 consolidated revenues

lower than previously announced preliminary unaudited consolidated revenues for the second quarter of 2004. Our fourth quarter is expected to

be our strongest quarter in 2004. Our quarterly results of operations will not necessarily be consistent with our historical quarterly profile or

indicative of our expected results in future quarters. See “Risk factors/forward looking statements” for other factors that may affect our

revenues.

Wireless Networks revenues

The following chart summarizes recent quarterly revenues for Wireless Networks:

Wireless Networks revenues increased 5% in 2003 compared to 2002 due to a 31% increase in the second half of 2003 partially offset by a

17% decrease in the first half of 2003 compared to the same periods in 2002. The 31% increase in the second half of 2003 was primarily due to

increased spending by our wireless service provider customers on our GSM, CDMA and UMTS technologies as a result of new contracts with

certain customers and other customers expanding their existing networks to meet increased subscriber demand. The 17% decline in the first

half of 2003 was primarily due to the ongoing focus by wireless service providers on capital and cash flow management and increased

competition for customers by wireless service providers. As a result, many of our customers heavily scrutinized their capital expenditure

requirements and postponed or reduced their capital spending during the first six months of 2003.

CDMA revenues increased in 2003 compared to 2002 due to a substantial increase in revenues in the second half of 2003 compared to the

same period in 2002. This substantial increase was partially offset by a decrease in the first half of 2003 compared to the same period in 2002.

The substantial increase in CDMA revenues in the second half of 2003 compared to the same period in 2002 was primarily due to a substantial

increase in the U.S. and Canada as a result of our customers expanding their existing networks and upgrading their existing networks to higher

data speeds. The substantial increase in the U.S. and Canada was partially offset by a substantial decrease in EMEA. This substantial decline

was primarily due to the completion of key customer network deployments during the first half of 2003, which had been underway in 2002.

The decrease in CDMA revenues in the first half of 2003 compared to the same period in 2002 was primarily due to a

• voice over packet technologies;

• third generation wireless technologies; and

• expansion and enhancement of existing networks due to subscriber growth and competitive pressures.

2003 vs. 2002

substantial decline in Canada and a decline in the U.S. as customers continued to experience capital spending restrictions as a result of their

continued focus on capital and cash flow management. In Asia Pacific, CDMA revenues increased substantially in the first half of 2003

compared to the same period in 2002 primarily due to new contracts with certain service provider customers and other customers expanding

their existing networks to meet increased subscriber demand.

GSM revenues increased significantly in 2003 compared to 2002 due to a substantial increase in revenues in the second half of 2003 compared

to the same period in 2002. This substantial increase was partially offset by a significant decrease in the first half of 2003 compared to the same

period in 2002.

The substantial increase in GSM revenues in the second half of 2003 compared to the same period in 2002 was primarily due to a substantial

increase in the U.S. and EMEA. The substantial increase in the U.S was primarily due to accelerated network expansions with certain service

providers to meet increased subscriber demand. The substantial increase in EMEA was mainly due to new contracts with certain service

provider customers and other customers expanding their existing networks.

The significant decrease in GSM revenues in the first half of 2003 compared to the same period in 2002 was primarily due to substantial

declines in Canada and Asia Pacific and a significant decline in the U.S. The substantial decline in Asia Pacific was mainly due to a decline in

the overall growth rate of GSM technology deployments by wireless service providers in the second half of 2002 and the first half of 2003. As

of the beginning of the first quarter of 2003, many of our GSM customers in Asia Pacific had completed their current network deployments

and, as a result, they had sufficient capacity to meet additional subscriber demand. The substantial decline in Canada and the significant decline

in the U.S. were mainly due to the completion of network deployments by certain service providers. In EMEA and CALA, GSM revenues

increased substantially in the first half of 2003 primarily due to new contracts with certain service providers.

Universal Mobile Telecommunications Systems, or UMTS, revenues increased substantially in 2003 compared to 2002. This substantial

increase was primarily due to new contracts with certain service providers and the continued transition to this next generation technology.

Time Division Multiple Access, or TDMA, revenues declined substantially in 2003 compared to 2002 primarily due to the continued transition

to newer wireless technologies. The substantial decline was primarily due to customers in the U.S. and CALA continuing to migrate from the

mature TDMA technology to GSM and CDMA technologies. In 2003, TDMA revenues accounted for less than 6% of total Wireless Networks

revenues, down from 11% in 2002.

From a geographic perspective, the 5% increase in Wireless Networks revenues in 2003 compared to 2002 was primarily due to a:

The 27% decline in Wireless Networks revenues in 2002 compared to 2001 was primarily due to a continued deterioration in wireless service

providers’ financial condition, slower subscriber growth and increased competition for customers by service providers which resulted in the

decision of many wireless service providers to delay capital expenditures.

CDMA revenues declined in 2002 compared to 2001 primarily due to continued capital spending constraints and financial difficulties

experienced by our customers globally. In 2002, we continued to experience significant pricing pressures on our CDMA technologies in the

U.S. and CALA resulting from the increased competition for customers.

TDMA revenues declined substantially in 2002 compared to 2001 primarily due to a substantial decline in the U.S. and CALA as customers

migrated from TDMA to CDMA and GSM technologies as a result of TDMA technology and networks being in their maturity stage.

Continued capital spending constraints and financial difficulties experienced by our customers

• 6% increase in the U.S. primarily due to certain of our major GSM and CDMA customers upgrading and expanding their existing

networks to meet increased subscriber demand in the second half of the year;

• 15% increase in EMEA primarily due to new GSM contracts with certain service providers and other customers expanding their

existing networks to meet increased subscriber demand; and

• 15% increase in CALA primarily due to new GSM contracts with certain service providers and other customers expanding their

existing networks to meet increased subscriber demand; partially offset by

• 16% decline in Canada primarily due to the completion of key customer network deployments, customers’ focus on capital and

cash flow management and a slower subscriber growth.

2002 vs. 2001

globally also contributed to the TDMA revenue declines. In 2002, we continued to experience significant pricing pressures on our TDMA

technologies in the U.S. resulting from the increased competition for customers. TDMA revenues continued to be a smaller portion of Wireless

Networks in 2002 compared to 2001.

GSM revenues declined substantially in 2002 compared to 2001 due to substantial declines in Asia Pacific and EMEA. These substantial

declines were primarily due to a continued deterioration in wireless service providers’ financial condition and slower subscriber growth, and

delays in capital expenditures. Also in Asia Pacific, customers began to deploy CDMA technology solutions as they migrated away from the

maturing GSM technologies. This shift in technology focus contributed to the substantial decline in GSM revenues in Asia Pacific.

In 2002, UMTS revenues continued to be an insignificant portion of overall Wireless Networks revenues. While the first commercial launches

in the industry did take place in EMEA and Asia Pacific, technology issues associated with third generation, or 3G, handsets contributed to

delays in larger deployments of 3G networks in 2002. Also, some of our 3G customers in EMEA incurred significant costs in 2002 associated

with licensing fees, which, along with their continued focus on improving their financial performance, limited their spending on network

deployments. As a result, 3G network deployments suffered delays in EMEA in 2002.

From a geographic perspective, the 27% decline in Wireless Networks revenues in 2002 compared to 2001 was primarily due to a 54% decline

in revenues in Asia Pacific, a 16% decline in revenues in the U.S., a 25% decline in revenues in EMEA and a 27% decline in revenues in

CALA. The declines in all regions were mainly due to the continued deterioration in wireless service providers’ financial condition and

subscriber growth and increased competition for customers by service providers which resulted in the decision of many wireless service

providers to delay capital expenditures.

During 2003 and 2004, Wireless Networks revenues continued to be primarily generated by sales of CDMA and GSM technologies. Also,

revenues associated with our TDMA technology continued to decline in 2004 compared to 2003 due to the continued transition to newer

wireless technologies. Regarding our UMTS technology, revenues have grown compared to 2003 as a result of contracts announced in the

second half of 2003 and in 2004 and the continued transition to this next generation technology. We expect a growing percentage of our

Wireless Networks revenues to come from our UMTS technology. While we have seen encouraging indicators in certain areas of the wireless

market, we can provide no assurance that these growth areas that have begun to emerge will continue in the future.

Enterprise Networks revenues

The following chart summarizes recent quarterly revenues for Enterprise Networks:

Enterprise Networks revenues increased 7% in 2003 compared to 2002 due to a substantial increase in the circuit and packet voice portion of

this segment offset by a significant decrease in the data networking and security portion of this segment.

Revenues from the circuit and packet voice portion of this segment increased substantially in 2003 compared to 2002. We experienced a

substantial increase in revenues associated with our traditional circuit switching and interactive voice response products primarily due to the

release of certain software including Succession 3.0. The general availability of this software in the fourth quarter of 2003 triggered the

recognition of associated revenues deferred from prior periods, resulting in a net

2004 and 2005

2003 vs. 2002

increase in revenues of $150 in 2003. In addition, there was a substantial increase in revenues associated with our Internet Protocol, or IP,

telephony solutions as customers continued to migrate towards converged packet voice solutions.

Revenues associated with the data networking and security portion of this segment decreased significantly in 2003 compared to 2002. The

significant decrease in revenues was primarily due to a decline in new service contracts and service contract renewals, a decline in revenues

associated with our legacy routing portfolio and a decline in revenue from certain of our data networking products primarily due to pricing

pressures driven by increased competition. This was partially offset by a net increase in previously deferred revenues associated with certain

data switch upgrades of approximately $60 in 2003.

Enterprise Networks revenues declined sequentially in the first and second quarters of 2003 and increased sequentially in the third and fourth

quarters of 2003. The sequential declines in the first half of 2003 were primarily due to customers having sufficient network capacity,

continued capital spending restrictions by our customers and delays associated with the establishment of new channel relationships to address

demand from small and medium sized enterprise customers. The sequential increases in revenues in the second half of 2003 were primarily due

to a sequential increase in revenues associated with our IP telephony solutions as our customers continued to migrate toward packet voice

solutions as well as revenue recognized due to the release of certain software including Succession 3.0 in the fourth quarter of 2003. Further,

we experienced sequential revenue increases in the third and fourth quarters of 2003 from our interactive voice response and security products

as a result of certain new product releases in the second half of 2003.

From a geographic perspective, the 7% increase in Enterprise Networks revenues in 2003 compared to 2002 was primarily due to a:

The 25% reduction in Enterprise Networks revenues in 2002 compared to 2001 was primarily a result of enterprise customers continuing to

reduce their spending due to the ongoing industry adjustment, the overall economic conditions and uncertainties surrounding the technology

evolution of next generation products.

Revenues from the circuit and packet voice portion of this segment declined substantially in 2002 compared to 2001. The substantial decline

was primarily due to reductions in customer spending in the U.S. and EMEA. Revenues for traditional circuit switching products did begin to

show signs of improvement in the U.S. in the second half of 2002 after experiencing sequential quarterly reductions during 2001 and the first

half of 2002. In 2002, traditional circuit switching also continued its evolution towards IP telephony solutions, as reliability and quality of

service concerns, traditionally associated with voice over packet solutions, were reduced. Regardless, customers remained cautious in 2002

with respect to their investment decisions due to uncertainties surrounding the migration to packet voice solutions.

The data networking and security portion of this segment experienced significant declines in 2002 compared to 2001. The significant decline in

revenues was primarily due to customer spending constraints and a decline in demand for mature products across all regions. Pricing pressures

continued in 2002 in the data networking and security portion of this segment as we experienced continued significant competition for

enterprise customers.

From a geographic perspective, the 25% decline in Enterprise Networks revenues in 2002 compared to 2001 was primarily due to a 28%

decline in the U.S., a 23% decline in EMEA and a 17% decline in Asia Pacific. These declines were all primarily due to the ongoing industry

adjustment, the overall economic conditions and uncertainties surrounding the technology evolution of next generation products.

During 2004, our Enterprise Networks customers have continued to increase the deployment of voice over packet technologies in their

communications networks. We expect that data, voice and multimedia communications will continue to converge, and enterprises will look for

ways to maximize the effectiveness of their existing networks while reducing ongoing

• 14% increase in revenues in the U.S. primarily due to the release of certain software including the general availability of Succession

3.0 in the fourth quarter of 2003 which triggered the recognition of associated revenues deferred from prior periods. In addition,

revenues increased due to the recognition of deferred revenues associated with certain data switch upgrades; partially offset by

• 19% decline in revenues in CALA primarily due to the reduction of inventory by the distribution network in the region and the

unfavorable economic conditions in certain countries.

2002 vs. 2001

2004 and 2005

capital expenditures and operating costs. Also, we anticipate that demand will continue to decline for our traditional circuit switching products,

however, it is difficult to determine the extent to which future declines in demand will occur as a result of the migration to voice over packet

technologies. In 2005, we are focused on increasing our market presence with enterprise customers. In particular, we are focusing on leading

enterprise customers with high performance networking needs. While we have seen encouraging indicators in certain parts of the enterprise

market, we can provide no assurance that the growth areas that have begun to emerge will continue in the future.

Wireline Networks revenues

The following chart summarizes recent quarterly revenues for Wireline Networks:

Wireline Networks revenues declined 22% in 2003 compared to 2002. This decline was primarily due to a substantial reduction in capital

spending by our service provider customers as a result of the continued industry adjustment.

Revenues from the circuit and packet voice portion of this segment decreased substantially in 2003 compared to 2002 primarily due to a

substantial decrease in our traditional circuit switching product revenues and also uncertainty related to the impact of the Federal

Communications Commission, or FCC, decision regarding the regulation of the availability of unbundled network elements, or UNEs, released

on August 21, 2003 and subsequent judicial review and FCC reconsideration of the decision. The substantial decline in our circuit switching

revenues was primarily due to the continuing impact of capital spending restrictions experienced by our service provider customers during

2003 and tightened capital markets mainly during the first half of 2003. Revenues from our packet voice solutions increased substantially

across all regions except EMEA in 2003 compared to 2002 primarily due to new service provider contracts throughout 2003.

Revenues from the data networking and security portion of this segment decreased significantly in 2003 compared to 2002 primarily due to

substantial declines in the U.S. and Asia Pacific and a significant decline in CALA. In these regions, we experienced a decline in demand for

our mature products primarily due to the ongoing shift towards IP-based technology.

From a geographic perspective, the 22% decline in Wireline Networks revenues in 2003 compared to 2002 was primarily due to a:

2003 vs. 2002

• 32% decline in revenues in the U.S. primarily due to the continuing impact of capital spending restrictions experienced by our

service provider customers, tightened capital markets mainly during the first half of 2003 and also uncertainty related to the impact

of the FCC decision regarding the regulation of the availability of UNEs;

• 43% decline in revenues in CALA primarily due to the completion of a major contract in the first quarter of 2002 and continued

capital spending restrictions experienced by our service provider customers; and

• 5% decline in revenues in EMEA primarily due to a reduction in capital spending by service provider customers during 2003 and

tightened capital markets mainly during the first half of 2003; partially offset by

• 15% increase in Canada primarily due to increased revenues from our packet voice solutions primarily due to new service provider

contracts throughout 2003.

The 41% decline in Wireline Networks revenues in 2002 compared to 2001 was primarily due to a substantial reduction in capital spending by

our service provider customers.

The considerable decline in the circuit and packet voice portion of this segment was the result of continued reduced demand in the local

exchange and interexchange carrier markets due to the significant industry adjustment, including industry consolidation and tightened capital

markets, and the substantial decline in demand for traditional circuit switching products. During 2002, many of our service provider customers

continued to delay their investment decisions on our packet voice solutions due to the technology evolution uncertainty in the industry. In

2002, we continued to experience significant pricing pressures on our traditional circuit switching products due to the increased competition for

service provider customers.

The considerable decline in revenues in the data networking and security portion of this segment was primarily due to a decline in demand for

mature products, compounded by the ongoing industry adjustment as our service provider customers, in all regions, continued to reduce their

capital expenditures.

From a geographic perspective, the 41% decline in Wireline Networks revenues in 2002 compared to 2001 was primarily due to a 41% decline

in the U.S., a 32% decline in EMEA, a 57% decline in CALA, and a 39% decline in Asia Pacific. The declines in all regions were primarily

attributable to the substantial reduction in spending by our service provider customers as a result of the factors mentioned above.

In 2004, our service provider customers continued to increase the deployment of packet-based technologies in their communications networks

as they looked for ways to optimize their existing networks and offer new revenue generating services while limiting capital expenditures and

operating costs. However, the timing of when service provider customers will deploy packet-based technologies on a wider scale is still

unclear. Further, it is difficult to determine the effect the FCC decision regarding the regulation of the availability of UNEs and subsequent

adoption on December 15, 2004 of new unbundling rules in response to the remand by the U.S. Court of Appeals for the D.C. Circuit will have

on our business. The demand for our traditional circuit switching products has continued to decline as certain service providers continued to

reduce their capital expenditures on these legacy technologies. While we have seen encouraging indicators in certain areas of the wireline

service provider market, we can provide no assurance that the growth areas that have begun to emerge will continue in the future.

Optical Networks revenues

The following chart summarizes recent quarterly revenues for Optical Networks:

Optical Networks revenues declined 35% in 2003 compared to 2002. The decline was primarily the result of the continuing industry

adjustment, excess capacity, tightened capital markets mainly during the first half of 2003 and reductions in capital spending by our EMEA,

U.S. and Canada customers in both the long-haul and metro optical portions of this segment.

Revenues in the long-haul portion of this segment declined substantially in 2003 compared to 2002. The substantial decline was primarily due

to the continuing industry adjustment, excess capacity, tightened capital markets mainly during the first

2002 vs. 2001

2004 and 2005

2003 vs. 2002

half of 2003 and continued capital spending restrictions in the U.S., Canada and EMEA as customers continued to focus on maximizing return

on invested capital by increasing the capacity utilization rates and efficiency of existing networks. In Asia Pacific, optical long-haul revenues

declined substantially in 2003 compared to 2002 primarily due to the completion of network build-outs for certain customers in 2002 that were

not repeated in 2003. In addition, significant excess inventories continued to exist in this portion of the segment which resulted in ongoing

pricing pressures across all regions.

In the fourth quarter of 2002, we sold certain optical components assets to Bookham Technology plc, or Bookham. As a result, our results in

2003 in the long-haul portion of this segment do not reflect revenues generated from these assets. In 2002, revenues generated from the optical

components assets sold to Bookham were approximately 3% of the total Optical Networks revenues of $1,820.

Revenues in the metro optical portion of this segment were relatively flat in 2003 compared to 2002. This was primarily due to a substantial

decrease in EMEA partially offset by an increase in revenues in the U.S. and a substantial increase in Asia Pacific. The substantial decrease in

EMEA was primarily the result of the continued industry adjustment, tightened capital markets mainly during the first half of 2003 and

customer spending restrictions. The increase in revenues in the U.S. and the substantial increase in Asia Pacific were primarily due to new

customer contracts during the first half of 2003 for expansions of existing networks to meet increased customer demand.

From a geographic perspective, the 35% decline in Optical Networks revenues in 2003 compared to 2002 was primarily due to a:

The 64% decline in Optical Networks revenues in 2002 compared to 2001 was primarily the result of substantial reductions in capital spending

by our major U.S. and EMEA customers. These reductions were partially offset by a significant increase in Asia Pacific revenues primarily due

to new customer contracts for expansions of existing networks to meet increased customer demand.

Our major customers in the long-haul portion of this segment focused on maximizing return on invested capital by increasing the capacity

utilization rates and efficiency of existing networks. Revenues in the optical long-haul portion of the segment declined substantially in 2002

compared to 2001. The considerable decline was primarily due to the continued industry adjustment, including industry consolidation,

continued capital spending constraints and, to a lesser extent, the large redeployment of assets that occurred in 2001 and continued throughout

2002. The spending constraints and redeployment of assets were caused primarily by significant excess inventories which resulted in

significant pricing pressures.

Revenues in the metro optical portion of the segment were primarily driven by demand for enterprise connectivity and storage solutions. The

substantial decline in revenue in the metro optical portion of the segment in 2002 compared to 2001 was primarily due to a decline in demand

for mature products. This substantial decline was compounded by the ongoing industry adjustment as customers continued to focus on

optimizing existing networks and delayed the deployment of next generation products. Industry consolidation also contributed to the reduction

in service provider capital spending during 2002 and 2001. The then current generation of metro products, namely, the OPTera Metro family of

products, were the key products contributing to revenue in 2002 and accounted for a substantial portion of the overall Optical Networks

revenues. Revenue in the metro optical portion of the segment increased as a percentage of total Optical Networks revenue in 2002 compared

to 2001.

From a geographic perspective, the 64% decline in Optical Networks revenues in 2002 compared to 2001 was primarily due to a 76% decline

in revenues in U.S., a 61% decline in revenues in EMEA and a 72% decline in revenues in CALA. The declines in all these regions were

primarily due to the continued industry adjustment, including industry consolidation, capital spending constraints and the redeployment of

assets in 2001 and 2002.

• 35% decline in the U.S., 40% decline in EMEA and a 32% decline in Canada primarily related to a substantial reduction in capital

spending as a result of the continuing industry adjustment, tightened capital markets mainly during the first half of 2003 and

customers continuing to focus on maximizing return on invested capital; and

• 33% decline in Asia Pacific primarily related to contractual issues experienced with certain customers in the fourth quarter of 2003

and the completion of network build-outs for certain customers in the long-haul portion of this segment in 2002 that were not

repeated in 2003.

2002 vs. 2001

During 2004, our major customers in the optical long-haul portion of Optical Networks remained focused on maximizing return on their

invested capital by increasing the capacity utilization rates and efficiency of existing networks. We expect that any additional capital spending

by those customers in the near term will be increasingly directed to opportunities that enhance customer performance, revenue generation and

cost reduction.

We see an increase in demand for metro Dense Wavelength Division Multiplexing, or metro DWDM. This increase is primarily due to new

network deployments by certain customers and other customers expanding their networks, driven by emerging applications such as Cable

Video on Demand, all of which have resulted in a need for low cost, high capacity connectivity between network sites. As a result, we expect

that the metro optical portion of this segment will continue to represent a larger percentage of overall Optical Networks revenues. While we

have seen encouraging indicators in certain parts of the optical market, we can provide no assurance that the growth areas that have begun to

emerge will continue in the future.

Gross profit and gross margin

Gross margin improved 7.1 percentage points in 2003 compared to 2002 primarily due to:

Gross margin improved 12.8 percentage points in 2002 compared to 2001 primarily due to:

While we cannot predict the extent to which changes in product mix and pricing pressures will impact our gross margin, we continue to see the

effects of improvements in our product costs primarily due to favorable material pricing. Considering the impacts of our strategic plan

described under “Business overview — Our strategic plan and outlook” and the higher costs associated with initial customer deployments in

emerging markets, we expect that gross margin will trend in the range of 40% to 44% through 2005. See “Risk factors/forward looking

statements” for factors that may affect our gross margins.

Segment gross profit and gross margin

Wireless Networks gross margin improved by approximately 6 percentage points in 2003 compared to 2002 primarily due to:

2004 and 2005

For the years ended December 31, 2003 vs 2002 2002 vs 2001

2003 2002 2001 Change % Change Change % Change

Gross profit $ 4,341 $ 3,905 $ 4,288 $ 436 11 $ (383) (9)

Gross margin 42.6% 35.5% 22.7% 7.1 pts 12.8 pts

• an increase related to continued improvements in our cost structure primarily as a result of favorable supplier pricing and changes

in product mix that resulted in increased volumes of certain products with higher margins; and

• an increase of approximately 4 percentage points related to reduced inventory provisioning and contract and customer settlement

costs. In 2003, we recorded approximately $299 of incremental inventory provisions compared to approximately $689 of similar

incremental charges in 2002; partially offset by

• pricing pressures on certain of our products; and

• an increase in expense related to our employee return to profitability, or RTP, and regular bonus plans.

• an increase of approximately 9 percentage points related to reduced inventory provisioning and contract and customer settlement

costs. In 2002, we recorded approximately $689 of incremental inventory provisions compared to approximately $1,631 of similar

incremental charges in 2001;

• improvements in our cost structure to more closely reflect our sales volume and as a result of favorable supplier pricing; partially

offset by

• pricing pressures on certain of our products.

Wireless Networks

• changes in product mix mainly related to increased volumes of certain products with higher margins;

• improvements in our product costs primarily as a result of favorable material pricing which was partially offset by

Wireless Networks gross margin improved by approximately 15 percentage points in 2002 compared to 2001 primarily due to:

Enterprise Networks gross margin improved by approximately 4 percentage points in 2003 compared to 2002 and by approximately

2 percentage points in 2002 compared to 2001 primarily due to:

Wireline Networks gross margin declined by approximately 4 percentage points in 2003 compared to 2002 primarily due to:

Wireline Networks gross margin improved by approximately 14 percentage points in 2002 compared to 2001 primarily due to:

Optical Networks gross margin improved by approximately 26 percentage points in 2003 compared to 2002 primarily due to:

reductions in the selling price of certain products; an

• improvements in other operations related costs; partially offset by

• an increase in contrac

-related costs including customer trials.

• changes in product mix mainly related to increased volumes of certain products with higher margins;

• improvements in our product costs primarily as a result of favorable material pricing;

• reduced inventory provisioning as a result of our inventory levels being better aligned to customer demand and a decrease in other

contract and customer settlement costs; and

• improvements in other operations related costs.

nter

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• improvements in our product costs primarily as a result of favorable material pricing;

• changes in product mix mainly related to increased volumes of certain products with higher margins;

• reductions in other operations related costs including product defects, customer service and warranty costs; an

• reduced inventory provisioning as a result of our inventory levels being better aligned to customer demand and a decrease in other

contract and customer settlement costs; partially offset by

• reductions in the selling price of certain of our products.

Wireline Networks

• changes in product mix mainly related to decreased volumes of certain products with higher margins; partially offset by

• improvements in our cost structure as a result of favorable supplier pricing and design improvements;

• reductions in other operations related costs, mainly in the U.S. and Canada; and

• reduced inventory provisioning as a result of our inventory levels being better aligned to customer demand.

• improvements in our cost structure as a result of favorable supplier pricing and design improvements;

• reductions in other operations related costs, mainly in the U.S. and Canada; and

• reduced inventory provisioning as a result of our inventory levels being better aligned to customer demand.

tical Networks

• reduced inventory provisioning and other contract and customer settlement costs throughout 2003 including a reduction in accruals

of $53 associated with a certain customer bankruptcy settlement;

• reductions in operations related costs throughout 2003 mainly in the U.S., Canada and EMEA;

• improvements in our cost structure primarily as a result of favorable supplier pricing which were partially offset by continued

pricing pressures on the sale of certain products;

• the sale of certain optical components assets to Bookham and, as a result, our 2003 gross margin excluded the impact of excess

capacity of those optical components assets; and

• reduced warranty charges in 2003.

Optical Networks gross margin declined by approximately 5 percentage points in 2002 compared to 2001 primarily due to:

Operating expenses

SG&A expense declined $614 in 2003 compared to 2002 primarily due to:

SG&A expense declined $3,558 in 2002 compared to 2001 primarily due to:

Overall in 2004, we expect increased SG&A expense compared to 2003 primarily as a result of net trade and customer financing receivable

recoveries of $180 that were included in our SG&A expense in 2003 that are not expected to be repeated in 2004, negative foreign exchange

impacts, increases in our stock-based compensation programs and costs of approximately $115 related to our restatement activities. Although

we expect increased SG&A expense in 2004 compared to 2003, through the implementation of our strategic plan, we expect to reduce

operating expenses (both SG&A and R&D expense) to 35% of revenues or lower on an annualized basis in 2005. See “Business overview —

Our strategic plan and outlook”.

Wireless Networks SG&A expense decreased substantially in 2003 compared to 2002 primarily due to:

Wireless Networks SG&A expense decreased substantially in 2002 compared to 2001 primarily due to:

• pricing pressures on the sale of certain products; partially offset by

• reduced inventory provisioning and other contract and customer settlement costs in 2002.

Sellin

g, g

eneral and administrative ex

ense

For the years ended December 31, 2003 vs 2002 2002 vs 2001

2003 2002 2001 $ Change % Change $ Change % Change

SG&A expense $ 1,939 $ 2,553 $ 6,111 $ (614) (24) $ (3,558) (58)

As % of revenues 19.0% 23.2% 32.3% (4.2 pts) (9.1 pts)

• the continued impact of our workforce reductions and associated reductions in other related costs such as information services and

real estate; an

• a net decrease of $471 (recovery of $180 in 2003 and expense of $291 in 2002) related to decreased provisioning for trade and

customer financing receivables; partially offset by

• an increase of approximately $120 related to our RTP and regular bonus plans in 2003 compared to 2002; and

• an increase due to significant foreign exchange impacts associated with the Canadian dollar, euro and British pound; and

• an increase related to our stock-based compensation, including restricted stock unit and stock option programs, both of which are

not allocated across all of our reportable segments.

• the impact of workforce reductions which, in turn, resulted in a reduction in other related costs including information services and

real estate; an

• a decrease of $1,500 (expense of $291 in 2002 and expense of $1,791 in 2001) related to decreased provisioning for trade and

customer financing receivables.

ment sellin

eneral and administrative ex

ense

Wireless Networks

• 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.

• the continued impact of our workforce reductions and organizational realignment across all regions and associated reductions in

other related costs such as information services and real estate; partially offset by

• an increase in provisioning for trade and customer financing receivables.

Enterprise Networks SG&A expense decreased in 2003 compared to 2002 and decreased substantially in 2002 compared to 2001 primarily due

to:

Wireline Networks SG&A expense decreased substantially in 2003 compared to 2002 and in 2002 compared to 2001 primarily due to:

Optical Networks SG&A expense decreased substantially in 2003 compared to 2002 and in 2002 compared to 2001 primarily due to:

In addition, Optical Networks SG&A expense decreased substantially in 2003 compared to 2002 due to a reduction in accruals in 2003

associated with a customer contract settlement.

R&D expense decreased $123 in 2003 compared to 2002 and decreased $1,033 in 2002 compared to 2001 primarily due to our workforce

reductions and a reduced level of R&D activity consistent with the volume of business. The $123 decline in 2003 compared to 2002 was net of

increases in R&D expense due to significant foreign exchange impacts associated with the Canadian dollar, euro and British pound in 2003 and

increases in expenses associated with our RTP and regular bonus plans.

Our continued strategic investments in R&D are aligned with technology leadership in anticipated growth areas. Although we experienced a

substantial decline in demand for our networking equipment in 2001 through 2003, we maintained a technology focus and commitment to

invest in new innovative solutions where we believed we would achieve the greatest future benefit from this investment. As a result, our R&D

expense as a percentage of our consolidated revenues remained relatively flat at 19.2% in 2003 compared to 18.9% in 2002, both of which

were up from 16.5% in 2001.

We expect to continue to manage R&D expense according to the requirements of our business, allocating resources and investment where

customer demand dictates, and reducing resources and investment where opportunities for improved efficiencies present themselves. Our R&D

efforts are currently focused on secure and reliable converged networks including:

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• the continued impact of our workforce reductions, primarily in the U.S. and Canada, and associated reductions in other related costs

such as information services and real estate; and

• a decrease in provisioning for trade receivables.

Wireline Networks

• a decrease in provisioning for trade and customer financing receivables; and

• the continued impact of our workforce reductions, primarily in the U.S. and Canada, and associated reductions in other related costs

such as information services and real estate.

tical Networks

• the continued impact of our workforce reductions across all regions and associated reductions in other related costs such as

information services and real estate;

• reduction in accruals of approximately $4 associated with a certain customer bankruptcy settlement; and

• a decrease in provisioning for trade and customer financing receivables.

Research and develo

ment ex

ense

For the years ended December 31, 2003 vs 2002 2002 vs 2001

2003 2002 2001 $ Change % Change $ Change % Change

R&D expense $ 1,960 $ 2,083 $ 3,116 $ (123) (6) $ (1,033) (33)

As % of revenues 19.2% 18.9% 16.5% 0.3 pts 2.4 pts

• packetization of voice and multimedia IP telephony solutions services;

We expect that our R&D expense as a percentage of revenue in 2004 will be similar to 2003 and 2005 will be lower than 2004 as we seek to

achieve ongoing cost reductions in R&D as part of our strategic plan first announced in August 2004. See “Business overview — Our strategic

plan and outlook”.

Wireless Networks R&D expense increased slightly in 2003 compared to 2002 primarily due to:

Wireless Networks R&D expense decreased in 2002 compared to 2001 primarily due to:

Enterprise Networks R&D expense was up slightly in 2003 compared to 2002 primarily due to:

Enterprise Networks R&D expense decreased substantially in 2002 compared to 2001 primarily due to:

Wireline Networks R&D expense decreased significantly in 2003 compared to 2002 and decreased substantially in 2002 compared to 2001

primarily due to:

Optical Networks R&D expense decreased substantially in 2003 compared to 2002 and in 2002 compared to 2001 primarily due to:

• services edge capability to realize simplification of customer network operations and broadband access technologies, including

wireless and wireline; and

• enhanced network security to ensure the level of reliability and performance that has traditionally existed in carrier networks.

ment research and develo

ment ex

ense

Wireless Networks

• significant unfavorable foreign exchange impacts associated with the Canadian dollar and euro; partially offset by

• the continued impact of our workforce reductions;

• transitioning R&D activities into lower cost markets; and

• focused cost-savings initiatives.

• reductions in our UMTS R&D programs as a result of delays in commercial launches by wireless carriers in EMEA;

• focused cost-savings initiatives; partially offset by

• continued investment in the development of new products.

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• unfavorable foreign exchange impacts associated with the Canadian dollar; partially offset by

• the continued impact of our workforce reductions that targeted a level of R&D that was more representative of the volume of our

business.

• the continued impact of our workforce reductions that targeted a level of R&D expense that was more representative of the volume

of our business; and

• effectively prioritizing investment in data products and increased outsourcing activity.

Wireline Networks

• the continued impact of our workforce reductions that targeted a level of R&D expense that was more representative of the volume

of our business; and

• effectively prioritizing investment in data products and increased outsourcing activity.

tical Networks

• the continued impact of our workforce reductions that targeted a level of R&D expense that was more representative

As a result of the gross margin and SG&A expense changes discussed above, our total segment contribution margin improved by $1,050 in

2003 compared to 2002 and by $3,175 in 2002 compared to 2001. See “Segment information” in note 6 of the accompanying consolidated

financial statements.

The changes in segment Management EBT are a result of the gross margin, SG&A expense and R&D expense changes discussed above. See

“Segment information” in note 6 of the accompanying consolidated financial statements for a reconciliation of segment Management EBT to

net earnings (loss) from continuing operations.

The amortization of acquired technology was $101 and $157 in 2003 and 2002, respectively, and primarily reflected the charge related to the

acquisition of Alteon WebSystems, Inc, or Alteon. The remaining net carrying value of acquired technology was fully amortized in the third

quarter of 2003.

On January 1, 2002, we adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets”, or SFAS 142. As a result,

amortization of goodwill, including goodwill recorded in past business combinations, and amortization of intangibles with an indefinite life

ceased upon adoption of SFAS 142.

The amortization of goodwill for 2001 primarily reflected the charges related to the acquisitions of Bay Networks, Inc., Alteon, Xros, Inc.,

Qtera Corporation, Clarify Inc. and the acquisition of JDS’s Switzerland-based subsidiary and its related assets in Poughkeepsie, New York

(also known as the 980 NPLC business).

The net carrying value of goodwill was $2,305 on December 31, 2003 and $2,199 on December 31, 2002.

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 acquired companies. This deferred compensation was amortized to net earnings

(loss) based on the graded vesting schedule of the stock option awards.

Deferred stock option compensation was $16 in 2003 compared to $110 in 2002 and $248 in 2001. The declines were

of the volume of our business.

ment contribution mar

For the years ended December 31, 2003 vs 2002 2002 vs 2001

2003 2002 2001 $ Change % Change $ Change % Change

Wireless Networks $ 1,573 $ 1,104 $ 515 $ 469 42 $ 589 114

Enterprise Networks 560 316 263 244 77 53 20

Wireline Networks 612 736 611 (124) (17) 125 20

Optical Networks (2) (778) (1,524) 776 100 746 49

Other (341) (26) (1,688) (315) (1,212) 1,662 98

Total $ 2,402 $ 1,352 $ (1,823) $ 1,050 78 $ 3,175 174

ment Mana

ement EBT

For the

ears ended December 31, 2003 vs 2002 2002 vs 2001

2003 2002 2001 $ Change % Change $ Change % Change

Wireless Networks $ 695 $ 256 $ (456) $ 439 171 $ 712 156

Enterprise Networks 279 29 (141) 250 862 170 121

Wireline Networks 171 178 (205) (7) (4) 383 187

Optical Networks (260) (1,274) (2,504) 1,014 80 1,230 49

Other (306) (209) (2,634) (97) (46) 2,425 92

Total $ 579 $ (1,020) $ (5,940) $ 1,599 157 $ 4,920 83

Amortization of intan

ibles

Deferred stock o

tion com

ensation

primarily due to the completion of the deferred compensation amortization associated with certain employees’ stock option vesting periods and

the cancellation of unvested stock options that were held by employees whose employment was terminated.

During 2003, we continued to implement our restructuring work plan initiated in 2001. In addition, as described below, certain exit activities

were initiated in 2003. Special charges recorded from January 1, 2001 to December 31, 2003 were as follows:

We implemented our work plan to streamline our operations and activities around our core markets and leadership strategies during 2001 in

light of the significant downturn in both the telecommunications industry and the economic environment, and capital market trends impacting

our operations and expected future growth rates. This work plan was adjusted during 2001, 2002 and 2003 to reflect the continued decline in

the industry and economic environment, and in the capital markets. In addition, we initiated activities in 2003 to exit certain leased facilities

and leases for assets no longer used across all segments.

In 2003, we recorded special charges of $284, net of revisions of $53, related to our restructuring work plan and contract settlement and lease

costs. Workforce reduction charges of $199 related to the cost of severance and benefits associated with approximately 1,800 employees

notified of termination during 2003 which extended across all segments. Net revisions of $44 to reduce prior accruals primarily related to

termination benefits where actual costs were lower than our original estimates across all segments. During 2003, the workforce reduction

provision balance was drawn down by cash payments of $274 and by a non-cash pension settlement loss of $41. The remaining provision is

expected to be substantially drawn down by the end of 2005. Contract settlement and lease costs were $64 and consisted of negotiated

settlements to cancel or renegotiate contracts and net lease charges related to leased facilities (comprised of office, warehouse and

manufacturing space) and leased furniture that were identified as no longer required across all segments. These lease costs, net of anticipated

sublease income, included non-cancelable lease terms from the date leased facilities ceased to be used and termination penalties.

ecial char

Contract Intan

ible

settlement Plant and asset

Workforce and lease equipment impair-

reduction costs write downs Other ments Total

Provision balance as of January 1, 2001 $ 45 $

–

$–$–$–$45

Goodwill impairment –

–

– – 11,426 11,426

Other special charges 1,174 897 1,000 39 407 3,517

Revisions to prior accruals 42 (108) (59) (2) – (127)

Cash drawdowns (1,003) (110) – (8) – (1,121)

Non-cash drawdowns 14

–

(941) – (11,833) (12,760)

Foreign exchange and other adjustments 10 (2) – – – 8

Provision balance as of December 31, 2001 $ 282 $ 677 $ – $ 29 $ – $ 988

Goodwill impairment –

–

––595595

Other special charges 952 225 475 – 27 1,679

Revisions to

rior accruals (132) 8 (55) – – (179)

Cash drawdowns (788) (286) – (20) – (1,094)

Non-cash drawdowns (100)

–

(420) – (622) (1,142)

Foreign exchange and other adjustments (2) (4) – – – (6)

Provision balance as of December 31, 2002 (a) $ 212 $ 620 $ – $ 9 $ – $ 841

Other special charges 199 64 74 – – 337

Revisions to prior accruals (44) 19 (28) – – (53)

Cash drawdowns (274) (275) – (9) – (558)

Non-cash drawdowns (41)

–

(46) – – (87)

Foreign exchange and other adjustments 12 28 – – – 40

Provision balance as of December 31, 2003 (a) $ 64$456$ –$ –$ –$520

a) As of December 31, 2003 and 2002, the short-term provision balance was $206 and $507, respectively, and the long-term provision balance was $314 and $334,

respectively, which was included in long-term provisions, as a component of other liabilities.

In addition to these charges were revisions to prior accruals of $19 resulting primarily from changes in estimates for sublease income and costs

to vacate certain properties, across all segments. During 2003, the provision balance for contract settlement and lease costs was drawn down by

cash payments of $275. The remaining provision, net of approximately $317 in estimated sublease income, is expected to be substantially

drawn down by the end of 2013. Also, we recorded charges of $74 related to current period write downs to fair value less costs to sell for

various leasehold improvements and excess Optical Networks equipment held for sale. Net revisions of $28 to reduce prior accruals related to

adjustments in our original plans or estimates for the closure of certain facilities. In 2003, we concluded that an impairment of our goodwill did

notexistandnowritedownwasrecorded.

In 2002, we recorded special charges of $2,095, net of revisions of $179, related to our restructuring work plan and contract settlement and

lease costs. Workforce reduction charges of $952 were related to the cost of severance and benefits associated with the approximately 12,700

employees notified of termination which was primarily in the U.S., Canada and EMEA and extended across all segments. Net revisions of $132

to reduce prior accruals primarily related to termination benefits where actual costs were lower than our original estimates across all segments.

Workforce reduction charges included $124 for pension and post-retirement benefits other than pension, settlement and curtailment costs.

During 2002, the workforce reduction provision balance was drawn down by cash payments of $788 and by $100 of non-cash pension and

post-retirement benefits other than pension, settlement and curtailment costs attributable to the notified employee group charged against the

provision. Contract settlement and lease costs of $225 consisted of negotiated settlements to cancel or renegotiate contracts and net lease

charges related to leased facilities (comprised of office, warehouse and manufacturing space) and leased manufacturing equipment that were no

longer required, across all segments. In addition to these charges were net revisions of $8 primarily from changes in estimates for sublease

income and costs to vacate certain properties, across all segments. During the year ended December 31, 2002, the provision balance for

contract settlement and lease costs was drawn down by cash payments of $286. The remaining provision balance was net of approximately

$402 in estimated sublease revenue. Plant and equipment charges of $475 were related to current period write downs to fair value less costs to

sell for various owned facilities and plant and manufacturing related equipment. These charges included $358 related to specialized plant

infrastructure and equipment within Optical Networks and the remaining charges for facilities and equipment arising across all segments.

Offsetting these charges were revisions of $55 to prior write downs of assets held for sale related primarily to additional proceeds from

disposals of equipment from Optical Networks and other segments in excess of amounts previously expected and adjustments to original plans

or estimated amounts for certain facility closures across all segments. Also in 2002, we recorded $27 related to the write downs of certain

acquired technology in Optical Networks due to our reassessment of market conditions.

In 2002, we also completed the SFAS 142 transitional impairment test and concluded at that time that there was no impairment of recorded

goodwill, as the fair values of our reporting units exceeded their carrying amounts as of January 1, 2002. Therefore, the second step of the

transitional impairment test under SFAS 142 was not required to be performed in 2002. However, as a result of the continued decline in 2002

in both our overall market value generally and within Optical Networks specifically, we evaluated the goodwill associated with the businesses

within Optical Networks for potential impairment. The conclusion of those evaluations was that the fair value associated with these businesses

could no longer support the carrying value of the remaining goodwill associated with them. As a result, we recorded a goodwill write down of

$595 in 2002.

In 2001, we recorded special charges of $14,816, net of revisions, related to our restructuring work plan and write downs of goodwill and other

assets. These special charges related to workforce reduction costs of $1,174, contract settlement and lease costs of $897, plant and equipment

write downs of $1,000, other charges of $39, intangible asset impairments of $407 and a goodwill write down of $11,426.

On December 31, 2003, our workforce was 35,160. In 2004 and into 2005, our focus is on managing each of our businesses based on financial

performance, the market and customer priorities. In the third quarter of 2004, we announced a strategic plan that includes a work plan

involving focused workforce reductions and a voluntary retirement program relating in the aggregate to approximately 3,250 employees, real

estate optimization and other cost containment actions such as reductions in information services costs, outsourced services and other

discretionary spending. Expected cash costs in connection with this work plan are approximately $430. See “Business overview — Our

strategic plan and outlook”.

For additional information on expected future cash outflows related to special charges, see “Liquidity and capital resources — Uses of

liquidity”. For additional information related to our restructuring activities, see “Special charges” in note 7 of the accompanying consolidated

financial statements.

Gain (loss) on sale of businesses and assets

In 2003, gain on sale of businesses and assets of $4 was primarily due to the recognition of the remaining unamortized deferred gain related to

the sale of substantially all of the assets of our Cogent Defence Systems, or CDS, business during the year ended December 31, 2001. The

remaining unamortized deferred gain of $23 was recognized as a result of the sale of our 41% interest in EADS Telecom as discussed in

“Developments in 2003 and 2004 — Other business developments — Ownership adjustment in our French and German operations”. This gain

was partially offset by a loss due to retirement of fixed assets.

In 2002, gain on sale of businesses and assets of $21 was primarily related to:

In 2001, loss on sale of businesses and assets of $138 was primarily related to a $233 write down of our Service Commerce operation support

system business to its net realizable value in the fourth quarter of 2001. The write down related primarily to goodwill and included the

operations acquired on the acquisition of Architel Systems Corporation. Net realizable value was determined based on the anticipated proceeds

on the sale of the business, which was completed on February 1, 2002. This loss was partially offset by net gains associated with both the

outsourcing of certain activities as part of our continued supply chain transformation strategy that began in 1999 and the divestiture of certain

non-core businesses in connection with our restructuring work plan. The loss was also partially offset by a gain of $37 associated with the sale

of assets of our CDS business.

For additional information relating to these asset sales, see “Acquisitions, divestitures and closures” in note 10 and “Commitments” in note 14

of the accompanying consolidated financial statements.

Other income (expense) — net

In 2003, other income — net was $445, which primarily included:

In 2002, other expense — net of $5 was primarily related to a foreign exchange loss of $65 and a $39 loss on the sale or write down of certain

minority investments, partially offset by interest income of $88 on our short-term investments.

In 2001, other expense — net of $506 was primarily related to a foreign exchange loss of $152 and a $368 loss on the sale or write down of

certain minority investments. This write down occurred during the third quarter of 2001 from our review of our investment portfolio, and was

due to a change in our strategic focus relative to certain minority investments, as well as an other than temporary decline in carrying values

caused by the continued significant downturn in both the industry and

• a gain of $29 on the sale of certain assets relating to our optical components business to Bookham;

• a gain of $41 related to a previously deferred gain associated with the sale of substantially all of the assets of our CDS business to

EADS Telecom as well as the cancellation and replacement of a call option to acquire an additional approximate 7% ownership

interest in NNF which was originally included as part of the consideration received on the sale of these assets; an

• a gain of $10 on the sale of certain assets of our Service Commerce operation support system business to MetaSolv, Inc; partially

offset by

• a loss of $68 due to retirement of fixed assets.

• gain of $96 related to the sale of our interest in EADS Telecom in conjunction with the changes in ownership of our French and

German operations;

• interest income of $75 on our short-term investments;

• gain of $30 related to a certain customer bankruptcy settlement;

• a payment of $25 received from a settlement related to intellectual property use;

• foreign exchange gains of $105 primarily related to day-to-day transactional activities;

• gain of $6 related to sale of our interest in Bookham;

• gain of $31 related to the sale of Arris Group, Inc., or Arris Group, shares. For additional information on our investment in Arris

Group see “Results of operations

—

discontinued operations”;

• gain of $10 related to sale of certain minority investments;

• dividend income of $19 on our shor

-term investments; and

• royalty income of $15 from patented technology.

economic environment. Public company investments were generally written down against earnings to their then current market value. Private

company investments were written down to the estimated current market value by applying a telecommunications market average adjustment

factor calculated using the declines of a representative group of public companies.

nterest expense

In 2003, interest expense decreased $63 ($209 in 2003 compared to $272 in 2002) primarily due to a reduction in the outstanding balances of

our notes payable and long-term debt.

In 2002, interest expense decreased $39 ($272 in 2002 compared to $311 in 2001). The decrease was primarily related to a lower level of short-

term notes payable in 2002, partially offset by additional interest expense due to long-term debt offerings during 2001.

Interest rates on our outstanding notes payable and long-term debt remained relatively flat during these periods.

Our quarterly interest expense in the first quarter of 2004 and the second quarter of 2004 was $52 and $50, respectively. We expect that the

quarterly interest expense for the remainder of 2004 will remain at similar levels.

ncome tax benefit (expense)

In 2003, we recorded a tax benefit of $80 on pre-tax earnings of $281 from continuing operations before minority interests and equity in net

loss of associated companies. This tax benefit resulted from tax audit settlements and the benefit of various R&D related tax incentives. This

benefit was partially offset by income tax provisions in certain taxable jurisdictions and various corporate minimum related income taxes.

In 2002, we recorded a tax benefit of $468 on a pre-tax loss of $3,349 from continuing operations before minority interests and equity in net

loss of associated companies. Our valuation allowances on tax benefits recorded in 2002 were $811. We assessed positive evidence including

forecasts of future taxable income to support realization of the net deferred tax assets, and other negative evidence including our eight

consecutive quarters of tax losses, and concluded that it was more likely than not that a portion of our deferred income tax asset would not be

realized.

As of December 31, 2003, we have substantial loss carryforwards and valuation allowances in our significant tax jurisdictions. These loss

carryforwards will serve to minimize our future cash income related taxes.

We will continue to assess the valuation allowance recorded against our deferred tax assets on a quarterly basis. The valuation allowance is in

accordance with SFAS No. 109, “Accounting for Income Taxes”, which requires that a tax valuation allowance be established when it is more

likely than not that some portion or all of a company’s deferred tax assets will not be realized. Our valuation allowance is primarily attributed

to ongoing industry concerns. Given the magnitude of our valuation allowance, future adjustments to this allowance based on actual cash

results could result in a significant adjustment to our effective tax rate. For additional information, see “Application of critical accounting

estimates — Income Taxes — Tax asset valuation”.

et earnings (loss) from continuing operations

As a result of the items discussed above under “Results of operations — continuing operations”, net earnings from continuing operations were

$262 in 2003. This amount represented an improvement of $3,155 compared to our net loss from continuing operations of $2,893 in 2002.

Also, our net loss from continuing operations improved by $20,377 in 2002 compared to our net loss from continuing operations of $23,270 in

2001.

Results of operations — discontinued operations

In 2003, we completed a number of transactions including the sale of certain assets and common shares of businesses associated with our

discontinued operations as well as the restructuring and/or collection of trade and customer financing receivables and a certain promissory note

receivable. We continued to wind-down our access solutions operations and recorded net earnings from discontinued operations of $184 (net of

tax) related to the sale of certain components of this business and other associated wind-down activities. We also continued to reassess the

remaining provisions associated with

our discontinued operations and recorded any resulting gains or losses in net earnings (loss) from discontinued operations in the period in

which they occurred.

As of December 31, 2003, there was no change to the initial disposal strategy or intent to exit the business which was approved by the Board of

Directors on June 14, 2001. However, the prolonged deterioration in the industry and market conditions during 2002 and 2003 delayed certain

disposal activities beyond the original planned timeframe of one year. In particular, actions involving negotiations with customers, who were

also affected by industry conditions, took longer than expected. Although disposal activities continued beyond the one-year period, we

continue to present the access solutions operations as discontinued operations in the accompanying consolidated financial statements. As of

December 31, 2003, we had substantially completed the wind-down of our access solutions operations. Net earnings from discontinued

operations of $184 (net of tax) primarily related to a number of transactions in 2003 as follows, as well as gains of $68 associated with

provision reassessments:

Following the March 2003 Arris Group transactions, we reduced our interest in Arris Group to 18.8%, and ceased equity accounting for the

investment. As a result, we reclassified our remaining ownership interest in Arris Group as an available-for-sale investment within continuing

operations effective in the second quarter of 2003. We continued to dispose of our interest in Arris Group in 2003 and the gain or loss on the

sale of shares subsequent to the first quarter of 2003 was included in other income (expense) — net. We sold 9 million common shares of Arris

Group on November 24, 2003. As of December 31, 2003, we owned 5 million Arris Group common shares or 6.6% of Arris Group’s

outstanding common shares.

For additional information, see “Discontinued operations” in note 20 of the accompanying consolidated financial statements and “Other

income (expense) — net”.

Liquidity and capital resources

Cash flows

The following table summarizes our cash flows by activity and cash on hand as of December 31:

• a gain of $14 on the sale of certain assets related to our fixed wireless access operations to Airspan Networks, Inc. for cash

consideration of $13 on December 23, 2003;

• a gain of $17 in the fourth quarter of 2003 associated with a cash settlement of $17 related to a certain note receivable which had

been previously reserved;

• a gain of $12 on March 24, 2003 from the sale of 8 million common shares of Arris Group, back to Arris Group for cash

consideration of $28 pursuant to a March 11, 2003 agreement. In addition, on March 18, 2003, we assigned our membership

interest in Arris Interactive LLC, or Arris, to ANTEC Corporation, an Arris Group company, for cash consideration of $88,

resulting in a loss of $2. Also in connection with these transactions, we received $11 upon the settlement of a sales representation

agreement with Arris Group and recorded a gain of $11; and

• a gain of $66 in the first quarter of 2003 from the settlement of certain trade and customer financing receivables, the majority of

which was previously provisioned.

2003 2002

Net cash from (used in) operating activities of continuing operations $ 85 $ (768)

Net cash from (used in) investing activities of continuing operations (85) 129

Net cash from (used in) financing activities of continuing operations (359) 532

Effect of foreign exchange rate changes on cash and cash equivalents 176 74

Net cash from (used in) continuing operations (183) (33)

Net cash from (used in) discontinued operations 390 349

Net increase (decrease) in cash and cash equivalents 207 316

Cash and cash e

uivalents at be

innin

eriod 3,790 3,474

Cash and cash equivalents at end of period $ 3,997 $ 3,790

In 2003, we continued to strengthen our liquidity position. As of December 31, 2003, our primary source of liquidity was cash. At

December 31, 2003, we had cash of $3,997 excluding $63 of restricted cash and cash equivalents. We believe this cash will be sufficient to

fund the changes to our business model in accordance with the strategic plan (see “Business overview — Our strategic plan and outlook”),

manage our investments and meet our customer commitments for at least the next 12 months. However, if capital spending by service

providers and other customers changes from what we currently expect, we may be required to adjust our current business model. As a result,

our revenues and cash flows may be materially lower than we expect and we may be required to further reduce our investments or take other

measures in order to meet our cash requirements. In the future, we may seek additional funds from liquidity generating transactions and other

sources of external financing. We continue to routinely monitor the capital markets for opportunities to improve our capital structure and

financial flexibility. Our ability and willingness to access the capital markets is based on many factors including market conditions and overall

financial objectives. Currently our ability is limited due to the impact of the delay in filing the Reports and the findings of the Independent

Review and related matters. We cannot provide any assurance that our net cash requirements will be as we currently expect, that we will

continue to have access to the EDC Support Facility when and as needed or that liquidity generating transactions or financings will be available

to us on acceptable terms. In addition, we have not assumed the need to make any payments in respect of judgments, settlements, fines or other

penalties in connection with our pending civil litigation or investigations related to the First Restatement and Second Restatement, which could

have a material adverse effect on our financial condition or liquidity, other than anticipated professional fees and expenses. See “Risk

factors/forward looking statements”.

In 2003, our cash flows from operating activities were $85 due to net earnings from continuing operations of $262, less adjustments of $24 for

non-cash and other items and $153 related to the change in our operating assets and liabilities. The use of cash of $153 resulting from the

change in our operating assets and liabilities was primarily due to:

The net decrease of $11 related to accounts payable and accrued liabilities and other operating assets and liabilities was mainly a result of:

As a result of previously incurred tax losses and tax credits, we do not expect that we will have to make significant cash income tax payments

in the foreseeable future.

Cash flows used in investing activities were $85 and were primarily due to $172 in plant and equipment expenditures and $58 associated with

acquisitions of certain investments and businesses including the ownership adjustment in our French and German operations. These amounts

were partially offset by proceeds of $107 from the sale of certain investments and businesses which we no longer considered strategic and

proceeds of $38 primarily from the sale of plant and equipment in the

• net cash of $200 from a reduction in restricted cash and cash equivalents primarily due to the release of restricted cash upon the

utilization of our EDC Support Facility as well as the release of other restrictions on cash through cancellation, renegotiation and/or

fulfillment of our contractual obligations with certain customers;

• net cash of $18 from income taxes; and

• net cash of $429 from inventory primarily related to product shipments exceeding additions to inventories during 2003; more than

offset by

• $231 related to accounts receivable primarily due to a significant increase in billings in the fourth quarter of 2003 as a result of the

substantial increase in revenues in the fourth quarter of 2003 compared to the fourth quarter of 2002;

• $558inrestructuringrelatedcashoutflows;and

• a net decrease of $11 related to accounts payable and accrued liabilities and other operating assets and liabilities.

• contributions to our defined benefit pension plans of approximately $300;

• the settlement of the liability associated with the put option related to the sale of our interest in EADS Telecom in conjunction with

the changes in ownership of our French and German operations;

• payments of certain contract manufacturer and supplier accruals;

• settlement of certain obligations related to our internal information systems infrastructure;

• activities associated with our outsourcing contracts; partially offset by

• cash collections of outstanding customer financing amounts associated with certain customers;

• reduction of certain customer contract settlement costs; and

• the proportionate decrease in these assets and liabilities as a result of the decline in sales volumes and the associated size of our

business.

U.S.

Cash flows used in financing activities were $359 and were primarily due to $270 used to reduce our long-term debt, a reduction of our notes

payable by a net amount of $45 and $35 used in connection with the payment of dividends to NNL’s preferred shareholders.

In 2003, our cash increased $176 due to favorable effects of changes in foreign exchange rates. Approximately $150 of the favorable impact

was the result of favorable changes in the euro and the British pound.

Also in 2003, our discontinued operations generated net cash of $390 related to certain investing and operating activities. We generated $241

of cash from investing activities primarily related to proceeds from the sale of the common shares of Arris and the settlement of certain

customer financing receivables. The remaining cash of $149 was generated from operating activities related to the continued wind down of our

discontinued operations.

Uses of liquidity

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

In particular, we are subject to significant pending civil litigation actions and regulatory and criminal investigations which could materially

adversely affect our financial condition and liquidity by requiring us to pay substantial judgments, settlements, fines or other penalties. See

“Risk factors/forward looking statements”. Considerable effort and resources have been expended on our restatement activities in 2004,

including the dedicated effort of hundreds of employees and numerous external consultants and advisors. The estimated costs of our

restatement activities in 2004 are approximately $115, which amount will be included in SG&A expense in our consolidated statements of

operations in the periods in which the costs are incurred.

Also, from time to time, we may purchase our outstanding debt securities and/or convertible notes in privately negotiated or open market

transactions, by tender offer or otherwise, in compliance with applicable laws. As well, we expect to be required to fund some portion of our

aggregate undrawn customer financing commitments.

• operations;

• research and development;

• costs relating to workforce reduction and other restructuring activities;

• capital expenditures;

• debt service;

• pension and post-retirement benefits; and

• costs in relation to the restatement activities, matters related to the Independent Review and other related matters, including

regulatory and other legal proceedings.

Purchase obligation amounts in the above table represent the minimum obligation under our supply arrangements related to product and/or

services entered into in the normal course of our business. Where the arrangement specifies quantity, pricing and timing information, we have

included that arrangement in the amounts presented above. In certain cases, these arrangements define an end date of the contract, but do not

specify timing of payments between December 31, 2003 and the end date of the agreement. In those cases, we have estimated the timing of the

payments based on forecasted usage rates.

During the third quarter of 2003, we renegotiated a key supply arrangement that was initially put into place prior to the industry and economic

downturn that commenced in 2001. The renegotiated agreement is reflective of the current market environment, and the terms include a

reduction in our minimum spending levels plus an extension in the time period, from 2004 to 2009, within which these minimum levels must

be met. As well, we are no longer obligated to compensate the supplier for direct costs if the minimum spending levels are not met. The

renegotiated agreement includes a graduated liquidated damages remedy for the benefit of the supplier if the minimum spending levels are not

met by the end of the agreement in 2009. However, based upon the renegotiated terms, we expect to meet the minimum spending levels. The

remaining minimum purchase obligation has been reflected in the contractual cash obligations table above.

Outsourcing contract amounts in the table above represent our minimum contractual obligation for services provided to us primarily related to

a portion of information services, payroll, capital services, accounts payable and training and human resource functions. The amount payable

under our outsourcing contracts is variable to the extent that our workforce fluctuates from the baseline levels contained in the contracts and

our contractual obligation could increase above such baseline amount. If our workforce were to fall below the baseline levels in the contracts,

we would be required to make the minimum payments included above.

Balance sheet provisions of $64 for workforce reduction costs, included in restructuring in current liabilities in the accompanying consolidated

financial statements, have not been reflected in the contractual cash obligations table above. The remaining balance sheet provision of $456,

net of approximately $317 in estimated sublease revenues, related to contract settlement and lease costs and is expected to be substantially

drawn down by the end of 2013.

Contractual cash obli

ations

Payments due

Contractual cash obligations (a) 2004 2005 2006 2007 2008 Thereafter

Total

obligations

Long-term debt (b) $ 119 $ 16 $ 1,492 $ 15 $ 1,816 $ 552 $ 4,010

Operating leases (c) 163 159 145 131 113 649 1,360

Purchase obligations 1,209 1,123 102 –

–

– 2,434

Outsourcing contracts 161 104 104 104 104 104 681

Obli

ations under s

ecial char

es 14595725949248668

Pension, post-retirement and post-employment obligations 170

–

––

–

–170

Other long-term liabilities reflected on the balance sheet 13 6 4 3 3 47 76

Total contractual cash obligations $ 1,980 $ 1,503 $ 1,919 $ 312 $ 2,085 $ 1,600 $ 9,399

(a) Amounts represented our known, undiscounted, minimum contractual payment obligations under our long-term obligations and include amounts identified as contractual

obligations in current liabilities of the accompanying consolidated financial statements.

(b) Included principal payments due on long term debt and $178 of capital lease obligations. As described in note 12 to the accompanying consolidated financial statements,

we have entered into certain interest rate swap contracts which swap fixed rate payments for floating rate payments. For additional information, also see note 11 “Long-

term debt, credit and support facilities” to the accompanying consolidated financial statements.

urchase obli

ations

Outsourcin

contracts

Obli

ations under s

ecial char

During 2003, we made cash contributions to our defined benefit pension plans of approximately $300. In 2004, we made cash contributions of

approximately $140 to our defined benefit pension plans, which excludes $78 of deferred contributions for 2004 which were made in 2003, and

approximately $30 to our post-retirement benefit plans.

The contractual cash obligations table above primarily included long-term balance sheet reserves related to asset retirement costs and deferred

compensation accruals. Payment information related to our asset retirement costs has been presented based on the termination date of the

associated lease contracts. Payment information related to our deferred compensation accruals has been presented based on the anticipated

retirement dates of the employees participating in the programs.

We agreed with JDS that if we purchased a minimum amount of designated products determined as a percentage of our total purchases for such

products during the period from January 1, 2001 to December 31, 2003, we would earn consideration from JDS as a reduction, in whole or in

part, of the deferred consideration otherwise payable in our common shares to JDS. We believe that our purchases over the term of the

purchase arrangement were sufficient to meet the required measurement metrics to December 31, 2003. No amounts relating to this

arrangement have been reflected in the contractual cash obligations table above. See note 3 “Restatement” to the accompanying consolidated

financial statements for information regarding changes in the accounting for the deferred consideration.

Generally, customer financing arrangements may include financing with deferred payment terms in connection with the sale of our products

and services, as well as funding for non-product costs associated with network installation and integration of our products and services. We

may also provide funding for working capital purposes and equity financing. The following table provides information related to our customer

financing commitments, excluding our discontinued operations as of:

In 2003, we entered into certain agreements to restructure and/or settle various customer financing and related receivables. As a result of these

transactions, we received cash consideration of approximately $230 to settle outstanding receivables of approximately $610 (with a net

carrying value of approximately $120). Also, we recorded net customer financing bad debt recoveries of $113 as a result of these favorable

settlements and adjustments to other existing provisions.

During 2003, we reduced undrawn commitments by $651 primarily as a result of the expiration or cancellation of commitments and changing

customer business plans. As of December 31, 2003, approximately $108 of the $177 in undrawn commitments was not available for funding

under the terms of our financing agreements.

We continue to regularly assess the levels of our customer financing provisions based on a loan-by-loan review to evaluate whether the terms

of each loan reflect current market conditions. We review the ability of our customers to meet their repayment obligations and determine our

provisions accordingly. Commitments to extend future financing generally have conditions for funding, fixed expiration or termination dates

and specific interest rates and purposes. We cannot predict with certainty the extent to which our customers will satisfy the applicable

conditions for funding, and subsequently request funding, prior to the termination date of the commitments. We are currently directly

supporting most outstanding balances and expect to initially fund any future commitments in the normal course of business from our working

capital.

ension,

ost-

etirement and

ost-em

ment obli

ations

Other lon

erm liabilities re

lected on the balance sheets

JDS

urchase arran

ement

Customer financin

December 31,

2003 2002

Drawn and outstandin

—

ross $ 401 $ 1,120

Provisions for doubtful accounts (281) (824)

Drawn and outstandin

—

120 296

Undrawn commitments(a) 180 831

Total customer financing $ 300 $ 1,127

(a) Included short-term and long-term amounts. Short-term and long-term amounts were included in accounts receivable — net and other assets, respectively, in the

consolidated balance sheets.

(b) On January 8, 2004, Nortel Networks renegotiated an agreement with a certain customer which reduced Nortel Networks aggregate undrawn customer financing

commitments from $177 to $69.

We expect to fund substantially all of our current remaining undrawn commitments of $69 in 2004 or 2005. However, we also expect that we

will be able to arrange for third party lenders to assume these obligations in the same timeframe.

Joint ventures/minority interests

As discussed in “Developments in 2003 and 2004 — Other business developments — Ownership adjustment in our French and German

operations”, on October 19, 2002, we entered into a number of put option and call option agreements as well as a share exchange agreement

with EADS, our partner at that time in three European joint ventures. During 2003, the options and share exchange were exercised which

resulted in us acquiring all of the equity interest of EADS in Nortel Networks Germany and Nortel Networks France. For additional

information, see “Nortel Networks Germany and Nortel Networks France” in note 10 of the accompanying consolidated financial statements.

iscontinued operations

As of December 31, 2003, accruals related to our discontinued access solutions operations totaled $6 and were related to future contractual

obligations and estimated liabilities during the planned period of disposition. The remaining accruals are expected to be substantially drawn

down by cash payments by the end of 2005.

For additional information related to our discontinued operations, see “Discontinued operations” in note 20 of the accompanying consolidated

financial statements.

Sources of liquidity

As of December 31, 2003, we had $750 in undrawn credit under the Five Year Facilities scheduled to expire in April 2005. These credit

facilities were entered into on April 12, 2000 by NNL and NNI and permitted borrowings for general corporate purposes. The Five Year

Facilities contained a financial covenant requiring that NNL’s consolidated tangible net worth be not less than $1,888 at any time. As of

December 31, 2003, we were in compliance with this covenant and there were no amounts drawn under the Five Year Facilities. On April 28,

2004, we notified the lenders under the Five Year Facilities that we were terminating these facilities. Due to NNL’s failure to file its 2003

Annual Report on Form 10-K by April 29, 2004, the banks under the Five Year Facilities would have otherwise been permitted to, upon

30 days’ notice, terminate their commitments under the Five Year Facilities. Upon termination, we were in compliance with that financial

covenant and the Five Year Facilities were undrawn. For additional information relating to the Five Year Facilities and the impact of the

termination of these facilities under the related security agreements, see “Developments in 2003 and 2004 — Nortel Networks Audit

Committee Independent Review; restatements; related matters — Credit facilities and security agreements” and “Risk factors/forward looking

statements”.

On February 14, 2003, NNL entered into the EDC Support Facility. As of December 31, 2003, the facility provided for up to $750 in support

including:

For additional information related to the EDC Support Facility subsequent to December 31, 2003 and waivers obtained in connection with the

defaults arising under the EDC Support Facility from the delay in filing the Reports, see “Developments in 2003 and 2004 — Nortel Networks

Audit Committee Independent Review; restatements; related matters — EDC Support Facility” and “Risk factors/forward looking statements”.

On March 29, 2004, NNL and EDC amended the EDC Support Facility to provide that EDC may suspend its obligation to issue NNL any

additional support if events occur that would have a material adverse effect on NNL’s business, financial position or results of operation. As a

result of an amendment on December 10, 2004, the EDC Support Facility will expire on

Credit facilities

Available su

ort facilit

• $300 of committed revolving support for performance bonds or similar instruments, of which $151 was utilized;

• $150 of uncommitted support for receivables sales and/or securitizations, of which none was utilized; and

• $300 of uncommitted support for performance bonds and/or receivables sales and/or securitizations, of which $183 was utilized.

December 31, 2006.

The EDC Support Facility does not materially restrict NNL’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. The EDC Support Facility can be suspended or terminated if NNL’s senior long-term

debt rating by Moody’s has been downgraded to less than B3 or if its debt rating by S&P has been downgraded to less than B–.

As of December 31, 2003, NNL’s obligations under the EDC Support Facility were secured on an equal and ratable basis under the security

agreements entered into by NNL and various of our subsidiaries that pledged substantially all of NNL’s and its subsidiaries’ assets in favor of

the holders of NNL’s public debt securities and the holders of our 4.25% Convertible Senior Notes. As of December 31, 2003, the security

provided under the security agreements was comprised of:

If NNL’s senior long-term debt rating by Moody’s returns to Baa2 (with a stable outlook) and its rating by S&P returns to BBB (with a stable

outlook), the security and guarantees will be released in full. If the EDC Support Facility is terminated, or expires, the security and guarantees

will also be released in full. 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 this facility (or any other alternative collateral or arrangements acceptable to EDC) in lieu of

the security provided under the security agreements. Accordingly, if the EDC Support Facility is secured by cash or other alternate collateral or

arrangements acceptable to EDC, the security and guarantees will also be released in full.

For information related to our outstanding public debt, see “Long-term debt, credit and support facilities” in note 11 of the accompanying

consolidated financial statements. For additional financial information related to those subsidiaries providing guarantees as of December 31,

2003, see “Supplemental consolidating financial information” in note 24 of the accompanying consolidated financial statements. For

information related to the security pledged, those subsidiaries providing guarantees and the impact of the termination of the Five Year Facilities

on the related security agreements, subsequent to December 31, 2003, see “Developments in 2003 and 2004 — Nortel Networks Audit

Committee Independent Review; restatements; related matters — Credit facilities and security agreements”. For information related to our debt

ratings, see “Credit ratings” below. See “Risk factors/forward looking statements” for factors that may affect our ability to comply with

covenants and conditions in our EDC Support Facility in the future.

In 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 U.S. and/or Canada. The qualifying securities

include common shares, preferred shares, debt securities, warrants to purchase equity or debt securities, share purchase contracts and share

purchase or equity units (subject to certain approvals). As of December 31, 2003, approximately $1,700 under the shelf registration statement

and base shelf prospectus has been utilized. As of June 6, 2004, the Canadian shelf registration expired. Owing to matters described above in

“Developments in 2003 and 2004 — Nortel Networks Audit Committee Independent Review; restatements; related matters” with respect to the

delayed filing of the Reports, we are currently unable to utilize the remaining capacity under the SEC shelf registration statement in its current

form. For the same reasons, we are also unable to permit holders of our prepaid forward purchase contracts to exercise certain “early

settlement” rights and receive Nortel Networks Corporation common shares in advance of the otherwise applicable August 15, 2005 settlement

date. These rights will again become exercisable upon the effectiveness of a registration statement (or a post-effective amendment to the shelf

registration statement) filed with the SEC (with respect to the common shares to be delivered) that contains a related current prospectus. Under

the terms of the Purchase Contract and Unit Agreement which governs the purchase contracts, we have agreed to use commercially reasonable

efforts to have, in effect, a registration statement covering the common shares to be delivered and to provide a prospectus in connection

therewith.

• pledges of substantially all of the assets of NNL and those of most of its U.S. and Canadian subsidiaries;

• share pledges in certain of NNL’s other subsidiaries; and

• guarantees by certain of NNL’s wholly owned subsidiaries organized in Canada, England, Ireland and Hong Kong.

Shelf re

istration statement and base shelf

ros

ectus

Credit ratings

On April 28, 2004, S&P downgraded its ratings on NNL, including its long-term corporate credit rating from “B” to “B–” and its preferred

shares rating from “CCC” to “CCC–”. At the same time, it revised its outlook to developing from negative. Moody’s outlook changed to

review for potential downgrade from uncertain on April 28, 2004. There can be no assurance that our credit ratings will not be lowered or that

these ratings agencies will not issue adverse commentaries, potentially resulting in higher financing costs and reduced access to capital markets

or alternative financing arrangements. A reduction in our credit ratings may also affect our ability, and the cost, to securitize receivables, obtain

bid, performance related and other bonds, access the EDC Support Facility and/or enter into normal course derivative or hedging transactions.

Off-balance sheet arrangements

id, performance related and other bonds

We have entered into bid, performance related and other bonds in connection with various contracts. Bid bonds generally have a term of less

than twelve months, depending on the length of the bid period for the applicable contract. Performance related and other bonds generally have

a term of twelve months and are typically renewed, as required, over the term of the applicable contract. The various contracts to which these

bonds apply generally have terms ranging from two to five years. Any potential payments which might become due under these bonds would

be related to our non-performance under the applicable contract. Historically, we have not had to make material payments and we do not

anticipate that we will be required to make material payments under these types of bonds.

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

The criteria under which bid, performance related and other bonds can be obtained changed due to the industry environment primarily in 2002

and 2001. During that timeframe, in addition to the payment of higher fees, we experienced significant cash collateral requirements in

connection with obtaining new bid, performance related and other bonds. Given that the EDC Support Facility is used to support bid and

performance bonds with varying terms, including those with at least 365 day terms, we will likely need to increase our use of cash collateral to

support these obligations beginning on January 1, 2006 absent a further extension of the facility.

The EDC Support Facility provides support for certain obligations under bid and performance related bonds and has reduced the requirement to

provide cash collateral to support these obligations. As of December 31, 2003, the EDC Support Facility provided for up to $750 in support, of

which $300 was committed revolving support for performance bonds of which $151 was utilized. The remainder was uncommitted support,

subject to certain limitations, for performance bonds, receivables sales and/or securitizations of which $183 was utilized as of December 31,

2003. Any bid or performance related bonds with terms that extend beyond December 31, 2006 are currently not eligible for the support

provided by this facility. In addition to the support facility with EDC, our existing security agreements permit us to secure additional

obligations under bid and performance related bonds with the assets pledged under the security agreements and to provide cash collateral

Ratin

on lon

-term debt Ratin

issued or guaranteed by preferred shares

Nortel Networks issued by

Limited/Nortel Networks Nortel Networks

Rating agency Corporation Limited Last change

Standard & Poor’s Ratings Service B

–

CCC– April 28, 2004

Moody’s Investors Service, Inc. B3 Caa3 November 1, 2002

December 31,

2003 2002

Bid and performance related bonds (a) $427 $299

Other bonds (b) 53 136

Total bid, performance related and other bonds $480 $435

(a) Net of restricted cash and cash equivalents of $14 as of December 31, 2003 and $188 as of December 31, 2002.

(b) Net of restricted cash and cash equivalents of $31 as of December 31, 2003 and $26 as of December 31, 2002.

as security for these types of bonds. See “Available support facility” for additional information on the EDC Support Facility and the security

agreements and see “Developments in 2003 and 2004 — Nortel Networks Audit Committee Independent Review; restatements; related matters

— EDC Support Facility” for additional information in connection with amendments to the EDC Support Facility and developments in

connection with the EDC Support Facility and related security agreements subsequent to December 31, 2003.

eceivables securitization and certain lease financing transactions

In January 2003, the Financial Accounting Standards Board, or FASB, issued FASB Interpretation, or FIN, No. 46, “Consolidation of Variable

Interest Entities — an Interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, or FIN 46, and in

December 2003, the FASB issued a revision of FIN 46 — FIN 46 (Revised 2003), or FIN 46R. FIN 46R provides guidance with respect to the

consolidation of variable interest entities, or VIEs. VIEs are characterized as entities in which equity investors do not have a “controlling

financial interest” or there is not sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.

Reporting entities which have a variable interest in such an entity and are deemed to be the primary beneficiary must consolidate the variable

interest entity.

As of December 31, 2003, our participation in a lease financing transaction was structured through a single transaction variable interest entity

which did not have sufficient equity at risk as defined in FIN 46R and is no longer considered an off-balance sheet arrangement effective

July 1, 2003. We retained certain risks associated with guaranteeing recovery of the unamortized principal balance of the special purpose

entity’s debt which represented the majority of the risks associated with the variable interest entity’s activities. For additional information, see

“Consolidation of variable interest entities” in note 4(d) of the accompanying consolidated financial statements.

We have also conducted certain receivable sales transactions either directly with financial institutions or with multi-seller conduits. Under

some of these agreements, we have continued as servicing agent and/or have provided limited recourse. The fair value of these retained

interests is based on the market value of servicing the receivables, historical payment patterns, expected future cash flows and appropriate

discount rates as applicable. Where we have acted as the servicing agent, we generally have not recorded an asset or liability related to

servicing as the annual servicing fees were equivalent to those that would have been paid to a third party servicing agent. Also, we have not

historically experienced significant credit losses with respect to receivables sold with limited recourse. As of December 31, 2003, we were not

required to, and did not, consolidate or provide any of the additional disclosures set out in FIN 46R with respect to the variable interest entities

involving receivable sales because we were not considered the primary beneficiary.

Additionally, we have agreed to indemnify our counterparties in receivables securitization transactions. The indemnifications provided to

counterparties in these types of transactions may require us to compensate counterparties for costs incurred as a result of changes in laws and

regulations (including tax legislation) or in the interpretations of such laws and regulations, or as a result of regulatory penalties that may be

suffered by the counterparty as a consequence of the transaction. Certain receivables securitization transactions include indemnifications

requiring the repurchase of the receivables if the particular transaction becomes invalid. As of December 31, 2003, we had approximately $327

of securitized receivables which were subject to repurchase under this provision, in which case we would assume all rights to collect such

receivables. The indemnification provisions generally expire upon expiration of the securitization agreements, which extend through 2005, or

collection of the receivable amount by the counterparty. We are generally unable to estimate the maximum potential liability for all of these

types of indemnification guarantees as certain agreements do not specify a maximum amount and the amounts are dependent upon the outcome

of future contingent events, the nature and likelihood of which cannot be determined at this time. Historically, we have not made any

significant indemnification payments or receivable repurchases under these agreements and no significant liability has been accrued in the

accompanying consolidated financial statements with respect to the obligation associated with these guarantees.

Other indemnifications or guarantees

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

arrangements including:

• business sale and business combination agreements;

• intellectual property indemnification obligations;

In 2003, we did not make any significant payments under any of these indemnifications or guarantees. In certain cases, due to the nature of the

agreement, we have not been able to estimate our maximum potential loss or the maximum potential loss has not been specified. For additional

information, see “Guarantees” in note 13 of the accompanying consolidated financial statements.

Application of critical accounting estimates

Our accompanying consolidated financial statements are based on the selection and application of accounting policies, generally accepted in

the U.S., which require us to make significant estimates and assumptions. We believe that the following accounting estimates may involve a

higher degree of judgment and complexity in their application and represent our critical accounting estimates. The application of these

estimates requires us to make subjective and objective judgments.

In general, any changes in estimates or assumptions relating to revenue recognition, provisions for doubtful accounts, provisions for inventory

and other contingencies (excluding legal contingencies) are directly reflected in the results of our reportable operating segments. Changes in

estimates or assumptions pertaining to our tax asset valuations, our pension and post-retirement benefits and our legal contingencies are

generally not reflected in our reportable operating segments, but are reflected on a consolidated basis.

We have discussed the application of these critical accounting estimates with the Audit Committee of our Board of Directors.

evenue recognition

Our material revenue streams are the result of a wide range of activities, from custom design and installation over a period of time to a single

delivery of equipment to a customer. Our networking solutions also cover a broad range of technologies and are offered on a global basis. As a

result, our revenue recognition policies can differ depending on the level of customization within the solution and the contractual terms with

the customer. Newer technologies within one of our reporting segments may also have different revenue recognition policies, depending on,

among other factors, the specific performance and acceptance criteria within the applicable contract. Therefore, management must use

udgment in determining how to apply the current accounting standards and interpretations, not only based on the networking solution, but also

within networking solutions based on reviewing the level of customization and contractual terms with the customer. As a result, our revenues

may fluctuate from period to period based on the mix of solutions sold and the geographic region in which they are sold.

When a sale involves multiple deliverables where the deliverables are governed by more than one authoritative standard, we evaluate all

deliverables to determine whether they represent separate units of accounting based on the following criteria:

Our determination of whether deliverables within a multiple element arrangement can be treated separately for revenue recognition purposes

involves significant estimates and judgment, such as whether fair value can be established on undelivered obligations and/or whether delivered

elements have standalone value to the customer. Changes to our assessment of the accounting units in an arrangement and/or our ability to

establish fair values could significantly change the timing of revenue recognition.

If objective and reliable evidence of fair value exists for all units of accounting in the contract, revenue is allocated to each unit of accounting

or element based on relative fair values. In situations where there is objective and reliable evidence of fair value for all undelivered elements,

but not for delivered elements, the residual method is used to allocate the contract consideration. Under the residual method, the amount of

revenue allocated to delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements.

Each unit of accounting is then accounted for under the applicable revenue recognition guidance. If fair value does not exist for any

undelivered element,

• lease agreements;

• third party debt agreements;

• indemnification of banks and agents under our credit and support facilities and security agreements; and

• other indemnification agreements.

• whether the delivered item has value to the customer on a stand-alone basis;

• whether there is objective and reliable evidence of the fair value of the undelivered item(s); and

• if the contract includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is

considered probable and is substantially in our control.

revenue is not recognized until the earlier of (i) the undelivered element is delivered or (ii) fair value of the undelivered element exists, unless

the undelivered element is a service, in which case revenue is recognized as the service is performed once the service is the only undelivered

element.

Our assessment of which revenue recognition guidance is appropriate to account for a deliverable also can involve significant judgment. For

instance, the determination of whether software is more than incidental to hardware can impact whether the hardware is accounted for under

software revenue recognition or general revenue recognition guidance. This assessment could impact the amount and timing of revenue

recognition.

For accounting units related to customized network solutions and certain network build outs, revenues are recognized under SOP 81-1 using

the percentage-of-completion method. In using the percentage-of-completion method, revenues are generally recorded based on a measure of

the percentage of costs incurred to date on a contract relative to the estimated total expected contract costs. Significant judgment is often

required when estimating total contract costs and progress to completion on these arrangements, as well as whether a loss is expected to be

incurred on the contract. Management uses historical experience, project plans and an assessment of the risks and uncertainties inherent in the

arrangement to establish these estimates. Uncertainties include implementation delays or performance issues that may or may not be within our

control. Changes in these estimates could result in a material impact on revenues and net earnings (loss).

We make certain sales through multiple distribution channels, primarily resellers and distributors. These customers are generally given certain

rights of return. Accruals for estimated sales returns and other allowances and deferrals are recorded as a reduction of revenue at the time of

revenue recognition. These provisions are based on contract terms and prior claims experience and involve significant estimates. If these

estimates are significantly different from actual results, our revenue could be impacted.

We provide extended payment terms on certain software contracts and may sell these receivables to third parties. The fees on these contracts

are considered fixed or determinable if the contracts are similar to others for which we have a standard business practice of providing extended

payment terms and have a history of successfully collecting under the original payment terms without making concessions. If fees are not

considered fixed or determinable at the outset of the arrangement, revenue for delivered products is deferred until the fees become legally due

and payable and therefore estimates and judgment in this area can impact the timing of revenue recognition.

The collectibility of trade and notes receivables is also critical in determining whether revenue should be recognized, especially considering the

current economic environment within our industry. As part of the revenue recognition process, we determine whether trade or notes receivables

are reasonably assured of collection and whether there has been deterioration in the credit quality of our customers that could result in our

inability to collect the receivables. We will defer revenue but recognize related costs if we are uncertain as to whether we will be able to collect

the receivable. As a result, our estimates and judgment regarding customer credit quality could significantly impact the timing and amount of

revenue recognition.

For further information on our revenue recognition policies relating to our material revenue streams, you should also refer to note 2(d) of the

accompanying consolidated financial statements.

rovisions for doubtful accounts

In establishing the appropriate provisions for trade, notes and long-term receivables due from customers, we make assumptions with respect to

their future collectibility. Our assumptions are based on an individual assessment of a customer’s credit quality as well as subjective factors

and trends, including the aging of receivable balances. Generally, these individual credit assessments occur prior to the inception of the credit

exposure and at regular reviews during the life of the exposure and consider:

Once we consider all of these individual factors, we make a determination as to the probability of default. An appropriate provision is then

made, which takes into consideration the severity of the likely loss on the outstanding receivable balance based on our experience in collecting

these amounts. In addition to these individual assessments, in general, outstanding trade

• a customer’s ability to meet and sustain its financial commitments;

• a customer’s current and projected financial condition;

• the positive or negative effects of the current and projected industry outlook; and

• the economy in general.

accounts receivable amounts that are greater than 365 days are fully provisioned for and amounts greater than 180 days are 50% provisioned

for. In subsequent periods, we may be required to make adjustments once further information becomes available or actual events occur. As a

result, we may incur significant adjustments to our provisions for trade, notes and long-term receivables.

We recorded net receivable recoveries, related to continuing operations, of $180 in 2003. In 2002 and 2001, we recorded receivable provisions,

related to continuing operations, of $291 and $1,791, respectively. The net receivable recoveries of $180 in 2003 primarily related to trade and

customer financing receivable recoveries as a result of favorable settlements related to our sale or restructuring of various receivables as well as

net recoveries on other trade and customer financing receivables due to subsequent collections for amounts exceeding our original estimates of

net recovery. These recoveries were partially offset by receivable provisions recorded during 2003 that related to our normal business activity.

The receivable provisions recorded in 2002 and 2001 primarily related to the financial difficulties of several of our service provider and

enterprise customers as a result of the significant industry adjustment.

The following table summarizes our accounts receivable and long-term receivable balances and related reserves of our continuing operations as

of:

Throughout 2002 and 2001, we recorded significant provisions related to receivables from our continuing operations compared to 2003 when

we recorded significant net recoveries. Given the current market conditions and creditworthiness of some of our customers, it is difficult to

determine the extent to which this trend will continue in the future.

rovisions for inventory

Management must make estimates about the future customer demand for our products when establishing the appropriate provisions for

inventory. When making these estimates, we consider general economic conditions and growth prospects within our customers’ ultimate

marketplace, and the market acceptance of our current and pending products. These judgments must be made in the context of our customers’

shifting technology needs and changes in the geographic mix of our customers. With respect to our provisioning policy, in general, we fully

reserve for surplus inventory in excess of our 365 day demand forecast or that we deem to be obsolete. Generally, our inventory provisions

have an inverse relationship with the projected demand for our products. For example, our provisions usually increase as projected demand

decreases due to adverse changes in the conditions mentioned above. We have experienced significant changes in required provisions in recent

periods due to changes in strategic direction, such as discontinuances of product lines, as well as declining market conditions. A

misinterpretation or misunderstanding of any of these conditions could result in inventory losses in excess of the provisions determined to be

appropriate as of the balance sheet date.

We recorded inventory provisions, related to continuing operations, of $1,226 as of December 31, 2003, $1,180 as of December 31, 2002 and

$918 as of December 31, 2001. The increase in inventory provisions was primarily due to our inventory levels being aligned to decreased

customer demand in 2003 compared to 2002 and 2001. The following table summarizes our inventory balances and other related reserves of

our continuing operations as of:

December 31,

2003 2002

Gross accounts receivable $ 2,699 $ 2,730

Provision for doubtful accounts (194) (502)

Accounts receivable — net $ 2,505 $ 2,228

Accounts receivable provision as a percentage of gross accounts receivables 7% 18%

Gross lon

-term receivables $ 386 $ 1,054

Provision for doubtful accounts (297) (780)

Net lon

-term receivables $89 $274

Long-term receivable provision as a percentage of gross long-term receivables 77% 74%

As of December 31, 2003, our inventory provisions as a percentage of gross inventory was 51%. In the future, we may be required to make

significant adjustments to these provisions for the sale and/or disposition of inventory that was previously provided for.

Customers continued to be cautious with their capital expenditures in 2004. As a result, we will continue to closely monitor our inventory

provisions to ensure that they appropriately reflect the current market conditions. However, the inventory provisions we have recorded in the

past may not be reflective of those in future quarters.

ncome taxes

Our net deferred tax asset balance was $3,575 at December 31, 2003 and $3,035 at December 31, 2002. The $540 increase was primarily due

to the impact of foreign exchange effects related primarily to the Canadian dollar and the British pound. We currently have deferred tax assets

resulting from net operating loss carryforwards, tax credit carryforwards and deductible temporary differences, all of which are available to

reduce future taxes payable in our significant tax jurisdictions. Generally, our loss carryforward periods range from seven years to an indefinite

period. As a result, we do not expect that a significant portion of these carryforwards will expire in the near future.

We assess the realization of these deferred tax assets quarterly to determine whether an income tax valuation allowance is required. Based on

available evidence, both positive and negative, we determine whether it is more likely than not that all or a portion of the remaining net

deferred tax assets will be realized. The main factors that we consider include:

In evaluating the positive and negative evidence, the weight given to each type of evidence must be proportionate to the extent to which it can

be objectively verified. If it is our belief that it is more likely than not that some portion of these assets will not be realized, an income tax

valuation allowance is recorded.

In 2003, our gross income tax valuation allowances increased to $3,344 as of December 31, 2003 from $3,024 as of December 31, 2002. The

increase was primarily due to the impact of foreign exchange effects and additional valuation allowances recorded against the deferred tax

assets recognized in connection with our minimum pension liability, partially offset by drawdowns related to our 2003 net earnings. We

assessed positive evidence including forecasts of future taxable income to support realization of the net deferred tax assets, and negative

evidence including our cumulative loss position, and concluded that the valuation allowances as of December 31, 2003 were appropriate.

If market conditions deteriorate further or future results of operations are less than expected, future assessments may result in a determination

that some or all of the net deferred tax assets are not realizable. As a result, we may need to establish an

December 31,

2003 2002

Gross inventory $ 2,416 $ 2,686

Inventory provisions (1,226) (1,180)

Inventories — net $ 1,190 $ 1,506

Inventory provisions as a percentage of gross inventory 51% 44%

Other reserves for claims related to our contract manufacturers and suppliers (a) (120) (171)

(a) This amount was included in other accrued liabilities and related to cancellation charges, contracted for inventory in excess of future demand and the settlement of certain

other claims.

Tax asset valuation

• cumulative losses in recent years;

• history of loss carryforwards and other tax assets expiring;

• the carryforward period associated with the deferred tax assets;

• the nature of the income that can be used to realize the deferred tax assets;

• our net earnings/loss; and

• future earnings potential determined through the use of internal forecasts.

additional tax valuation allowance for all or a portion of the net deferred tax assets, which may have a material adverse effect on our business,

results of operations and financial condition. Alternatively, if our future results of operations are better than expected, these assessments may

result in the reduction of our valuation allowances. Given the magnitude of our valuation allowance, future adjustments to this allowance based

on actual results could result in a significant adjustment to our net earnings.

We are subject to ongoing examinations by certain taxation authorities of the jurisdictions in which we operate. We regularly assess the status

of these examinations and the potential for adverse outcomes to determine the adequacy of the provision for income and other taxes. We

believe that we have adequately provided for tax adjustments that we believe are probable as a result of any ongoing examination.

We had previously entered into Advance Pricing Arrangements, or APAs, with the taxation authorities of the U.S. and Canada in connection

with our intercompany transfer pricing and cost sharing arrangements between Canada and the U.S. These arrangements expired in 1999 and

2000. In 2002, we filed APA requests with the taxation authorities of the U.S. Canada and the United Kingdom, or the U.K., that are expected

to apply to the taxation years beginning in 2000. The APA requests are currently under consideration. We have applied the transfer pricing

methodology proposed in the APA requests since 2001. As part of the APA applications, we have requested that the methodology adopted in

2001 be applied retroactively to the 2000 taxation year. If the retroactive application is accepted by the taxation authorities, it would result in

an increase in taxable income in certain jurisdictions offset by an equal decrease in taxable income in the other jurisdictions. We have provided

for any taxes and interest that would be due as a result of retroactive application of the APAs.

Although the outcome of the APA applications are uncertain, we do not believe the ultimate resolution of these negotiations will have a

material adverse effect on our consolidated financial position, results of operations or cash flows. However, if this matter is resolved

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

Goodwill valuation

Commencing January 1, 2002, we test goodwill for possible impairment on an annual basis on October 1 of each year and at any other time if

an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

Circumstances that could trigger an impairment test include, but are not limited to:

The determination as to whether a write down of goodwill is necessary involves significant judgment based on the short-term and long-term

projections of the future performance of the reporting unit to which the goodwill is attributed. The assumptions supporting the estimated future

cash flows of the reporting unit, including the discount rate used and estimated terminal value, reflect our best estimates.

We have not yet finalized our assessment for potential triggering events for fiscal year 2004 and further have not yet completed our annual

impairment test for 2004, which is to be performed effective October 1, 2004. The results of these assessments may or may not result in a

triggering event. We do not believe that our goodwill impairment test would result in an impairment charge.

In 2003, we concluded that an impairment of our goodwill did not exist and no write down was recorded.

In 2002, we incurred a goodwill write down of $595. As a result of the continued decline in both our overall market value generally and within

Optical Networks specifically, we evaluated the goodwill associated with the businesses within Optical Networks for potential impairment. The

conclusion of those evaluations was that the fair value associated with the businesses within Optical Networks could no longer support the

carrying value of the remaining goodwill associated with them. Fair value was estimated using the then expected present value of discounted

future cash flows of these businesses. The discount rate used ranged from 12% to 16% and the terminal values were estimated based on

terminal growth rates ranging from 3% to 5%.

Tax contin

encies

• a significant adverse change in the business climate or legal factors;

• an adverse action or assessment by a regulator;

• unanticipated competition;

• loss of key personnel;

• the likelihood that a reporting unit or a significant portion of a reporting unit will be sold or disposed of;

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

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

In 2001, we incurred a goodwill write down of $11,426. In 2001, we performed an assessment of the carrying values of goodwill associated

with our acquisitions. The assessment during that period was performed in light of the significant negative industry and economic trends

impacting our operations and expected future growth rates, and the adjustment of technology valuations. The conclusion of our assessment was

that the decline in market conditions within the industry was significant and other than temporary. The write downs were primarily related to

the goodwill within Enterprise Networks, Optical Networks and Other. Fair value was determined based on discounted future cash flows for

the businesses within these reportable segments that had separately distinguishable goodwill balances and whose operations had not yet been

fully integrated. The cash flow periods used were five years, the discount rate used was 20%, and the terminal values were estimated based

upon terminal growth rates ranging from 5% to 11%. The discount rate was based on our weighted average cost of capital, adjusted for the

risks associated with the operations.

The carrying value of goodwill was $2,305 as of December 31, 2003 and $2,199 as of December 31, 2002. The increase in goodwill primarily

related to our acquisition of the minority interests in our French and German operations as discussed in “Developments in 2003 and 2004”. For

additional information on this transaction, including the allocation of the purchase price, see “Nortel Networks Germany and Nortel Networks

France” in note 10 of the accompanying consolidated financial statements.

ension and post-retirement benefits

We maintain various pension and post-retirement benefit plans for our employees globally. These plans include significant pension and post-

retirement benefit obligations which are calculated based on actuarial valuations. Key assumptions are made in determining these obligations

and related expenses, including expected rates of return on plan assets and discount rates.

For 2003, the expected long-term rate of return on plan assets used to estimate pension expenses was 7.8% on a weighted average basis, which

was the rate determined at September 30, 2002. The expected long-term rate of return on plan assets remained unchanged from 2002. The

discount rates used to estimate the net pension obligations and expenses for 2003 were 5.8% and 6.3%, respectively, on a weighted average

basis, compared to 6.3% and 6.7%, respectively, in 2002.

The key assumptions used to estimate the post-retirement costs for 2003 were an expected long-term rate of return on plan assets of 8.0% and a

discount rate of 6.0% and 6.8% for the obligations and costs, respectively, both on a weighted average basis. The expected long-term rate of

return on plan assets remained unchanged from 2002. The discount rates for the obligations and costs decreased in 2003 to 6.0% and 6.8%,

respectively, from 6.8% and 7.0%, respectively, in 2002 due to the decline experienced in global interest rates during 2001 through 2002.

The difference between the expected long-term rate of return on plan assets and the discount rate reported for the net pension obligations and

expenses and those rates reported for the net post-retirement benefit obligations and costs is due to the weighted-average calculation as a result

of the number of countries in which we offer either pension or pension and post-retirement benefits. In developing these assumptions, we

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

Changes in net periodic pension and post retirement benefit expense may occur in the future due to changes in our expected rate of return on

plan assets and discount rate resulting from economic events. The following table highlights the sensitivity of our pension and post retirement

benefit expense to changes in these assumptions, assuming all other assumptions remain constant:

Plan assets were primarily comprised of debt and equity securities. Included in the equity securities of the defined benefit plan were common

shares of Nortel Networks Corporation with an aggregate market value of $13 (0.2 % of total plan assets) as of December 31, 2003 and $3

(0.1% of total plan assets) as of December 31, 2002.

Unrecognized actuarial gains and losses are being recognized over approximately a 12 year period, which represents the weighted-average

expected remaining service life of the employee group. Unrecognized actuarial gains and losses arise from several factors including experience

and assumption changes in the obligations and from the difference between expected returns and actual returns on assets. At the end of 2003,

we had unrecognized net actuarial losses related to the defined benefit plans of $1,664 which could result in an increase to pension expenses in

future years depending on several factors, including whether such losses exceed the corridor in accordance with SFAS No. 87, “Employers’

Accounting for Pensions”. The post-retirement benefit plans had unrecognized actuarial losses of $119 at the end of 2003.

The estimated accumulated benefit obligations for the defined benefit plans exceeded the fair value of the plan assets at September 30, 2003 as

a result of reductions in discount rates and changes in foreign exchange rates which more than offset the favorable impacts of strong pension

asset returns and the voluntary contributions made by us during 2003. Accordingly, we recorded a non-cash charge of $219 ($187 after tax) to

shareholders’ equity for the minimum pension liability. A similar charge may be required in the future as the impact of changes in global

capital markets and interest rates on the value of our pension plan assets and obligations is measured.

During 2003, we made cash contributions to our defined benefit pension plans of approximately $300. In 2004, we expect to make cash

contributions of approximately $140 to our defined benefit pension plans, which excludes $78 of deferred contributions for 2004 that were

made in 2003, and approximately $30 to our post-retirement benefit plans.

For 2004, our expected rate of return on plan assets was lowered from 7.8% to 7.4% for defined benefit pension plans and was lowered from

8.0% to 6.0% for 2004 for post-retirement benefit plans. Also for 2004, we lowered our discount rate on a weighted-average basis for pension

expenses from 6.3% to 5.8% for the defined benefit pension plans and from 6.8% to 6.0% for post-retirement benefit plans given the declining

trend in current global interest rates. We will continue to evaluate our expected long-term rates of return on plan assets and discount rates at

least annually and make adjustments as necessary, which could change the pension and post-retirement obligations and expenses in the future.

If the actual operation of the plans differs from the assumptions, additional contributions by us may be required. If we are required to make

significant contributions to fund the defined benefit plans, reported results could be materially and adversely affected and our cash flow

available for other uses may be significantly reduced.

For additional information, see “Employee benefit plans” in note 9 of the accompanying consolidated financial statements.

Special charges

In 2001 we entered into an unprecedented period of business realignment in response to a significant adjustment in the industry. We

implemented a company-wide restructuring plan to streamline our operations and activities around core markets and operations, which

included significant workforce reductions, global real estate closures and dispositions, substantial write-downs of our plant and equipment,

goodwill and other intangible assets and extensive contract settlements with customers and suppliers around the world. As a result of these

actions, our workforce declined significantly from January 1, 2001 to December 31, 2003 and over the same time period, we significantly

reduced our facilities.

At each reporting date, we evaluate our accruals related to workforce reduction charges, contract settlement and lease costs

Effect on 2003 pre-tax

Effect on 2003 pre-tax post-retirement

Change in Assumption pension expense * benefit expense

Increase/(decrease) Increase/(decrease)

1 percentage point increase in the expected return on assets ($50) $ <1

1 percentage point decrease in the expected return on assets 50 <1

1 percentage point increase in the discount rate (73) (3)

1 percentage point decrease in the discount rate 67 2

* excludes settlement costs (lump sum and termination payments to participants which discharges our obligations)

and plant and equipment write downs to ensure that these accruals are still appropriate. As of December 31, 2003, we had $64 in accruals

related to workforce reduction charges and $456 in accruals related to contract settlement and lease costs, which included significant estimates,

primarily related to sublease income over the lease terms and other costs for vacated properties. In certain instances, we may determine that

these accruals are no longer required because of efficiencies in carrying out our restructuring work plan. In these cases, we reverse any related

accrual to income when it is determined it is no longer required. Alternatively, in certain circumstances, we may determine that certain accruals

are insufficient as new events occur or as additional information is obtained. In these cases, we would increase the applicable existing accrual

with the offset recorded against income.

Other contingencies

We are subject to the possibility of various loss contingencies arising in the ordinary course of business. As a result, we consider the likelihood

of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining

loss contingencies. We recognize a reserve for an estimated loss contingency when it is probable that an asset has been impaired or a liability

has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine

whether such accruals should be adjusted.

We are also subject to proceedings, lawsuits, investigations and other claims (some of which may involve substantial dollar amounts),

including proceedings under laws and government regulations related to securities, income and other taxes, environmental, labor, product and

other matters. In particular, our two restatements of our consolidated financial statements and related events have caused us to be subject to

ongoing regulatory and criminal investigations and significant pending civil litigation actions in the U.S. and Canada. We are required to assess

the likelihood of any adverse judgments or outcomes in any of these matters, as well as potential ranges of probable losses. A determination of

the amount of reserves required, if any, for these contingencies is based on an analysis of each individual issue. The required reserves may

change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with

these matters. We cannot determine whether these matters will, individually or collectively, have a material adverse effect on our business,

results of operations and financial condition. See “Risk factors/forward looking statements”.

For more information related to our outstanding legal and other proceedings, see “Contingencies” in note 22 of the accompanying consolidated

financial statements.

Accounting changes and recent accounting pronouncements

ccounting changes

Our consolidated financial statements are based on the selection and application of accounting policies, generally accepted in the U.S. For more

information related to the accounting policies that we adopted as a result of new accounting standards, see “Accounting changes” in note 4 of

the accompanying consolidated financial statements. The following summarizes the accounting changes that we have adopted:

• Guarantees — the adoption of FASB Interpretation FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for

Guarantees, Including Indirect Guarantees of Indebtedness of Others — an Interpretation of FASB Statement Nos. 5, 57 and 107

and Rescission of FIN No. 34” did not have a material impact on our results of operations and financial condition.

• Asset retirement obligations — the adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations”, or SFAS No. 143,

resulted in a decrease to net earnings of $12 (net of tax of nil) which has been reported as a cumulative effect of accounting changes

— net of tax, an increase in plant and equipment — net of $4 and an asset retirement obligation liability of $16 as of January 1,

2003. The adoption of SFAS No. 143 did not have a material impact on depreciation and accretion expense.

• Accounting for costs associated with exit or disposal activities — the adoption of SFAS No. 146, “Accounting for Costs Associated

with Exit or Disposal Activities” did not have a material impact on our results of operations and financial condition.

• Consolidation of variable interest entities — the adoption of FIN 46 resulted in the inclusion of $184 in long-term debt and $183 of

plant and equipment — net. These amounts represented both the collateral and maximum exposure to loss as a result of our

involvement with VIEs.

ecent accounting pronouncements

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or the MPDIM Act, was signed into law

in the U.S. The MPDIM Act introduced a prescription drug benefit under Medicare (specifically, Medicare Part D) as well as a federal subsidy

to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. As permitted by

FASB Staff Position, or FSP, Financial Accounting Standard, or FAS 106-1, “Accounting and Disclosure Requirements Related to the

Medicare Prescription Drug, Improvement and Modernization Act of 2003”, we chose to make the one-time deferral election which remained

in effect for our plans in the U.S. until the earlier of the issuance of specific authoritative guidance by the FASB on how to account for the

federal subsidy to be provided to plan sponsors under the MPDIM Act, or the remeasurement of plan assets and obligations subsequent to

January 31, 2004. Therefore, our post-retirement benefit obligation as of December 31, 2003 and net post-retirement benefit cost for the year

ended December 31, 2003 did not reflect the effects of the MPDIM Act on the plans. On May 19, 2004, FSP FAS 106-2, “Accounting and

Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, or FSP FAS 106-2, was

issued by the FASB to provide guidance relating to the prescription drug subsidy provided by the MPDIM Act. We expect to have portions of

• Accounting for certain financial instruments with characteristics of both liabilities and equity — the adoption of SFAS No. 150,

“Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” did not have a material impact

on our results of operations and financial condition.

• Accounting for revenue arrangements with multiple deliverables — the adoption of Emerging Issues Task Force 00-21, “Revenue

Arrangements with Multiple Deliverables” did not have a material impact on our results of operations and financial condition.

• Amendment of SFAS No. 133 on derivative instruments and hedging activities — the adoption of SFAS No. 149, “Amendment of

SFAS No. 133 on Derivative Instruments and Hedging Activities” did not have a material impact on our results of operations and

financial condition.

• Determining whether an arrangement contains a lease — the impact of the adoption of the Emerging Issues Task Force 01-8,

“Determining Whether an Arrangement Contains a Lease” on our future results of operations and financial condition will depend

on the terms contained in contracts signed or contracts amended in the future.

• Pensions and other post-retirement benefits — the adoption of SFAS No. 132 (Revised 2003), “Employers’ Disclosures about

Pensions and Other Post-retirement Benefits” requires additional disclosures regarding defined benefit pension plan and other post-

retirement benefit plan assets, obligations, cash flows and net cost as well as retaining a number of disclosures required by SFAS

No. 132, “Employers’ Disclosures about Pensions and Other Post-retirement Benefits”. The applicable current year requirements

have been applied in the presentation of the consolidated financial statements.

• Stock-based compensation — we adopted SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and

Disclosure — an Amendment of FASB Statement No. 123” which amended the transitional provisions of SFAS No. 123,

“Accounting for Stock-based Compensation” for companies electing to recognize employee stock-based compensation using the

fair value based method. Effective January 1, 2003 we elected to expense employee stock-based compensation using the fair value

based method prospectively for all awards granted, modified, or settled on or after January 1, 2003. The impact of the adoption of

the fair value based method for expense recognition of employee awards resulted in $26 (net of tax of nil) of stock option expense

during 2003.

• Accounting for goodwill and other intangible assets — the adoption of SFAS No. 142, effective January 1, 2002, which changed

the accounting for goodwill from an amortization method to an impairment approach, had a material impact on our results of

operations and financial condition through the elimination of amortization expense.

• Impairment or disposal of long-lived assets (plant and equipment and acquired technology) — the adoption of SFAS No. 144,

“Accounting for the Impairment or Disposal of Long-Lived Assets” resulted in write downs for plant and equipment of $382 related

to long-lived assets held and used, and $38 related to long-lived assets held for sale for the year ended December 31, 2002. See

“Special charges” in note 7 of the accompanying consolidated financial statements for further information regarding these write

downs.

• Derivative financial instruments — the adoption of SFAS No. 133 and the corresponding amendments under SFAS No. 138,

“Accounting for Certain Derivative Instruments and Certain Hedging Activities — an Amendment of SFAS No. 133” resulted in a

cumulative decrease in net loss of $15 (net of tax of $9), which has been reported as cumulative effect of accounting changes-net of

tax and a charge to other comprehensive income of $7 (net of tax of $4) in 2001.

our post-retirement benefit plans qualify as actuarially equivalent to the benefit provided under the MPDIM Act, for which it expects to receive

federal subsidies. We expect that other portions of the plans will not be actuarially equivalent. The financial impact of the federal subsidies was

determined by remeasuring our retiree life and medical obligation as of January 1, 2004, as provided under the retroactive application provision

of FSP FAS 106-2. The effective date of FSP FAS 106-2 is the first annual or interim period beginning after June 15, 2004, with earlier

adoption encouraged. We adopted FSP FAS 106-2 for the three-month period ended June 30, 2004. As a result of adoption, the accrued post-

retirement benefit obligation decreased by $31. Net periodic post-retirement benefit costs are expected to decrease by $2 for 2004, as a result of

the subsidy.

In March 2004, the Emerging Issues Task Force, or EITF reached consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary

Impairment and Its Application to Certain Investments”, or EITF 03-1. EITF 03-1 provides guidance on determining when an investment is

considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. EITF 03-1 is applicable to

marketable debt and equity securities within the scope of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”,

or SFAS 115, and SFAS No. 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations”, and equity securities that are

not subject to the scope of SFAS 115 and not accounted for under the equity method of accounting. In September 2004, the FASB issued FSP

EITF 03-1-1, “Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, ‘The Meaning of Other-Than-Temporary Impairment and Its

Application to Certain Investments’”, which delays the effective date for the measurement and recognition criteria contained in EITF 03-1 until

final application guidance is issued. The delay does not suspend the requirement to recognize other-than-temporary impairments as required by

existing authoritative literature. The adoption of EITF 03-1 is not expected to have a material impact on our results of operations and financial

position.

On September 30, 2004, the EITF reached a consensus on Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings

Per Share”, or EITF 04-8, which addresses when the dilutive effect of contingently convertible debt instruments should be included in diluted

earnings (loss) per share. EITF 04-8 requires that contingently convertible debt instruments be included in the computation of diluted earnings

(loss) per share regardless of whether the market price trigger has been met. EITF 04-8 also requires that prior period diluted earnings

(loss) per share amounts presented for comparative purposes be restated. EITF 04-8 is effective for reporting periods ending after

December 15, 2004. The adoption of EITF 04-8 is not expected to have an impact on our diluted earnings (loss) per share.

Market risk

Market risk represents the risk of loss that may impact our consolidated financial statements through adverse changes in financial market prices

and rates. Our market risk exposure results primarily from fluctuations in interest rates and foreign exchange rates. To manage the risk from

these fluctuations, we enter into various derivative-hedging transactions that we have authorized under our policies and procedures. We

maintain risk management control systems to monitor market risks and counterparty risks. These systems rely on analytical techniques

including both sensitivity analysis and value-at-risk estimations. We do not hold or issue financial instruments for trading purposes.

For a discussion of our accounting policies for derivative financial instruments, see “Significant accounting policies” in note 2(t) and

“Accounting changes” in note 4(e), (g), and (m) of the accompanying consolidated financial statements. Additional disclosure of our financial

instruments is included in “Financial instruments and hedging activities” in note 12 of the accompanying consolidated financial statements.

We manage foreign exchange exposures using forward and option contracts to hedge sale and purchase commitments. Our most significant

foreign exchange exposures are in the Canadian dollar, the British pound and the euro. We enter into U.S. to Canadian dollar forward and

option contracts intended to hedge the U.S. to Canadian dollar exposure on future revenues and expenditure streams. In accordance with SFAS

No. 133, we recognize the gains and losses on the effective portion of these contracts in income when the hedged transaction occurs. Any

ineffective portion of these contracts is recognized in income immediately.

We expect to continue to expand our business globally and, as such, expect that an increasing proportion of our business may be denominated

in currencies other than U.S. dollars. As a result, fluctuations in foreign currencies may have a material impact on our business, results of

operations and financial condition. We try to minimize the impact of such currency fluctuations through our ongoing commercial practices and

by attempting to hedge our major currency exposures. In attempting to manage this foreign exchange risk, we identify operations and

transactions that may have exposure based upon the excess or deficiency of foreign currency receipts over foreign currency expenditures. Our

significant currency flows for the year ended December 31, 2003 were in U.S. dollars, Canadian dollars, British pounds and euros. The net

impact of foreign exchange fluctuations resulted in a gain of $105 in 2003, a loss of $65 in 2002 and a loss of $152 in 2001. Given our

exposure to international markets, we regularly monitor all of our material foreign currency exposures. We cannot predict whether we will

incur foreign exchange gains or losses in the future. However, if significant foreign exchange losses are experienced, they could have a

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

We use sensitivity analysis to measure our foreign currency risk by computing the potential decrease in cash flows that may result from

adverse changes in foreign exchange rates. The balances are segregated by source currency, and a hypothetical unfavorable variance in foreign

exchange rates of 10% is applied to each net source currency position using year-end rates, to determine the potential decrease in cash flows

over the next year. The sensitivity analysis includes all foreign currency-denominated cash, short-term and long-term debt, and derivative

instruments that will impact cash flows over the next year that are held at December 31, 2003 and 2002, respectively. The underlying cash

flows that relate to the hedged firm commitments are not included in the analysis. The analysis is performed at the reporting date and assumes

no future changes in the balances or timing of cash flows from the year-end position. Further, the model assumes no correlation in the

movement of foreign exchange rates. Based on a one-year time horizon, a 10% adverse change in exchange rates would result in a potential

decrease in after-tax cash flows of $195 as of December 31, 2003 and $132 as of December 31, 2002. This potential decrease would result

primarily from our exposure to the Canadian dollar, the British pound and the euro.

A portion of our long-term debt is subject to changes in fair value resulting from changes in market interest rates. We have hedged a portion of

this exposure to interest rate volatility using fixed for floating interest rate swaps. The change in fair value of the swaps are recognized in

earnings with offsetting amounts related to the change in the fair value of the hedged debt attributable to interest rate changes. Any ineffective

portion of the swaps is recognized in income immediately. We record net settlements on these swap instruments as adjustments to interest

expense.

Historically, we have managed interest rate exposures, as they relate to interest expense, using a diversified portfolio of fixed and floating rate

instruments denominated in several major currencies. We use sensitivity analysis to measure our interest rate risk. The sensitivity analysis

includes cash, our outstanding floating rate long-term debt and any outstanding instruments that convert fixed rate long-term debt to floating

rate. A 100 basis point adverse change in interest rates would result in a potential decrease in cash flows of $51 as of December 31, 2003 and

$39 as of December 31, 2002.

Equity price risk

The values of our equity investments in several publicly traded companies are subject to market price volatility. These investments are

generally in companies in the technology industry sector and are classified as available for sale. We typically do not attempt to reduce or

eliminate the market exposure on these investment securities. We also hold certain derivative instruments or warrants that are subject to market

price volatility because their value is based on the common share price of a publicly traded company. These derivative instruments are

generally acquired through business acquisitions or divestitures. In addition, derivative instruments may also be purchased to hedge exposure

to certain compensation obligations that vary based on future Nortel Networks Corporation common share prices. We do not hold equity

securities or derivative instruments for trading purposes. As of December 31, 2003, a hypothetical 20% adverse change in the stock prices of

our publicly traded equity securities and the related underlying stock prices of publicly traded equity securities for certain of our derivative

instruments would result in a loss in their aggregate fair values of $52 and $12, respectively, which would be offset by a corresponding

reduction in future compensation expense. As of December 31, 2002, a hypothetical 20% adverse change in the stock prices of our publicly

traded equity securities and the related underlying stock prices of publicly traded equity securities for certain of our derivative instruments

would result in a loss in their aggregate fair values of $27.

Environmental matters

We are subject to numerous environmental protection laws and regulations in various jurisdictions around the world, primarily due to our

manufacturing operations. As a result, we are exposed to liabilities and compliance costs arising from our past and current generation,

management and disposition of hazardous substances and wastes.

We have remedial activities under way at twelve of our facilities which are either currently occupied or were previously owned or occupied.

We have also been listed as a potentially responsible party at six Superfund sites in the U.S. An estimate of our anticipated remediation costs

associated with all such facilities and sites, to the extent probable and reasonably estimable, is included in our environmental accruals in an

approximate amount of $33.

For a discussion of Environmental matters, see “Contingencies” in note 22 of the accompanying consolidated financial statements.

Legal proceedings

Nortel Networks and/or certain of our directors and officers have been named as defendants in various class action lawsuits. We are unable to

determine the ultimate aggregate amount of monetary liability or financial impact to us in these legal matters, which unless otherwise specified,

seek damages from the defendants of material or indeterminate amounts. We are also a defendant in various other suits, claims, proceedings

and investigations which are in the normal course of business. We cannot determine whether these matters will, individually or collectively,

have a material adverse effect on our business, results of operations, financial condition and liquidity. We, and any of our named directors or

officers, intend to vigorously defend these actions, suits, claims, proceedings and investigations. We are also subject to significant pending

civil litigation and ongoing regulatory and criminal investigations in the U.S. and Canada which could require us to pay substantial judgments,

settlements, fines or other penalties. For additional information related to our legal proceedings, see “Contingencies” in note 22 of the

accompanying consolidated financial statements and “Risk factors/forward looking statements”.

Risk factors/forward looking statements

You should carefully consider the risks described below before investing in our securities. The risks described below are not the only ones

acing us. Additional risks not currently known to us or that we currently believe are immaterial may also impair our business, results of

operations, financial condition and liquidity. Unless required by applicable securities laws, we do not have any intention or obligation to

ublicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise.

Certain statements in this Annual Report on Form 10-K contain words such as “could”, “expects”, “may”, “anticipates”, “believes”,

“intends”, “estimates”, “plans”, “envisions”, “seeks” and other similar language and are considered forward looking statements. These

statements are based on our current expectations, estimates, forecasts and projections about the operating environment, economies and

markets in which we operate. In addition, other written or oral statements which are considered forward looking may be made by us or others

on our behalf. These statements are subject to important risks, uncertainties and assumptions, which are difficult to predict and the actual

outcome may be materially different. In particular, the risks described below could cause actual events to differ materially from those

contemplated in forward looking statements.

isks relating to our restatements and related matters

Our two restatements of our consolidated financial statements and related events have had, and will continue to have, a material

adverse effect on us.

In May 2003, we commenced certain balance sheet reviews at the direction of certain members of former management that led to the

Comprehensive Review, which resulted in the First Restatement. In late October 2003, the Audit Committee initiated the Independent Review

and engaged WCPHD to advise it in connection with the Independent Review. The Audit Committee sought to gain a full understanding of the

events that caused significant excess liabilities to be maintained on the balance sheet that needed to be restated, and to recommend that our

Board of Directors adopt, and direct management to implement, necessary remedial measures to address personnel, controls, compliance and

discipline. As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns

identified by WCPHD regarding provisioning activity and to review certain provision releases. That examination, and other errors identified by

management, led to the Second Restatement and our revision of previously announced unaudited results for the year ended December 31, 2003.

The need for the Second Restatement resulted in delays in filing the Reports.

Over the course of the Second Restatement process, management identified certain accounting practices that it determined should be adjusted

as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and undertook a process of

revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit Committee has determined to review the facts

and circumstances leading to the restatement of these revenues for specific transactions identified in the Second Restatement. The review will

have a particular emphasis on the underlying conduct that led to the initial recognition of these revenues. The Audit Committee will seek a full

understanding of the historic events that required the revenues for these specific transactions to be restated and will consider any appropriate

additional remedial measures, including those involving internal controls and processes. The Audit Committee has engaged WCPHD to advise

it in connection with this review.

For more information on the Comprehensive Review, Independent Review, First Restatement, Second Restatement and Revenue Independent

Review, see the “MD&A” and “Controls and Procedures” sections of this report.

As a result of these events, we have become subject to the following key risks, each of which is described in more detail below. Each of these

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

• We are subject to ongoing regulatory and criminal investigations in the U.S. and Canada, which could require us to pay substantial

fines or other penalties.

• We are subject to significant pending civil litigation, which if decided against us, could require us to pay

We are subject to ongoing regulatory and criminal investigations in the U.S. and Canada, which could require us to pay substantial

fines or other penalties.

We are under investigation by the SEC and the OSC. On April 5, 2004, we announced that the SEC had issued a formal order of investigation

in connection with our previous restatement of financial results for certain periods and our announcements in March 2004 regarding the likely

need to revise certain previously announced results and restate previously filed financial results for one or more earlier periods.

On April 13, 2004, we announced that we had received a letter from the staff of the OSC advising us of an OSC Enforcement Staff

investigation into the same matters that are the subject of the SEC investigation.

We have also received a U.S. federal grand jury subpoena for the production of certain documents sought in connection with an ongoing

criminal investigation being conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division. Further, the

Integrated Market Enforcement Team of the RCMP has advised us that it would be commencing a criminal investigation into our financial

accounting situation.

Our senior management and Board of Directors have been required to devote significant time to these investigations and related matters. We

cannot predict when these investigations will be completed, nor can we predict what the results of these investigations may be. Expenses

incurred in connection with these investigations (which include substantial fees of lawyers and other professional advisors and potential

obligations to indemnify officers and directors who may be parties to such actions) could adversely affect our cash position. We may be

required to pay material fines, consent to injunctions on future conduct or suffer other penalties, each of which could have a material adverse

effect on our business, results of operations, financial condition and liquidity. The investigations may adversely affect our ability to obtain,

and/or increase the cost of obtaining, directors’ and officers’ liability insurance and/or other types of insurance, which could have a material

adverse affect on our business, results of operations and financial condition. In addition, the findings and outcomes of the Independent Review

and the regulatory and criminal investigations may affect the course of the civil litigation pending against us, which are more fully described

below.

The effects and results of these or other investigations may have a material adverse effect on our business, results of

substantial judgments, settlements or other penalties.

• Material adverse legal judgments, fines, penalties or settlements could have a material adverse effect on our business, results of

operations, financial condition and liquidity, which could be very significant.

• We cannot predict the outcome of the Revenue Independent Review being undertaken by our Audit Committee.

• We and our independent auditors have identified a number of material weaknesses related to our internal control over financial

reporting, which could continue to impact our ability to report our results of operations and financial condition accurately and in a

timely manner.

• The governing principles of the Independent Review particularly as they relate to remedial measures may take time to implement.

• The delayed filing of our Reports and related matters caused us to breach our public debt indentures and seek waivers from EDC

under the EDC Support Facility, which may affect our liquidity. The continuing delays in filing certain of our Reports and related

matters has resulted in a continuing breach of our public debt indentures and our obligations under the EDC Support Facility. It is

possible that the holders of our public debt will seek to accelerate the maturity of that debt and EDC will not grant us additional

waivers.

• Our credit ratings have been downgraded, we are currently unable to access our shelf registration statement filed with the SEC and

we terminated the Five Year Facilities, each of which may affect our liquidity.

• The delay in filing certain of our Reports could cause the TSX and/or the NYSE to commence suspension or delisting procedures in

respect of Nortel Networks Corporation’s common shares or other of our or NNL’s listed securities.

• Continuing negative publicity may adversely affect our business and the market price of our publicly traded securities.

• We may not be able to attract or retain the personnel necessary to achieve our business objectives.

• Ongoing SEC review may require us to amend our public disclosures further.

operations, financial condition and liquidity.

We are subject to significant pending civil litigation, which if decided against us, could require us to pay substantial judgments,

settlements or other penalties.

In addition to being subject to litigation in the ordinary course of business, we are currently, and may in the future be, subject to class actions,

other securities litigation and other actions arising in relation to our accounting restatements. Subsequent to our March 10, 2004 announcement

of the likely need for the Second Restatement, numerous class action complaints, including ERISA class action complaints and a derivative

action complaint, have been filed against Nortel Networks and certain current and former officers and directors.

We expect that this litigation will be time consuming, expensive and distracting from the conduct of our daily business. The adverse resolution

of any specific lawsuit could have a material adverse effect on our ability to favorably resolve other lawsuits and on our financial condition and

liquidity. We are unable at this time to estimate what our ultimate liability in these matters may be, and it is possible that we will be required to

pay substantial judgments, settlements or other penalties and incur expenses that could have a material adverse effect on our business, results o

operations, financial condition and liquidity, and such effects could be very significant. Expenses incurred in connection with these

investigations (which include substantial fees of lawyers and other professional advisors and potential obligations to indemnify officers and

directors who may be parties to such actions) could adversely affect our cash position.

We cannot predict the outcome of the Revenue Independent Review being undertaken by our Audit Committee.

As discussed in greater detail in the “Controls and Procedures” section of this report, our Audit Committee initiated the Revenue Independent

Review to achieve a full understanding of the historic events that required revenues for certain specific transactions to be restated. The

Revenue Independent Review will have a particular emphasis on the underlying conduct that led to the initial recognition of these revenues.

The review will also consider any appropriate additional remedial measures, including those involving internal controls and processes. The

Audit Committee has engaged WCPHD to advise it in connection with this review. We cannot predict the outcome of the Revenue Independent

Review.

Material adverse legal judgments, fines, penalties or settlements could have a material adverse effect on our financial condition and

liquidity, which could be very significant.

We estimate that our available cash and our cash flow from operations will be adequate to fund our operations and service our debt for at least

the next 12 months. In making this estimate, we have not assumed the need to make any payments in connection with our pending civil

litigation or investigations related to the First Restatement and Second Restatement, other than our anticipated professional fees and expenses.

Any material adverse legal judgments, fines, penalties or settlements arising from the pending civil litigation and investigations could require

additional funding which may not be available on commercially reasonable terms, or at all. This could have a material adverse effect on our

business, results of operations, financial condition and liquidity, including by:

We and our independent auditors have identified a number of material weaknesses related to our internal control over financial

reporting, which could continue to impact our ability to report our results of operations and financial condition accurately and in a

timely manner.

Two material weaknesses in our internal control over financial reporting were identified at the time of the First Restatement. Over the course of

Second Restatement, we and D&T identified a number of additional material weaknesses in our internal control over financial reporting. D&T

confirmed to the Audit Committee these material weaknesses, listed below, on January 10, 2005:

• requiring us to dedicate a substantial portion of our cash and/or cash flow from operations to payments of such judgments, fines,

penalties or settlements, thereby reducing the availability of our cash and/or cash flow to fund working capital, capital expenditures,

R&D efforts and other general corporate purposes, including debt reduction;

• making it more difficult for us to satisfy our payment obligations with respect to our outstanding indebtedness;

• increasing the difficulty and/or cost to us of refinancing our indebtedness;

• increasing our vulnerability to general adverse economic and industry conditions;

• limiting our flexibility in planning for, or reacting to, changes in our businesses and the industries in which we operate;

• making it more difficult for us to make acquisitions and investments;

• limiting our ability to obtain, and/or increase the cost of obtaining, directors’ and officers’ liability insurance and/or other types of

insurance; and

• restricting our ability to introduce new technologies and products and/or exploit business opportunities.

• lack of compliance with written Nortel Networks procedures for monitoring and adjusting balances related to certain accruals and

provisions, including restructuring charges and contract and customer accruals;

• lack of compliance with Nortel Networks procedures for applying applicable GAAP to the initial recording of certain liabilities

including those described in SFAS No. 5, and to foreign currency translation as described in SFAS No. 52;

• lack of sufficient personnel with appropriate knowledge, experience and training in U.S. GAAP and lack of sufficient analysis and

documentation of the application of U.S. GAAP to transactions, including but not limited to revenue transactions;

• lack of a clear organization and accountability structure within the accounting function, including insufficient review and

supervision, combined with financial reporting systems that are not integrated and which require extensive manual interventions;

• lack of sufficient awareness of, and timely and appropriate remediation of, internal control issues by Nortel Networks personnel;

and

Upon completion of management’s assessment of our internal control over financial reporting as at December 31, 2004 pursuant to SOX 404,

we currently expect to conclude that the first five of these six material weaknesses continue to exist as at December 31, 2004, and we continue

to identify, develop and begin to implement remedial measures to address them. These material weaknesses, if not fully addressed, could result

in accounting errors such as those underlying the restatements of our consolidated financial statements more fully discussed in “Developments

in 2003 and 2004—Nortel Networks Audit Committee Independent Review; restatements; related matters” in the MD&A and “Controls and

Procedures” section of this report. While our Board of Directors has approved the adoption of all of the recommendations for remedial

measures contained in the “Summary of Findings and of Recommended Remedial Measures of the Independent Review” in the “Controls and

Procedures” section of this report, and our management has adopted a number of measures to strengthen our internal control over financial

reporting and address the material weaknesses identified above, we may be unable to address such material weaknesses in a timely manner,

which could adversely impact the accuracy and timeliness of future reports and filings we make with the SEC and OSC.

• an inappropriate ‘tone at the top’, which contributed to the lack of a strong control environment; as reported in the Independent

Review Summary set forth in the “Controls and Procedures” section of this report, there was a “Management ‘tone at the top’ that

conveyed the strong leadership message that earnings targets could be met through application of accounting practices that finance

managers knew or ought to have known were not in compliance with U.S. GAAP and that questioning these practices was not

acceptable”.

In addition, starting with our fiscal year 2004 Annual Report on Form 10-K, we must comply with Section 404(a) of the Sarbanes-Oxley Act of

2002, and the related SEC rules, which require management to assess the effectiveness of our internal control over financial reporting annually

and to include in our Annual Report on Form 10-K a management report on that assessment, together with an attestation by our independent

registered public accounting firm. In light of the material weaknesses identified in connection with the First Restatement and Second

Restatement, our management expects to conclude that our internal control over financial reporting as at December 31, 2004 is ineffective, and

D&T has advised us that they expect their report on management’s assessment of internal control over financial reporting also to indicate that

internal control over financial reporting is ineffective. While we are implementing steps to ensure the effectiveness of our internal control over

financial reporting, failure to restore the effectiveness of our internal control over financial reporting could continue to impact our ability to

report our financial condition and results of operations accurately and could have a material adverse effect on our business, results of

operations, financial condition and liquidity.

The governing principles of the Independent Review for remedial measures may take time to implement.

As a result of the Independent Review, a number of significant remedial steps have been identified as necessary to improve our process and

procedures. These remedial steps may take time to implement. In addition, the process of implementing the governing principles of the

Independent Review may be time consuming for our senior management and disrupt our business.

The delayed filing of our Reports and related matters caused us to breach our public debt indentures and seek waivers from EDC

under the EDC Support Facility, which may affect our liquidity. Continuing delays in filing certain of our Reports and related matters

has resulted in a breach of our public debt indentures and our obligations under the EDC Support Facility. It is possible that the

holders of our public debt will seek to accelerate the maturity of that debt and EDC will not grant us additional waivers.

As a result of the delayed filing of our Reports, we and NNL breached our obligations to deliver the Reports to the trustees under our and

NNL’s public debt indentures. While continuing delays in filing certain of our Reports will not result in an automatic event of default and

acceleration of the outstanding debt, if holders of 25% of the outstanding principal amount of

any relevant series of debt securities provide notice of this non-compliance and we or NNL, as applicable, fail to file and deliver the relevant

Report within 90 days after the notice is provided, then the trustee under the indenture or the holders will have the right to accelerate the

maturity of the relevant series of debt securities. While such notice could have been given any time after March 30, 2004, neither we nor NNL

has received a notice as of the date of this report. If the required percentage of holders under one series of debt securities were to give such a

notice and, after the 90 day cure period expired, were to accelerate the maturity of such series of debt securities, then the principal amount of

each other series of debt securities could, upon 10 days notice, be accelerated without the lapse of an additional 90 day cure period. If an

acceleration of our debt securities were to occur, we may be unable to meet our payment obligations. Based on publicly available information,

we have reason to believe that more than 25% of the outstanding principal amount of the $150 of 7.875% notes due June 2026 issued by a

subsidiary of NNL and guaranteed by us are held by one holder, or a group of related holders. Other than with respect to that series of debt

securities, based on such publicly available information, neither we nor NNL are aware of any holder, or group of related holders, that holds at

least 25% of the outstanding principal amount of any relevant series of debt securities. However, based on such publicly available information,

we have reason to believe that there is sufficient concentration among holders of the $150 of 7.40% notes due June 2006 issued by NNL that

the acquisition of a relatively small additional amount of these notes by certain holders could result in a holder or a group of related holders

holding 25% or more of the outstanding principal amount of these notes. See “Liquidity and capital resources”.

As a result of the delayed filing of our Reports and the Related Breaches, we were also required to seek waivers from EDC under the EDC

Support Facility. Our continuing delays in filing certain of our Reports will require us to seek an additional waiver from EDC. EDC may not

grant an additional waiver and the terms of such a waiver may be unfavorable. If we do not obtain an additional waiver from EDC, EDC would

have the right to terminate the EDC Support Facility, require cash collateral, or exercise its rights against the collateral pledged under the

related security agreements. In addition, the Related Breaches will continue beyond the filing of the Reports. Accordingly, EDC has the right

(absent a further waiver of the Related Breaches) to terminate or suspend the EDC Support Facility notwithstanding the filing of the Reports.

While NNL is seeking a permanent waiver from EDC in connection with the Related Breaches, there can be no assurance that NNL will

receive such waiver, or any waiver or as to the terms of any such waiver.

Any future delay in the filing of our periodic reports with the SEC would similarly result in a breach of our public debt indentures and require

us to seek additional waivers from EDC under the EDC Support Facility, which could reduce our access to the EDC Support Facility and may

adversely affect our liquidity.

Our credit ratings have been downgraded, we are currently unable to access our shelf registration statement filed with the SEC and

NNL terminated the Five Year Facilities, each of which may adversely affect our liquidity.

On April 28, 2004, S&P downgraded its ratings of NNL, including its long-term corporate credit rating from “B” to “B-” and its preferred

share rating from “CCC” to “CCC-”. At the same time, it revised its outlook to developing from negative. Moody’s current long-term debt

rating for NNL is “B3” and its preferred share rating is “Caa3”. On April 28, 2004, Moody’s changed its outlook to potential downgrade from

uncertain. These ratings are below investment grade. Our credit ratings could be lowered or rating agencies could issue adverse commentaries

in the future, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. These ratings

and our current credit condition affect, among other things, our ability to raise debt, access the commercial paper market (which is currently

closed to us), engage in alternative financing arrangements, and affect our ability, and the cost, to securitize receivables, obtain customer bid,

performance-related and other bonds and contracts, access the EDC Support Facility and/or enter into normal course derivative or hedging

transactions and also affect the price of our stock.

As a result of a ratings downgrade in 2002, security agreements became effective under which substantially all of NNL’s assets located in the

U.S. and Canada and those of most of our U.S. and Canadian subsidiaries, including the shares of certain of NNL’s U.S. and Canadian

subsidiaries, were pledged. In addition, certain of NNL’s wholly owned subsidiaries have guaranteed NNL’s obligations under the EDC

Support Facility and NNL’s and Nortel Networks outstanding debt securities. These agreements will continue to secure the EDC Support

Facility and our and NNL’s outstanding public debt until the EDC Support Facility expires, alternative collateral is provided, alternative

arrangements are made, or NNL’s public debt ratings return to at least BBB (stable outlook) by S&P and Baa2 (stable outlook) by Moody’s.

The continued existence of these security arrangements may adversely affect our ability to incur additional debt or obtain alternative financing

arrangements. In addition, EDC is not obligated to make any support available under the EDC Support Facility if NNL’s senior long-term

rating by Moody’s is downgraded to less than B3 or if its debt rating by S&P is downgraded to less than B-.

In addition, in April 2004, NNL terminated the Five Year Facilities. Absent this termination, the banks would have been permitted, upon

30 days notice, to terminate their commitments under the Five Year Facilities as a result of NNL’s failure to file the NNL 2003 Annual Report

on Form 10-K by April 29, 2004. Although the Five Year Facilities were undrawn at termination, this termination may adversely affect our

liquidity.

Further, the delayed filing of the Reports has resulted in our inability to use, in its current form, the remaining approximately $800 of capacity

under our shelf registration statement filed with the SEC for various types of securities. As a result, our ability to access the capital markets is

constrained, which may adversely affect our liquidity.

The delay in filing certain of our Reports could cause the Toronto Stock Exchange and/or the New York Stock Exchange to commence

suspension or delisting procedures in respect of Nortel Networks Corporation common shares or other of our or NNL’s listed

securities.

Although we have cured breaches of the TSX’s and NYSE’s continued listing requirements caused by the delayed filing of our and NNL’s

2003 Annual Reports, the delayed filing of certain of our Reports causes us to continue to be in breach of these listing requirements. Although

each of the NYSE and TSX has verbally confirmed that it has not commenced, nor has any intention of commencing, any suspension or

delisting procedures in respect of our and NNL’s listed securities at the date of this report, the commencement of any suspension or delisting

procedures by either exchange remains, at all times, at the discretion of such exchange and would be publicly announced by the exchange.

Pending the filing of our and NNL’s 2003 Annual Reports, the NYSE had permitted our and NNL’s listed securities to continue to be traded on

the exchange for the three month period ended March 31, 2005. In exercising the discretion relating to the grant of that additional three month

period and the continued listing of our and NNL’s securities in light of the delayed filing of certain of our Reports, the NYSE’s procedures

provide that the NYSE would consider, among other things, the likelihood of the relevant Reports being filed, the Company’s and NNL’s

general financial status and the frequency and detail of the Company’s and NNL’s ongoing disclosures to the market on the status of such

filings.

If a suspension or delisting were to occur, there would be significantly less liquidity in the suspended or delisted securities. In addition, our

ability to raise additional necessary capital through equity or debt financing, and attract and retain personnel by means of equity compensation,

would be greatly impaired. Furthermore, with respect to any suspended or delisted securities, we would expect decreases in institutional and

other investor demand, analyst coverage, market making activity and information available concerning trading prices and volume, and fewer

broker-dealers would be willing to execute trades with respect to such securities. A suspension or delisting would likely decrease the

attractiveness of our common shares or other listed securities of Nortel Networks Corporation and NNL to investors and cause the trading

volume of our common shares or other listed securities of Nortel Networks Corporation and NNL to decline, which could result in a decline in

the market price of such securities.

Continuing negative publicity may adversely affect our business and the market price of our publicly traded securities.

As a result of the First Restatement and Second Restatement, we have been the subject of continuing negative publicity. This negative publicity

has contributed to significant declines in the prices of our publicly traded securities. This negative publicity may have an effect on the terms

under which some customers and suppliers are willing to continue to do business with us and could affect our financial performance or

financial condition. We also believe that many of our employees are operating under stressful conditions, which reduce morale and could lead

to increased employee turnover. Continuing negative publicity could have a material adverse effect on our business and the market price of our

publicly traded securities.

As a result of the delay in the filing of our 2003 Annual Report (containing our audited consolidated financial statements for the year ended

December 31, 2003), we were required to apply to the Ontario Superior Court of Justice for an order permitting the postponement of our 2004

Annual Shareholders’ Meeting. The Ontario Superior Court of Justice granted that order, which permitted us to extend the time for calling the

meeting to a date not later than December 31, 2004, or such later date as the Court may permit. As a result of the continued delay in the filing

of our 2003 Annual Report, in October 2004 we announced that we intended to seek a further order extending the time for calling the meeting

to a date no later than March 31, 2005, which order the Court granted on December 10, 2004. A further extension to a date no later than

May 31, 2005 was obtained from the Court on December 21, 2004 to permit us to comply with a specific SEC rule which would require us, in

our circumstances, to provide to shareholders our 2004 audited financial statements either prior to or concurrently with the mailing of proxy

materials for the Meeting. This postponement has, among other things, contributed to the continuing negative publicity related to us, which

may adversely affect our business and the market price of our publicly traded securities.

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

Competition for certain key positions and specialized technical personnel in the high-technology industry remains strong. Our future success

depends in part on our continued ability to hire, assimilate in a timely manner and retain qualified personnel, particularly in key senior

management positions and in our key areas of potential growth. An important factor in attracting and retaining qualified employees is our

ability to provide employees with the opportunity to participate in the potential growth of our business through programs such as stock option

plans, restricted stock unit plans and employee investment and share purchase plans. The scope and value of these programs will be adversely

affected by the volatility or negative performance of the market price for our common shares.

In connection with the delay in filing our 2003 Annual Reports, as of March 10, 2004, we suspended the purchase of our common shares under

the stock purchase plans for eligible employees in eligible countries that facilitate the acquisition of our common shares; the exercise of

outstanding options granted under the 2000 Plan or the 1986 Plan, or the grant of any additional options under those plans, or the exercise of

outstanding options granted under employee stock option plans previously assumed by us in connection with mergers and acquisitions; and the

purchase of units in Nortel Networks stock fund or purchase of our common shares under our defined contribution and investments plans until

such time as, at the earliest, we are in compliance with U.S. and Canadian regulatory securities filing requirements. On May 31, 2004, the OSC

issued a final order prohibiting all trading by our directors, officers and certain current and former employees in our securities and those of

NNL. This order will remain in effect until two full business days following the receipt by the OSC of all filings required to be made by us and

NNL pursuant to Ontario securities law. Accordingly, our ability to provide employees with the opportunity to participate in our stock option

plans, restricted stock unit plans and employee investment and share purchase plans has been adversely affected and certain employees have

not been able to trade in our securities. The current suspension of these programs and OSC trading order, and any future suspension or OSC

order, may have a material adverse effect on our ability to hire, assimilate in a timely manner and retain qualified personnel.

In addition, in 2004 we terminated for cause our former president and chief executive officer, former chief financial officer, former controller

and seven additional individuals with significant responsibilities for financial reporting. In August and September 2004, as part of our new

strategic plan, we announced an anticipated workforce reduction of approximately 3,250 employees. Approximately 64% of employee actions

related to the focused workforce reduction were completed by the end of 2004, including approximately 55% that were notified of termination

or acceptance of voluntary retirement, with the remainder comprised of voluntary attrition of employees that were not replaced. The remainder

of employee actions are expected to be completed by June 30, 2005. In addition, in 2001, 2002 and 2003, we implemented a company-wide

restructuring plan, which included a reduction of approximately two-thirds of our workforce over the three-year period.

We may find it more difficult to attract or retain qualified employees because of our recent significant workforce reductions, business

performance, management changes, restatement activities and resulting negative publicity and the resulting impacts on our incentive programs

and incentive compensation plans. If we have not properly sized our workforce and retained those employees with the appropriate skills, our

ability to compete effectively may be adversely affected. We are also more dependent on those employees we have retained, as many have

taken on increased responsibilities due to workforce reductions. If we are not successful in attracting, recruiting or retaining qualified

employees, including members of senior management, we may not have the personnel necessary to achieve our business objectives, including

the implementation of our remedial measures.

Ongoing SEC review may require us to amend our public disclosures further.

We have received comments on our periodic filings from the staff of the SEC’s Division of Corporation Finance. As part of this comment

process, we may receive further comments from the staff of the SEC relating to this Annual Report on Form 10-K and our other periodic

filings. As a result, we may be required by the SEC to amend this Form 10-K or other reports filed with the SEC in order to make adjustments

or additional disclosures. However, we do not believe that it will be feasible to amend our 2002 Form 10-K/A or 2003 Form 10-Qs due to,

among other factors, the identified material weaknesses in our internal control over financial reporting, the significant turnover in our finance

personnel, changes in accounting systems, documentation weaknesses, a likely inability to obtain third party corroboration in certain cases due

to the substantial industry adjustment in recent years and the passage of time generally. Amendments to our prior filings would be required for

us to be in full compliance with our Exchange Act reporting obligations.

isks relating to our business

We continue to restructure our business to respond to industry and market conditions. The assumptions underlying our restructuring

efforts may prove to be inaccurate and we may have to restructure our business again in the future.

We continue to restructure our business to realign resources and achieve desired cost savings in an increasingly competitive market. Our new

strategic plan includes an anticipated further workforce reduction of approximately 3,250 employees. We have based our restructuring efforts

on certain assumptions regarding the cost structure of our business. Our current assumptions may or may not be correct and as a result, we may

determine that further restructuring in the future will be needed. Our restructuring efforts may not be sufficient for us to achieve improved

results and meet the changes in industry and market conditions, including increased competition. In particular, we face increased competition

from low cost competitors such as Huawei Technologies Co., Ltd. and ZTE Corporation. We must manage the potentially higher growth areas

of our business, as well as the non-core areas, in order for us to achieve improved results.

We have made, and will continue to make, judgments as to whether we should further reduce our workforce or exit, or dispose of, certain

businesses. These workforce reductions may impair our ability to achieve our current or future business objectives. Costs incurred in

connection with restructuring efforts may be higher than estimated. Any decision by management to further limit investment or exit, or dispose

of, businesses may result in the recording of additional charges.

As a result, the costs actually incurred in connection with the restructuring efforts may be higher than originally planned and may not lead to

the anticipated cost savings and/or improved results.

As part of our review of restructured businesses, we look at the recoverability of their tangible and intangible assets. Future market conditions

may trigger further write downs of these assets due to uncertainties in:

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

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

which may adversely affect the market price of our publicly traded securities.

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 decision to adopt fair value accounting for employee stock options on a prospective basis as of January 1, 2003 has

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

• accounting estimates related to the useful life and recoverability of the net book value of these assets, including inventory,

goodwill, net deferred taxes and other intangible assets.

• our ability to execute our strategic plan, including the planned workforce reductions, without negatively impacting our relationships

with our customers, the delivery of products based on new and developing technologies at competitive prices, the effectiveness of

our internal processes and organizations and the retention of qualified personnel;

• our ability to focus on the day-to-day operation of our business while implementing improvements in our internal controls and

procedures, including our accounting systems, and addressing the civil litigation actions and investigations related to our

restatements;

• our ability to successfully implement programs to stimulate customer spending by anticipating and offering the kinds of products

and services customers will require in the future to increase the efficiency and profitability of their networks;

• our ability to successfully complete programs on a timely basis to reduce our cost structure, including fixed costs, to streamline our

operations and to reduce product costs;

• our ability to successfully comply with increased and complex regulations;

• our ability to focus our business on what we believe to be potentially higher growth, higher margin businesses and to dispose of or

exit non-core businesses;

• increased price and product competition in the networking industry, including from low cost competitors;

• the inherent uncertainties of using forecasts, estimates and assumptions for asset valuations and in determining the amounts of

accrued liabilities, provisions and other items in our consolidated financial statements;

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

• fluctuations in our gross margins;

• the development, introduction and market acceptance of new technologies, and integrated networking solutions, as well as the

adoption of new networking standards;

• the overall trend toward industry consolidation and rationalization among our customers, competitors and suppliers;

• our ability to make investments, including acquisitions, to strengthen our business;

• the ability of our customers and suppliers to obtain financing to fund capital expenditures;

• 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.

caused us to record an expense over the stock option vesting period, based on the fair value at the date the options are granted, and could have a

significant negative effect on our reported results.

Additionally, we are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances, to

value our deferred tax assets and to accrue unfunded pension liabilities, each of which may result in a negative effect on our reported results.

We enter into agreements that may require us to make certain indemnification payments to third parties in the event of certain changes in an

underlying economic characteristic related to assets, liabilities or equity securities of such third parties. The occurrence of events that may

cause us to become liable to make an indemnification payment is not within our control and an obligation to make a significant indemnification

payment under such agreements could have a significant negative effect on our reported results.

As a consequence, operating results for a particular future period are difficult to predict, and therefore, prior results are not necessarily

indicative of results to be expected in future periods. Any of the foregoing factors, or any other factors described herein, could have a material

adverse effect on our business, results of operations and financial condition that could adversely affect the price of our publicly traded

securities.

Global economic conditions and other trends and factors affecting the telecommunications industry are beyond our control and may

result in reduced demand and pricing pressure on our products.

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

Cautious capital spending in our industry has affected, and could affect, demand for, or pricing pressures on, our products.

Our gross margins may decline, which would reduce our operating results and could contribute to volatility in the market price of our

publicly traded securities.

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

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• adverse changes in the public and private equity and debt markets and our ability, as well as the ability of our customers and

suppliers, to obtain financing or to fund working capital and capital expenditures;

• adverse changes in the credit quality of our customers and suppliers;

• adverse changes in the market conditions in our industry and the specific markets for our products;

• the trend towards the sale of converged networking solutions, which could lead to reduced capital spending on multiple networks

by our customers;

• visibility to, and the actual size and timing of, capital expenditures by our customers;

• inventory practices, including the timing of product and service deployment, of our customers;

• the amount of network capacity and the network capacity utilization rates of our customers, and the amount of sharing and/or

acquisition of new and/or existing network capacity by our customers;

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

• the overall trend toward industry consolidation and rationalization among our customers, competitors and suppliers;

• conditions in the broader market for communications products, including data networking products and computerized information

access equipment and services;

• increased price competition, particularly from low cost competitors;

• changes in legislation or accounting rules and governmental and environmental regulation or intervention affecting communications

or data networking;

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

• acts of war or terrorism that could lead to disruptions in general global economic activity, changes in logistics and security

arrangements and reduced customer demand for our products and services.

• increased price competition, particularly from low cost competitors;

• changes in product and geographic mix;

• customer and contract settlement costs;

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

publicly traded securities.

Cash flow fluctuations may affect our ability to fund our working capital requirements or achieve our business objectives in a timely

manner. Additional sources of funds may not be available or may not be available on acceptable terms.

Our working capital requirements and cash flows historically have been, and are expected to continue to be, subject to quarterly and yearly

fluctuations, depending on such factors as timing and size of capital expenditures, levels of sales, timing of deliveries and collection of

receivables, inventory levels, customer payment terms, customer financing obligations and supplier terms and conditions. In addition, if the

industry or our current condition deteriorates, notwithstanding the EDC Support Facility, an increased portion of our cash and cash equivalents

may be restricted as cash collateral for customer performance bonds and contracts. We believe our cash on hand will be sufficient to fund our

current business model, manage our investments and meet our customer commitments for at least the next 12 months. In making this estimate,

we have not made provision for any material payments in connection with our pending civil litigation actions and investigations related to the

First Restatement and Second Restatement, other than our anticipated professional fees and expenses. Any material adverse legal judgments,

fines, penalties or settlements arising from these pending civil litigation actions and investigations could require additional funding which may

not be available on commercially reasonable terms, or at all. This could have a material adverse effect on our liquidity, which could be very

significant.

In addition, a greater than expected slow down in capital spending by service providers and other customers may require us to adjust our

current business model. As a result, our revenues and cash flows may be materially lower than we expect and we may be required to further

reduce our capital expenditures and investments or take other measures in order to meet our cash requirements.

We may seek additional funds from liquidity-generating transactions and other sources of external financing (which may include a variety of

debt, convertible debt and/or equity financings). We cannot provide any assurance that our net cash requirements will be as we currently

expect, that we will continue to have access to the EDC Support Facility when and as needed, or that liquidity-generating transactions or

financings will be available to us on acceptable terms or at all. Our inability to manage cash flow fluctuations resulting from the above factors

and the potential reduction, expiry or termination of the EDC Support Facility could have a material adverse effect on our ability to fund our

working capital requirements from operating cash flows and other sources of liquidity or to achieve our business objectives in a timely manner.

We may be materially and adversely affected by cautious capital spending by our customers. The loss of customers in certain markets

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

We expect that our consolidated revenues in 2004 will be slightly lower compared to 2003. The 2003 consolidated revenues included revenues

that were deferred from prior periods. Continued cautiousness in capital spending by service providers and other customers may affect our

revenues more than we currently expect. Our revenues and operating results have been and may continue to be materially and adversely

affected by the continued cautiousness in capital spending by our customers. We have focused on the larger customers in certain markets,

which provide a substantial portion of our revenues. A reduction or delay in business from one or more of these customers, or a failure to

achieve a significant market share with

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• higher product, material or labor costs;

• increased inventory provisions or contract and customer settlement costs;

• warranty costs;

• obsolescence charges;

• loss of cost savings on future inventory purchases as a result of high inventory levels;

• introduction of new products and costs of entering new markets;

• increased levels of customer services;

• changes in distribution channels;

• excess capacity or excess fixed assets;

• accruals for employee incentive bonuses;

• further restructuring costs; and

• costs related to our restatements, including the possibility of substantial fines, settlements and/or damages or other penalties, and/or

remedial actions.

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

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

In order to finance our business, we have incurred significant levels of debt compared to historical levels, and we may need to secure additional

sources of funding, which may include debt or convertible debt financing, in the future. A high level of debt, arduous or restrictive terms and

conditions related to accessing certain sources of funding, failure to meet the covenants in the EDC Support Facility and any significant

reduction in, or access to, such facility, poor business performance or lower than expected cash inflows could materially and adversely affect

our ability to fund the operation of our business.

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

An increased portion of our cash and cash equivalents may be restricted as cash collateral if we are unable to secure alternative

support for certain obligations arising out of our normal course business activities.

The EDC Support Facility may not provide all the support we require for certain of our obligations arising out of our normal course of business

activities. In particular, although this facility provides for up to $750 in support, the $300 revolving small bond sub-facility will not become

committed support until all of the Reports are filed and NNL obtains a permanent waiver of the Related Breaches. As of December 31, 2004,

there was approximately $296 of outstanding support utilized under the EDC Support Facility, approximately $212 of which was outstanding

under the small bond sub-facility. In addition, bid and performance related bonds with terms that extend beyond December 31, 2006, which,

absent any early termination of the EDC Support Facility, is the expiry date of this facility, are currently not eligible for the support provided

by the EDC Support Facility. Given that the EDC Support Facility is used to support bid and performance bonds with varying terms, including

those with at least 365 days, we may need to increase our use of cash collateral to support these obligations beginning on January 1, 2006

absent a further extension of the facility. Unless EDC agrees to extend the facility or agrees to provide support outside the scope of the facility,

we may be required to provide cash collateral to support these obligations. We cannot provide any assurance that we will reach an agreement

with EDC on these matters. Under the terms of the waiver letter with EDC dated March 29, 2004, EDC may also suspend its obligation to issue

NNL any additional support if events occur that have a material adverse effect on NNL’s business, financial position or results of operations. If

we do not have access to sufficient support under the EDC Support Facility, and if we are unable to secure alternative support, an increased

portion of our cash and cash equivalents may be restricted as cash collateral, which could adversely affect our ability to fund some of our

normal course business activities, capital expenditures, R&D and our ability to borrow in the future.

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

obligations.

We may at times depend primarily on loans, dividends or other forms of financing from our subsidiaries to meet our obligations to pay interest

and principal on outstanding public debt and to pay corporate expenses. If our subsidiaries are unable to pay dividends or provide us with loans

or other forms of financing in sufficient amounts, it could adversely affect our ability to meet our obligations.

We may need to make larger contributions to our defined benefit plans in the future.

We currently maintain various defined benefit plans in North America and the U.K. which cover various categories of employees and retirees,

which represent our major retirement plans. In addition, we have smaller retirement plans in other countries. Our obligations to make

contributions to fund benefit obligations under these plans are based on actuarial

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• 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.

valuations, which themselves are based on certain assumptions about the long-term operation of the plans, including employee turnover and

retirement rates, the performance of the financial markets and interest rates. If experience differs from the assumptions, the amounts we are

obligated to contribute to the plans may increase. In particular, the performance of the financial markets is difficult to predict, particularly in

periods of high volatility in the equity markets. If the financial markets perform lower than the assumptions, we may have to make larger

contributions in the future than we would otherwise have to make and expenses related to defined benefit plans could increase. Similarly,

changes in interest rates can impact our contribution requirements. In a low interest rate environment, the likelihood of required contributions

in the future increases. If interest rates are lower in the future than we assume they will be, then we would probably be required to make larger

contributions than we would otherwise have to make.

In addition, the 2004 decision of the Supreme Court of Canada in “Monsanto Canada Inc. v. Superintendent of Financial Services” has caused

companies in Canada that sponsor defined benefit plans, including us, to review certain of our past activities that may have triggered partial

wind-ups of such plans to determine whether a distribution of plan surplus, if any, should have occurred at the time of any triggering event.

Although the full impact of the decision remains unclear and we have not yet made any determination regarding our plans, if it is determined

that a distribution of plan surplus should have occurred at the time of any triggering event, we may be required to make a distribution out of our

plan assets, which may lead to an increase in the amount of future contributions that we are required to make.

If market conditions deteriorate or future results of operations are less than expected, an additional valuation allowance may be

required for all or a portion of our deferred tax assets.

We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred

tax assets quarterly, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax

valuation allowance is recorded. Our valuation allowance is primarily attributable to continued uncertainty in the industry. If market conditions

deteriorate or future results of operations are less than expected, future assessments may result in a determination that it is more likely than not

that some or all of our net deferred tax assets are not realizable. As a result, we may need to establish an additional valuation allowance for all

or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial

condition.

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

prove to be wrong.

We expect that data communications traffic will grow at a faster rate than the growth expected for voice traffic and that the use of the Internet

will continue to increase. We expect the growth of data traffic and the use of the Internet will significantly impact traditional voice networks,

both wireline and wireless. We believe that this will create market discontinuities, which will make traditional voice network products and

services less effective as they were not designed for data traffic. We believe that these market discontinuities in turn will lead to the

convergence of data and voice through upgrades of traditional voice networks to transport large volumes of data traffic or through the

construction of new networks designed to transport both voice and data traffic. Either approach would require significant capital expenditures

by service providers. We also believe that such developments will give rise to the demand for IP optimized networking solutions, and third

generation, or 3G, wireless networks.

We cannot be sure what the rate of this convergence of voice and data networks will be, due to the dynamic and rapidly evolving nature of the

communications business, the technology involved and the availability of capital. Consequently, market discontinuities and the resulting

demand for IP-optimized networking solutions or 3G wireless networks may not continue. Alternatively, the pace of that development may be

slower than currently anticipated. The market may also develop in an unforeseen direction. Certain events, including the commercial

availability and actual implementation of new technologies, including 3G networks, or the evolution of other technologies, may occur, which

would affect the extent or timing of anticipated market demand, or increase demand for products based on other technologies, or reduce the

demand for IP-optimized networking solutions or 3G wireless networks. Any such change in demand may reduce purchases of our networking

solutions by our customers, require increased expenditures to develop and market different technologies, or provide market opportunities for

our competitors. Our performance may also be materially and adversely affected by a lack of growth in the rate of data traffic, a reduction in

the use of the Internet or a reduction in the demand for IP-optimized networking solutions or 3G wireless networks in the future.

We have made, and may continue to make, strategic acquisitions. If we are not successful in operating or integrating these acquisitions,

our business, results of operations and financial condition may be materially and adversely affected.

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In the past, we acquired companies that we believed would enhance the expansion of our business and products. We may make selective

opportunistic acquisitions of companies or businesses with resources and product or service offerings capable of providing us with additional

product and/or market strengths. Acquisitions involve significant risks and uncertainties, including:

Our inability to successfully operate and integrate newly acquired businesses appropriately, effectively and in a timely manner could have a

material adverse effect on our ability to take advantage of further growth in demand for IP-optimized network solutions and other advances in

technology, as well as on our revenues, gross margins and expenses.

Acquisitions are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and will not

materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions

could materially harm our business and operating results.

We operate in highly dynamic and volatile industries characterized by rapidly changing technologies, evolving industry standards,

frequent new product introductions and short product life cycles.

The markets for our products are characterized by rapidly changing technologies, evolving industry standards, frequent new product

introductions and short product life cycles. Our success depends, in substantial part, on the timely and successful introduction of high quality

new products and upgrades, as well as cost reductions on current products to address the operational speed, bandwidth, efficiency and cost

requirements of our customers. Our success will also depend on our ability to comply with emerging industry standards, to operate with

products of other suppliers, to integrate, simplify and reduce the number of software programs used in our portfolio of products, to address

emerging market trends, to provide our customers with new revenue-generating opportunities and to compete with technological and product

developments carried out by others. The development of new, technologically advanced products, including IP-optimized networking

solutions, software products and 3G wireless networks, is a complex and uncertain process requiring high levels of innovation, as well as the

accurate anticipation of technological and market trends. Investments in this development may result in our expenses growing at a faster rate

than our revenues, particularly since the initial investment to bring a product to market may be high. We may not be successful in targeting

new market opportunities, in developing and commercializing new products in a timely manner or in achieving market acceptance for our new

products.

The success of new or enhanced products, including IP-optimized networking solutions and 3G wireless networks, depends on a number of

other factors, including the timely introduction of those products, market acceptance of new technologies and industry standards, the quality

and robustness of new or enhanced products, competing product offerings, the pricing and marketing of those products and the availability of

funding for those networks. Products and technologies developed by our competitors may render our products obsolete. Hackers may attempt

to disrupt or exploit our customers’ use of our technologies. If we fail to respond in a timely and effective manner to unanticipated changes in

one or more of the technologies affecting telecommunications and data networking or our new products or product enhancements fail to

achieve market acceptance, our ability to compete effectively in our industry, and our sales, market share and customer relationships

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• the industry may develop in a different direction than anticipated and the technologies we acquire may not prove to be those we

need;

• the future valuations of acquired businesses may decrease from the market price we paid for these acquisitions;

• the revenues of acquired businesses may not offset increased operating expenses associated with these acquisitions;

• potential difficulties in completing in-process research and development projects and delivering high quality products to our

customers;

• potential difficulties in integrating new products, software, businesses and operations in an efficient and effective manner;

• our customers or customers of the acquired businesses may defer purchase decisions as they evaluate the impact of the acquisitions

on our future product strategy;

• potential loss of key employees of the acquired businesses;

• diversion of the attention of our senior management from the operation of our daily business;

• entering new markets in which we have limited experience and where competitors may have a stronger market presence;

• potential issuance of common stock that would dilute our shareholders’ percentage ownership; and

• potential assumption of liabilities.

could be materially and adversely affected.

In addition, unanticipated changes in market demand for products based on a specific technology, particularly lower than anticipated, or delays

in, demand for IP-optimized networking solutions, particularly long-haul and metro optical networking solutions, or 3G wireless networks,

could have a material adverse effect on our business, results of operations and financial condition if we fail to respond to those changes in a

timely and effective manner.

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

We operate in a highly volatile industry that is characterized by industry rationalization and consolidation, vigorous competition for market

share and rapid technological development. Competition is heightened in periods of slow overall market growth. These factors could result in

aggressive pricing practices and growing competition from smaller niche companies, established competitors, as well as well-capitalized

computer systems and communications companies, which, in turn, could have a material adverse effect on our gross margins.

Since some of the markets in which we compete are characterized by the potential for rapid growth and, in certain cases, low barriers to entry

and rapid technological changes, smaller, specialized companies and start-up ventures are now, or may in the future become, principal

competitors. We may also face competition from the resale of used telecommunications equipment, including our own on occasion, by failed,

downsized or consolidated high technology enterprises and telecommunications service providers. In addition, we face the risk that certain of

our competitors may enter into additional business combinations, accelerate product development, or engage in aggressive price reductions or

other competitive practices, which make them more powerful or aggressive competitors.

We expect that we will face additional competition from existing competitors and from a number of companies that have entered or may enter

our existing and future markets. In particular, we currently, and may in the future, face increased competition from low cost competitors such

as Huawei Technologies Co., Ltd. and ZTE Corporation. Some of our current and potential competitors have greater marketing, technical and

financial resources, including access to capital markets and/or the ability to provide customer financing in connection with the sale of products.

Many of our current and potential competitors have also established, or may in the future establish, relationships with our current and potential

customers. Other competitive factors include the ability to provide new technologies and products, end-to-end networking solutions, and new

product features, such as security, as well as conformance to industry standards. Increased competition could result in price reductions,

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

For a list of our principal competitors, see “Competition” in each of the business segment descriptions in the “Business” section of this report.

We face certain barriers in our efforts to expand internationally.

We intend to continue to pursue international and emerging market growth opportunities. In many international markets, long-standing

relationships between potential customers and their local suppliers and protective regulations, including local content requirements and type

approvals, create barriers to entry. In addition, pursuing international opportunities may require significant investments for an extended period

before returns on such investments, if any, are realized and such investments may result in expenses growing at a faster rate than revenues.

Furthermore, those projects and investments could be adversely affected by:

106

• 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;

Difficulties in foreign financial markets and economies and of foreign financial institutions, particularly in emerging markets, could adversely

affect demand from customers in the affected countries. An inability to maintain or expand our business in international and emerging markets

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

Fluctuations in foreign currency exchange rates could negatively impact our business, results of operations and financial condition.

As an increasing proportion of our business may be denominated in currencies other than U.S. dollars, fluctuations in foreign currency

exchange rates may have an adverse impact on our business, results of operations and financial condition. Our primary currency exposures are

to Canadian dollars, British pounds and the euro. These exposures may change over time as we change the geographic mix of our global

business and as our business practices evolve. For instance, if we increase our presence in emerging markets, we may see an increase in our

exposure to emerging market currencies, such as, for example, the Indian rupee. These currencies may be affected by internal factors and

external developments in other countries. Also, our ability to enter into normal course derivative or hedging transactions in the future may be

impacted by our current credit condition. We cannot predict whether foreign exchange losses will be incurred in the future, and significant

foreign exchange rate fluctuations may have a material adverse effect on our business, results of operations and financial condition.

If we fail to protect our intellectual property rights, or if we are subject to adverse judgments or settlements arising out of disputes

regarding intellectual property rights, our business, results of operations and financial condition could be materially and adversely

affected.

Our industry is subject to uncertainty over adoption of industry standards and protection of intellectual property rights. Our success is

dependent on our proprietary technology, for the protection of which we rely on patent, copyright, trademark and trade secret laws. Our

business is global and the level of protection of our proprietary technology provided by those laws varies by jurisdiction. Our issued patents

may be challenged, invalidated or circumvented, and our rights under issued patents may not provide us with competitive advantages. Patents

may not be issued from pending applications, and claims in patents issued in the future may not be sufficiently broad to protect our proprietary

technology. In addition, claims of intellectual property infringement or trade secret misappropriation may be asserted against us or our

customers in connection with their use of our products and the outcome of any of those claims may be uncertain. An unfavorable outcome in

such a claim could require us to cease offering for sale the products that are the subject of such a claim, pay substantial monetary damages to a

third party and/or make ongoing royalty payments to a third party. In addition, any defense of claims of intellectual property infringement or

trade secret misappropriation may require extensive participation by senior management and/or other key employees and may reduce their time

and ability to focus on other aspects of our business. A failure by us to react to changing industry standards, the lack of broadly-accepted

industry standards, successful claims of intellectual property infringement or other intellectual property claims against us or our customers, or a

failure by us to protect our proprietary technology could have a material adverse effect on our business, results of operations and financial

condition. In addition, if others infringe on our intellectual property rights, we may not be able to successfully contest such challenges.

Rationalization and consolidation in the industry may lead to increased competition and harm our business.

The industry has experienced consolidation and rationalization and we expect this trend to continue. There have been adverse changes in the

public and private equity and debt markets for industry participants which have affected their ability to obtain financing or to fund capital

expenditures. Some operators have experienced financial difficulty and have, or may, file for bankruptcy protection or be acquired by other

operators. Other operators may merge and we and one or more of our competitors may each supply products to the companies that have

merged or will merge. This rationalization and/or consolidation could result in our dependence on a smaller number of customers, purchasing

decision delays by the merged companies and/or our playing a lesser role, or no longer playing a role, in the supply of communications

products to the merged companies. This rationalization and/or consolidation, including the acquisition by Cingular Wireless of AT&T

Wireless, could also cause increased competition among our customers and pressure on the pricing of their products and services, which could

cause further financial difficulties for our customers. A rationalization of industry participants could also increase the supply of used

communications products for resale, resulting in increased competition and pressure on the pricing for our new products. In addition,

telecommunications equipment suppliers may enter into business combinations, or may be acquired by or sell a substantial portion of their

assets to other competitors, resulting in accelerated product

107

• challenges in staffing and managing international opportunities;

• other factors, depending on the country involved; and

• acts of war or terrorism.

development, increased financial strength, or a broader base of customers, creating even more powerful or aggressive competitors. We may

also see rationalization among equipment/component suppliers. The business failures of operators, competitors or suppliers may cause

uncertainty among investors and in the industry generally and harm our business.

Changes in regulation of the Internet and/or other aspects of the industry may affect the manner in which we conduct our business and

may materially and adversely affect our business, results of operations and financial condition.

Investment decisions of our customers could be affected by regulation of the Internet or other aspects of the industry in any country where we

operate. We could also be materially and adversely affected by an increase in competition among equipment suppliers or by reduced capital

spending by our customers, as a result of a change in the regulation of the industry. If a jurisdiction in which we operate adopts measures which

affect the regulation of the Internet and/or other aspects of the industry, we could experience both decreased demand for our products and

increased costs of selling such products. Changes in laws or regulations governing the Internet, Internet commerce and/or other aspects of the

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

In the U.S., on February 20, 2003, the FCC announced a decision in its triennial review proceeding of the agency’s rules regarding UNEs. The

text of the FCC’s order and reasons for the decision were released on August 21, 2003. The uncertainty surrounding the impact of the FCC

decision and subsequent adoption on December 15, 2004 of new unbundling rules in response to the remand by the U.S. Court of Appeals for

the D.C. Circuit is affecting, and may continue to affect, the decisions of certain of our U.S.-based service provider customers regarding

investment in their telecommunications infrastructure. These UNE rules and/or material changes in other country-specific telecommunications

or other regulations may affect capital spending by certain of our service provider customers, which could have a material adverse effect on our

business, results of operations and financial condition.

In Europe, we expect to become subject to new product content laws and product takeback and recycling requirements that will require full

compliance by 2006. We expect that these laws will require us to incur additional compliance costs. Although compliance costs relating to

environmental matters have not resulted in a material adverse effect on our business, results of operations and financial condition in the past,

they may result in a material adverse effect in the future.

Our stock price has historically been volatile and further declines in the market price of our publicly traded securities may negatively

impact our ability to make future acquisitions, raise capital, issue debt and retain employees.

Our publicly traded securities 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, including our announcements related to the Independent Review, our management changes, the

First Restatement and the Second Restatement, the regulatory and criminal investigations, the class action litigations and other civil

proceedings and related matters. Our credit quality, any equity or equity related offerings, operating results and prospects, restatements of

previously issued financial statements, including any exclusion of our publicly traded securities from any widely followed stock market

indices, among other factors, will also affect the market price of our publicly traded securities.

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 those companies.

A major decline in the capital markets generally, or an adjustment in the market price or trading volumes of our publicly traded securities, may

negatively impact our ability to raise capital, issue debt, secure customer business, retain employees or make future acquisitions. These factors,

as well as general economic and geopolitical conditions, and continued negative events within the technology sector, may in turn have a

material adverse effect on the market price of our publicly traded securities.

Early settlement of our purchase contracts is currently not available to holders of purchase contracts. Acceleration of the settlement

date on early settlement of our purchase contracts could contribute to volatility in the market price of our common shares.

Owing to matters described above in “Developments in 2003 and 2004 — Nortel Networks Audit Committee Independent Review;

restatements; related matters” with respect to the delayed filing of the Reports, we are currently unable to permit holders of our prepaid forward

purchase contracts to exercise certain “early settlement” rights and receive Nortel Networks Corporation common shares in advance of the

otherwise applicable August 15, 2005 settlement date. These rights again will become exercisable upon the effectiveness of a registration

statement (or a post-effective amendment to the shelf registration

108

statement) filed with the SEC (with respect to the common shares to be delivered) that contains a related current prospectus. Under the terms of

the Purchase Contract and Unit Agreement, which governs the purchase contracts, we have agreed to use commercially reasonable efforts to

have in effect a registration statement covering the common shares to be delivered and to provide a prospectus in connection therewith.

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. As of December 31, 2004, 3,840 purchase contracts were outstanding. The aggregate number of our common shares issuable on

the settlement date of the remaining purchase contracts will be between approximately 65 million and 78 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. 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 NNL or certain

other subsidiaries) in which all of our common shares are exchanged for consideration of at least 30% 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 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. For more information on early settlement of our purchase contracts, see “Capital stock —

Prepaid forward purchase contracts” in note 16 of the accompanying consolidated financial statements. 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.

Industry concerns could continue and increase our exposure to our customers’ credit risk and the risk that our customers will not be

able to fulfill their payment obligations to us under customer financing arrangements.

The competitive environment in which we operate has required us in the past to provide significant amounts of medium-term and long-term

customer financing. Customer financing arrangements may include financing in connection with the sale of our products and services, funding

for certain non-product and service costs associated with network installation and integration of our products and services, financing for

working capital and equity financing. While we have significantly reduced our customer financing exposure, we expect we may continue in the

future to provide customer financing to customers in areas that are strategic to our core business activity.

We expect to continue to hold most current and future customer financing obligations for longer periods prior to any possible placement with

third-party lenders, due to, among other factors, recent economic uncertainty in various countries, adverse capital market conditions, our

current credit condition, adverse changes in the credit quality of our customers and reduced demand for telecommunications financing in

capital and bank markets. In addition, risks generally associated with customer financing, including the risks associated with new technologies,

new network construction, market demand and competition, customer business plan viability and funding risks, may require us to hold certain

customer financing obligations over a longer term. We may not be able to place any of our current or future customer financing obligations

with third-party lenders on acceptable terms.

Certain customers have been experiencing financial difficulties and have failed to meet their financial obligations. As a result, we have

incurred charges for increased provisions related to certain trade and customer financing receivables. If there are further increases in the failure

of our customers to meet their customer financing and receivables obligations to us or if the assumptions underlying the amount of provisions

we have taken with respect to customer financing and receivables obligations do not reflect actual future financial conditions and customer

payment levels, we could incur losses in excess of our provisions, which could have a material adverse effect on our cash flow and operating

results.

Negative developments associated with our supply contracts and contract manufacturing agreements may materially and adversely

affect our business, results of operations, financial condition and supply relationships.

We have entered into supply contracts with customers to provide products and services, which in some cases involve new

109

technologies currently being developed, or which we have not yet commercially deployed, or which require us to build networks. Some of

these supply contracts contain delivery and installation timetables, performance criteria and other contractual obligations which, if not met,

could result in our having to pay substantial penalties or liquidated damages and/or the termination of the supply contract. Unexpected

developments in these supply contracts could have a material adverse effect on our revenues, cash flows and relationships with our customers.

Our ability to meet customer demand is, in part, dependent on us obtaining timely and adequate component parts and products from suppliers,

contract manufacturers, and internal manufacturing capacity. As part of the transformation of our supply chain from a vertically integrated

manufacturing model to a virtually integrated model, we have outsourced substantially all of our manufacturing capacity to contract

manufacturers, including an agreement with Flextronics announced on June 29, 2004 regarding the divestiture of certain of our manufacturing

operations and related activities. The transfer to Flextronics of our optical design operations and related assets in Ottawa, Canada and

Monkstown, Northern Ireland was completed in the fourth quarter of 2004. The transfer of our manufacturing activities in Montreal, Canada is

expected to be completed in the first quarter of 2005. The balance of the divestiture is anticipated to close in the first half of 2005, subject to

completion of the required information and consultation processes with the relevant employee representatives. Upon the completion of the

divestiture, a significant portion of our supply chain will be concentrated with Flextronics. We work closely with our suppliers and contract

manufacturers to address quality issues and to meet increases in customer demand, when needed, and we also manage our internal

manufacturing capacity, quality, and inventory levels as required. However, we may encounter shortages of quality components and/or

products in the future. In addition, our component suppliers and contract manufacturers have experienced, and may continue to experience, a

consolidation in the industry and financial difficulties, both of which may result in fewer sources of components or products and greater

exposure to the financial stability of our suppliers. A reduction or interruption in component supply or external manufacturing capacity, a

significant increase in the price of one or more components, or excessive inventory levels could materially and negatively affect our gross

margins and our operating results and could materially damage customer relationships.

Many of our current and planned products are highly complex and may contain defects or errors that are detected only after

deployment in telecommunications networks, which could harm our reputation.

Our products are highly complex, and some of them can be fully tested only when deployed in telecommunications networks or with other

equipment. From time to time, our products have contained undetected defects, errors or failures. The occurrence of any defects, errors or

failures could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers or our customers’ end

users and other losses to us or to our customers or end users. Any of these occurrences could also result in the loss of or delay in market

acceptance of our products and loss of sales, which would harm our business and adversely affect our business, results of operations and

financial condition.

Our business may suffer if our strategic alliances are not successful.

We have entered into a number of strategic alliances with suppliers, developers and members in our industry to facilitate product compatibility,

encourage adoption of industry standards or to offer complementary product or service offerings to meet customer needs. In some cases, the

companies with which we have strategic alliances also compete against us in some of our business areas. If a member of a strategic alliance

fails to perform its obligations, if the relationship fails to develop as expected or if the relationship is terminated, we could experience delays in

product availability or impairment of our relationships with our customers.

In addition to the investigations and litigation arising out of our restatements, we are also subject to numerous class actions and other

lawsuits as well as lawsuits in the ordinary course of business.

In addition to the investigations and litigation arising out of our restatements, we are currently a defendant in numerous class actions and other

lawsuits, including lawsuits initiated on behalf of holders of our common shares, which seek damages of material and indeterminate amounts,

as well as lawsuits in the ordinary course of our business. In the future, we may be subject to similar litigation. The defense of these lawsuits

may divert our management’s attention, and we may incur significant expenses in defending these lawsuits (including substantial fees of

lawyers and other professional advisors and potential obligations to indemnify officers and directors who may be parties to such actions). In

addition, we may be required to pay judgments or settlements that could have a material adverse effect on our results of operations, financial

condition and liquidity.

110

Refer to “Market risk” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

111

ITEM 7A.

uantitative and

ualitative Disclosures about Market Risk

PART II

ITEM 8. Consolidated Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

112

PAGE

Report of Independent Registered Chartered Accountants F-1

Consolidated Statements of Operations F-2

Consolidated Balance Sheets F-3

Consolidated Statements of Changes in Equity and Comprehensive Income (Loss) F-4

Consolidated Statements of Cash Flows F-5

Notes to Consolidated Financial Statements F-6

*********

Quarterly Financial Data (Unaudited) F-92

REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS

To the Shareholders and Board of Directors of Nortel Networks Corporation

We have audited the accompanying consolidated balance sheets of Nortel Networks Corporation and its subsidiaries (“Nortel Networks”) as of

December 31, 2003 and 2002 and the related consolidated statements of operations, changes in equity and comprehensive income (loss) and

cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of Nortel

Networks management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those

standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An

audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall

financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Nortel Networks as of

December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended December

31, 2003 in conformity with accounting principles generally accepted in the United States of America.

As described in note 3 to the consolidated financial statements, the accompanying consolidated financial statements of Nortel Networks as of

December 31, 2002, and for the years ended December 31, 2002 and 2001 have been restated.

As described in note 4 to the consolidated financial statements, effective January 1, 2003, Nortel Networks changed its method of accounting

for stock-based compensation and asset retirement obligations, in accordance with Statement of Financial Accounting Standards (“SFAS”)

SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”, and SFAS No. 143, “Accounting for Asset

Retirement Obligations”, respectively. Also, as described in note 4, effective January 1, 2002, Nortel Networks changed its method of

accounting for goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”.

On January 10, 2005, we reported separately to the Shareholders of Nortel Networks on consolidated financial statements for the same periods,

audited in accordance with Canadian generally accepted auditing standards and prepared in accordance with Canadian generally accepted

accounting principles.

/s/ Deloitte & Touche LLP

Independent Registered Chartered Accountants

Toronto, Canada

January 10, 2005

F-1

NORTEL NETWORKS CORPORATION

Consolidated Statements of Operations for the years ended December 31

* See note 3

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

F-2

(millions of U.S. dollars, except per share amounts) 2003 2002 2001

As restated * As restated *

Revenues $10,193 $11,008 $18,900

Cost of revenues 5,852 7,103 14,612

Gross profit 4,341 3,905 4,288

Selling, general and administrative expense 1,939 2,553 6,111

Research and development expense 1,960 2,083 3,116

In-process research and development expense

–

–15

Amortization of intan

ibles

Acquired technology and other 101 157 806

Goodwill

–

–4,058

Deferred stock option compensation 16 110 248

Special charges

Goodwill impairment

–

595 11,426

Other special charges 284 1,500 3,390

(Gain) loss on sale of businesses and assets (4) (21) 138

Operating earnings (loss) 45 (3,072)(25,020)

Other income (expense) — net 445 (5) (506)

Interest expense

Long-term debt (181) (220) (208)

Othe

(28)(52)(103)

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of associated

com

anies 281 (3,349) (25,837)

Income tax benefit (expense) 80 468 2,751

361 (2,881) (23,086)

Minority interests — net of tax (63) 5 (34)

Equity in net loss of associated companies — net of tax (36) (17) (150)

Net earnings (loss) from continuing operations 262 (2,893)(23,270)

Net earnings (loss) from discontinued operations — net of tax 184 (101) (2,467)

Net earnings (loss) before cumulative effect of accounting changes 446 (2,994)(25,737)

Cumulative effect of accounting changes — net of tax (12) – 15

Net earnings (loss) $434 $(2,994) $ (25,722)

Basic earnings (loss) per common share

— from continuing operations $0.06 $(0.75) $ (7.30)

— from discontinued operations 0.04 (0.03) (0.78)

Basic earnings (loss) per common share $0.10 $(0.78) $ (8.08)

Diluted earnings (loss) per common share

— from continuing operations $0.06 $(0.75) $ (7.30)

— from discontinued operations 0.04 (0.03) (0.78)

Diluted earnings (loss) per common share $0.10 $(0.78) $ (8.08)

Dividends declared

er common share $

–

$ 0.0375

NORTEL NETWORKS CORPORATION

Consolidated Balance Sheets as of December 31

* See note 3

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

F-3

(millions of U.S. dollars) 2003 2002

As restated *

ASSETS

Current assets

Cash and cash equivalents $3,997 $3,790

Restricted cash and cash equivalents 63 249

Accounts receivable

—

2,505 2,228

Inventories — net 1,190 1,506

Income taxes recoverable 90 114

Deferred income taxes — net 369 790

Other current assets 315 650

Total current assets 8,529 9,327

Investments 244 237

Plant and equipment — net 1,656 1,692

Goodwill 2,305 2,199

Intangible assets — net 86 139

Deferred income taxes — net 3,397 2,582

Other assets 374 785

Total assets $16,591 $16,961

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities

Notes

able $17$ 30

Trade and other accounts payable 861 803

Payroll and benefit-related liabilities 764 485

Contractual liabilities 530 894

Restructuring 206 507

Other accrued liabilities 2,505 3,257

Long-term debt due within one year 119 243

Total current liabilities 5,002 6,219

Long-term debt 3,891 3,960

Deferred income taxes — net 191 337

Other liabilities 2,945 2,761

Total liabilities 12,029 13,277

Minority interests in subsidiary companies 617 631

Commitments and contingencies (notes 14 and 22)

SHAREHOLDERS’ EQUITY

Common shares, without par value — Authorized shares: unlimited;

Issued and outstanding shares: 4,166,714,475 for 2003 and 3,844,171,700 for 2002 33,674 33,234

Additional paid-in capital 3,341 3,753

Deferred stock option compensation –(17)

Accumulated deficit (32,532)(32,966)

Accumulated other comprehensive loss (538) (951)

Total shareholders’ equity 3,945 3,053

Total liabilities and shareholders’ equity $ 16,591 $ 16,961

NORTEL NETWORKS CORPORATION

Consolidated Statements of Changes in Equity and Comprehensive Income (Loss)

* See note 3

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

F-4

(millions of U.S. dollars) 2003 2002 2001

As restated * As restated *

Common shares

Balance at the beginning of the year $ 33,234 $ 32,245 $ 29,141

Common shares issued (cancelled) — net 3863 207

Conversion of prepaid forward purchase contracts 413 1 –

Common shares issued (cancelled) related to ac

uisitions — ne

(11)(12)2,509

Fair value and costs associated with assumed options and stock purchase plans 35 137 388

Balance at the end of the year 33,674 33,234 32,245

Additional

aid-in ca

ital

Balance at the beginning of the year 3,753 3,256 3,637

Adjustments as of January 1, 2001 due to restatement *

–

–(10)

Additions resulting from acquisition related share cancellations 11 12 10

Prepaid forward purchase contracts issued

–

623 –

Prepaid forward purchase contracts settled (413)(1) –

Fair value and costs associated with assumed options and stock purchase plans (35) (137) (401)

Stock option compensation 26 – –

Cancellation of deferred stock options (1) (13) (85)

Tax benefit associated with stock options

–

13 105

Balance at the end of the year 3,341 3,753 3,256

Deferred stock option compensation

Balance at the beginning of the year (17) (140) (413)

Adjustments as of January 1, 2001 due to restatement *

–

–(56)

Additions resulting from acquisitions

–

–(8)

Amortization of deferred stock o

tion com

ensatio

16 110 252

Cancellation of deferred stock options 11385

Balance at the end of the

ear

–

(17)(140)

Accumulated deficit

Balance at the be

innin

of the

(32,966)(29,972)(2,695)

Adjustments as of January 1, 2001 due to restatement *

–

– (1,432)

Net earnings (loss) 434 (2,994)(25,722)

Dividends on common shares

–

– (123)

Balance at the end of the year (32,532)(32,966)(29,972)

Accumulated other comprehensive loss

Balance at the beginning of the year (951)(581)(499)

Adjustments as of January 1, 2001 due to restatement *

–

–189

Foreign currency translation adjustment 529 157 (134)

Unrealized gain (loss) on investments — net 57 19 (39)

Unrealized derivative gain (loss) on cash flow hedges — net 15 11 (7)

Minimum pension liability adjustment — net (188) (557) (84)

Cumulative effect of accounting change — net

–

–(7)

Other comprehensive income (loss) 413 (370) (271)

Balance at the end of the year (538)(951)(581)

Total shareholders’ equity $ 3,945 $ 3,053 $ 4,808

Total comprehensive income (loss) for the year

Net earnings (loss) $ 434 $ (2,994) $ (25,722)

Other comprehensive income (loss) 413 (370)(271)

Total comprehensive income (loss) for the year $ 847 $ (3,364) $ (25,993)

NORTEL NETWORKS CORPORATION

Consolidated Statements of Cash Flows for the years ended December 31

* See note 3

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

F-5

(millions of U.S. dollars) 2003 2002 2001

As restated * As restated *

Cash flows from (used in) operating activities

Net earnings (loss) from continuing operations $ 262 $ (2,893) $ (23,270)

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 de

reciation 541 701 5,665

In-process research and development expense

–

–15

Non-cash portion of special charges and related asset write downs 87 1,142 12,760

Equity in net loss of associated companies 36 17 150

Current and deferred stock option compensation 42 110 248

Deferred income taxes (50)(425)(1,513)

Other liabilities 161 (2) (9)

(Gain) loss on repurchases of outstanding debt securities (4)(60) –

(Gain) loss on sale or write down of investments and businesses (51) 18 506

Other — net (786)(191)(1,529)

Change in operating assets and liabilities (153) 815 7,183

Net cash from (used in) operating activities of continuing operations 85 (768)206

Cash flows from (used in) investing activities

Expenditures for plant and equipment (172)(352)(1,302)

Proceeds on disposals of plant and equipment 38 406 208

uisitions of investments and businesses

—

net of cash ac

uired (58)(29)(79)

Proceeds on sale of investments and businesses 107 104 604

Net cash from (used in) investing activities of continuing operations (85)129 (569)

Cash flows from (used in) financin

activities

Dividends on common shares

–

–(123)

Dividends paid by subsidiaries to minority interests (35) (26) (27)

Increase (decrease) in notes payable — net (45)(333)(230)

Proceeds from long-term debt

–

33 3,286

Repayments of long-term debt (270)(611)(470)

Repayments of capital leases payable (12) (17) (26)

Issuance of common shares 3863 146

Issuance of prepaid forward purchase contracts

–

623 –

Net cash from (used in) financing activities of continuing operations (359)532 2,556

Effect of foreign exchange rate changes on cash and cash equivalents 176 74 (10)

Net cash from (used in) continuing operations (183)(33)2,183

Net cash from (used in) discontinued operations 390 349 (331)

Net increase (decrease) in cash and cash equivalents 207 316 1,852

Cash and cash equivalents at beginning of year 3,790 3,474 1,622

Cash and cash equivalents at end of year $3,997 $3,790 $3,474

NORTEL NETWORKS CORPORATION

Notes to Consolidated Financial Statements

(millions of U.S. dollars, except per share amounts, unless otherwise stated)

F-6

ortel Networks Cor

oration

Nortel Networks Corporation (“Nortel Networks”) is a recognized leader in delivering communications capabilities, serving both service

provider and enterprise customers. Nortel Networks delivers innovative technology solutions encompassing end-to-end broadband, Voice

over IP, multimedia services and applications, and wireless broadband solutions. Nortel Networks business consists of the design,

development, manufacture, assembly, marketing, sale, licensing, installation, servicing and support of these networking solutions. A

substantial portion of Nortel Networks business has a technology focus and is dedicated to research and development.

For 2003, Nortel Networks operations were organized into four reportable segments consisting of Wireless Networks, Enterprise

Networks, Wireline Networks and Optical Networks. See note 6 for information concerning a change in Nortel Networks organizational

structure in 2004.

The common shares of Nortel Networks Corporation are publicly traded on the New York Stock Exchange (“NYSE”) and Toronto Stock

Exchange (“TSX”) under the symbol “NT”. Nortel Networks Limited (“NNL”) is Nortel Networks principal direct operating subsidiary

and its results are consolidated into Nortel Networks results. Nortel Networks holds all of NNL’s outstanding common shares but none of

its outstanding preferred shares. NNL’s preferred shares are reported in minority interests in subsidiary companies in the consolidated

balance sheets and dividends and the related taxes on preferred shares are reported in minority interests — net of tax in the consolidated

statements of operations.

.Si

icant accountin

olicies

Basis of

resentation

The consolidated financial statements of Nortel Networks have been prepared in accordance with accounting principles generally

accepted in the United States (“U.S.”) (“GAAP”) and the rules and regulations of the U.S. Securities and Exchange Commission (the

“SEC”) for the preparation of financial statements. Although Nortel Networks is headquartered in Canada, the consolidated financial

statements are expressed in U.S. dollars as the greater part of the financial results and net assets of Nortel Networks are denominated in

U.S. dollars.

As described in note 3, the consolidated statements of operations, changes in equity and comprehensive income (loss) and cash flows for

the years ended December 31, 2002 and 2001 and the consolidated balance sheet as of December 31, 2002, including the applicable

notes, were restated.

(a)

rinci

les o

consolidation

The financial statements of entities which are controlled by Nortel Networks through voting equity interests, referred to as

subsidiaries, are consolidated. Entities which are jointly controlled, referred to as joint ventures, and entities which are not

controlled but over which Nortel Networks has the ability to exercise significant influence, referred to as associated companies, are

accounted for using the equity method. Variable Interest Entities (“VIEs”) (which include, but are not limited to, special purpose

entities, trusts, partnerships, certain joint ventures and other legal structures), as defined by the Financial Accounting Standards

Board (“FASB”) in FASB Interpretation (“FIN”) No. 46 (Revised 2003), “Consolidation of Variable Interest Entities — an

Interpretation of Accounting Research Bulletin No. 51” (“FIN 46R”), are entities in which equity investors do not have the

characteristics of a “controlling financial interest” or there is not sufficient equity at risk for the entity to finance its activities

without additional subordinated financial support. VIEs are consolidated by Nortel Networks when it is determined that it will, as

the primary beneficiary, absorb the majority of the VIEs expected losses and/or expected residual returns. Intercompany accounts

and transactions are eliminated upon consolidation and unrealized intercompany gains and losses are eliminated when accounting

under the equity method.

(b) Use of estimates

Nortel Networks makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of

contingent assets and liabilities as of the date of the consolidated financial statements and the reported

F-7

amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Estimates are used

when accounting for items and matters such as revenue recognition, allowances for uncollectible accounts receivable and customer

financing, receivables sales, inventory obsolescence, product warranty, amortization, asset valuations, impairment assessments,

employee benefits including pensions, taxes, restructuring and other provisions, in-process research and development (“IPR&D”),

stoc

-based compensation and contingencies.

orei

n currencies

The consolidated financial statements of Nortel Networks are presented in U.S. dollars. The financial statements of Nortel

Networks operations whose functional currency is not the U.S. dollar (except for highly inflationary economies as described below)

are translated into U.S. dollars at the exchange rates in effect at the balance sheet dates for assets and liabilities, and at average rates

for the period for revenues and expenses. The unrealized translation gains and losses on Nortel Networks net investment in these

operations, including long-term intercompany advances considered to form part of the net investment, are accumulated as a

component of other comprehensive income (loss) (“OCI”).

Transactions and financial statements for Nortel Networks operations in countries considered to have highly inflationary economies

and whose functional currency is not the U.S. dollar are translated into U.S. dollars at the exchange rates in effect at the balance

sheet dates for monetary assets and liabilities, and at historical exchange rates for non-monetary assets and liabilities. Revenue and

expenses are translated at average rates for the period, except for amortization and depreciation which are translated on the same

basis as the related assets. Resulting translation gains or losses are reflected in net earnings (loss).

When appropriate, Nortel Networks may hedge a designated portion of the exposure to foreign exchange gains and losses incurred

on the translation of specific foreign operations. Hedging instruments used by Nortel Networks can include foreign currency

denominated debt, foreign currency swaps and foreign currency forward contracts that are denominated in the same currency as the

hedged foreign operations. The translation gains and losses on the effective portion of the hedging instruments that qualify for

hedge accounting are recorded in OCI; other translation gains and losses are recorded in net earnings (loss).

(d)

evenue reco

nition

Nortel Networks products and services are generally sold as part of a contract and the terms of the contracts, taken as a whole,

determine the appropriate revenue recognition methods.

Depending upon the terms of the contract and types of products and services sold, Nortel Networks recognizes revenue under

American Institute of Certified Public Accountants Statement of Position (“SOP”) 81-1, “Accounting for Performance of

Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”), SOP 97-2, “Software Revenue Recognition” (“SOP 97-

2”), and SEC Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition” (“SAB 104”), which was preceded by SAB 101,

“Revenue Recognition in Financial Statements” (“SAB 101”). Revenue is recognized net of cash discounts and allowances.

Effective July 1, 2003, for contracts involving multiple deliverables, where the deliverables are governed by more than one

authoritative accounting standard, Nortel Networks generally applies the FASB Emerging Issues Task Force (“EITF”) Issue

No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”), and evaluates each deliverable to determine

whether it represents a separate unit of accounting based on the following criteria: (a) whether the delivered item has value to the

customer on a standalone basis, (b) whether there is objective and reliable evidence of the fair value of the undelivered item(s), and

(c) if the contract includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s)

is considered probable and substantially in the control of Nortel Networks. If objective and reliable evidence of fair value exists for

all units of accounting in the contract, revenue is allocated to each unit of accounting or element based on relative fair values. In

situations where there is objective and reliable evidence of fair value for all undelivered elements, but not for delivered elements,

the residual method is used to allocate the contract consideration. Under the residual method, the amount of revenue allocated to

delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements. Each unit

of accounting is then accounted for under the applicable revenue recognition guidance.

F-8

For arrangements that include hardware and software where software is considered more than incidental to the hardware, provided

that the software is not essential to the functionality of the hardware and the hardware and software represent separate units of

accounting, revenue related to the software element is recognized under SOP 97-2 and revenue related to the hardware element is

recognized under SOP 81-1 or SAB 104. For arrangements where the software is considered more than incidental and essential to

the functionality of the hardware, or where the hardware is not considered a separate unit of accounting from the software

deliverables, revenue is recognized for the software and the hardware as a single unit of accounting pursuant to SOP 97-2 for off-

the-shelf products and pursuant to SOP 81-1 for customized products.

Prior to July 1, 2003, for contracts involving multiple elements, Nortel Networks allocated revenue to each element based on the

relative fair value or the residual method, as applicable. Provided none of the undelivered elements are essential to the functionality

of the delivered elements, revenue related to the software element is recognized under SOP 97-2 and revenue related to the

hardware element is recognized under SOP 81-1 or SAB 101.

For accounting units related to customized network solutions and certain network build outs, revenues are recognized under SOP

81-1 using the percentage-of-completion method. In using the percentage-of-completion method, revenues are generally recorded

based on a measure of the percentage of costs incurred to date on a contract relative to the estimated total expected contract costs.

Profit estimates on long-term contracts are revised periodically based on changes in circumstances and any losses on contracts are

recognized in the period that such losses become known. Generally, the terms of long-term contracts provide for progress billing

based on completion of certain phases of work. Contract revenues recognized, based on costs incurred towards the completion of

the project, that are unbilled are accumulated in the contracts in progress account included in accounts receivable — net. Billings in

excess of revenues recognized to date on long-term contracts are recorded as advance billings in excess of revenues within other

accrued liabilities.

Revenue for hardware that does not require significant customization, and where any software is considered incidental, is

recognized under SAB 104. Under SAB 104, revenue is recognized provided that persuasive evidence of an arrangement exists,

delivery has occurred or services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured. For

hardware, delivery is considered to have occurred upon shipment provided that risk of loss, and title in certain jurisdictions, have

been transferred to the customer.

Engineering, installation and other service revenues are recognized as the services are performed.

Nortel Networks makes certain sales through multiple distribution channels, primarily resellers and distributors. These customers

are generally given certain rights of return. For products sold through these distribution channels, revenue is recognized from

product sale at the time of shipment to the distribution channel when persuasive evidence of an arrangement exists, delivery has

occurred, the fee is fixed or determinable and collection is reasonably assured. Accruals for estimated sales returns and other

allowances are recorded at the time of revenue recognition and are based on contract terms and prior claims experience.

Software revenue is generally recognized under SOP 97-2. For software arrangements involving multiple elements, Nortel

Networks allocates revenue to each element based on the relative fair value or the residual method, as applicable, and using vendor

specific objective evidence of fair values, which is based on prices charged when the element is sold separately. Software revenue

accounted for under SOP 97-2 is recognized when: persuasive evidence of an arrangement exists; the software is delivered in

accordance with all terms and conditions of the customer contracts; the fee is fixed or determinable; and collection is reasonably

assured. Revenue related to post-contract support, including technical support and unspecified when-and-if available software

upgrades (“PCS”), is recognized ratably over the PCS term. Nortel Networks provides extended payment terms on certain software

contracts and may sell these receivables to third parties. The fees on these contracts are considered fixed or determinable if the

contracts are similar to others for which Nortel Networks has a standard business practice of providing extended payment terms and

has a history of successfully collecting under the original payment terms without making concessions.

Under SAB 104 or SOP 97-2, if fair value does not exist for any undelivered element, revenue is not recognized until the earlier of

(i) the undelivered element is delivered or (ii) fair value of the undelivered element exists, unless the undelivered element is a

service, in which case revenue is recognized as the service is performed once the service is the only undelivered element.

(e)

esearch and develo

ment

F-9

Research and development (“R&D”) costs are charged to net earnings (loss) in the periods in which they are incurred. However,

costs incurred pursuant to specific contracts with third parties for which Nortel Networks is obligated to deliver a product are

charged to cost of revenues in the same period as the related revenue is recognized. Related global investment tax credits are

deducted from the income tax provision.

(f)

ncome taxes

Nortel Networks provides for income taxes using the asset and liability method. This approach recognizes the amount of taxes

payable or refundable for the current year as well as deferred tax assets and liabilities for the future tax consequence of events

recognized in the consolidated financial statements and tax returns. Deferred income taxes are adjusted to reflect the effects of

changes in tax laws or enacted tax rates.

In establishing the appropriate income tax valuation allowances, Nortel Networks assesses the realizability of its net deferred tax

assets quarterly and based on all available evidence, both positive and negative, determines whether it is more likely than not that

the remaining net deferred tax assets or a portion thereof will be realized.

(

)

arnin

s(loss)

er common share

Basic earnings (loss) per common share is calculated by dividing the net earnings (loss) by the weighted-average number of Nortel

Networks Corporation’s common shares outstanding during the period. Diluted earnings (loss) per common share is calculated by

dividing the applicable net earnings (loss) by the sum of the weighted-average number of common shares outstanding and all

additional common shares that would have been outstanding if potentially dilutive common shares had been issued during the

period. The treasury stock method is used to compute the dilutive effect of warrants, options and similar instruments. The if-

converted method is used to compute the dilutive effect of convertible debt. A comparison of the conditions required for issuance of

shares compared to those existing at the end of the period is used to compute the dilutive effect of contingently issuable shares.

(h) Cash and cash equivalents

Cash and cash equivalents consist of cash on hand, balances with banks and short-term investments. All highly liquid investments

with original maturities of three months or less are classified as cash and cash equivalents. The fair value of cash and cash

equivalents approximates the amounts shown in the consolidated financial statements.

(i)

estricted cash and cash e

uivalents

Cash and cash equivalents are considered restricted when they are subject to contingent rights of a third party customer under bid,

performance related and other bonds associated with contracts that Nortel Networks is not able to unilaterally revoke.

(

)

rovision

or doubt

ul accounts

The provision for doubtful accounts for trade, notes and long-term receivables due from customers is established based on an

assessment of a customer’s credit quality, as well as subjective factors and trends, including the aging of receivable balances.

Generally, these credit assessments occur prior to the inception of the credit exposure and at regular reviews during the life of the

exposure.

Customer financing receivables include receivables from customers with deferred payment terms. Customer financing receivables

are considered impaired when they are classified as non-performing, payment arrears exceed 90 days or a major credit event such as

a material default has occurred, and management determines that collection of amounts due according to the contractual terms is

doubtful. Provisions for impaired customer financing receivables are recorded based on the expected recovery of defaulted

customer obligations, being the present value of expected cash flows, or the realizable value of the collateral if recovery of the

receivables is dependent upon a liquidation of the assets. Interest income on impaired customer finance receivables is recognized as

the cash payments are collected.

(k)

nventories

F-10

Inventories are valued at the lower of cost (calculated generally on a first-in, first-out basis) or market. The cost of finished goods

and work in process is comprised of material, labor and manufacturing overhead. Provisions for inventory are based on estimates of

future customer demand for products, including general economic conditions, growth prospects within the customer’s ultimate

marketplaces and market acceptance of current and pending products. In addition, full provisions are generally recorded for surplus

inventory in excess of one year’s forecast demand or inventory deemed obsolete.

(l)

eceivables sales

Transfers of accounts receivable that meet the criteria for surrender of control under FASB Statement of Financial Accounting

Standard (“SFAS”) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, are

accounted for as sales. Generally, Nortel Networks retains servicing rights and, in some cases, provides limited recourse when it

sells receivables. A gain or loss is recorded in other income (expense) — net at the date of the receivables sale and is based upon, in

part, the previous carrying amount of the receivables involved in the transfer allocated between the assets sold and the retained

interests based on their relative fair value at the date of the transfer. Fair value is generally estimated based on the present value of

the estimated future cash flows expected under management’s assumptions, including discount rates assigned commensurate with

risks. Retained interests are classified as available-for-sale securities.

Nortel Networks, when acting as the servicing agent, generally does not record an asset or liability related to servicing as the annual

servicing fees are equivalent to those that would be paid to a third party servicing agent. Certain transactions will enable Nortel

Networks, when acting as the servicing agent, to receive a servicing bonus at the maturity of the transaction if certain performance

criteria are met. The ultimate collection of servicing bonuses is based primarily on the collectibility and credit experience of the

receivables sold and is sometimes paid at the discretion of the transferee. Nortel Networks initially records the non-discretionary

servicing bonus at fair value which is the discounted value of the estimated future cash flows taking into consideration future

estimated interest rates and credit losses. Generally, the discretionary servicing bonus is initially recorded at a fair value of nil due

to the fact that it is paid at the discretion of the transferee and based on the determination that future credit losses will offset any

such servicing bonus.

Nortel Networks reviews the fair value assigned to retained interests, including the servicing bonus, at each reporting date

subsequent to the date of the transfer to determine if there is an other than temporary impairment. Fair value is reviewed using

similar valuation techniques as those used to initially measure the retained interest and, if a change in events or circumstances

warrants, the fair value is adjusted and any other than temporary impairments are recorded in other income (expense)

—

net.

(m)

nvestments

Investments in publicly traded equity securities of companies over which Nortel Networks does not exert significant influence are

accounted for at fair value and are classified as available for sale. Unrealized holding gains and losses related to these securities are

excluded from net earnings (loss) and are included in OCI until such gains or losses are realized.

Investments in equity securities of private companies over which Nortel Networks does not exert significant influence are

accounted for using the cost method. Investments in associated companies and joint ventures are accounted for using the equity

method. An impairment loss is recorded when there has been a loss in value of the investment that is other than temporary.

Nortel Networks monitors its investments for factors indicating other than temporary impairment and records a charge to net

earnings (loss) when appropriate.

(n)

lant and e

ment

Plant and equipment are stated at cost less accumulated depreciation. Depreciation is generally calculated on a straight-line basis

over the expected useful lives of the plant and equipment. The expected useful lives of buildings are twenty to forty years, and of

machinery and equipment are five to ten years.

(o)

airment or dis

osal o

lon

-lived assets (

lant and e

ment and ac

uired technolo

)

F-11

-lived assets held and used

Nortel Networks tests long-lived assets or asset groups held and used for recoverability when events or changes in circumstances

indicate that their carrying amount may not be recoverable. Circumstances which could trigger a review include, but are not limited

to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; the

accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset;

current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the

use of the asset; and a current expectation that the asset will more likely than not be sold or disposed of significantly before the end

of its estimated useful life.

Recoverability is assessed based on the carrying amount of the asset and the sum of the undiscounted cash flows expected to result

from the use and the eventual disposal of the asset or asset group. An impairment loss is recognized when the carrying amount is

not recoverable and exceeds the fair value of the asset or asset group. The impairment loss is measured as the amount by which the

carrying amount exceeds fair value.

-lived assets held

or sale

Long-lived assets are classified as held for sale when certain criteria are met, which include: management’s commitment to a plan

to sell the assets; the availability of the assets for immediate sale in their present condition; whether an active program to locate

buyers and other actions to sell the assets have been initiated; whether the sale of the assets is probable and their transfer is expected

to qualify for recognition as a completed sale within one year; whether the assets are being marketed at reasonable prices in relation

to their fair value; and how unlikely it is that significant changes will be made to the plan to sell the assets.

Nortel Networks measures long-lived assets to be disposed of by sale at the lower of carrying amount or fair value less cost to sell.

These assets are not depreciated. Fair value is determined using quoted market prices or the anticipated cash flows discounted at a

rate commensurate with the risk involved.

-lived assets to be dis

osed o

other than b

sale

Nortel Networks classifies assets that will be disposed of other than by sale as held and used until the disposal transaction occurs.

The assets continue to be depreciated based on revisions to their estimated useful lives until the date of disposal or abandonment.

Recoverability is assessed based on the carrying amount of the asset and the sum of the undiscounted cash flows expected to result

from the remaining period of use and the eventual disposal of the asset or asset group. An impairment loss is recognized when the

carrying amount is not recoverable and exceeds the fair value of the asset or asset group. The impairment loss is measured as the

amount by which the carrying amount exceeds fair value.

(

) Goodwill

Goodwill represents the excess of the purchase price of an acquired enterprise over the fair value of the identifiable assets acquired

and liabilities assumed. Nortel Networks tests for impairment of goodwill on an annual basis as of October 1 and at any other time

if events occur or circumstances change that would indicate that it is more likely than not that the fair value of the reporting unit has

been reduced below its carrying amount (see note 4(k)).

Circumstances that could trigger an impairment test include: a significant adverse change in the business climate or legal factors; an

adverse action or assessment by a regulator; unanticipated competition; the loss of key personnel; the likelihood that a reporting

unit or significant portion of a reporting unit will be sold or otherwise disposed of; the results of testing for recoverability of a

significant asset group within a reporting unit; and the recognition of a goodwill impairment loss in the financial statements of a

subsidiary that is a component of a reporting unit.

The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with

its carrying amount, including the goodwill allocated to the reporting unit. Measurement of the fair value of a reporting unit is based

on one or more fair value measures including present value techniques of estimated future cash flows and estimated amounts at

which the unit as a whole could be bought or sold in a current transaction between willing parties. Nortel Networks also considers

its market capitalization as of the date of the impairment test. If the carrying amount of the reporting unit exceeds the fair value,

step two requires the fair value

F-12

of the reporting unit to be allocated to the underlying assets and liabilities of that reporting unit, resulting in an implied fair value of

goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss

equal to the excess is recorded in net earnings (loss).

(q)

ntangible assets

Acquired technology represents the value of the proprietary know-how which was technologically feasible as of the acquisition

date, and is charged to net earnings (loss) on a straight-line basis over its estimated useful life of two to three years. Other intangible

assets are amortized into net earnings (loss) based on their expected pattern of benefit to future periods using estimates of

undiscounted cash flows.

IPR&D represents the value, on closing of a business combination, of acquired research and development which was not

technologically feasible as of the acquisition date and, other than its intended use, had no alternative future use. Independent

valuations are performed to assess and allocate a value to IPR&D. The value allocated to IPR&D represents the estimated fair value

based on risk-adjusted future cash flows generated from the products that would result from each of the in-process projects.

Estimated future after tax cash flows of each project, on a product by product basis, are based on Nortel Networks estimates of

revenues less operating expenses, cash flow adjustments, income taxes and charges for the use of contributory assets. Future cash

flows are also adjusted for the value contributed by any core technology and development efforts that would be completed post-

acquisition. IPR&D is charged to net earnings (loss) as of the date of acquisition.

(r) Warrant

costs

As part of the normal sale of product, Nortel Networks provides its customers with product warranties that extend for periods

generally ranging from one to six years from the date of sale. A liability for the expected cost of warranty-related claims is

established when products are sold. In estimating warranty liability, historical material replacement costs and the associated labor to

correct the product defect are considered. Revisions are made when actual experience differs materially from historical experience.

Known product defects are specifically accrued for as Nortel Networks becomes aware of such defects.

(s)

ension,

ost-

etirement and

ost-em

ment bene

its

Pension expense, based on management’s assumptions, consists of the: actuarially computed costs of pension benefits in respect of

the current year’s service; imputed returns on plan assets and imputed interest on pension obligations; and straight-line amortization

under the corridor approach of experience gains and losses, assumption changes and plan amendments over the expected average

remaining service life of the employee group.

The expected costs of post-retirement and certain post-employment benefits, other than pensions, for active employees are accrued

in the consolidated financial statements during the years employees provide service to Nortel Networks. These costs are recorded

based on actuarial methods and assumptions. Other post-employment benefits are recognized when the event triggering the

obligation occurs.

(t)

erivative

inancial instruments

F-13

Nortel Networks net earnings (loss) and cash flows may be negatively impacted by fluctuating interest rates, foreign exchange rates

and equity prices. To effectively manage these market risks, Nortel Networks enters into foreign currency forward contracts,

foreign currency swaps, foreign currency option contracts, interest rate swaps and equity forward contracts. Nortel Networks does

not hold or issue derivative instruments for trading purposes. Nortel Networks policy is to formally document all relationships

between hedging instruments and hedged items, as well as its risk management objectives and strategy for undertaking various

hedge transactions. Where hedge accounting will be applied, this process includes linking all derivatives to specific assets and

liabilities on the consolidated balance sheet or to specific firm commitments or forecasted transactions. Nortel Networks also

formally assesses, both at the hedge’s inception and on an ongoing basis, as applicable, whether the derivatives that are used in

hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

For a derivative designated as a fair value hedge, changes in the fair value of the derivative and of the hedged item attributable to

the hedged risk are recognized in net earnings (loss). For a derivative designated as a cash flow hedge, the effective portions of

changes in the fair value of the derivative are recorded in OCI and are recognized in net earnings (loss) when the hedged item

affects net earnings (loss). Ineffective portions of changes in the fair value of cash flow hedges are recognized in other income

(expense) — net. If the derivative used in an economic hedging relationship is not designated in an accounting hedging relationship

or if it has become ineffective, changes in the fair value of the derivative are recognized in net earnings (loss).

When a cash flow or fair value hedging relationship is terminated because the derivative is sold, terminated or de-designated as a

hedge, the accumulated OCI balance to the termination date or the fair value basis adjustment recorded on the hedged item is

amortized into other income (expense) — net or interest expense on an effective yield basis over the original term of the hedging

relationship. If a cash flow or fair value hedging relationship is terminated because the underlying hedged item is repaid or is sold,

or it is no longer probable that the hedged forecasted transaction will occur, the accumulated balance in OCI or the fair value basis

adjustment recorded on the hedged item is recorded immediately in net earnings (loss).

Nortel Networks generally classifies cash flows resulting from its derivative financial instruments in the same manner as the cash

flows from the item that the derivative is hedging. Typically, this is within cash flows from (used in) operating activities in the

consolidated statements of cash flows, or, for derivatives designated as hedges relating to the cash flows associated with settlement

of the principal component of long-term debt, within cash flows from (used in) financing activities.

Nortel Networks may also invest in warrants to purchase securities of other companies as a strategic investment or receive warrants

in various transactions. Warrants that relate to publicly traded companies or that can be net share settled are deemed to be derivative

financial instruments. Such warrants, however, are generally not eligible to be designated as hedging instruments as there is no

corresponding underlying exposure. In addition, Nortel Networks may enter into certain commercial contracts containing embedded

derivative financial instruments. Generally, for these embedded derivatives, for which the economic characteristics and risks are not

clearly and closely related to the economic characteristics and risks of the host contract, the changes in fair value are recorded in net

earnings (loss).

(u) Stock-

ased com

ensation

In December 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-

Based Compensation — Transition and Disclosure — an Amendment of FASB Statement No. 123” (“SFAS 148”), which amended

the transitional provisions of SFAS No. 123, “Accounting for Stock-based Compensation” (“SFAS 123”), for companies electing to

recognize employee stock-based compensation using the fair value based method.

Prior to January 1, 2003, Nortel Networks, as permitted under SFAS 123, applied the intrinsic value method under Accounting

Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations in

accounting for its employee stock-based compensation plans.

Effective January 1, 2003, Nortel Networks elected to expense employee stock-based compensation using the fair value based

method prospectively for all awards granted, modified, or settled on or after January 1, 2003. The fair value at grant date of stock

options is estimated using the Black-Scholes option-pricing model. Compensation expense is recognized on a straight line basis

over the stock option vesting period. The impact of the adoption of the

F-14

fair value based method for expense recognition of employee awards resulted in $26 (net of tax of nil) of stock option expense

during 2003.

Stock-based awards that are settled or may be settled in cash or shares purchased on the open market at the option of employees or

directors are recorded as liabilities. The measurement of the liability and compensation cost for these awards is based on the

intrinsic value of the award and is recorded in net earnings (loss) over the vesting period of the award. Changes in Nortel Networks

payment obligation subsequent to vesting of the award and prior to the settlement date are recorded in net earnings (loss) in the

period incurred. The payment amount is established for Stock Appreciation Rights (“SARs”) on the date of exercise of the award by

the employee, for Restricted Stock Units (“RSUs”) on the vesting date of the award and for Deferred Stock Units (“DSUs”) on the

later of the date of termination of employment and/or directorship. Stock-based awards which are substantively discretionary in

nature are recorded in the period that the issuance and settlement of the award is approved.

Nortel Networks has stock purchase plans for eligible employees in eligible countries, and a stock purchase plan for eligible

unionized employees in Canada (collectively, the “ESPPs”), to facilitate the acquisition of the common shares of Nortel Networks

Corporation at a discount. Nortel Networks contribution to the ESPPs is recorded as compensation expense on a quarterly basis as

the obligation to contribute is incurred.

Had Nortel Networks applied the fair value based method to all stock-based awards in all periods, reported net earnings (loss) and

earnings (loss) per common share would have been adjusted to the pro forma amounts indicated below for the following years

ended December 31:

2003 2002 2001

Net earnings (loss) — reported $434 $(2,994) $ (25,722)

Stock-based compensation — reported (a) 55 18 15

Deferred stock option compensation — reported (b) 16 79 151

Stock-based compensation — pro forma (c) (481) (1,149) (1,766)

Net earnin

s (loss)

—

ro forma $24 $(4,046) $ (27,322)

Basic earnings (loss) per common share:

Reported $0.10 $(0.78) $ (8.08)

Pro forma $0.01 $(1.06) $(8.58)

Diluted earnings (loss) per common share:

Reported $0.10 $(0.78) $(8.08)

Pro forma $0.01 $(1.06) $ (8.58)

(a) Stoc

-based compensation — reported, included, for the years ended December 31, 2003, 2002 and 2001:

i. Stock option expense of $26, nil and nil, respectively, which was net of tax of nil in each period;

ii. Employer portion of ESPPs contributions expense of $6, $6 and $12, respectively, which was net of tax of nil, $2 and $6,

respectively;

iii. RSUs expense of $19, $5 and $4, respectively, which was net of tax of nil, $1 and $2, respectively; and

iv. DSUs expense of $4, $7 and $(1), respectively, which was net of tax of nil, $3 and nil, 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 years ended

December 31, 2003, 2002 and 2001, the amounts were net of tax of nil, $31 and $97, respectively. In 2001, amortization of deferred

stock option compensation of $4 was included within discontinued operations.

(c) Stock-based compensation — pro forma expense for the years ended December 31, 2003, 2002 and 2001 was net of tax of nil, $170

and $484, respectively.

The following weighted-average assumptions were used in computing the fair value of stock options for purposes of expense recognition

and pro forma disclosures, as applicable, for the following periods:

2003 2002 2001

Black-Scholes weighted-average assumptions

Expected dividend yield 0.00% 0.00% 0.00%

ected volatilit

92.49%71.33%70.64%

Risk-free interest rate 2.81% 4.49% 4.74%

Expected option life in years 4 4 4

Weighted-average stock option fair value per option granted $1.57 $3.50 $8.38

F-15

(v)

ecent accountin

ronouncements

(i) On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “MPDIM Act”) was

signed into law in the U.S. The MPDIM Act introduced a prescription drug benefit under Medicare (specifically, Medicare Part

D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially

equivalent to Medicare Part D. As permitted by FASB Staff Position (“FSP”) Financial Accounting Standard (“FAS”) 106-1,

“Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of

2003”, Nortel Networks chose to make the one-time deferral election which remained in effect for its plans in the U.S. until the

earlier of the issuance of specific authoritative guidance by the FASB on how to account for the federal subsidy to be provided

to plan sponsors under the MPDIM Act, or the remeasurement of plan assets and obligations subsequent to January 31, 2004.

Therefore, Nortel Networks post-retirement benefit obligation as of December 31, 2003 and net post-retirement benefit cost for

the year ended December 31, 2003 did not reflect the effects of the MPDIM Act on the plans. On May 19, 2004, FSP FAS 106-

2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act

of 2003” (“FSP FAS 106-2”) was issued by the FASB to provide guidance relating to the prescription drug subsidy provided by

the MPDIM Act. Nortel Networks expects to have portions of its post-retirement benefit plans qualify as actuarially equivalent

to the benefit provided under the MPDIM Act, for which it expects to receive federal subsidies. Nortel Networks expects that

other portions of the plans will not be actuarially equivalent. The financial impact of the federal subsidies was determined by

remeasuring Nortel Networks retiree life and medical obligation as of January 1, 2004, as provided under the retroactive

application provision of FSP FAS 106-2. The effective date of FSP FAS 106-2 is the first annual or interim period beginning

after June 15, 2004, with earlier adoption encouraged. Nortel Networks adopted FSP FAS 106-2 for the three-month period

ended June 30, 2004. As a result of adoption, the accrued post-retirement benefit obligation decreased by $31. Net periodic

post-retirement benefit costs are expected to decrease by $2 for 2004, as a result of the subsidy.

(ii) In March 2004, the EITF reached consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its

Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides guidance on determining when an investment is

considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. EITF 03-1

is applicable to marketable debt and equity securities within the scope of SFAS No. 115, “Accounting for Certain Investments

in Debt and Equity Securities” (“SFAS 115”), and SFAS No. 124, “Accounting for Certain Investments Held by Not-for-Profit

Organizations”, and equity securities that are not subject to the scope of SFAS 115 and not accounted for under the equity

method of accounting. In September 2004, the FASB issued FSP EITF 03-1-1, “Effective Date of Paragraphs 10-20 of EITF

Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments””, which

delays the effective date for the measurement and recognition criteria contained in EITF 03-1 until final application guidance is

issued. The delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing

authoritative literature. The adoption of EITF 03-1 is not expected to have a material impact on Nortel Networks results of

operations and financial position.

(iii) On September 30, 2004, the EITF reached a consensus on Issue No. 04-8, “The Effect of Contingently Convertible Debt on

Diluted Earnings Per Share” (“EITF 04-8”), which addresses when the dilutive effect of contingently convertible debt

instruments should be included in diluted earnings (loss) per share. EITF 04-8 requires that contingently convertible debt

instruments be included in the computation of diluted earnings (loss) per share regardless of whether the market price trigger

has been met. EITF 04-8 also requires that prior period diluted earnings (loss) per share amounts presented for comparative

purposes be restated. EITF 04-8 is effective for reporting periods ending after December 15, 2004. The adoption of EITF 04-8

is not expected to have an impact on Nortel Networks diluted earnings (loss) per share.

Com

arative fi

ures

Certain 2002 and 2001 figures in the consolidated financial statements have been reclassified to conform to the 2003 presentation and

have been restated as set out in note 3.

F-16

estatement

First Restatemen

In May 2003, Nortel Networks commenced certain balance sheet reviews at the direction of certain members of former management that

led to a comprehensive review and analysis of its assets and liabilities (the “Comprehensive Review”), which resulted in the restatement

(effected in December 2003) of its consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the

quarters ended March 31, 2003 and June 30, 2003 (the “First Restatemen

”).

The Comprehensive Review purported to (i) identify balance sheet accounts that, as of June 30, 2003, were not supportable and required

adjustment; (ii) determine whether such adjustments related to the third quarter of 2003 or prior periods and (iii) document certain

account balances in accordance with Nortel Networks accounting policies and procedures. The Comprehensive Review as supplemented

by additional procedures carried out between July 2003 and November 2003 to quantify the effects of potential adjustments in the

relevant periods and review the appropriateness of releases of certain contractual liability and other related provisions (also called

accruals, reserves or accrued liabilities) in the six fiscal quarters ending with the fiscal quarter ended June 30, 2003 formed the basis for

the adjustments made to the financial statements in the First Restatement.

On December 23, 2003, Nortel Networks filed with the SEC an amended Annual Report on Form 10-K/A for the year ended

December 31, 2002 (the “2002 Form 10-K/A”) and amended Quarterly Reports on Form 10-Q/A for the first and second quarters of 2003

(the “2003 Form 10-Q/As”) reflecting the First Restatement. As disclosed in those reports, the net effect of the First Restatement

adjustments was a reduction in accumulated deficit of $497, $178 and $31 as of December 31, 2002, 2001 and 2000, respectively.

Second Restatemen

In late October 2003, the Audit Committee of Nortel Networks and NNL’s Boards of Directors (the “Audit Committee”) initiated an

independent review of the facts and circumstances leading to the First Restatement (the “Independent Review”) and engaged the law firm

now known as Wilmer Cutler Pickering Hale & Dorr LLP (“WCPHD”) to advise it in connection with the Independent Review. The

Audit Committee sought to gain a full understanding of the events that caused significant excess liabilities to be maintained on the

balance sheet that needed to be restated, and to recommend that the Board adopt, and direct management to implement, necessary

remedial measures to address personnel, controls, compliance and discipline. The Independent Review focused initially on events relating

to the establishment and release of contractual liability and other related provisions in the second half of 2002 and the first half of 2003,

including the involvement of senior corporate leadership. As the Independent Review evolved, its focus broadened to include specific

provisioning activities in each of the business units and geographic regions. In light of concerns raised in the initial phase of the

Independent Review, the Audit Committee expanded the review to include provisioning activities in the third and fourth quarters of 2003.

As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns

identified by WCPHD regarding provisioning activity and to review provision releases in each of the four quarters of 2003, down to a

low threshold. That examination, and other errors identified by management, led to the restatement of Nortel Networks consolidated

financial statements for the years ended December 31, 2002 and 2001 and the quarters ended March 31, 2003 and 2002, June 30, 2003

and 2002 and September 30, 2003 and 2002 (the “Second Restatement”).

Over the course of the Second Restatement process, management also identified certain accounting practices that it determined should be

adjusted as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and

undertook a process of revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit Committee has

determined to review the facts and circumstances leading to the restatement of these revenues for specific transactions identified in the

Second Restatement. This review will have a particular emphasis on the underlying conduct that led to the initial recognition of these

revenues. Other accounting practices that management examined and adjusted as part of the Second Restatement included, among other

things, the following:

• Nortel Networks foreign exchange accounting as part of management’s plan to address an identified material weakness related

to foreign currency translation;

• intercompany balances that did not eliminate upon consolidation and related provisions;

• the accounting treatment of the February 2001 acquisition of the 980 NPLC business from JDS Uniphase Corporation (“JDS”)

and the related OEM Purchase and Sale Agreement;

• special charges relating to goodwill, inventory impairment, contract settlement costs and other charges; and

• the accounting treatment of certain elements of discontinued operations.

Due to, among other factors, significant turnover in Nortel Networks finance personnel, changes in accounting systems, documentation

weaknesses, and identified material weaknesses in internal control over financial reporting, the Second Restatement involved hundreds of

Nortel Networks finance personnel and a number of outside consultants and advisors. The process required the review and verification of

a substantial number of documents and

F-17

communications and related accounting entries over multiple fiscal periods. In addition, the review of accruals and provisions and the

application of accounting literature to certain matters in the Second Restatement, including revenue recognition, foreign exchange,

special charges and discontinued operations, was complicated by the passage of time, lack of availability of supporting records and the

turnover of finance personnel. As a result of this complexity, estimates and assumptions that impact both the quantum of the various

recorded adjustments and the fiscal period to which they were attributed were required in the determination of certain of the Second

Restatement adjustments. Nortel Networks believes the procedures followed in determining such estimates were appropriate and

reasonable using the best available information.

The following tables present the impact of the Second Restatement adjustments on Nortel Networks previously reported consolidated

statements of operations and a summary of the adjustments from the Second Restatement for the years ended December 31, 2002 and

2001. The Second Restatement adjustments related primarily to the following items, each of which reflect a number of related

adjustments that have been aggregated for disclosure purposes, and are described in the paragraphs following the tables below:

• Revenues and cost of revenues;

• Foreign exchange;

• Intercompany balances;

• Special charges;

•Other;

• Reclassifications; and

• Discontinued operations.

Consolidated Statement of Operations for the year ended December 31, 2002

F-18

As previously

reported Adjustments As restated

Revenues $10,569 $439 $11,008

Cost of revenues 6,798 305 7,103

Gross profit 3,771 134 3,905

Selling, general and administrative expense 2,636 (83) 2,553

Research and development expense 2,208 (125)2,083

Amortization of acquired technology and other 157 – 157

Deferred stock option compensation 87 23 110

Special charges

Goodwill impairment 595 –595

Other s

ecial char

es 1,578 (78) 1,500

(Gain) loss on sale of businesses and assets (55)34 (21)

eratin

earnin

s (loss) (3,435) 363 (3,072)

Other income (expense) — net (30)25 (5)

Interest expense

Long-term debt (215)(5)(220)

Other (41) (11) (52)

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of associated

companies (3,721)372 (3,349)

Income tax benefit (expense) 453 15 468

(3,268)387 (2,881)

Minority interests — net of tax

–

Equity in net loss of associated companies — net of tax (18) 1 (17)

Net earnings (loss) from continuing operations (3,286) 393 (2,893)

Net earnings (loss) from discontinued operations — net of tax 20 (121)(101)

Net earnings (loss) $ (3,266) $ 272 $ (2,994)

Basic earnings (loss) per common share

— from continuing operations $ (0.86) $ 0.11 $ (0.75)

— from discontinued operations 0.01 (0.04)(0.03)

Basic earnings (loss) per common share $ (0.85) $ 0.07 $ (0.78)

Diluted earnings (loss) per common share

— from continuing operations $ (0.86) $ 0.11 $ (0.75)

— from discontinued o

erations 0.01 (0.04)(0.03)

Diluted earnings (loss) per common share $ (0.85) $ 0.07 $ (0.78)

Summary of Restatement Adjustments for the year ended December 31, 2002:

F-19

Revenues Inter- Dis-

and cost o

Foreign company Special Reclassifi- continued Total

revenues exchange balances charges Other cations operations adjustments

Revenues $442 $(3) $

–

$ – $ – $ – $ – $ 439

Cost of revenues 153 (51) (16) 237 (64) 46 – 305

Gross profit 289 48 16 (237)64 (46) – 134

Sellin

eneral and administrative ex

ense – (1)

–

– (115) 33 – (83)

Research and development expense –

–

(14) – (89)(22) – (125)

Deferred stock option compensation –

–

24 – (1) – 23

Special charges — other special charges –

–

(78) – – – (78)

(Gain) loss on sale of businesses and assets –

–

–(4) 38 – 34

Other income (expense) — net –(112) 3 – 19 115 –25

Interest expense — long term debt –

–

–(5) – – (5)

Interest expense — other –

–

3 – (14) – – (11)

Income tax benefit (expense) –

–

–15 – – 15

Minority interests — net of tax –

–

–26 (21) – 5

Equity in net loss of associated companies — net of tax –

–

–1 – – 1

Net earnings (loss) from discontinued operations — net of tax –

–

– – – (121)(121)

Total restatement adjustments $ 289 $ (63) $ 36 $ (183) $ 314 $ – $ (121) $ 272

Consolidated Statement of Operations for the year ended December 31, 2001

F-20

As previously

reported Adjustments As restated

Revenues $17,408 $1,492 $18,900

Cost of revenues 14,014 598 14,612

Gross profit 3,394 894 4,288

Selling, general and administrative expense 5,809 302 6,111

Research and develo

ment ex

ense 3,202 (86)3,116

In-process research and development expense 15 – 15

Amortization of intangibles

Acquired technology and other 806 – 806

Goodwill 4,149 (91)4,058

Deferred stock option compensation 109 139 248

Special charges

Goodwill impairment 12,121 (695) 11,426

Other special charges 3,540 (150)3,390

(Gain) loss on sale of businesses and assets 112 26 138

Operating earnings (loss) (26,469)1,449 (25,020)

Other income (expense) — net (388) (118) (506)

Interest expense

Lon

-term deb

(204) (4) (208)

Other (115)12 (103)

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of associated

companies (27,176) 1,339 (25,837)

Income tax benefit (expense) 3,152 (401)2,751

(24,024) 938 (23,086)

Minority interests — net of tax

–

(34)(34)

Equity in net loss of associated companies — net of tax (150) – (150)

Net earnings (loss) from continuing operations (24,174)904 (23,270)

Net earnings (loss) from discontinued operations — net of tax (2,996) 529 (2,467)

Net earnings (loss) before cumulative effect of accounting changes (27,170)1,433 (25,737)

Cumulative effect of accounting change — net of tax 15 – 15

Net earnings (loss) $(27,155) $ 1,433 $(25,722)

Basic earnings (loss) per common share

— from continuing operations $(7.58) $ 0.28 $(7.30)

— from discontinued o

erations (0.94) 0.16 (0.78)

Basic earnings (loss) per common share $(8.52) $ 0.44 $(8.08)

Diluted earnings (loss) per common share

— from continuing operations $(7.58) $ 0.28 $(7.30)

— from discontinued operations (0.94) 0.16 (0.78)

Diluted earnings (loss) per common share $(8.52) $ 0.44 $(8.08)

Summary of Restatement Adjustments for the year ended December 31, 2001:

Additionally, the cumulative effect of the Second Restatement adjustments was a (decrease) increase to additional paid-in capital, deferred

stock option compensation, accumulated deficit and accumulated other comprehensive loss as of January 1, 2001, as previously reported, of

$(10), $56, $1,432 and $(189), respectively. The effect of the Second Restatement adjustments on the consolidated balance sheet as of

December 31, 2002 is shown following the discussion below.

Revenues and cost of revenues

Revenues and cost of revenues were impacted by various errors related to revenue recognition, corrections to foreign exchange accounting,

intercompany related items, special charges and other adjustments, including financial statement reclassifications. These items are further

described below. The net impact to revenues of the adjustments was an increase of $439 and $1,492 for the years ended December 31, 2002

and 2001, respectively. The net impact to cost of revenues related to these revenue adjustments, and the other corrections was an increase of

$305 and $598 for the years ended December 31, 2002 and 2001, respectively. The following table summarizes the revenue recognition

adjustments and other adjustments to revenues and cost of revenues, which increased gross profit by $134 and increased gross profit by $894

for the years ended December 31, 2002 and 2001, respectively:

F-21

Revenues Inter- Dis-

and cost o

Foreign company Special Reclassifi- continued Total

revenues exchange balances charges Other cations operations adjustments

Revenues $1,534 $(42) $

–

$ – $ – $ – $ – $ 1,492

Cost of revenues 522 (73) 45 152 (88) 40 – 598

Gross profit 1,012 31 (45)(152)88 (40) – 894

Sellin

eneral and administrative ex

ense – (31) 42 – (233) (12) 536 302

Research and development expense –

–

(27) – (54)(5) – (86)

Amortization of intangibles — goodwill –

–

(91) – – – (91)

Deferred stock option compensation –

–

123 –16 –139

Special charges

Goodwill impairment –

–

(695) – – – (695)

Other special charges –

–

(150) – – – (150)

(Gain) loss on sale of businesses and assets –

–

–(3)29 –26

Other income (expense) — net – (194) 8 – (22) 90 – (118)

Interest expense — long term debt –

–

–(4) – – (4)

Interest expense — other –

–

10 – 2 – – 12

Income tax benefit (expense) –

–

–(401) – – (401)

Minorit

interests

—

net of tax –

–

–(12) (22) – (34)

Net earnings (loss) from

discontinued operations — net of tax –

–

– – – 529 529

Total restatement adjustments $ 1,012 $ (132) $ (42) $ 661 $ (59) $ – $ (7) $ 1,433

pplication of SAB 101 or SOP 97-2

Title and delivery

Revenues were recognized on certain sales (primarily prior to 2001) for which it was subsequently determined that the criteria for revenue

recognition under SAB 101 or SOP 97-2, as applicable, had not been met, including arrangements in which legal title or risk of loss on

products did not transfer to the buyer until full payment was received, and arrangements where delivery had not occurred. Revenues and related

cost of revenues for these agreements should have been deferred until title or risk of loss had passed and all criteria for revenue recognition had

been met. Therefore, adjustments were made to defer revenues and related cost of revenues from the periods in which they were originally

recorded and to recognize them in the periods in which all revenue recognition criteria were met.

Undelivered elements and liquidated damages

In certain multiple element arrangements, total arrangement fees were recognized as revenue at the time of delivery of software or hardware,

but prior to the delivery of future contractual or implicit PCS or other services. Revenues should have been allocated to these future

deliverables based on their fair value and recognized ratably over the PCS period or as the future obligations were performed. As well, in

certain circumstances where the criteria to treat delivered software and hardware elements and undelivered PCS services as separate accounting

units were not met, the entire arrangement fee should have been recognized over the PCS period. Adjustments were made to appropriately

allocate revenue among the accounting units and recognize the allocated revenue in accordance with the applicable revenue recognition

guidance.

Revenues were also recognized for certain contracts that involved undelivered elements as a result of product development delays. The lack of

relative fair value for the undelivered element meant that revenues and cost of revenues for all products delivered should have been deferred

until the undelivered element was delivered. As originally recorded, revenues were recognized upon delivery of an alternative product and

costs were accrued for the undelivered element. To correct for these items, related cost provisions were reversed and revenues and associated

cost of revenues were recognized in the appropriate periods when all elements had been delivered.

Revenues were recognized on certain contracts with potential liquidated damages arising primarily from network outages, shipment delays or

product development delays on undelivered elements. Generally, revenues and related cost of revenues should have been deferred up to the

maximum potential liquidated damages until the damages had been incurred or there was no longer a possibility of incurring such damages.

Specific contracts, primarily in the Asia region, had the potential for liquidated damages plus right of return privileges if such damages

exceeded contractually defined thresholds due to a product development delay (undelivered element). Revenues for all products delivered

should have been deferred until the undelivered element was delivered. After delivery of the undelivered element, and in light of a lack of a

reasonable and reliable history of comparable product returns on which to base a returns allowance, revenues should have been deferred until

the right of return had lapsed or until expected returns could be reasonably estimated. After the right of return had lapsed or reasonable

estimates of expected returns could be made, revenues should have

F-22

Revenues Cost of revenues

2002 2001 2002 2001

Revenue recognition adjustments:

Application of SAB 101 or SOP 97-2

Title and delivery $211 $1,624 $107 $727

Undelivered elements and liquidated damages 45 (190) 117 (231)

Fixed or determinable fees 133 –

–

Reseller transactions –151

–

Other revenue reco

nition ad

ustments 53 (51)(71)(57)

Increase associated with revenue recognition adjustments 442 1,534 153 522

Other adjustments:

Foreign exchange (3)(42)(51)(73)

Intercompany – – (16)45

Special charges ––237152

Other – – (64)(88)

Reclassifications – – 46 40

Total increase to revenues and cost of revenues $439 $1,492 $305 $598

F-23

continued to be deferred up to the amount of the maximum potential liquidated damages until either the earlier of when the damages were

incurred, or there was no longer the possibility of incurring any damages. As originally recorded, cost provisions were recorded for the

amount of the estimated damages and/or cost of product replacement. To correct these items, related cost provisions were reversed and

revenues and associated cost of revenues were recognized in the appropriate periods.

Fixed or determinable fees

Revenues were recognized on certain sales for which it was subsequently determined that the criteria for revenue recognition under SOP

97-2 had not been met, including arrangements in which the criteria for fixed or determinable fees was not met. Revenues and related

cost of revenues for these agreements were deferred to later periods when payments became due and all criteria for revenue recognition

hadbeenmet.

eseller transactions

Prior to 2001, revenues were recognized upon product delivery to a certain reseller who lacked economic substance apart from Nortel

Networks. Revenue should have been deferred and only recognized by Nortel Networks upon sale by the reseller to an end customer.

Correction of this resulted in revenues and cost of revenues being deferred with ultimate recognition in 2001.

Other revenue recognition adjustments

Other adjustments included corrections related to an overstatement of revenues and cost of revenues related to a specific contract in the

Caribbean and Latin American (“CALA”) region, two specific transactions recorded in the first quarter of 2003 which should have been

recorded in 2002, a specific contract with a reciprocal arrangement that should have been treated as a reduction of revenues and therefore

the revenues recorded in 2001 have been reversed, errors in the application of percentage-of-completion accounting for certain contracts,

other errors related to non-cash incentives and concessions provided to customers and other calculation errors.

Foreign exchange

As part of the plan to address a material weakness reported in Nortel Networks Quarterly Report on Form 10-Q for the period ended

September 30, 2003, a review of foreign exchange accounting was undertaken. The net impact was an increase to pre-tax loss of $63 and

$132 for the years ended December 31, 2002 and 2001, respectively. The following presents the impact of these restatement adjustments

on the consolidated statements of operations for the years ended December 31, which are described below:

resentation errors

2002 2001

Gross profit

Presentation errors $42 $31

Other errors 6 –

Total increase to gross profit $48 $31

Operating expenses

Presentation errors $(1)$(31)

Total decrease to operating expenses $(1) $ (31)

Other expense

Functional currency designation $87 $133

Intercompany transaction designation (43) 14

Presentation errors 43 62

Other errors 25 (15)

Total increase to other expense $112 $194

Total increase to pre-tax loss $63 $132

F-24

For a period of six consecutive quarters ended June 30, 2002, foreign exchange gains or losses were recorded to various components of

the consolidated statements of operations rather than as part of other income (expense) — net. This presentation has been adjusted with

no effect on net earnings (loss) in any period.

Functional currency designation

The determination of the functional currency for certain entities was re-examined, based on the guidance under SFAS No. 52, “Foreign

Currency Translation” (“SFAS 52”). As a result, Nortel Networks identified four instances in which the functional currency designation

of an entity was incorrect. These revisions resulted in increases or decreases to other income (expense) — net.

ntercompany transaction designation

Nortel Networks identified two instances of incorrect treatment of significant foreign currency translation gains and losses arising from

intercompany positions. Under SFAS 52, intercompany foreign currency transactions that were long-term in nature should have been

recorded in accumulated other comprehensive loss on the balance sheet when translated rather than recorded as a transactional gain or

loss in the statement of operations. The net impact of the adjustments was an increase or decrease to other income (expense) — net, with

an offset to accumulated other comprehensive loss.

Other errors

Other errors identified were related to translation of foreign denominated intercompany transactions, revaluation of certain foreign

denominated intercompany transactions and accounting for mark-to-market adjustments for foreign exchange contracts as required under

SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”).

Intercompany balances

Historically, Nortel Networks had certain intercompany balances that did not eliminate upon consolidation (“out-of-balance positions”),

and provisions had been recorded accordingly. As part of the Second Restatement, Nortel Networks reviewed these provisions and

determined that they should not have been recorded. Adjustments were recorded in the appropriate periods to reverse these provisions

and to correct the significant out-of-balance positions. The adjustments to reverse the provisions affected the second quarter of 2003 and

periods prior to 2000. The net impact of the adjustments to correct the significant out-of-balance positions was a decrease of $36 and an

increase of $42 to the previously reported pre-tax loss for the years ended December 31, 2002 and 2001, respectively.

Special charges

As part of the Second Restatement, the components of special charges were re-examined and decreases to special charges of $78 and

$845 for the years ended December 31, 2002 and 2001, respectively, were recorded. The following table summarizes the adjustments,

which are discussed below:

Goodwill impairment — 980 NPLC business acquisition

As a result of issues raised in connection with the Independent Review, the accounting for the deferred consideration associated with the

acquisition of the JDS Zurich, Switzerland based subsidiary and related assets in Poughkeepsie, New York (the “980 NPLC business”)

from JDS (the “Purchase Agreement”) and the related OEM Purchase and Sale Agreement (the “OEM Agreement”) in February 2001

was re-examined as part of the Second Restatement. The

2002 2001

Goodwill impairment

980 NPLC business acquisition $–$473

Other acquisitions –222

Total decrease from goodwill impairment $–$695

Other special charges

Inventory impairment reclassification $89 $ –

Other adjustments (11)150

Total decrease other special charges $78 $150

Total decrease to special charges $78 $845

F-25

purchase price was originally recorded as $2,818, payable in common shares of Nortel Networks, $2,318 of which was delivered upon

closing and $500 of which was deferred. The deferred consideration could be reduced to zero if Nortel Networks met certain performance

criteria under the OEM Agreement. The original accounting assumed the Purchase Agreement and the OEM Agreement were two

transactions with separate economic value. As a result, the deferred consideration was included in the purchase price of the 980 NPLC

business and any reduction in the deferred consideration over time was reflected as a reduction of cost of revenues.

Based on the re-examination, Nortel Networks has determined that it lacks sufficient independent evidence of the fair value of the OEM

Agreement to record the Purchase Agreement and the OEM Agreement as separate transactions. Accordingly, as part of the Second

Restatement, Nortel Networks revised the accounting for the Purchase Agreement and the OEM Agreement. The assets acquired from

JDS have been valued based on the value of the consideration issued in accordance with the guidance in APB Opinion No. 16, “Business

Combinations”; no value has now been attributed to the deferred consideration at the date of the acquisition and no purchase discounts

have been subsequently recognized. Therefore, the purchase price and, as a result, the amount allocated to goodwill have been reduced by

$500. The purchase price and the amount allocated to goodwill were further reduced by $25 for an unrelated correction to the liabilities

assumed at acquisition. These reductions in the amount allocated to goodwill reduced the goodwill impairment subsequently recorded in

June 2001 by $473 and reduced the amount of goodwill amortization for the year ended December 31, 2001 by $52. Other impacts

included an increase to cost of revenues (reversing the previous reductions for purchase discounts) of $148 and $152 for the years ended

December 31, 2002 and 2001, respectively, with corresponding reversals of these amounts which were previously recorded against

common shares.

Goodwill impairment — other acquisitions

As part of the Second Restatement, a review of the accounting for various other acquisitions determined that adjustments were required

to the amounts allocated to goodwill as a result of the corrections to purchase accounting allocations, and to correct valuations of the

consideration paid. The adjustments related to purchase accounting allocations were as a result of the incorrect calculation of the

valuation of deferred compensation on the acquisitions of Alteon WebSystems Inc. (“Alteon”) and CoreTek Inc. (“CoreTek”). In

addition, Nortel Networks determined that it had incorrectly calculated the amount of consideration paid in the acquisition of CoreTek

due to inappropriate measurement dates for valuing the equity instruments issued. The reductions in the amounts allocated to goodwill

reduced the goodwill impairment that was subsequently recorded in June 2001 by $222, and reduced the amount of goodwill amortization

for the year ended December 31, 2001 by $39. Other impacts included an increase to deferred stock option compensation expense of $24

and $123 for the years ended December 31, 2002 and 2001, respectively.

Other special charges

As part of the Second Restatement, inventory impairments of $89 previously incorrectly classified as special charges in the year ended

December 31, 2002 were reclassified to cost of revenues. Also impacting special charges were adjustments for restructuring related to

contract settlement costs, including real estate related items, severance and fringe benefit related costs and plant and equipment

impairment costs. Nortel Networks determined that these items were either recorded in special charges in error or, although correctly

recorded when originally recognized, were not adjusted in the appropriate subsequent periods for changes in estimates and/or

assumptions. The adjustments to special charges for these other items were an increase of $11 and a decrease of $150 for the years ended

December 31, 2002 and 2001, respectively. The following presents the impact of these other adjustments on special charges for the years

ended December 31:

Other

Other adjustments were primarily to correct certain accruals, provisions or other transactions which were either initially recorded

incorrectly in prior periods, or not properly released or adjusted for changes in estimates and/or assumptions in the appropriate

subsequent periods. The components of these adjustments are described below.

2002 2001

Other adjustments

Contract settlement costs $36 $(85)

Severance and fringe benefit related costs (21)(35)

Plant and equipment impairment costs (4) (30)

Increase (decrease) to special charges $11 $(150)

F-26

Cost of revenues

For the year ended December 31, 2002, the decrease to cost of revenues of $64 was comprised primarily of reductions of approximately

$43 to inventory provisions and related accruals (such as accounts payable and contract manufacturer related accruals, including

approximately $39 for a correction to the accounting for a spares inventory management program which should have been treated as

warranty costs), approximately $19 decrease related to customer and contract related accruals and other accruals for such items as

vacation and fringe benefits, partially offset by an increase of approximately $15 for warranty costs.

For the year ended December 31, 2001, the decrease to cost of revenues of $88 was comprised primarily of reductions of approximately

$84 to contract and customer related accruals and approximately $72 for inventory provisions and related accruals (such as accounts

payable and contract manufacturer related accruals, including approximately $16 for correction to the accounting for a spares inventory

management program which should have been treated as warranty costs), partially offset by increases of approximately $53 for warranty

costs and approximately $14 for a correction to the accounting for retention bonuses associated with an acquisition.

Selling, general and administrative expense

For the year ended December 31, 2002, the decrease of $115 to selling, general and administrative expense was comprised primarily of

reductions of approximately $45 related to contract amendments and settlements with certain service providers, approximately $30 for

salary and fringe benefit related accruals, approximately $29 from the reversal of rent expense associated with certain facilities for

corrections to accounting for sale-leaseback transactions, approximately $13 related to the capitalization of certain software development

costs under SOP 98-1, “Accounting for Software Development Costs”, and decreases to other accruals, partially offset by a net increase

of $19 in bad debt expense.

For the year ended December 31, 2001, the decrease of $233 to selling, general and administrative expense was comprised primarily of

reductions of approximately $88 from the reversal of bad debt expense related to revenue and receivables that had been reversed as part

of the Second Restatement, approximately $52 from adjustments to customer and contractual accruals, approximately $41 for the reversal

of items previously expensed related to reciprocal agreements with customers (the offset was a reduction to revenues primarily in prior

periods), approximately $30 related to contract amendments and settlements with certain service providers and decreases to other

accruals.

esearch and development expense

For the year ended December 31, 2002, the decrease of $89 in research and development expense was primarily the result of a decrease

of approximately $68 to correctly treat certain software repair costs as warranty costs, reductions to accruals related to various research

and development projects and to other accruals for such items as vacation and fringe benefits.

For the year ended December 31, 2001, the decrease of $54 in research and development expense was primarily the result of a decrease

of approximately $36 to correctly treat certain software repair costs as warranty costs, reductions to accruals related to various research

and development projects and to other accruals for such items as vacation and fringe benefits.

2002 2001

Other adjustments

Cost of revenues $64 $88

Selling, general and administrative expense 115 233

Research and development expense 89 54

(Gain) loss on sale of businesses and assets 4 3

Other income (ex

ense)

—

19 (22)

Interest expense (19)(2)

Income tax benefit (expense) 15 (401)

Minority interests — net of tax 26 (12)

Equity in net loss of associated companies — net of tax 1–

Decrease (increase) to net loss $314 $(59)

F-27

Other income (expense) — net

For the year ended December 31, 2002, the decrease of $19 in other expense was primarily the result of a $10 reversal of an item

previously expensed related to a reciprocal agreement (offset by a reduction to revenues in a prior period), a $9 decrease from corrections

to interest rate swaps relating to debt buybacks and the reduction to other accruals totaling $38, partially offset by a $20 increase from

adjustments to the recognition of income and expense associated with sales of receivables and an $18 increase from corrections to the

timing of the recognition of impairment of investments.

For the year ended December 31, 2001, the $22 increase to other expense was primarily the result of adjustments of approximately $40

for the recognition of the income and expense associated with the sale of receivables, partially offset by decreases to other accruals.

nterest expense

For the year ended December 31, 2002, the increase to interest expense of $19 was primarily the result of a $32 increase related to long-

term debt for corrections to accounting for certain sale-leaseback transactions, partially offset by a $13 decrease from adjustments to the

timing of the recognition of costs associated with sales of receivables and customer financing.

For the year ended December 31, 2001, the increase to interest expense of $2 was primarily the result of a $10 increase related to long-

term debt recognized on certain sale-leaseback transactions, partially offset by a $4 decrease from adjustments to the timing of the

recognition of costs associated with sales of receivables and customer financing.

ncome taxes and minority interests

Income tax benefit and minority interests were also adjusted as part of the Second Restatement. The adjustment to income tax benefit,

substantially all as a result of the Second Restatement adjustments, was an increase of $15 and a decrease of $401 for the years ended

December 31, 2002 and 2001, respectively. In addition to the reclassifications noted below, the adjustment to minority interests as a

result of the Second Restatement adjustments was an increase of $26 and a decrease of $12 for the years ended December 31, 2002 and

2001, respectively.

Reclassifications

As a result of the restatement process, various presentation inconsistencies were identified. Adjustments were made to appropriately

reflect certain items in the consolidated statements of operations. The reclassifications were made for royalty expense, (gain) loss on sale

of businesses and assets, minority interest — net of tax (now reported separately), and other items including certain functional spending

and specific expenses. The amounts that were reclassified for the years ended December 31 are detailed below:

F-28

Discontinued operations

As a result of the restatement process, the initial provision for loss on disposal of the access solutions discontinued operations recorded in

June 2001, and the subsequent activity during 2001 through 2004 were re-examined. Nortel Networks concluded that the net loss on

disposal of operations recognized in the second quarter of 2001 was overstated. In addition, other adjustments were necessary to correct

certain items that were either initially recorded incorrectly, or not properly released or adjusted for changes in estimates in the appropriate

periods subsequent to the second quarter of 2001. The net impact of all of these changes was an increase of $121 and a decrease of $529

to net loss from discontinued operations — net of tax for the years ended December 31, 2002 and 2001, respectively, as follows:

ecrease to net loss on disposal of operations — net of tax

The components of the decrease to the initial loss on disposal of operations recorded in the second quarter of 2001 were as follows:

Royalty Disposal Minority

expense of assets interests Other Total

2002 Reclassifications

Cost of revenues $ 49 $ 7 $ – $ (10) $ 46

Selling, general and administrative expense – – – 33 33

Research and development expense – – – (22) (22)

Deferred stock option compensation – – – (1)(1)

(Gain) loss on sale of businesses and assets – 38 – – 38

Other expense (49)(45)(21) – (115)

Minority interests — net of tax – – 21 – 21

Net impact of reclassifications $ – $ – $ – $ – $

–

2001 Reclassifications

Cost of revenues $59 $(20) $ – $ 1 $ 40

Selling, general and administrative expense – – – (12) (12)

Research and development expense – – – (5)(5)

Deferred stock option compensation – – – 16 16

(Gain) loss on sale of businesses and assets –29 – – 29

Other expense (59) (9) (22) – (90)

Minority interests — net of tax – – 22 –22

Net impact of reclassifications $ – $ – $ – $ – $

–

2002 2001

Decrease to net loss on dis

osal of o

erations

Items that should have been charged to continuing operations $–$520

Overstatement of accruals –438

Investment impairments –41

Taxeffectontheabove –(261)

Decrease to net loss on disposal of operations — net of tax –738

Other adjustments (121)(209)

Decrease (increase) to the net loss from discontinued operations — net of tax $ (121) $ 529

• a $520 decrease for contingent liabilities and customer financing provisions that should have been charged to continuing operations

rather than discontinued operations;

• a $438 decrease to accruals for contingent liabilities and for other contingencies that did not meet the definition of a liability under

SFAS No. 5, “Accounting for Contingencies”, when initially recorded;

• a $41 decrease for investment impairments that should have been charged to the net loss from discontinued operations rather than

the net loss on disposal of operations; and

• the tax effect on the above of $261.

F-29

Other adjustments

In periods subsequent to the second quarter of 2001, adjustments were necessary to record gains and losses from the reassessment of the

remaining discontinued operations provisions in net earnings (loss) from discontinued operations, in accordance with APB No. 30,

“Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and

Infrequently Occurring Events and Transactions” (“APB 30”). These adjustments, which included gains and losses arising from

divestitures of the access solutions assets, were previously recorded as an increase or decrease to the estimated remaining provisions for

discontinued operations on the consolidated balance sheets. In the Second Restatement, these adjustments were appropriately recorded in

net earnings (loss) from discontinued operations — net of tax in the period they occurred.

For the year ended December 31, 2002, these adjustments increased the net loss from discontinued operations by approximately $121.

This consisted primarily of $206 for additional customer financing provisions, partially offset by the release of $51 due to changes in

estimates for other provisions, and an increase to the income tax recovery of $16.

For the balance of the year ended December 31, 2001, the adjustments increased the net loss from discontinued operations by

approximately $209. This consisted primarily of $223 for additional provisions related to the discontinued operations, and $126 for

equity losses and impairment charges on investments, partially offset by $104 due to the reversal of a provision originally recorded in

error related to an investment interest, $16 for contingent liabilities that should have been charged to continuing operations, and $15 for

gross margin impacts resulting from revenue recognition adjustments as detailed above.

Balance sheet

The following table presents the impact of the Second Restatement adjustments on Nortel Networks previously reported consolidated

balance sheet as of December 31, 2002. The impact on inventories — net and various liabilities, including deferred revenue, was

primarily due to the adjustments to revenues and cost of revenues described above. The adjustments to plant and equipment — net and

long-term debt primarily related to corrections to the accounting for certain sale-leaseback transactions. In addition, there were

reclassifications resulting from the restatement adjustments and to conform to the 2003 presentation in the consolidated balance sheet.

F-30

ccountin

chan

(a) Guarantees

In November 2002, the FASB issued FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including

Indirect Guarantees of Indebtedness of Others

—

an interpretation of FASB Statements No. 5,

Consolidated Balance Sheet as of December 31, 2002

As previously

reported Adjustments As restated

ASSETS

Current assets

Cash and cash equivalents $3,791 $(1) $ 3,790

Restricted cash and cash equivalents 249

–

249

Accounts receivable — net 2,163 65 2,228

Inventories — net 986 520 1,506

Income taxes recoverable 58 56 114

Deferred income taxes — net 790

–

790

Other current assets 681 (31)650

Total current assets 8,718 609 9,327

Investments 248 (11)237

Plant and equipment — net 1,467 225 1,692

Goodwill 2,201 (2)2,199

Intangible assets — net 139

–

139

Deferred income taxes — net 2,579 32,582

Other assets 761 24 785

Total assets $16,113 $848 $16,961

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities

Notes payable $30$

–

$30

Trade and other accounts payable 872 (69)803

Payroll and benefit-related liabilities 507 (22) 485

Contractual liabilities 1,215 (321)894

Restructuring 548 (41) 507

Other accrued liabilities 2,974 283 3,257

Long-term debt due within one year 233 10 243

Total current liabilities 6,379 (160)6,219

Lon

-term deb

3,749 211 3,960

Deferred income taxes — net 345 (8)337

Other liabilities 2,323 438 2,761

Total liabilities 12,796 481 13,277

Minorit

interests in subsidiar

com

anies 665 (34) 631

SHAREHOLDERS’ EQUITY

Common shares, without par value 33,583 (349) 33,234

Additional paid-in capital 3,754 (1)3,753

Deferred stock option compensation (91) 74 (17)

Accumulated deficit (33,239)273 (32,966)

Accumulated other comprehensive loss (1,355) 404 (951)

Total shareholders’ equity 2,652 401 3,053

Total liabilities and shareholders’ equity $ 16,113 $ 848 $ 16,961

F-31

57 and 107 and rescission of FASB interpretation No. 34” (“FIN 45”). FIN 45 defines a guarantee as a contract that contingently

requires a guarantor to pay a guaranteed party as a result of changes in an underlying economic characteristic (such as interest rates

or market value) that is related to an asset, a liability or an equity security of the guaranteed party or a third party’s failure to

perform under a specified agreement. FIN 45 requires that a liability be recognized for the estimated fair value of the guarantee at

its inception. Guarantees issued prior to January 1, 2003 are not subject to the recognition and measurement provisions, but are

subject to expanded disclosure requirements. Nortel Networks has entered into agreements that contain features which meet the

definition of a guarantee under FIN 45. Effective December 31, 2002, Nortel Networks adopted the disclosure requirements of FIN

45. In addition, effective January 1, 2003, Nortel Networks adopted the initial recognition and measurement provisions of FIN 45

which apply on a prospective basis to certain guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did

not have a material impact on the results of operations and financial condition of Nortel Networks (see note 13).

(b) Asset retirement obli

ations

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”), which applies to

certain obligations associated with the retirement of tangible long-lived assets. SFAS 143 requires that a liability be initially

recognized for the estimated fair value of the obligation when it is incurred. The associated asset retirement cost is capitalized as

part of the carrying amount of the long-lived asset and depreciated over the remaining life of the underlying asset and the associated

liability is accreted to the estimated fair value of the obligation at the settlement date through periodic accretion charges to net

earnings (loss). When the obligation is settled, any difference between the final cost and the recorded amount is recognized as

income or loss on settlement. Effective January 1, 2003, Nortel Networks adopted the initial recognition and measurement

provisions of SFAS 143 and identified certain asset retirement obligations to remediate leased premises and buildings and

equipment situated on leased land. The adoption of SFAS 143 resulted in a decrease to net earnings (loss) of $12 (net of tax of nil)

which has been reported as a cumulative effect of accounting changes — net of tax, an increase in plant and equipment — net of $4

and an asset retirement obligation liability of $16 as of January 1, 2003. The adoption of SFAS 143 did not have a material impact

on depreciation and accretion expense or basic and diluted earnings (loss) per share.

for costs associated with exit or dis

osal activities

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”),

which is effective for exit or disposal activities initiated after December 31, 2002. SFAS 146 supercedes EITF Issue No. 94-3,

“Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs

Incurred in a Restructuring)” (“EITF 94-3”). SFAS 146 requires recognition of costs associated with an exit or disposal activity

when the liability is incurred, whereas under EITF 94-3, a liability for an exit cost was recognized when an entity committed to an

exit plan. In addition, SFAS 146 establishes that fair value is the objective for initial measurement of the liability. The effect of

SFAS 146 was to change the timing of recognition and the basis for measuring certain liabilities and therefore created valuation

differences between SFAS 146 and EITF 94-3. Exit and disposal activities initiated before December 31, 2002 continue to be

accounted for under EITF 94-3. Nortel Networks adopted the requirements of SFAS 146 effective January 1, 2003. The adoption of

SFAS 146 did not have a material impact on Nortel Networks results of operations and financial condition.

(d) Consolidation of variable interest entities

In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities — an interpretation of Accounting Research

Bulletin No. 51, ‘Consolidated Financial Statements’” (“FIN 46”). FIN 46 clarifies the application of consolidation guidance to

those entities defined as VIEs (which includes, but is not limited to, special purpose entities, trusts, partnerships, certain joint

ventures and other legal structures) in which equity investors do not have the characteristics of a “controlling financial interest” or

there is not sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN 46

applied immediately to all VIEs created after January 31, 2003 and by the beginning of the first interim or annual reporting period

commencing after June 15, 2003 for VIEs created prior to February 1, 2003. In October 2003, the FASB issued FSP FIN 46-6,

“Effective Date of FASB Interpretation No. 46”, deferring the effective date for applying the provisions of FIN 46 for VIEs created

prior to February 1, 2003 to the end of the first interim or annual period ending after December 15, 2003. While the criteria for

deferral were met, Nortel Networks elected early application of FIN 46.

F-32

Effective July 1, 2003, Nortel Networks prospectively began consolidating two VIEs for which Nortel Networks was considered the

primary beneficiary following the guidance of FIN 46, on the basis that Nortel Networks retained certain risks associated with

guaranteeing recovery of the unamortized principal balance of the VIEs’ debt, in two lease financing transactions, which

represented the majority of the risks associated with the respective VIEs’ activities. The amount of the guarantees will be adjusted

over time as the underlying debt matures. As of December 31, 2003, Nortel Networks consolidated balance sheet included $184 of

long-term debt (see note 11) and $183 of plant and equipment — net (see note 5) related to these VIEs. These amounts represented

both the collateral and maximum exposure to loss as a result of Nortel Networks involvement with these VIEs.

In December 2003, the FASB issued FIN 46R which amends and supercedes the original FIN 46. Effective December 2003, Nortel

Networks adopted FIN 46R. Any impacts of applying FIN 46R to an entity to which FIN 46 had previously been applied are

considered immaterial to Nortel Networks results of operations and financial condition and Nortel Networks accounting treatment

of VIEs.

Nortel Networks has conducted certain receivable sales with multi-seller conduits. As well, Nortel Networks has other financial

interests and contractual arrangements which would meet the definition of a variable interest under FIN 46R, including investments

in associated companies and joint ventures, customer financing arrangements, guarantees and indemnification arrangements, certain

leasing arrangements and certain compensation arrangements. As of December 31, 2003, none of these interests or arrangements

met the requirements for consolidation under FIN 46R.

(e) Accountin

for certain financial instruments with characteristics of both liabilities and e

uit

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both

Liabilities and Equity” (“SFAS 150”). SFAS 150 clarifies the accounting for certain financial instruments with characteristics of

both liabilities and equity, including mandatorily redeemable non-controlling interests, and requires that those instruments be

classified as liabilities on the balance sheets. Previously, many of those financial instruments were classified as equity. SFAS 150 is

effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the

first interim period beginning after June 15, 2003. In November 2003, the FASB issued FSP FAS 150-3, “Effective Date,

Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain

Mandatorily Redeemable Non-controlling Interests under FASB Statement No. 150, Accounting for Certain Financial Instruments

with Characteristics of Both Liabilities and Equity” (“FSP FAS 150-3”), which deferred indefinitely the effective date for applying

the specific provisions within SFAS 150 related to the classification and measurement of mandatorily redeemable non-controlling

interests.

As of December 31, 2003, Nortel Networks continued to consolidate two enterprises with limited lives. Upon liquidation in 2024,

the net assets of these entities will be distributed to the owners based on their relative interests at that time. The minority interest

included in the consolidated balance sheet related to these entities as of December 31, 2003 was $45. Nortel Networks has not yet

determined the fair value of this minority interest as of December 31, 2003. The adoption of SFAS 150, as amended by FSP FAS

150-3, did not have a material impact on Nortel Networks results of operations and financial condition.

(f) Accountin

for revenue arran

ements with multi

le deliverables

In November 2002, the EITF reached a consensus on EITF 00-21. In the absence of higher level accounting literature, EITF 00-21

governs how to separate and allocate revenue to goods or services or both that are to be delivered in a bundled sales arrangement.

EITF 00-21 applies to revenue arrangements entered into after June 30, 2003 and allows for either prospective application or

cumulative adjustment upon adoption. Nortel Networks adopted the requirements of EITF 00-21 on a prospective basis effective

July 1, 2003. On October 1, 2003, Nortel Networks has also adopted related interpretive guidance contained in EITF 03-5,

“Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-

Incidental Software” (“EITF 03-5”), which addresses whether non-software deliverables included in an arrangement that contains

software that is more than incidental to the products or services as a whole are included within the scope of SOP 97-2. The adoption

of EITF 00-21 and EITF 03-5 did not have a material impact on Nortel Networks results of operations and financial condition.

F-33

(

) Amendment of SFAS 133 on derivative instruments and hed

activities

In April 2003, the FASB issued SFAS No. 149, “Amendment of SFAS No. 133 on Derivative Instruments and Hedging

Activities” (“SFAS 149”). SFAS 149 amends and clarifies the accounting for derivative instruments, including certain derivative

instruments embedded in other contracts and hedging activities under SFAS 133. In particular, SFAS 149: clarifies under what

circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS 133; clarifies

when a derivative contains a financing component; amends the definition of an “underlying” to conform it to the language used in

FIN 45; and amends certain other existing pronouncements. SFAS 149 is effective for contracts entered into or modified after

June 30, 2003, except as stated below, and for hedging relationships designated after June 30, 2003.

The provisions of SFAS 149 that relate to guidance in SFAS 133 that have been effective for fiscal quarters which began prior to

June 15, 2003 continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to

forward purchases or sales of when-issued securities or other securities that do not yet exist are applied to both existing contracts as

well as new contracts entered into after June 30, 2003.

Effective July 1, 2003, Nortel Networks applied the requirements of SFAS 149 on a prospective basis to contracts entered into or

modified after June 30, 2003. The adoption of SFAS 149 did not have a material impact on Nortel Networks results of operations

and financial condition.

(h) Determinin

whether an arran

ement contains a lease

In May 2003, the EITF reached a consensus on Issue No. 01-8, “Determining Whether an Arrangement Contains a Lease” (“EITF

01-8”). EITF 01-8 provides guidance on how to determine whether an arrangement contains a lease that is within the scope of

FASB Statement No. 13, “Accounting for Leases”. The guidance in EITF 01-8 is based on whether the arrangement conveys to the

purchaser (or the lessee) the right to use or control the use of a specific asset, and is effective for Nortel Networks for arrangements

entered into or modified after June 30, 2003. As of December 31, 2003, Nortel Networks recorded embedded lease assets and

liabilities of $2 included in each of plant and equipment — net (see note 5) and long-term debt (see note 11), respectively. The

impact of EITF 01-8 on Nortel Networks future results of operations and financial condition will depend on the terms contained in

contracts signed or contracts amended in the future.

(i) Pensions and other

ost-retirement benefits

On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other

Postretirement Benefits” (“SFAS 132R”). SFAS 132R is a replacement of SFAS No. 132, “Employers’ Disclosures about Pensions

and Other Postretirement Benefits (“SFAS 132”). It is effective for fiscal years ended after December 15, 2003 and the applicable

current year requirements have been applied in the presentation of the consolidated financial statements. SFAS 132R requires

additional disclosures regarding defined benefit pension plan and other post-retirement benefit plan assets, obligations, cash flows

and net cost as well as retaining a number of disclosures required by SFAS 132.

(

) Stock-based com

ensation

In December 2002, the FASB issued SFAS 148, which amended the transitional provisions of SFAS 123 for companies electing to

recognize employee stock-based compensation using the fair value based method. Effective January 1, 2003, Nortel Networks

elected to expense employee stock-based compensation using the fair value based method prospectively for all awards granted,

modified, or settled on or after January 1, 2003 (see note 2(u)).

(k) Accountin

for

oodwill and other intan

ible assets

In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), effective for fiscal years

beginning after December 15, 2001. SFAS 142 changed the accounting for goodwill from an amortization method to an

impairment-only approach. Thus, amortization of goodwill, including goodwill recorded in past business combinations and

amortization of intangibles with an indefinite life, ceased upon adoption of SFAS 142. For any acquisitions completed after

June 30, 2001, goodwill and intangible assets with an indefinite life are not amortized. Nortel Networks adopted the provisions of

SFAS 142 effective January 1, 2002.

F-34

The following table presents the impact on net earnings (loss) and on basic and diluted earnings (loss) per common share for the

year ended December 31, 2001 from both continuing and discontinued operations of the SFAS 142 requirement to cease the

amortization of goodwill as if the standard had been in effect beginning January 1, 2001:

(l) Im

airment or dis

osal of lon

-lived assets (

lant and e

ment and ac

uired technolo

)

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS

144”), which addressed financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 is

applicable to certain long-lived assets, including those reported as discontinued operations, and develops one accounting model for

long-lived assets to be disposed of by sale. SFAS 144 superseded SFAS No. 121, “Accounting for the Impairment of Long-lived

Assets and for Long-lived Assets to be Disposed Of”, and APB 30 for the disposal of a segment of a business. Nortel Networks

adopted the provisions of SFAS 144 effective January 1, 2002.

SFAS 144 requires that long-lived assets to be disposed of by sale be measured at the lower of carrying amount or fair value less

cost to sell, whether reported in continuing operations or in discontinued operations. Discontinued operations will no longer be

measured at net realizable value or include amounts for operating losses that have not yet been incurred. SFAS 144 also broadened

the reporting of discontinued operations to include the disposal of a component of an entity provided that the operations and cash

flows of the component will be eliminated from the ongoing operations of the entity and the entity will not have any significant

continuing involvement in the operations of the component. During the year ended December 31, 2002, Nortel Networks recorded

write downs for plant and equipment of $382 related to long-lived assets held and used, and $38 related to long-lived assets held for

sale. See note 7 for further information regarding these write downs.

2001

Reported results:

Net earnings (loss) from continuing operations $ (23,270)

Net earnings (loss) from discontinued operations — net of tax (2,467)

Cumulative effect of accounting change — net of tax 15

Net earnings (loss) — reported $(25,722)

Adjustments:

Amortization of goodwill from continuing operations — net of tax(a) $4,067

Amortization of goodwill from discontinued operations — net of tax 195

Total net adjustments $4,262

Adjusted results:

Net earnings (loss) from continuing operations $(19,203)

Net earnings (loss) from discontinued operations — net of tax (2,272)

Cumulative effect of accounting change — net of tax 15

Net earnings (loss) — adjusted $ (21,460)

Reported basic earnings (loss) per common share:

— from continuing operations $(7.30)

—

from discontinued o

erations (0.78)

Basic earnings (loss) per common share — reported $(8.08)

Reported diluted earnings (loss) per common share:

— from continuing operations $(7.30)

— from discontinued operations (0.78)

Diluted earnings (loss) per common share — reported $(8.08)

Adjusted basic earnings (loss) per common share:

— from continuing operations $(6.03)

— from discontinued operations (0.71)

Basic earnings (loss) per common share — adjusted $(6.74)

Adjusted diluted earnings (loss) per common share:

— from continuing operations $(6.03)

—

from discontinued o

erations (0.71)

Diluted earnings (loss) per common share — adjusted $(6.74)

(a) Included goodwill amortization of equity accounted investments of $9 (net of tax of $5).

F-35

(m) Derivative financial instruments

Effective January 1, 2001, Nortel Networks adopted SFAS 133, and the corresponding amendments under SFAS No. 138,

“Accounting for Certain Derivative Instruments and Certain Hedging Activities — an amendment of SFAS No. 133” (“SFAS

138”). See note 2(t) for further information regarding the accounting for derivatives under SFAS 133.

For the year ended December 31, 2001, the adoption of SFAS 133 resulted in a cumulative decrease in net loss of $15 (net of tax of

$9), which has been reported as cumulative effect of accounting changes — net of tax, and a charge to OCI of $7 (net of tax of $4).

The decrease in net loss is primarily attributable to embedded derivatives. The charge to OCI is primarily attributable to the

effective portion of option and forward contracts related to the Canadian dollar hedge program that are designated as cash flow

hedges. The adoption of SFAS 133 did not materially affect either the basic or diluted loss per common share.

. Consolidated

inancial statement details

The following consolidated financial statement details are presented as of December 31 for the consolidated balance sheets and for each

of the years ended December 31 for the consolidated statements of operations and consolidated statements of cash flows.

Consolidated statements of operations

Selling, general and administrative expense:

Selling, general and administrative (“SG&A”) expense included bad debt recoveries of $180 and expense of $291 and $1,791 in the years

ended December 31, 2003, 2002 and 2001, respectively.

esearch and development expense:

Other income (expense) — net:

During the year ended December 31, 2003, reversals of provisions of $87 relating to a customer bankruptcy settlement reduced cost of

revenues and SG&A expense by $53 and $4, respectively, and increased other income (expense)

—

net by $30.

2003 2002 2001

R&D expense $1,960 $2,083 $3,116

R&D costs incurred on behalf of others(a) 72 49 68

Total $2,032 $2,132 $3,184

(a) These costs included R&D charged to customers of Nortel Networks pursuant to contracts that provided for full recovery of the estimated cost of development,

material, en

ineerin

, installation and other a

licable costs, which were accounted for as contract costs.

2003 2002 2001

Interest income $75 $88 $133

Gain (loss) on sale or write down of investments 143 (39) (368)

Currency exchange gains (losses) 105 (65)(152)

Other — net 122 11 (119)

Other income (expense) — net $445 $(5) $ (506)

F-36

Consolidated balance sheets

ccounts receivable — net:

nventories — net:

Other current assets:

lant and equipment — net:

2003 2002

Trade receivables $2,117 $1,863

Contracts in process 582 867

2,699 2,730

Less: provision for doubtful accounts (194) (502)

Accounts receivable — net $2,505 $2,228

2003 2002

Raw materials $249 $339

Work in process 172 256

Finished goods 769 911

Inventories

—

(a) $ 1,190 $ 1,506

(a) Net of inventory provisions of $1,226 and $1,180 as of December 31, 2003 and 2002, respectively. Other reserves for claims related to contract manufacturers and

suppliers of $120 and $171 as of December 31, 2003 and 2002, respectively, were included in other accrued liabilities. These accruals were related to cancellation

charges, contracted-for inventory in excess of future demand and the settlement of certain other claims.

2003 2002

Prepaid expenses $176 $162

Current assets of discontinued operations(a) 28 209

Other 111 279

Other current assets $315 $650

(a) See note 20 for additional information.

2003 2002

Cost:

Land $62 $63

Buildings 1,483 1,433

Machinery and equipment 2,749 3,492

4,294 4,988

Less accumulated depreciation:

Buildings (457)(532)

Machinery and equipment (2,181) (2,764)

(2,638)(3,296)

Plant and equipment — net(a)(b)(c) $ 1,656 $ 1,692

(a) Included assets held for sale with a carrying value of $30 and $73 as of December 31, 2003 and 2002, respectively, related to owned facilities that were being

actively marketed. These assets were written down in previous periods to their estimated fair values less costs to sell. The write downs were included in special

charges. Nortel Networks expects to dispose of all of these facilities by mid-2005.

(b) Included VIE assets consolidated prospectively, as required by FIN 46R, of $183 as of December 31, 2003 (see note 4(d)).

(c) Included embedded leases recorded prospectively, as required by EITF 01-8, of $2 as of December 31, 2003 (see note 4(h)).

F-37

Goodwill:

The following table outlines goodwill by reportable segment:

During the year ended December 31, 2003, Nortel Networks performed its annual goodwill impairment test and concluded that there was

no impairment. During the three months ended September 30, 2002, an impairment test was performed on goodwill in accordance with

SFAS 142 for all reporting units due to a significant adverse change in the business climate and taking into consideration Nortel

Networks market capitalization at the end of the third quarter of 2002. All of Nortel Networks reporting units had fair values in excess of

their carrying values with the exception of Optical Networks. As a result of the impairment test, Nortel Networks recorded a write down

of goodwill of $595 within the Optical Networks segment during the year ended December 31, 2002.

ntangible assets — net:

Other accrued liabilities:

Wireless Enterprise Wireline Optical

Networks Networks Networks Networks Other Total

Balance — net as of December 31, 2001 $21 $1,658 $524 $590 $15 $2,808

Change:

Disposal – –

–

–(15)(15)

Impairment – –

–

(595) – (595)

Foreign exchange –(2)(2) 5 – 1

Balance — net as of December 31, 2002 21 1,656 522 – – 2,199

Change:

Additions(a) 13 31 43 9 – 96

Foreign exchange 1 5 4 – – 10

Balance — net as of December 31, 2003 $ 35 $ 1,692 $ 569 $ 9 $ – $ 2,305

(a) See note 10 for additional information.

2003 2002

Acquired technology(a) $ – $ 98

Other intangible assets(b) 45 –

Pension intangible assets(c) 41 41

Intangible assets — net $86 $139

(a) As of December 31, 2003, acquired technology was fully amortized.

(b) Other intangible assets are being amortized over a ten year period ending in 2013. Amortization expense for the next five years commencing in 2004 is expected to

be $9, $6, $5, $5 and $4, respectively. The amortization expense is denominated in a foreign currency and may fluctuate due to changes in foreign exchange rates.

(c) Pension intangible assets were recorded as required by SFAS No. 87, “Employers’ Accounting for Pensions”. Amounts are not amortized but are adjusted as part of

the annual minimum pension liability assessment.

2003 2002

Outsourcing and selling, general and administrative related $302 $486

Customer deposits 73 69

Product related 120 171

Warrant

387 408

Deferred income 761 1,108

Miscellaneous taxes 76 74

Income taxes payable 111 150

Current liabilities of discontinued operations 663

Interest payable 62 67

Advance billings in excess of revenues recognized to date on long-term contracts 509 394

Other 98 267

Other accrued liabilities $ 2,505 $ 3,257

F-39

Other liabilities:

inority interests in subsidiary companies:

Consolidated statements of cash flows

Change in operating assets and liabilities:

Cash and cash equivalents at end of year:

cquisitions of investments and businesses — net of cash acquired:

nterest and taxes

aid (recovered):

2003 2002

Pension, post-employment and post-retirement benefit liabilities $1,973 $1,645

Long-term provisions 972 1,116

Other liabilities $2,945 $2,761

2003 2002

Preferred shares of principal operating subsidiary(a)

Series 5, issued November 26, 1996 for consideration of Canadian $400(b) $294 $294

Series 7, issued November 28, 1997 for consideration of Canadian $350(c) 242 242

Othe

81 95

Minority interests in subsidiary companies $617 $631

(a) NNL is authorized to issue an unlimited number of Class A and Class B preferred shares.

(b) As of December 31, 2003 and 2002, 16 million of Class A Series 5 preferred shares were outstanding. As of December 1, 2001, holders of Series 5 preferred shares

are entitled to, if declared, a monthly floating cumulative preferential cash dividend based on Canadian prime rates.

(c) As of December 31, 2003 and 2002, 14 million of Class A Series 7 preferred shares were outstanding. As of December 1, 2002, holders of the Series 7 preferred

shares are entitled to, if declared, a monthly floating non-cumulative preferential cash dividend based on Canadian prime rates.

2003 2002 2001

Restricted cash and cash equivalents $200 $(231) $ –

Accounts receivable (231) 938 5,564

Inventories 429 984 2,757

Income taxes 18 1,256 (959)

Restructuring (558)(1,094)(1,121)

Accounts payable and accrued liabilities (462) (1,324) (556)

Other o

eratin

assets and liabilities 451 286 1,498

Change in operating assets and liabilities $ (153) $ 815 $ 7,183

2003 2002 2001

Cash on hand and balances with banks $756 $934 $1,312

Short-term investments 3,241 2,856 2,162

Cash and cash equivalents at end of year $3,997 $3,790 $3,474

2003 2002 2001

Cash acquired $(12) $ – $ (10)

Total net assets acquired other than cash (163) (29) (2,370)

Total purchase price (175)(29)(2,380)

Less:

Cash ac

uire

–

Non-cash consideration paid other than common share options and contingent consideration 105 – 2,291

uisitions of investments and businesses — net of cash ac

uired $(58) $ (29) $ (79)

F-40

6. Se

ment in

ormation

General descri

tion

During 2003 and up to September 30, 2004, Nortel Networks operations were organized around four reportable segments consisting of

Wireless Networks, Enterprise Networks, Wireline Networks and Optical Networks. Wireless Networks included network access and

core networking products for voice and data communications that span second and third generation wireless technologies and most major

global standards for mobile networks and related professional services. Enterprise Networks included circuit and packet voice solutions,

data networking and security solutions and the related professional services used by enterprise customers. Wireline Networks included

circuit and packet voice solutions, data networking and security solutions and the related professional services used by service provider

customers. Optical Networks included metropolitan, regional and long-haul optical transport and switching solutions and managed

broadband services and related professional services for both service provider and enterprise customers.

“Other” represented miscellaneous business activities and corporate functions. None of these activities meet the quantitative criteria to be

disclosed as reportable segments. As described in note 20, Nortel Networks access solutions operations were discontinued during the year

ended December 31, 2001. These operations were previously included as a separate business activity within “other”. The data below

excludes amounts related to the access solutions operations.

Effective October 1, 2004, a new streamlined organizational structure was established that involved, among other things, combining the

businesses of Nortel Networks four segments into two business organizations: (i) Carrier Networks and Global Operations, and

(ii) Enterprise Networks. Nortel Networks is reviewing the impact of these changes on its reportable segments.

Nortel Networks president and chief executive officer (the “CEO”) has been identified as the chief operating decision maker in assessing

the performance of the segments and the allocation of resources to the segments. Each reportable segment is managed separately with

each segment manager reporting directly to the CEO. The CEO relies on the information derived directly from the Nortel Networks

management reporting system. In 2003, Nortel Networks reported that the primary financial measure used by the former chief operating

decision maker in assessing performance and allocating resources to the segments was contribution margin, a measure that was

comprised of gross profit less SG&A expense. In April 2004, Nortel Networks and NNL’s board of directors appointed a new CEO.

Commencing in the second quarter of 2004, the primary financial measure used by the CEO in assessing performance and allocating

resources to the segments is management earnings (loss) before income taxes (“Management EBT”), a measure that includes contribution

margin, R&D expense, interest expense, other income (expense) — net, minority interests — net of tax and equity in net loss of

associated companies — net of tax. As a result of the change in Nortel Networks primary financial measure used to assess the

performance of the segments during the period in which Nortel Networks financial reports as described in note 23 have been delayed, and

because both contribution margin and Management EBT were available to the former chief operating decision maker during 2003, Nortel

Networks has determined that it is appropriate to disclose both contribution margin and Management EBT for the periods presented.

Costs associated with shared services and other corporate costs are allocated to the segments based on usage determined generally by

headcount. Costs not allocated to the segments are primarily related to Nortel Networks corporate compliance and other non-operational

activities and are included in “other”. In addition, the CEO does not review asset information on a segmented basis in order to assess

performance and allocate resources. The accounting policies of the reportable segments are the same as those applied to the consolidated

financial statements.

eceivables sales:

2003 2002 2001

Cash interest paid $186 $289 $253

Cash taxes paid (recovered) — net $ (4) $ (1,208) $ 20

2003 2002 2001

Proceeds from new securitizations $651 $562 $789

Proceeds from collections reinvested in revolving period securitizations $ 52 $ 276 $ 688

F-40

Segments

The following tables set forth information by segment for the years ended December 31:

Product revenues

The following table sets forth external revenues by product for the years ended December 31:

2003 2002 2001

Revenues

Wireless Networks $ 4,389 $ 4,161 $ 5,699

Enterprise Networks 2,589 2,422 3,222

Wireline Networks 2,005 2,572 4,328

Optical Networks 1,179 1,820 5,050

Othe

31 33 601

Total $10,193 $11,008 $18,900

Contribution margin

Wireless Networks $1,573 $1,104 $515

Enterprise Networks 560 316 263

Wireline Networks 612 736 611

Optical Networks (2) (778) (1,524)

Other (341)(26)(1,688)

Total $ 2,402 $ 1,352 $ (1,823)

Management EBT

Wireless Networks $695 $256 $(456)

Enter

rise Networks 279 29 (141)

Wireline Networks 171 178 (205)

Optical Networks (260)(1,274)(2,504)

Other (306) (209) (2,634)

Total 579 (1,020)(5,940)

In-process research and development expense – – (15)

Amortization of acquired technology and other (101) (157) (806)

Amortization of goodwill – – (4,058)

Deferred stock option compensation (16) (110) (248)

Special charges (284)(2,095)(14,816)

Gain (loss) on sale of businesses and assets 421(138)

Income tax benefit (expense) 80 468 2,751

Net earnings (loss) from continuing operations $ 262 $ (2,893) $ (23,270)

2003 2002 2001

Wireless solutions $4,389 $4,161 $5,699

Circuit and packet voice solutions 3,044 3,193 5,224

Optical solutions 1,413 1,997 5,409

Data networking and security solutions 1,316 1,624 1,967

Other 31 33 601

Total $ 10,193 $ 11,008 $ 18,900

F-41

During the years ended December 31, 2003, 2002 and 2001, no customers had revenues greater than 10 percent of consolidated revenues.

Geographic information

The following table sets forth external revenues by geographic region based on the location of the customer for the years ended

December 31:

Long-lived assets

The following table sets forth long-lived assets representing plant and equipment — net, goodwill and other intangible assets — net by

geographic region as of December 31:

2003 2002 2001

U.S. $5,424 $5,823 $10,136

EMEA 2,366 2,500 4,380

Canada 587 648 1,076

Other regions(a) 1,816 2,037 3,308

Total $10,193 $11,008 $18,900

(a) The Asia Pacific and CALA regions.

2003 2002

U.S. $2,648 $2,734

EMEA 616 506

Canada 683 646

Other regions 100 144

Total $4,047 $4,030

F-42

7. S

ecial char

During 2003, Nortel Networks continued to implement its restructuring work plan initiated in 2001. In addition, as described below,

certain exit activities were initiated in 2003.

Special charges recorded from January 1, 2001 to December 31, 2003 were as follows:

Regular full-time (“RFT”) employee notifications included in special charges were as follows:

Year ended December 31, 2003

For the year ended December 31, 2003, Nortel Networks recorded total special charges of $284, which was net of revisions of $53 related

to prior accruals.

Workforce reduction charges of $199 were related to severance and benefit costs associated with approximately 1,800 employees notified

of termination. The workforce reduction was primarily in the U.S., Canada and EMEA and extended across all segments.

Contract Intangible

settlement Plant and asset

Workforce and lease equipment impair-

reduction costs write downs Other ments Total

Provision balance as of January 1, 2001 $45 $ – $ – $ – $ – $ 45

Goodwill impairment – – – – 11,426 11,426

Other special charges 1,174 897 1,000 39 407 3,517

Revisions to prior accruals 42 (108) (59) (2) – (127)

Cash drawdowns (1,003)(110) – (8) – (1,121)

Non-cash drawdowns 14 – (941) – (11,833) (12,760)

Foreign exchange and other adjustments 10 (2) – – – 8

Provision balance as of December 31, 2001 $ 282 $ 677 $ – $ 29 $ – $ 988

Goodwill im

airmen

–

– – – 595 595

Other special charges 952 225 475 – 27 1,679

Revisions to prior accruals (132) 8 (55) – – (179)

Cash drawdowns (788) (286) – (20) – (1,094)

Non-cash drawdowns (100) – (420) – (622)(1,142)

Foreign exchange and other adjustments (2) (4) – – – (6)

Provision balance as of December 31, 2002(a) $212 $620 $ – $ 9 $ – $ 841

Other special charges 199 64 74 – – 337

Revisions to prior accruals (44)19 (28) – – (53)

Cash drawdowns (274) (275) – (9) – (558)

Non-cash drawdowns (41) – (46) – – (87)

Foreign exchange and other adjustments 12 28 – – – 40

Provision balance as of December 31, 2003(a) $64 $456 $ – $ – $ – $ 520

(a) As of December 31, 2003 and 2002, the short-term provision balance was $206 and $507, respectively, and the long-term provision balance was $314 and $334,

respectively, which was included in long-term provisions, as a component of other liabilities.

Employees (approximate)

Direct(a) Indirect(b) Total

RFT employee notifications by period:

During 2001 13,900 22,200 36,100

Durin

2002 3,400 9,300 12,700

During 2003 400 1,400 1,800

RFT em

ee notifications for the three

ears ended December 31, 2003 17,700 32,900 50,600

(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.

F-43

Offsetting these charges were revisions to prior accruals of $44 which were primarily related to termination benefits where actual costs

were lower than the estimated amounts across all segments. During 2003, the workforce reduction provision balance was drawn down by

cash payments of $274 and by a non-cash pension settlement loss of $41. The remaining provision is expected to be substantially drawn

down by the end of 2004.

Contract settlement and lease costs of $64 consisted of negotiated settlements to cancel or renegotiate contracts and net lease charges

related to leased facilities (comprised of office, warehouse and manufacturing space) and leased furniture that were identified as no

longer required across all segments. These lease costs, net of anticipated sublease income, included non-cancelable lease terms from the

date leased facilities ceased to be used and termination penalties. In addition to these charges were revisions to prior accruals of $19

resulting primarily from changes in estimates for sublease income and costs to vacate certain properties, across all segments. During

2003, the provision balance for contract settlement and lease costs was drawn down by cash payments of $275. The remaining provision,

net of approximately $317 in estimated sublease income, is expected to be substantially drawn down by the end of 2013.

Included in the above contract settlement and lease costs and net revisions to prior accruals were charges related to activities initiated by

Nortel Networks in 2003 to exit certain leased facilities and leases for assets no longer used, across all segments. The table below

summarizes the total costs estimated to be incurred as a result of these activities, which have met the criteria described in SFAS 146, the

balance of these accrued expenses as of December 31, 2003 and the movement in these accruals. These costs have been valued using the

estimated fair value method prescribed under SFAS 146. Nortel Networks expects to have completed these activities by mid-2022, based

on existing lease terms.

Plant and equipment charges of $74 were largely related to current period write downs to fair value less costs to sell for various leasehold

improvements and excess Optical Networks equipment held for sale. Offsetting these charges were revisions of $28 to prior write downs

of assets held for sale related primarily to adjustments to original plans or estimated amounts for certain facility closures.

Year ended December 31, 2002

For the year ended December 31, 2002, Nortel Networks recorded total special charges of $2,095, which were net of revisions of $179

relatedtoprioraccruals.

Workforce reduction charges of $952 were related to severance and benefit costs associated with approximately 12,700 employees

notified of termination. The workforce reduction was primarily in the U.S., Canada and EMEA and extended across all segments.

Offsetting these charges were revisions to prior accruals of $132 which were primarily related to termination benefits where actual costs

were lower than the estimated amounts across all segments. Workforce reduction charges included $124 for pension and post-retirement

benefits other than pension, settlement and curtailment costs. During 2002, the workforce reduction provision balance was drawn down

by cash payments of $788 and by $100 of non-cash pension and post-retirement benefits other than pension, settlement and curtailment

costs attributable to the notified employee group charged against the provision.

Contract settlement and lease costs of $225 consisted of negotiated settlements to cancel or renegotiate contracts and net lease charges

related to leased facilities (comprised of office, warehouse and manufacturing space) and leased manufacturing equipment that were no

longer required, across all segments. In addition to these charges were revisions to prior accruals of $8 resulting primarily from changes

in estimates for sublease income and costs to vacate certain properties, across all segments. During the year ended December 31, 2002,

the provision balance for contract settlement and lease costs was drawn down by cash payments of $286. The remaining provision

balance was net of approximately $402 in estimated sublease income.

Plant and equipment charges of $475 were related to current period write downs to fair value less costs to sell for various owned facilities

and plant and manufacturing related equipment. These charges for facilities and equipment included $358 related to specialized plant

infrastructure and equipment within Optical Networks with the remaining charges for facilities and equipment arising across all

segments.

Accrued Costs Payments Adjustments Accrued

balance as incurred made made balance as

of January during during during of December

1, 2003 2003 2003 2003 31, 2003

Lease costs (a) $ – $ 50 $ (8) $ (6) $ 36

(a) Total estimated costs, net of estimated sublease income, associated with these accruals are $62.

F-44

Fair value was determined using quoted market prices or the anticipated cash flows discounted at a rate commensurate with the risks

involved. Offsetting these charges were revisions of $55 to prior write downs of assets held for sale related primarily to additional

proceeds from disposals of equipment from Optical Networks and other segments in excess of amounts previously expected and

adjustments to original plans or estimated amounts for certain facility closures across all segments.

Within Optical Networks, Nortel Networks performed assessments of certain plant and equipment due to the then current market

conditions and the delay in the anticipated recovery of that segment and concluded that the assets’ carrying values were not fully

recoverable from estimated future cash flows. As a result, Nortel Networks recorded a charge to income of $358 to write down the value

of this equipment to its fair value less costs to sell. Included in the $358 write down was $34 related to equipment held for sale, which

was part of the Bookham Technology plc (“Bookham”) transaction (see note 10).

Intangible asset impairments of $27 reflected write downs in acquired technology associated with Xros, Inc. (“Xros”), the 980 NPLC

business and CoreTek.

Goodwill impairment charges were $595. As a result of the continued decline during 2002, in both Nortel Networks overall market value

generally and within Optical Networks specifically, Nortel Networks as part of its review of financial results during the year ended

December 31, 2002, evaluated the goodwill associated with the businesses within Optical Networks for potential impairment. The

conclusion of those evaluations was that the fair value associated with the businesses within Optical Networks could no longer support

the carrying value of the remaining goodwill associated with them. As a result, Nortel Networks recorded a goodwill impairment charge

of $595. Fair value was estimated using the then expected present value of discounted future cash flows of the businesses within Optical

Networks. The discount rate used ranged from 12 to 16 percent and the terminal values were estimated based on terminal growth rates

ranging from 3 to 5 percent. The assumptions supporting the estimated future cash flows, including the discount rate and estimated

terminal values, reflected management’s best estimates.

Year ended December 31, 2001

For the year ended December 31, 2001, Nortel Networks recorded total special charges of $14,816, which were net of revisions of $127

relatedtoprioraccruals.

Workforce reduction charges of $1,174 were related to the cost of severance and benefits associated with approximately 36,100

employees notified of termination. The workforce reduction was primarily in the U.S., Canada and EMEA and extended across all

segments. In addition to these charges were revisions to prior accruals of $42 which were primarily related to termination benefits where

actual costs were higher than the estimated amounts across all segments. During the year ended December 31, 2001, the workforce

reduction provision balance was drawn down by cash payments of $1,003 and offset by $14 of non-cash pension settlement and

curtailment costs attributable to the notified employee group charged against the provision.

Contract settlement and lease costs of $897 related to negotiated settlements to cancel or renegotiate contracts and net lease charges

related to a number of leased facilities (comprised of office, warehouse and manufacturing space) and leased manufacturing equipment

that were no longer required, across all segments. Offsetting these charges were revisions to prior accruals of $108 primarily related to

contract settlement costs which were lower than the estimated amounts across all segments. During the year ended December 31, 2001,

the provision balance for contract settlement and lease costs was drawn down by cash payments of $110. The remaining provision

balance was net of approximately $496 in estimated sublease revenues.

Plant and equipment charges of $1,000 included write downs of $167 for owned facilities, $435 for leasehold improvements and certain

information technology equipment associated with the exiting of leased and owned facilities and $398 for certain plant and

manufacturing related equipment. Owned facility write downs of $167 included $76 for specific owned facilities across all segments

primarily within the U.S., Canada and EMEA and $91 for a specialized manufacturing facility in the U.S. within Optical Networks. The

carrying values of the above owned facilities have been reflected at their net realizable value based on market assessments for general

purpose facilities. Offsetting these charges were revisions of $59 to prior write downs resulting primarily from adjustments to original

plans or estimated amounts for certain facility closures. These revisions related primarily to global operations and Optical Networks.

Plant and manufacturing related equipment write downs of $398 included $103 for equipment within global operations, and $295 for

specialized plant infrastructure and equipment within Optical Networks.

F-45

Goodwill and other intangible assets impairment charges totaled $11,833 during the year ended December 31, 2001. In addition to the

charge of $11,727 described below, this amount included a goodwill impairment charge of $106 related to the remaining net book value

of goodwill associated with the prior acquisitions of MICOM Communications, Corp. and Dimension Enterprises, Inc. (“Dimension”).

As part of Nortel Networks work plan to streamline its business, the decision was made to exit all technologies and consulting services

related to these prior acquisitions. The results related to these prior acquisitions were not material to the business, results of operations

and financial condition of Nortel Networks.

Nortel Networks, as part of its review of financial results during the year ended December 31, 2001, performed an assessment of the

carrying values of intangible assets recorded in connection with its various acquisitions. The assessment during that period was

performed in light of the then significant negative industry and economic trends impacting Nortel Networks operations and expected

future growth rates, and the adjustment of technology valuations. The conclusion of the assessment was that the decline in market

conditions within the telecommunications industry was significant and other than temporary. As a result, Nortel Networks recorded a

$11,727 impairment of goodwill and other intangible assets based on the amount by which the carrying amount of these assets exceeded

their fair value. The impairment was primarily related to the goodwill within Enterprise Networks, Optical Networks and Other and was

associated with the acquisitions of Alteon, the 980 NPLC business, Xros, Qtera Corporation, Photonic Technologies, Inc. (“Photonic”),

EPiCON, Inc. (“EPiCON”) and Clarify Inc. (“Clarify”).

Fair value was determined based on discounted future cash flows for the businesses that had separately distinguishable goodwill and

intangible asset balances and whose operations had not yet been fully integrated into Nortel Networks. The cash flow periods used were

five years, the discount rate used was 20 percent and the terminal values were estimated based upon terminal growth rates ranging from 5

to 11 percent reflecting management’s best estimates at the time. The discount rate was based upon Nortel Networks weighted-average

cost of capital as adjusted for the risks associated with the operations.

ncome taxes

As of December 31, 2003, Nortel Networks net deferred tax assets, excluding discontinued operations, were $3,575, reflecting temporary

differences between the financial reporting and tax treatment of certain current assets and liabilities and non-current assets and liabilities,

in addition to the tax benefit of net operating and capital loss carryforwards and tax credit carryforwards.

In accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”), Nortel Networks reviews all available positive and

negative evidence to evaluate the recoverability of the deferred tax assets. This includes a review of such evidence as the carryforward

periods of the significant tax assets, Nortel Networks history of generating taxable income in its material tax jurisdictions and Nortel

Networks cumulative consolidated loss position.

Based on this review, Nortel Networks concluded that the valuation allowance as of December 31, 2003 was appropriate. Further, Nortel

Networks determined that it was more likely than not that the remaining deferred tax assets would be realized. If market conditions

deteriorate or future results of operations are less than expected, an additional tax valuation allowance may be required for all or a portion

of Nortel Networks deferred tax assets.

Nortel Networks is subject to ongoing examinations by certain taxation authorities of the jurisdictions in which it operates. Nortel

Networks regularly assesses the status of these examinations and the potential for adverse outcomes to determine the adequacy of the

provision for income and other taxes. Nortel Networks believes that it has adequately provided for tax adjustments that are probable as a

result of any ongoing examination.

Nortel Networks had previously entered into Advance Pricing Arrangements (“APAs”) with the taxation authorities of the U.S. and

Canada in connection with its intercompany transfer pricing and cost sharing arrangements between Canada and the U.S. These

arrangements expired in 1999 and 2000. In 2002, Nortel Networks filed APA requests with the taxation authorities of the U.S., Canada

and the United Kingdom (“U.K.”) that are expected to apply to the taxation years beginning in 2000. The APA requests are currently

under consideration. Nortel Networks has applied the transfer pricing methodology proposed in the APA requests since 2001. As part of

the APA applications, Nortel Networks has requested that the methodology adopted in 2001 be applied retroactively to the 2000 taxation

year. If the retroactive application is accepted by the taxation authorities, it would result in an increase in taxable income in certain

urisdictions offset by an equal decrease in taxable income in the other jurisdictions. Nortel Networks has provided for any taxes and

interest that would be due as a result of retroactive application of the APAs.

F-46

Although the outcome of the APA applications are uncertain, Nortel Networks does not believe the ultimate resolution of these

negotiations will have a material adverse effect on its consolidated financial position, results of operations or cash flows. However, if this

matter is resolved unfavorably, it could have a material adverse effect on Nortel Networks consolidated financial position, results of

operations or cash flows.

The following is a reconciliation of income taxes, calculated at the Canadian combined federal and provincial income tax rate, to the

income tax benefit (expense) included in the consolidated statements of operations for each of the years ended December 31:

2003 2002 2001

Income taxes at Canadian rates

(2003

—

35.8%, 2002

—

39.4%, 2001

—

40.8%) $ (101) $ 1,320 $ 10,541

Reduction of Canadian taxes applicable to manufacturing profits –(54)(64)

Difference between Canadian rates and rates applicable to subsidiaries in the U.S. and other jurisdictions (23) (33) (524)

Difference between basic Canadian rates and rates applicable to gain (loss) on sale of businesses –(4)(128)

Non-deductible amortization of acquired intangibles and IPR&D expense – (219) (6,800)

Foreign operation tax credit – – 902

Valuation allowances on tax benefits (15) (811) (1,348)

Utilization of losses 98 71 24

Other 121 198 148

Income tax benefit (expense) $80 $468 $2,751

Details of Nortel Networks income (loss):

Earnings (loss) from continuing operations before income taxes, minority interests and equity in net loss of associated

companies:

Canadian, excluding gain (loss) on sale of businesses and assets $ (201) $ (1,270) $ (3,457)

U.S. and other, excluding gain (loss) on sale of businesses and assets 478 (2,100)(22,242)

Gain (loss) on sale of businesses and assets 421(138)

$281 $(3,349) $ (25,837)

Income tax benefit (expense):

Canadian, excluding gain (loss) on sale of businesses and assets $188 $140 $329

U.S. and other, excluding gain (loss) on sale of businesses and assets (108) 335 2,510

Gain on sale of businesses and assets –(7)(88)

$ 80 $ 468 $ 2,751

Income tax benefit (expense):

Current $ 30 $ 43 $ 1,238

Deferred 50 425 1,513

Income tax benefit (expense) $ 80 $ 468 $ 2,751

F-47

ee bene

lans

Nortel Networks maintains various retirement programs covering substantially all of its employees, consisting of defined benefit, defined

contribution and investment plans.

Nortel Networks has four kinds of capital accumulation and retirement programs: balanced capital accumulation and retirement programs

(the “Balanced Program”) and investor capital accumulation and retirement programs (the “Investor Program”) available to substantially

all of its North American employees; flexible benefits plan, which includes a group personal pension plan (the “Flexible Benefits Plan”),

available to substantially all of its employees in the U.K.; and traditional capital accumulation and retirement programs that include

The following table shows the significant components included in deferred income taxes as of December 31:

Subsequent to 2003, Nortel Networks determined that it expects to settle certain income tax matters which will result in a reduction of its

provisions and reserves liability along with an offsetting reduction in its tax benefit of loss carryforwards and tax credits of approximately

$140. The balance of the provisions and reserves liability relates to certain tax credit and transfer pricing matters, including the

retroactive application of the APA.

Nortel Networks has not provided for foreign withholding taxes or deferred income tax liabilities for temporary differences related to the

undistributed earnings of foreign subsidiaries since Nortel Networks does not currently expect to repatriate these earnings. It is not

practical to reasonably estimate the amount of additional deferred income tax liabilities or foreign withholding taxes that may be payable

should these earnings be distributed in the future.

As of December 31, 2003, Nortel Networks had the following net operating and capital loss carryforwards and tax credits which are

scheduled to expire in the following years:

2003 2002

Assets:

Tax benefit of loss carryforwards and tax credits $ 5,633 $ 4,602

Provisions and reserves 714 1,735

Post-retirement benefits other than pensions 234 104

Plant and equipment 122 72

Pension plan liabilities 433 285

Deferred compensation 277 32

Unrealized losses on investments

–

7,413 6,833

Valuation allowance (3,344) (3,024)

4,069 3,809

Liabilities:

Acquired technology –38

Provisions and reserves 341 679

Plant and equipment 48 6

Other 105 51

494 774

Net deferred income tax assets $ 3,575 $ 3,035

Net

Operating Capital Tax

losses losses(a) credits(b) Total

2004 - 2006 $102 $ – $ 268 $370

2007 - 2009 776 – 319 1,095

2010 - 2016 1,806 80 550 2,436

2017 - 2023 3,251 – 243 3,494

Indefinitely 1,784 4,426 23 6,233

$ 7,719 $ 4,506 $ 1,403 $ 13,628

(a) The capital losses related primarily to the U.K. and may only be used to offset future capital gains. Nortel Networks has recorded a full valuation allowance against

this future tax benefit.

(b) Global investment tax credits of $41, $78 and $154 have been applied against the income tax provision in 2003, 2002 and 2001, respectively. Unused tax credits can

be utilized to offset future income taxes payable primarily in Canada.

F-48

defined benefit pension plans (the “Traditional Program”) which are closed to new entrants in the U.K. and portions of which are closed

to new entrants in the U.S. and Canada. Although these four kinds of programs represent Nortel Networks major retirement programs and

may be available to employees in combination and/or as options within a program, Nortel Networks also has smaller pension plan

arrangements in other countries. Certain of the prior year amounts for 2002 and 2001 have been adjusted to include pension plans not

previously presented.

Nortel Networks also provides other benefits, including post-retirement benefits and post-employment benefits. Employees in the

Traditional Program are eligible for their existing company sponsored post-retirement benefits or a modified version of these benefits,

depending on age or years of service. Employees in the Balanced Program are eligible for post-retirement benefits at reduced company

contribution levels, while employees in the Investor Program have access to post-retirement benefits by purchasing a Nortel Networks-

sponsored retiree health care plan at their own cost.

Nortel Networks policy is to fund defined benefit pension and other benefits based on accepted actuarial methods as permitted by

regulatory authorities. The funded amounts reflect actuarial assumptions regarding compensation, interest and other projections. Pension

and other benefit costs reflected in the consolidated statements of operations are based on the projected benefit method of valuation. A

measurement date of September 30 is used annually to determine pension and other post-retirement benefit measurements for the pension

plans and other post-retirement benefit plans that make up the majority of plan assets and obligations.

In 2003, the impact of reductions in discount rates and changes in foreign exchange rates more than offset the favorable impacts of strong

pension asset returns and the voluntary contributions made by Nortel Networks. As a result, Nortel Networks was required to adjust the

minimum pension liability for certain plans, representing the amount by which the accumulated benefit obligation less the fair value of

the plan assets was greater than the recorded liability. The effect of this adjustment was to increase accumulated other comprehensive

loss (before tax) by $219, increase intangible assets by $1 and increase pension liabilities by $220.

F-49

The following details the unfunded status of the defined benefit plans and post-retirement benefits other than pensions, and the associated

amounts recognized in the consolidated balance sheets as of December 31:

The following details selected information for defined benefit plans, all of which have accumulated benefit obligations in excess of the

fair value of plan assets as of December 31:

Defined benefit plans Post-retirement benefits

2003 2002 2003 2002

Chan

e in benefit obli

ation:

Benefit obligation — beginning $ 6,187 $ 6,053 $ 568 $ 529

Service cost 118 158 910

Interest cost 401 402 40 37

Plan participants’ contributions 712 3 2

Plan amendments 5–––

Actuarial loss (gain) 362 (19)106 20

Divestitures/settlements (116) (386) – (3)

Benefits paid (459)(320)(37)(31)

Foreign exchange 850 287 65 4

Benefit obligation — ending $7,355 $6,187 $754 $568

Change in plan assets:

Fair value of plan assets — beginning $4,386 $5,009 $41 $41

Actual return on plan assets 626 (270) 3 –

Employer contributions 399 153 31 28

Plan

artici

ants’ contributions 712 3 2

Divestitures/settlements (170)(424) – –

Benefits paid (459) (320) (37) (31)

Foreign exchange 626 226 9 1

Fair value of plan assets — ending $ 5,415 $ 4,386 $ 50 $ 41

Unfunded status of the plans $(1,940) $ (1,801) $ (704) $ (527)

Unrecognized net plan benefits existing at January 1, 1987 (1) (4) – –

Unrecognized prior service cost (credit) 20 20 (29)(31)

Unrecognized net actuarial losses (gains) 1,664 1,403 119 13

Contributions after measurement date 108 113 3 –

Net amount recognized $(149) $(269) $(611) $(545)

Amount recognized in the accompanying consolidated balance sheets consist of:

Other liabilities — long-term $ (1,290) $ (1,040) $ (581) $ (516)

Other liabilities — current (72)(93)(30)(29)

Intangible assets — net 42 41 – –

Foreign currency translation adjustment 151 22 – –

Accumulated other comprehensive loss 1,020 801 – –

Net amount recognized $(149) $ (269) $ (611) $ (545)

2003 2002

Projected benefit obligation $7,355 $6,187

Accumulated benefit obligation $ 6,797 $ 5,562

Fair value of plan assets $5,415 $4,386

F-50

The following details the net pension expense and the underlying assumptions for the defined benefit plans for the years ended

December 31:

2003 2002 2001

Pension expense:

Service cost $ 118 $ 158 $ 200

Interest cost 401 402 413

Expected return on plan assets (395) (417) (470)

Amortization of prior service cost 9 7 8

Amortization of net losses (

ains) 50 17 (26)

Settlement losses (gains) 48 94 1

Curtailment losses (gains) –4017

Net pension expense $231 $301 $143

Allocation of net pension expense:

Continuing operations $231 $301 $141

Discontinued operations ––2

Net pension expense $231 $301 $143

Weighted-average assumptions used to determine benefit obligations as at December 31:

Discount rate 5.8%6.3%6.7%

Rate of compensation increase 3.7% 3.7% 3.7%

Weighted-average assumptions used to determine net pension expense for years ended December 31:

Discount rate 6.3% 6.7% 7.0%

ected rate of return on

lan assets 7.8%7.8%8.1%

Rate of compensation increase 3.7% 3.7% 4.6%

The following details the amounts included within other comprehensive income (loss) for the year ended December 31:

Defined benefit plans

2003 2002

Increase in minimum pension liability included in other comprehensive income (loss) $ 219 $ 690

F-51

The following details the net cost components, all related to continuing operations, and underlying assumptions of post-retirement

benefits other than pensions for the years ended December 31:

2003 2002 2001

Post-retirement benefit cost:

Service cos

$9$10$13

Interest cost 40 37 36

Expected return on plan assets (3) (3) (3)

Amortization (3)(3)(5)

Settlements and curtailments –(9)(21)

Net post-retirement benefit cost $43 $32 $20

Weighted-average assumptions used to determine benefit obligations as at December 31:

Discount rate 6.0%6.8%7.0%

Weighted-average assumptions used to determine net post-retirement benefit cost for years ended December 31:

Discount rate 6.8%7.0%7.5%

ected rate of return on

lan assets 8.0% 8.0% 8.0%

Weighted-average health care cost trend rate 8.5%8.0%7.3%

Weighted-average ultimate health care cost trend rate 4.8% 4.7% 5.1%

Year in which ultimate health care cost trend rate will be achieved 2010 2009 2005

Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percentage-point

change in assumed health care cost trend rates would have the following effects for the years ended December 31:

2003 2002 2001

Effect on aggregate of service and interest costs

1% increase $5$5$5

1% decrease $(4) $ (4) $ (4)

Effect on accumulated post-retirement benefit obligations

1% increase $66 $57 $56

1% decrease $(55) $(46) $(46)

The target allocation percentages and the year-end percentages based on actual asset balances of the defined benefit plans as of

December 31 are as follows:

2003 2002

Target Actual Target Actual

Debt instruments 39%39%39%44%

Equity securities 61%61%61%56%

The primary investment objective of the defined benefit plans is to invest in a cost effective manner which will provide sufficient funding

for the liabilities of these plans. The defined benefit plans maintain a long-term perspective in regard to investment philosophy and return

expectations which are reflective of the fact that the liabilities of the defined benefit plans mature over an extended period of time. The

investments have risk characteristics consistent with underlying defined benefit plan demographics and liquidity requirements, and are

consistent and compliant with all regulatory standards.

The primary investment performance objective is to obtain competitive rates of return on investments at or above their assigned

benchmarks while minimizing risk and volatility by maintaining an appropriately diversified portfolio. The benchmarks selected are

industry-standard and widely-accepted indices.

The primary method of managing risk within the portfolio is through diversification among and within asset categories, and through the

utilization of a wide array of active and passive investment managers. Broadly, the assets are allocated between debt and equity

instruments. Included within the debt instruments are government and corporate fixed income securities, money market securities,

mortgage-backed securities and inflation indexed securities. Generally, these debt

F-52

instruments are considered investment grade. Included in equity securities are developed and emerging market stocks of companies at a

variety of capitalization levels. The securities are predominantly publicly traded. The amount of employer and related-party securities

that the defined benefit plans may hold is governed by the statutory limitations of the jurisdictions of the applicable plans. Included in

equity securities of the defined benefit plans are common shares of Nortel Networks Corporation with an aggregate market value of $13

(0.2 percent of total plan assets) and $3 (0.1 percent of total plan assets) as of December 31, 2003 and 2002, respectively.

As a policy, assets within the defined benefit plans are reviewed to the target allocations at least on a quarterly basis and adjustments

made as appropriate. The plans commission periodic asset and liability studies to determine the optimal allocation of the portfolio’s

assets. These studies consider a variety of the plan characteristics, including membership, benefits, and liquidity needs, and utilize mean-

variance analysis of historic and projected investment returns to develop a range of acceptable asset mixes among a variety of asset

classes.

To develop the expected long-term rate of return on assets assumption, Nortel Networks considered the weighted-average historical

returns and the future expectations for returns for each asset class.

Nortel Networks made cash contributions of approximately $140 in 2004 to the defined benefit plans, which excluded $78 of deferred

contributions for 2004 which were made in 2003, and approximately $30 in 2004 to the post-retirement benefit plans.

Under the terms of the Balanced Program, Investor Program and Traditional Program, eligible employees may contribute a portion of

their compensation to an investment plan. Based on the specific program that the employee is enrolled in, Nortel Networks matches a

percentage of the employee’s contributions up to a certain limit. The cost of these investment plans was $73, $89 and $139 for the years

ended December 31, 2003, 2002 and 2001, respectively.

Under the terms of the Balanced Program and Flexible Benefits Plan, Nortel Networks contributes a fixed percentage of employees’

eligible earnings to a defined contribution plan arrangement. The cost of these plan arrangements was $17, $21 and $30 for the years

ended December 31, 2003, 2002 and 2001, respectively.

10.

uisitions

divestitures and closures

uisitions

ortel Networks German

and Nortel Networks France

On October 19, 2002, Nortel Networks, through various subsidiaries, entered into a number of put option and call option agreements as

well as a share exchange agreement with European Aeronautic Defence and Space Company EADS N.V. (“EADS”), its partner at that

time in three European joint ventures. The written options were marked to fair value through the consolidated statements of operations at

each period end until they were exercised. At December 31, 2002, Nortel Networks estimated the fair value of the written options to be

approximately $81, which was included within other accrued liabilities, and the corresponding loss was recorded in other income

(expense) — net during the year ended December 31, 2002. A further mark to fair value adjustment and loss of $18 was recorded during

the year ended December 31, 2003. The purchased options and the share exchange were initially recorded at fair value and were assessed

for impairment throughout their term until they were exercised or expired. The estimated fair values of the options were based on an

estimate of the current fair values of the respective joint ventures using an option-pricing model that is dependent on the assumptions

used concerning the amount of volatility and the discount rates that reflect varying degrees of risk.

On July 1, 2003, EADS exercised its put option to sell its minority interest of 45 percent in Nortel Networks France S.A.S. (“NNF”) to

Nortel Networks. On July 18, 2003, Nortel Networks exercised its call option and share exchange rights to acquire the minority interest

held by EADS of 42 percent in Nortel Networks Germany GmbH & Co. KG (“NNG”) and to sell Nortel Networks equity interest of

41 percent in EADS Telecom S.A.S., formerly EADS Defence and Security Networks S.A.S (“EADS Telecom”) to EADS. The

transactions were completed on September 18, 2003.

During the three months ended September 30, 2003, Nortel Networks recorded the acquisitions of the minority interests of NNF and

NNG based on preliminary valuation estimates totaling $241. The purchase price of $241 included $58 of cash, an in-kind component of

approximately $82 representing the return of a loan note that was owed to Nortel Networks by EADS Telecom and the remaining shares

of EADS Telecom held by Nortel Networks. The allocation of the purchase price resulted in the elimination of $23 of minority interest,

settlement of a net liability of $94 related to the

F-53

put and call options and an increase of $45 in intangible assets and $79 in goodwill. The intangible assets of $45 related primarily to

customer contracts and customer relationships and are being amortized based on their expected pattern of benefit to future periods using

estimates of undiscounted cash flows, and were included in intangible assets on the consolidated balance sheet as of December 31, 2003.

The sale of Nortel Networks 41 percent interest in EADS Telecom has resulted in the receipt of cash of $12 and a reduction in equity

investments of $23. As a result of this transaction, Nortel Networks recognized a gain of $79 which is included in other income (expense)

— net for the year ended December 31, 2003. Except as noted below, there was no additional impact on the results of operations and

financial condition, as NNF and NNG were already included in the consolidated results.

During the three months ended December 31, 2003, the valuation report for NNF and NNG was completed by a third party appraiser. As

a result of the finalization of this valuation, an additional gain of $17 was recorded with a corresponding increase in goodwill on the

transaction (see note 5 for goodwill by reportable segment).

Other ac

uisitions

The following table sets out certain information for an acquisition completed by Nortel Networks in the year ended December 31, 2001,

and excludes those entities acquired which were subsequently included as discontinued operations (see note 20). This acquisition was

accounted for using the purchase method. The consolidated financial statements include the operating results of this business from the

date of acquisition.

Purchase

rice allocation

Net tangible Deferred

Purchase Acquired assets stock option

Closin

dat

uisition

rice Goodwill technolo

IPR&D (liabilities) com

ensation

2001

February 13 980 NPLC business (a) (b) $ 2,291 $ 1,890 $ 402 $ 15 $ (16) $ –

(a) The 980 NPLC business consisted of the design and manufacture of G08 980 nanometer pump-laser chips.

(b) Excludes additional consideration that may become payable.

F-54

In connection with the acquisition of the 980 NPLC business from JDS, Nortel Networks Corporation issued approximately 65.7 million

common shares. The Purchase Agreement included additional consideration, not included in the purchase price, which would be payable

after December 31, 2003 in common shares of Nortel Networks Corporation. The actual number of common shares to be issued to satisfy

the additional consideration was between 10.9 million and 16.4 million common shares depending on Nortel Networks Corporation

common share price at that date. A purchase arrangement with JDS may reduce in whole or in part the number of common shares that

Nortel Networks would be required to deliver. There were no assumed options, assumed warrants or cash included as part of the

acquisition. As of December 31, 2003, the purchase arrangement was completed (see note 14).

Divestitures

Sale o

Arris Grou

,Inc.investment

On November 24, 2003, Nortel Networks sold 9 million shares of Arris Group, Inc. (“Arris Group”) for cash consideration of $49, which

resulted in a gain of $31. Following this transaction, Nortel Networks owned 5 million Arris Group common shares or 6.6 percent of

Arris Group outstanding common shares (see note 20).

eed module o

erations

On August 10, 2003, Nortel Networks sold certain assets related to its high speed module operations to BreconRidge Manufacturing

Solutions Corporation (“BreconRidge”). Nortel Networks received proceeds of $6 in the form of cash and a note receivable. As a result

of this transaction, Nortel Networks recorded a loss of $1 during the year ended December 31, 2003. The transaction included a minimum

purchase commitment with BreconRidge requiring Nortel Networks to purchase approximately $11 and $33 of products during 2003 and

2004, respectively (see note 14).

tical com

onents o

erations

On November 8, 2002, Nortel Networks sold certain plant and equipment, inventory, patents and other intellectual property and

trademarks relating to its optical components business to Bookham. Included in the sale was the transfer of Nortel Networks transmitter

and receiver, pump laser and amplifier businesses located in Paignton, U.K., Harlow, U.K., Ottawa, Canada, Zurich, Switzerland and

Poughkeepsie, New York. Nortel Networks also transferred approximately 1,200 employees to Bookham in the transaction. Nortel

Networks received 61 million common shares of Bookham, 9 million warrants with a strike price of one-third pence Sterling, notes

receivable of $50 and cash of $10. The transaction included a minimum purchase commitment with Bookham requiring Nortel Networks

to purchase approximately $120 of product from Bookham between November 8, 2002 and March 31, 2004 (see note 14).

During the three months ended September 30, 2002, Nortel Networks classified the assets sold to Bookham as held for sale and assigned

an estimated fair value of $47 to them resulting in a charge of $123 ($89 to cost of revenues and $34 to special charges). A subsequent

increase in Bookham’s common share price prior to the November 8, 2002 close date resulted in an increase in the value assigned to the

consideration received. As a result, Nortel Networks recorded a gain on sale of businesses and assets of $29 during the year ended

December 31, 2002.

As a result of the transaction, Nortel Networks received a 29.8 percent ownership interest in Bookham. Due to restrictions on Nortel

Networks ability to vote the common shares, ability to appoint directors to the board or otherwise exercise significant influence over

Bookham, the investment has been accounted for using the cost method.

During 2003, Nortel Networks sold 30 million shares of Bookham for cash proceeds of $32 and recorded a gain of $6 which is included

in other income (expense) — net for the year ended December 31, 2003. As a result of this transaction, Nortel Networks reduced its

ownership interest in Bookham to approximately 14 percent.

Service commerce o

erations

On February 1, 2002, Nortel Networks sold to MetaSolv, Inc. (“MetaSolv”) certain assets of its Service Commerce operation support

system (“OSS”) business and MetaSolv assumed certain liabilities. The transaction included software assets obtained as part of the

Architel Systems Corporation (“Architel”) acquisition and certain additional assets of Nortel Networks service management and business

management OSS groups. Nortel Networks received proceeds of $35 and recorded a gain on sale of $10 related to the transaction in

2002. During the year ended December 31, 2001, Nortel Networks recorded a write down of the carrying value of the Architel assets

identified for disposition of $233 to estimated net realizable value.

F-55

Sale o

Clari

On November 28, 2001, Nortel Networks sold substantially all of the assets of its then wholly owned subsidiary, Clarify, including

patents, intellectual property and trademarks, to Amdocs Limited for approximately $200 in cash, resulting in a gain of $16.

Closures

As part of its restructuring work plan initiated in 2001, Nortel Networks closed the operations of CoreTek and Xros in 2002. In 2001,

Nortel Networks closed the operations of EPiCON, Photonic and Dimension (see note 7).

As described in note 7, the amount of goodwill and acquired technology associated with a number of Nortel Networks prior acquisitions

was written down by $622 and $11,833, during the years ended December 31, 2002 and 2001, respectively.

11.

erm debt, credit and su

ort

acilities

Lon

-term deb

The following table shows the components of long-term debt as of December 31:

2003 2002

6.00% Notes due September 1, 2003 $ – $ 164

6.125% Notes due February 15, 2006 1,275 1,314

7.40% Notes due June 15, 2006(a) 150 150

4.25% Convertible Senior Notes due September 1, 2008 1,800 1,800

6.875% Notes due September 1, 2023 200 200

7.875% Notes due June 15, 2026(a) 150 150

Other long-term debt with various repayment terms and a weighted-average interest rate of 3.49% for 2003 and 4.60% for 2002 20 88

Fair value adjustment attributable to hedged debt obligations 53 72

Obligations associated with consolidated VIEs(b) 184 –

Obli

ations under ca

ital leases and sale leasebacks(c) 178 265

4,010 4,203

Less: Lon

-term debt due within one

119 243

Long-term debt $3,891 $3,960

(a) Notes were issued by Nortel Networks Capital Corporation, an indirect wholly owned finance subsidiary of NNL, and are fully and unconditionally guaranteed by

NNL.

(b) Represents obligations of certain VIEs consolidated prospectively, as required by FIN 46R, of $184 as of December 31, 2003 (see note 4(d)).

(c) Included lease obligations recorded prospectively, in accordance with EITF 01-8, of $2 as of December 31, 2003 (see note 4(h)).

As of December 31, 2003, the amounts of long-term debt payable for each of the years ending December 31 consisted of:

2004 $119

2005 16

2006 1,492

2007 15

2008 1,816

Thereafter 552

Total long-term debt payable $4,010

F-56

On August 15, 2001, Nortel Networks completed an offering of $1,800 of 4.25% convertible Senior Notes (the “Senior Notes”), due on

September 1, 2008. The Senior Notes pay interest on a semi-annual basis on March 1 and September 1, which began March 1, 2002. The

Senior Notes are convertible, at any time by holders into common shares of Nortel Networks Corporation, at an initial conversion price of

$10 per common share, subject to adjustment upon the occurrence of certain events. Nortel Networks may redeem some or all of the

Senior Notes in cash at any time on or after September 7, 2004 at a redemption price of between 100% and 102.125% of the principal

amount of the Senior Notes, depending on the redemption date, plus accrued and unpaid interest and additional interest, if any, to the date

of the redemption. In addition, Nortel Networks may be required to redeem the Senior Notes in cash and/or common shares of Nortel

Networks Corporation under certain circumstances such as a change in control, or Nortel Networks may redeem the Senior Notes at its

option under certain circumstances such as a change in the applicable Canadian withholding tax legislation. NNL is the full and

unconditional guarantor of the Senior Notes in the event Nortel Networks does not make payments for the principal, interest, premium, if

any, or other amounts, if any, as they are due. The guarantee is a direct, unconditional and unsubordinated obligation of NNL.

On February 8, 2001, NNL completed an offering of $1,500 of 6.125% Notes due on February 15, 2006 (the “6.125% Notes”). The

6.125% Notes pay interest on a semi-annual basis on February 15 and August 15, which began on August 15, 2001. The 6.125% Notes

are redeemable, at any time at NNL’s option, at a redemption price equal to the principal amount thereof plus accrued and unpaid interest

and a make-whole premium.

During the year ended December 31, 2003, Nortel Networks purchased a portion of its 6.125% Notes with a face value of $39. The

transaction resulted in a gain of $4 which was included in the consolidated statement of operations within other income (expense) — net

for the year ended December 31, 2003.

During the year ended December 31, 2002, Nortel Networks paid $162 to purchase a portion of its 6.00% Notes due on September 1,

2003 and its 6.125% Notes with carrying values of $36 and $186, respectively. The early extinguishment of debt resulted in a gain of $60

which was included in the consolidated statement of operations within other income (expense) — net for the year ended December 31,

2002.

During the year ended December 31, 2002, Nortel Networks sold an office building for $24 and concurrent with the sale Nortel Networks

leased the property back for a period of fifteen years at an average annual rental of $3. The lease is renewable at Nortel Networks option

for four additional five year terms. The lease requires that a letter of credit for $1 be provided while Nortel Networks bonds are rated

below investment grade. As a result of the letter of credit structure, the transaction has been recorded as a financing transaction rather

than a sale, and the building and related accounts will continue to be recognized in the consolidated financial statements.

During the year ended December 31, 2001, Nortel Networks sold an office building for $9 and, concurrent with the sale, Nortel Networks

leased the property back for a period of fifteen years at an average annual rental of $1. The lease is renewable at Nortel Networks option

for three additional five year terms. The lease requires that Nortel Networks indemnify the landlord against environmental contamination

caused by unrelated third parties during the lease term. As a result of the indemnification, the transaction has been recorded as a financing

transaction rather than a sale, and the building and related accounts will continue to be recognized in the consolidated financial

statements.

During the year ended December 31, 2001, Nortel Networks sold an office building for $137 and, concurrent with the sale, Nortel

Networks leased the property back for a period of fifteen years at an average annual rental of $18. The lease is renewable at Nortel

Networks option for four additional five year terms. The lease is classified as a capital lease. As such, the transaction has been recorded

as a financing transaction rather than a sale, and the building and related accounts will continue to be recognized in the consolidated

financial statements.

See note 23 for additional information related to Nortel Networks and NNL’s debt securities.

Credit facilities

As of December 31, 2003 and 2002, Nortel Networks had total unused committed credit facilities of $750 under the NNL and Nortel

Networks Inc. (“NNI”) $750 April 2000 five year credit facilities (the “Five Year Facilities”). See note 23 for additional information.

F-57

ort facilit

On February 14, 2003, Nortel Networks principal operating subsidiary, 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”). On July 10, 2003, NNL and EDC

amended the terms of the EDC Support Facility by extending the termination date of the facility to December 31, 2005 from June 30,

2004 (see notes 23 and 24).

As of December 31, 2003, the EDC Support Facility provided for up to $750 in support including $300 of committed revolving support

for performance bonds or similar instruments, of which $151 was utilized, $150 of uncommitted support for receivables sales and/or

securitizations, of which none was utilized, and $300 of uncommitted support for performance bonds and/or receivables sales and/or

securitizations, of which $183 was utilized (see note 23).

On February 14, 2003, NNL’s obligations under the EDC Support Facility became secured on an equal and ratable basis under the

security agreements entered into by NNL and various of its subsidiaries that pledged substantially all of the assets of NNL in favor of the

banks under the Five Year 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 (for additional information relating to the EDC Support Facility and the related

security agreements, see notes 23 and 24).

12.

inancial instruments and hed

activities

Risk mana

emen

Nortel Networks net earnings (loss) and cash flows may be negatively impacted by fluctuating interest rates, foreign exchange rates and

equity prices. To effectively manage these market risks, Nortel Networks enters into foreign currency forwards, foreign currency swaps,

foreign currency option contracts, interest rate swaps and equity forward contracts. Nortel Networks does not hold or issue derivative

financial instruments for trading purposes.

Forei

n currenc

risk

Nortel Networks enters into option contracts to limit its exposure to exchange fluctuations on future revenue or expenditure streams

expected to occur within the next twelve months, and forward contracts, which are denominated in various currencies, to limit its

exposure to exchange fluctuations on existing assets and liabilities and on future revenue or expenditure streams expected to occur within

the next twelve months. Option and forward contracts used to hedge future revenue or expenditure streams are designated as cash flow

hedges and hedge specific exposures. Option and forward contracts that do not meet the criteria for hedge accounting are also used to

economically hedge the impact of fluctuations in exchange rates on existing assets and liabilities and on future revenue and expenditure

streams.

The following table provides a summary of the total notional amounts of option and forward contracts as of December 31:

Currency 2003(a) 2002(b)

Options

Canadian dollar $37 $52

Forwards

Canadian dollar 375 920

British pound 435 8

Euro 74 555

Other 206 75

$ 1,127 $ 1,610

(a) All notional amounts of option and forward contracts matured no later than the end of 2004.

(b) All notional amounts of option and forward contracts matured no later than the end of 2003.

Interest rate risk

Nortel Networks enters into interest rate swap contracts to minimize the impact of interest rate fluctuations on the fair value of its long-

term debt. These contracts swap fixed interest rate payments for floating rate payments and certain swaps are designated as fair value

hedges. The fair value adjustment related to the effective portion of interest rate

F-58

swaps and the corresponding fair value adjustment to the hedged debt obligation included within long-term debt are recorded to interest

expense within the consolidated statements of operations. These swap contracts have remaining terms to maturity between 2 and

2.5 years.

On January 27, 2003, various cross currency coupon swaps (notional amount of Canadian $350) were terminated. There was no impact to

net earnings (loss) on termination as these instruments were not designated as hedges and changes in fair value were previously

accounted for in the consolidated statements of operations.

Hedge ineffectiveness and the discontinuance of cash flow hedges and fair value hedges that were accounted for in accordance with

SFAS 133 had no material impact on the net earnings (loss) for the years ended December 31, 2003 and 2002 and were reported within

other income (expense) — net in the consolidated statements of operations.

The following table provides a summary of interest rate swap contracts and cross currency coupon swap contracts and their aggregated

weighted-average rates as of December 31:

2003 2002

Interest rate swap contracts:

Receive

-fixed swa

—

notional amoun

$875 $975

Average fixed rate received 6.3%6.3%

Average floating rate paid 2.6% 3.2%

Cross currency coupon swap contracts:

Received-cross currency coupon swaps — notional amount $

–

$224

Average floating rate received (Canadian $)

–

2.9%

Average floating rate paid (U.S. $)

–

1.5%

uit

rice risk

Nortel Networks enters into equity forward contracts with terms from eight to fourteen months to hedge the variability in future cash

flows associated with certain compensation obligations that vary based on future Nortel Networks Corporation common share prices.

These contracts fix the price of Nortel Networks Corporation common shares and are cash settled on maturity to offset changes in the

compensation liability based on changes in the share price from the inception of the forward contract. Certain equity forward contracts

are designated as cash flow hedges when all criteria for hedge accounting are met and the changes in fair value of the forward contract

are recorded in OCI and reclassified to SG&A when the underlying compensation expense is recorded. Other equity forward contracts

that are not designated in a hedging relationship and are considered economic hedges of the compensation obligation are carried at fair

value with changes in fair value recorded in other income (expense) — net. The total notional amount of these contracts as of

December 31, 2003 and 2002 was $47 and $4, respectively, and the average fixed Nortel Networks Corporation common share price was

$3.45 and $2.42, respectively. The fair value of these contracts as of December 31, 2003 and 2002 was $10 and $(2), respectively.

Fair value

The estimated fair values approximate amounts at which financial instruments could be exchanged in a current transaction between

willing parties. The fair values are based on estimates using present value and other valuation techniques that are significantly affected by

the assumptions used concerning the amount and timing of estimated future cash flows and discount rates that reflect varying degrees of

risk. Specifically, the fair value of interest rate swaps and forward contracts reflected: the present value of the expected future cash flows

if settlement had taken place on December 31, 2003 and 2002; the fair value of option contracts reflected the cash flows due to or by

Nortel Networks if settlement had taken place on December 31, 2003 and 2002; and the fair value of long-term debt instruments reflected

a current yield valuation based on observed market prices as of December 31, 2003 and 2002. Accordingly, the fair value estimates are

not necessarily indicative of the amounts that Nortel Networks could potentially realize in a current market exchange.

F-59

The following table provides the carrying amounts and fair values for financial assets and liabilities for which fair value differed from the

carrying amount and fair values recorded for derivative financial instruments in accordance with SFAS 133 as of December 31:

2003 2002

Carrying Fair Carrying Fair

amount valu

Financial liabilities:

Lon

-term debt due within one

$ 119 $ 119 $ 243 $ 234

Long-term debt $3,891 $3,812 $3,960 $2,413

Derivative financial instruments net asset (liability) position:

Interest rate swap contracts(a) $61 $61 $80 $80

Forward and option contracts(b) $19 $19 $(28)$(28)

Cross currency coupon swap contracts(a ) $ – $ – $ 1 $ 1

(a) Recorded in other assets.

(b) Comprised of other assets of $34 and other liabilities of $15 as of December 31, 2003, and other assets of $10 and other liabilities of $38 as of December 31, 2002.

Credit risk

Credit risk on financial instruments arises from the potential for counterparties to default on their contractual obligations to Nortel

Networks. Nortel Networks is exposed to credit risk in the event of non-performance, but does not anticipate non-performance by any of

the counterparties. Nortel Networks limits its credit risk by dealing with counterparties that are considered to be of high credit quality.

The maximum potential loss on all financial instruments may exceed amounts recognized in the consolidated financial statements.

However, Nortel Networks maximum exposure to credit loss in the event of non-performance by the other party to the derivative

contracts is limited to those derivatives that had a positive fair value of $95 as of December 31, 2003. Nortel Networks is also exposed to

credit risk from customers. However, Nortel Networks global orientation has resulted in a large number of diverse customers which

minimizes concentrations of credit risk.

Other derivatives

Nortel Networks may invest in warrants to purchase securities of other companies as a strategic investment or receive warrants in various

transactions. Warrants that relate to publicly traded companies or that can be net share settled are deemed derivative financial instruments

under SFAS 133. Such warrants are generally not eligible to be designated as hedging instruments as there is no corresponding

underlying exposure. In addition, Nortel Networks may enter into certain commercial contracts containing derivative financial

instruments.

Receivables sales

In 2003, 2002 and 2001, Nortel Networks entered into various agreements to sell certain of its receivables. These receivables were sold at

a discount of $20, $25 and $36 from book value for the years ended December 31, 2003, 2002 and 2001, respectively, at annualized

discount rates of approximately 2 percent to 6 percent, 3 percent to 5 percent and 5 percent to 8 percent for the years ended December 31,

2003, 2002 and 2001, respectively. Certain receivables have been sold with limited recourse, not exceeding 10 percent, of $7, $9 and $7

as of December 31, 2003, 2002 and 2001, respectively.

Under certain agreements, Nortel Networks has continued as servicing agent and/or has provided limited recourse. The fair value of these

retained interests is based on the market value of servicing the receivables, historical payment patterns and appropriate discount rates as

applicable. Generally, trade receivables that are sold do not experience prepayments. Nortel Networks, when acting as the servicing

agent, generally does not record an asset or liability related to servicing as the annual servicing fees are equivalent to those that would be

paid to a third party servicing agent. Also, Nortel Networks has not historically experienced significant credit losses with respect to

receivables sold with limited recourse and, as such, no liability was recognized.

F-60

As of December 31, 2003 and 2002, total accounts receivable securitized and under Nortel Networks management were $359 and $423,

respectively.

There is a possibility that the actual performance of receivables or the cost of servicing the receivables will differ from the assumptions

used to determine fair values at the transfer date and at each reporting date. Assuming hypothetical, simultaneous, unfavorable variations

of up to 20 percent in credit losses, discount rate used and cost of servicing the receivables, the pre-tax impact on the value of the retained

interests and servicing assets would not be significant.

13. Guarantees

Nortel Networks has entered into agreements that contain features which meet the definition of a guarantee under FIN 45. FIN 45 defines

a guarantee as a contract that contingently requires Nortel Networks to make payments (either in cash, financial instruments, other assets,

common shares of Nortel Networks Corporation or through the provision of services) to a third party based on changes in an underlying

economic characteristic (such as interest rates or market value) that is related to an asset, a liability or an equity security of the guaranteed

party or a third party’s failure to perform under a specified agreement. A description of the major types of Nortel Networks outstanding

guarantees as of December 31, 2003 is provided below:

(a) Business sale and business combination a

reements

In connection with agreements for the sale of portions of its business, including certain discontinued operations, Nortel Networks

has typically retained the liabilities of a business which relate to events occurring prior to its sale, such as tax, environmental,

litigation and employment matters. Nortel Networks generally indemnifies the purchaser of a Nortel Networks business in the event

that a third party asserts a claim against the purchaser that relates to a liability retained by Nortel Networks. Some of these types of

guarantees have indefinite terms while others have specific terms extending to June 2008.

Nortel Networks also entered into guarantees related to the escrow of shares in business combinations in prior periods. These types

of agreements generally include indemnities that require Nortel Networks to indemnify counterparties for loss incurred from

litigation that may be suffered by counterparties arising under such agreements. These types of indemnities apply over a specified

period of time from the date of the business combinations and do not provide for any limit on the maximum potential amount.

Nortel Networks is unable to estimate the maximum potential liability for these types of indemnification guarantees as the business

sale agreements generally do not specify a maximum amount and the amounts are dependent upon the outcome of future contingent

events, the nature and likelihood of which cannot be determined.

Historically, Nortel Networks has not made any significant indemnification payments under such agreements and no significant

liability has been accrued in the consolidated financial statements with respect to the obligations associated with these guarantees.

In conjunction with the sale of a subsidiary to a third party, Nortel Networks guaranteed to the purchaser that specified annual

volume levels would be achieved by the business sold over a ten year period ending December 31, 2007. The maximum amount

that Nortel Networks may be required to pay under the volume guarantee as of December 31, 2003 is $8. A liability of $6 has been

accrued in the consolidated financial statements with respect to the obligation associated with this guarantee as of December 31,

2003.

(b) Intellectual

ert

indemnification obli

ations

Nortel Networks has periodically entered into agreements with customers and suppliers that include limited intellectual property

indemnification obligations that are customary in the industry. These types of guarantees typically have indefinite terms and

generally require Nortel Networks to compensate the other party for certain damages and costs incurred as a result of third party

intellectual property claims arising from these transactions.

F-61

The nature of the intellectual property indemnification obligations generally prevents Nortel Networks from making a reasonable

estimate of the maximum potential amount it could be required to pay to its customers and suppliers. Historically, Nortel Networks

has not made any significant indemnification payments under such agreements. A liability of $6 has been accrued in the

consolidated financial statements with respect to the obligations associated with these guarantees as of December 31, 2003.

reements

Nortel Networks has entered into agreements with its lessors that guarantee the lease payments of certain assignees of its facilities

to lessors. Generally, these lease agreements relate to facilities Nortel Networks vacated prior to the end of the term of its lease.

These lease agreements require Nortel Networks to make lease payments throughout the lease term if the assignee fails to make

scheduled payments. Most of these lease agreements also require Nortel Networks to pay for facility restoration costs at the end of

the lease term if the assignee fails to do so. These lease agreements have expiration dates through June 2015. The maximum amount

that Nortel Networks may be required to pay under these types of agreements is $57 as of December 31, 2003. Nortel Networks

generally has the ability to attempt to recover such lease payments from the defaulting party through rights of subrogation.

Historically, Nortel Networks has not made any significant payments under these types of guarantees and no significant liability has

been accrued in the consolidated financial statements with respect to the obligations associated with these guarantees.

(d) Third

art

debt a

reements

Nortel Networks has guaranteed the debt of certain customers. These third party debt agreements require Nortel Networks to make

debt payments throughout the term of the related debt instrument if the customer fails to make scheduled debt payments. These

third party debt agreements have expiration dates extending to May 2012. The maximum amount that Nortel Networks may be

required to pay under these types of debt agreements is $8 as of December 31, 2003. Under most such arrangements, the Nortel

Networks guarantee is secured, usually by the assets being purchased or financed. A liability of $7 has been accrued in the

consolidated financial statements with respect to the obligations associated with these financial guarantees as of December 31,

2003.

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

reements

As of December 31, 2003, Nortel Networks had agreed to indemnify the banks and agents under its credit facilities against costs or

losses resulting from changes in laws and regulations which would increase the banks’ costs or reduce their return and from any

legal action brought against the banks or agents related to the use of loan proceeds. Nortel Networks has also agreed to indemnify

EDC under the EDC Support Facility against any legal action brought against EDC that relates to the provision of support under the

EDC Support Facility. Nortel Networks has also agreed to indemnify the collateral agent under the security agreements against any

legal action brought against the collateral agent in connection with the collateral pledged under the security agreements. These

indemnifications generally apply to issues that arise during the term of the credit and support facilities, or for as long as the security

agreements remain in effect (see notes 11, 23 and 24).

Nortel Networks is unable to estimate the maximum potential liability for these types of indemnification guarantees as the

agreements typically do not specify a maximum amount and the amounts are dependent upon the outcome of future contingent

events, the nature and likelihood of which cannot be determined at this time.

Historically, Nortel Networks has not made any significant indemnification payments under such agreements and no significant

liability has been accrued in the consolidated financial statements with respect to the obligations associated with these

indemnification guarantees.

F-62

Nortel Networks has agreed to indemnify its counterparties in receivables securitization transactions. The indemnifications

provided to counterparties in these types of transactions may require Nortel Networks to compensate counterparties for costs

incurred as a result of changes in laws and regulations (including tax legislation) or in the interpretations of such laws and

regulations, or as a result of regulatory penalties that may be suffered by the counterparty as a consequence of the transaction.

Certain receivables securitization transactions include indemnifications requiring the repurchase of the receivables if the particular

transaction becomes invalid. As of December 31, 2003, Nortel Networks had approximately $327 of securitized receivables which

were subject to repurchase under this provision, in which case Nortel Networks would assume all rights to collect such receivables.

The indemnification provisions generally expire upon expiration of the securitization agreements, which extend through 2005, or

collection of the receivable amounts by the counterparty.

Nortel Networks is generally unable to estimate the maximum potential liability for all of these types of indemnification guarantees

as certain agreements do not specify a maximum amount and the amounts are dependent upon the outcome of future contingent

events, the nature and likelihood of which cannot be determined at this time.

Historically, Nortel Networks has not made any significant indemnification payments or receivable repurchases under such

agreements and no significant liability has been accrued in the consolidated financial statements with respect to the obligations

associated with these guarantees.

(f) Other indemnification a

reements

Nortel Networks has also entered into other agreements that provide indemnifications to counterparties in certain transactions

including investment banking agreements, guarantees related to the administration of capital trust accounts, guarantees related to

the administration of employee benefit plans, indentures for its outstanding public debt and asset sale agreements (other than the

business sale agreements noted above). These indemnification agreements generally require Nortel Networks to indemnify the

counterparties for costs incurred as a result of changes in laws and regulations (including tax legislation) or in the interpretations of

such laws and regulations and/or as a result of losses from litigation that may be suffered by the counterparties arising from the

transactions. These types of indemnification agreements normally extend over an unspecified period of time from the date of the

transaction and do not typically provide for any limit on the maximum potential payment amount.

The nature of such agreements prevents Nortel Networks from making a reasonable estimate of the maximum potential amount it

could be required to pay to its counterparties. The difficulties in assessing the amount of liability result primarily from the

unpredictability of future changes in laws, the inability to determine how laws apply to counterparties and the lack of limitations on

the potential liability.

Historically, Nortel Networks has not made any significant indemnification payments under such agreements and no significant

liability has been accrued in the consolidated financial statements with respect to the obligations associated with these guarantees.

Product warranties

The following summarizes the accrual for product warranties that was recorded as part of other accrued liabilities in the consolidated

balance sheets as of December 31:

2003 2002

Balance at the beginning of the year $408 $469

Payments (347) (370)

Warranties issued 337 317

Revisions (11) (8)

Balance at the end of the year $387 $408

14. Commitments

Bid,

erformance related and other bonds

Nortel Networks has entered into bid, performance related and other bonds associated with various contracts. Bid bonds generally have a

term of less than twelve months, depending on the length of the bid period for the applicable contract.

F-63

Performance related and other bonds generally have a term of twelve months and are typically renewed, as required, over the term of the

applicable contract. The various contracts to which these bonds apply generally have terms ranging from two to five years. Any potential

payments which might become due under these bonds would be related to Nortel Networks non-performance under the applicable

contract. Historically, Nortel Networks has not had to make material payments under these types of bonds and does not anticipate that

any material payments will be required in the future. The following table sets forth the maximum potential amount of future payments

under bid, performance related and other bonds, net of the corresponding restricted cash and cash equivalents, as of December 31:

2003 2002

Bid and performance related bonds(a) $427 $299

Other bonds(b) 53 136

Total bid, performance related and other bonds $480 $435

(a) Net of restricted cash and cash equivalent amounts of $14 and $188 as of December 31, 2003 and 2002, respectively.

(b) Net of restricted cash and cash equivalent amounts of $31 and $26 as of December 31, 2003 and 2002, respectively.

Customer financin

Pursuant to certain financing agreements, Nortel Networks is committed to provide future financing in connection with purchases of

Nortel Networks products and services. Commitments to extend future financing generally have conditions for funding, fixed expiration

or termination dates and specific interest rates and purposes. Nortel Networks attempts to limit its financing credit risk by utilizing an

internal credit committee that monitors the credit exposure of Nortel Networks. The following table sets forth customer financing related

information and commitments, excluding discontinued operations, as of December 31:

2003 2002

Drawn and outstanding — gross $401 $1,120

Provisions for doubtful accounts (281) (824)

Drawn and outstanding — net(a) 120 296

Undrawn commitments(b) 180 831

Total customer financin

$300 $1,127

(a) Included short-term and long-term amounts. Short-term and long-term amounts were included in accounts receivable — net and other assets, respectively, in the

consolidated balance sheets.

(b) See note 23.

During the year ended December 31, 2003, Nortel Networks recorded net customer financing bad debt recoveries of $113 as a result of

settlements and adjustments to other existing provisions. During the year ended December 31, 2002, Nortel Networks recorded net

customer financing bad debt expense of $171. The recoveries and expense were included in the consolidated statements of operations

within SG&A.

During the year ended December 31, 2003, Nortel Networks entered into certain agreements to restructure and/or settle various customer

financing and related receivables. As a result of these transactions, Nortel Networks received cash consideration of approximately $230

to settle outstanding receivables of approximately $610 (with a net carrying value of $120). Additional non-cash consideration received

under one such restructuring agreement included a five year equipment and services supply agreement and the mutual release of all other

claims between the parties.

During the year ended December 31, 2003, Nortel Networks reduced undrawn customer financing commitments by $651 as a result of

the expiration or cancellation of commitments and changing customer business plans. As of December 31, 2003, approximately $108 of

the $180 in undrawn commitments was not available for funding under the terms of the financing agreements.

Venture ca

ital financin

Nortel Networks has entered into agreements with selected venture capital firms where the venture capital firms make and manage

investments in start-ups and emerging enterprises. The agreements require Nortel Networks to fund requests for additional capital up to

its commitments when and if requests for additional capital are solicited by the venture capital

F-64

firm. Nortel Networks had remaining commitments, if requested, of $24 and $30 as of December 31, 2003 and 2002, respectively. These

commitments expire at various dates through 2012.

Purchase commitments

Nortel Networks has entered into purchase commitments with certain suppliers under which it commits to buy a minimum amount or

percentage of designated products in exchange for price guarantees or similar concessions. In certain of these agreements, Nortel

Networks may be required to acquire and pay for such products up to the prescribed minimum or forecasted purchases.

During the third quarter of 2003, Nortel Networks renegotiated a key supply arrangement with a supplier. The renegotiated agreement

requires that $2,800 in aggregate purchases with the supplier be made between June 2003 and June 2009. As of December 31, 2003, the

remaining purchase commitment under the agreement was $2,300. The renegotiated agreement includes a graduated liquidated damages

remedy for the benefit of the supplier if the minimum purchase commitment is not met by the end of the agreement in 2009, however,

Nortel Networks expects to meet the minimum purchase commitment.

Nortel Networks entered into an arrangement with a minimum purchase commitment of $120 with Bookham. The terms of the

commitment require Nortel Networks to purchase $120 of product from Bookham between November 8, 2002 and May 31, 2004. The

purchase commitment was fully met by December 31, 2004.

Nortel Networks entered into an arrangement with BreconRidge with purchase commitments of approximately $11 and $33 of products

during 2003 and 2004, respectively. The 2003 and 2004 commitments have both been met.

Nortel Networks has agreed with JDS that if Nortel Networks purchased a minimum amount of designated products determined as a

percentage of Nortel Networks total purchases for such products during the period from January 1, 2001 to December 31, 2003, Nortel

Networks would be entitled to a reduction, in whole or in part, of the additional consideration otherwise payable in Nortel Networks

Corporation common shares to JDS in connection with the acquisition of the 980 NPLC business from JDS (see note 10). On

November 13, 2003, Nortel Networks and JDS agreed upon a modification to the measurement metrics for the period from November 8,

2002 through the remainder of the purchase arrangement to reflect, in accordance with the terms of the underlying agreement, the

disposition by Nortel Networks of certain of its operations. Nortel Networks believes that its purchases over the term of the purchase

arrangement were sufficient to meet the required measurement metrics of Nortel Networks total purchases to December 31, 2003, and as

such does not expect that any additional common shares will be issued.

eratin

leases and other commitments

As of December 31, 2003, the future minimum payments under operating leases, outsourcing contracts, special charges related to lease

commitments accrued for as part of restructuring contract settlement and lease costs and related sublease recoveries (see note 7),

consisted of:

Operating Outsourcing Special Sublease

leases contracts charges income

2004 $163 $161 $145 $(23)

2005 159 104 95 (29)

2006 145 104 72 (41)

2007 131 104 59 (38)

2008 113 104 49 (33)

Thereafter 649 104 248 (153)

Total future minimum payments $1,360 $681 $668 $(317)

Rental expense on operating leases for the years ended December 31, 2003, 2002 and 2001, net of applicable sublease income, amounted

to $260, $469 and $756, respectively.

During the years ended December 31, 2003 and 2002, Nortel Networks entered into sale leaseback transactions for certain of its

properties with carrying values of approximately $17 and $250, respectively, which resulted in a loss on disposal of $6 and $7,

respectively.

F-65

Expenses related to outsourcing contracts for the years ended December 31, 2003, 2002 and 2001 amounted to $308, $364 and $498,

respectively, and were for services provided to Nortel Networks primarily related to a portion of information services, payroll, capital

services, accounts payable and training and human resource functions. The amount payable under Nortel Networks outsourcing contracts

is variable to the extent that Nortel Networks workforce fluctuates from the baseline levels contained in the contracts. The table above

shows the minimum commitment contained in the outsourcing contracts.

15.

estricted cash and cash e

uivalents

As of December 31, 2003 and 2002, approximately $63 and $249, respectively, of cash and cash equivalents was restricted as collateral

for certain bid, performance related and other bonds as well as for certain normal course of business transactions. The cash and cash

equivalents collateral was in addition to the payment of fees and was required as a result of the general economic and industry

environment and NNL’s credit ratings.

16. Ca

ital stock

Common shares

Nortel Networks Corporation is authorized to issue an unlimited number of common shares without nominal or par value. The

outstanding number of common shares and prepaid forward purchase contracts included in shareholders’ equity consisted of the

following as of December 31:

2003 2002 2001

Number $ Number $ Number $

(Number of common shares in thousands)

Common shares:

Balance at beginning of the year 3,844,172 $33,234 3,208,285 $32,245 3,102,019 $29,141

Shares issued pursuant to:

Shareholder dividend reinvestment and stock purchase plan 484 6

Stock o

tion

lans 1,550 38 3,269 142 20,836 528

Acquisition and acquisition related(a) (330)(11)(330)(12)75,911 2,509

Common share offering(b) – – 632,500 858 – –

Conversion of subsidiary preferred shares – – – – 9,035 61

Pre

aid forward

urchase contracts(c) 321,322 413 448 1

–

Balance at end of the year 4,166,714 $33,674 3,844,172 $33,234 3,208,285 $32,245

(Number of prepaid forward purchase contracts)

Prepaid forward purchase contracts:(c)

Balance at beginning of the year 28,722 $ 622 – $ – – $ –

Pre

aid forward

urchase contract offerin

–

–28,750 623

–

Prepaid forward purchase contracts settled (19,029) (413) (28) (1) – –

Balance at end of the

ear 9,693 $209 28,722 $622

–

$ –

(a) Common shares issued as part of the purchase price consideration. During the years ended December 31, 2003 and 2002, common shares were cancelled asearnout

provisions were forfeited pursuant to their applicable agreements.

(b) On June 12, 2002, Nortel Networks issued 632,500 common shares for net proceeds of approximately $858, net of issue costs of $36.

(c) Concurrent with the common share offering on June 12, 2002, Nortel Networks issued 28,750 prepaid forward purchase contracts for net proceeds of $623, net of

issue costs of $26, which were recorded as an element of additional paid-in capital. During the years ended December 31, 2003 and 2002, respectively, 321,322 and

448 common shares were issued as a result of the early settlement of 19,029 and 28 prepaid forward purchase contracts. The net proceeds from the settled contracts

of $413 and $1, respectively, were transferred from additional paid-in capital to common shares.

During the year ended December 31, 2001, Nortel Networks Corporation issued common shares to the holders of the 200 Cumulative

Redeemable Class A Preferred Shares Series 4 (“Series 4 Preferred Shares”) of NNL, each of whom had exercised their right to exchange

their Series 4 Preferred Shares for common shares of Nortel Networks Corporation. The number of common shares issued for each

Series4PreferredSharewasdeterminedbydividingCanadian$0.50bythe

F-66

greater of Canadian $2.50 per common share and 95 percent of the weighted-average trading price per common share of Nortel Networks

Corporation on the TSX for the 10 trading days immediately preceding the date on which such common shares were issued in the

exchange.

Pre

aid forward

urchase contracts

On June 12, 2002, concurrent with Nortel Networks Corporation common share offering, 28,750 equity units were offered, each initially

evidencing its holder’s ownership of a prepaid forward purchase contract (“purchase contract”), entitling the holder to receive Nortel

Networks Corporation common shares and specified zero-coupon U.S. treasury strips (“U.S. treasury strips”). Net proceeds to Nortel

Networks from the purchase contracts were $623. During the year ended December 31, 2003, 19,029 purchase contracts were settled

early, resulting in 321,322,349 Nortel Networks Corporation common shares being issued for net proceeds of $413. During the year

ended December 31, 2002, 28 purchase contracts were settled early, resulting in 448,309 common shares being issued for net proceeds of

$1. As of December 31, 2003 and 2002, 9,693 and 28,722 purchase contracts, respectively, were outstanding. The purchase contracts are

classified in shareholders’ equity as part of additional paid-in capital.

The settlement date for each remaining purchase contract is August 15, 2005, subject to acceleration or early settlement in certain cases.

As of December 31, 2003, the aggregate number of Nortel Networks Corporation common shares issuable on the settlement date will be

between approximately 164 million and 196 million shares, subject to certain anti-dilution adjustments (which included adjustments for

the proposed consolidation of Nortel Networks Corporation common shares). On the settlement date (or earlier if an acceleration event

occurs prior to the settlement date or if the holder has elected an early settlement option), Nortel Networks Corporation will issue and

deliver to the holder of each purchase contract after February 15, 2003 between 16,885.93 and 20,263.12 of its common shares

(depending on the applicable market value), subject to certain anti-dilution adjustments. The applicable market value will be the average

of the closing prices of Nortel Networks Corporation common shares on the NYSE during a period shortly before the settlement date. If

the applicable market value of Nortel Networks Corporation common shares is:

• greater than $1.692 per share, 16,885.93 common shares will be issued and delivered for each purchase contract;

• less than or equal to $1.692 per share but greater than $1.410 per share, the number of common shares to be issued and

delivered for each purchase contract will be equal to $28,571.00 divided by the applicable market value; and

• less than or equal to $1.410 per share, 20,263.12 common shares will be issued and delivered for each purchase contract.

A holder of purchase contracts may elect to accelerate the settlement date in respect of some or all of its purchase contracts. Upon an

early settlement on or after August 15, 2002 and prior to February 15, 2003, the holder was entitled to receive 16,011.04 Nortel Networks

Corporation common shares per purchase contract (regardless of the market price of Nortel Networks Corporation common shares at that

time), subject to certain anti-dilution adjustments. Upon an early settlement on or after February 15, 2003, the holder will receive

16,885.93 Nortel Networks Corporation common shares per purchase contract (regardless of the market price of Nortel Networks

Corporation common shares at that time), subject to certain anti-dilution adjustments. Owing to the matters described in note 3 with

respect to the delayed filings of the Reports, Nortel Networks is currently unable to permit holders of purchase contracts to exercise their

early settlement rights. These rights will again become exercisable upon the effectiveness of a registration statement (or post-effective

amendment to the shelf registration statement) filed with the SEC (with respect to the common shares to be delivered) that contains a

related current prospectus.

If Nortel Networks is involved in a merger, amalgamation, arrangement, consolidation or other reorganization event (other than with or

into NNL or certain other subsidiaries) in which all of its 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 Nortel Networks Corporation common shares.

The settlement date under each purchase contract will automatically accelerate upon occurrence of specified events of bankruptcy,

insolvency or reorganization with respect to Nortel Networks. Upon acceleration of the settlement date, holders will be entitled to receive

20,263.12 Nortel Networks Corporation common shares per purchase contract (regardless of the market price of Nortel Networks

Corporation common shares at that time), subject to certain anti-dilution adjustments.

F-67

The U.S. treasury strips were purchased directly by a representative of the underwriters from the gross proceeds of the equity unit

offering and were delivered to a third party acting as a custodian on behalf of the equity unit holders. Nortel Networks has no obligations

with respect to or interest in the U.S. treasury strips. Accordingly, they are not reflected in the consolidated financial statements.

Preferred shares

Nortel Networks Corporation is authorized to issue an unlimited number of Class A preferred shares, which rank senior to the Class B

preferred shares and the common shares upon a distribution of capital or assets, and an unlimited number of Class B preferred shares,

which rank junior to the Class A preferred shares and senior to the common shares upon a distribution of capital or assets, in each case

without nominal or par value. Each of the Class A and Class B preferred shares is issuable in one or more series, each series having such

rights, restrictions and provisions as determined by the Board of Directors of Nortel Networks Corporation at the time of issue. None of

the Class A or Class B preferred shares of Nortel Networks Corporation has been issued.

Dividends

Dividends on the outstanding common shares are declared in U.S. dollars. Nortel Networks Corporation suspended future common share

dividends after payment on June 29, 2001 of the $0.01875 per common share dividend.

Shareholder ri

hts

lan

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 Corporation common

share outstanding. These rights become exercisable upon the occurrence of certain events associated with an unsolicited takeover bid.

17.

arnin

s(loss)

er common share

The following table details the weighted-average number of Nortel Networks Corporation common shares outstanding for the purposes o

computing basic and diluted earnings (loss) per common share for the following periods:

(Number of common shares in millions) 2003 2002(a) 2001(a)

Basic wei

hted-avera

e shares outstandin

Issued and outstanding 3,952 3,562 3,185

Prepaid forward purchase contracts(b) 378 270 –

Basic weighted-average shares outstanding 4,330 3,832 3,185

Weighted-average shares dilution adjustments:

Dilutive stock options 2

–

Diluted weighted-average shares outstanding 4,332 3,832 3,185

Weighted-average shares dilution adjustments — exclusions:

Stock options 286 257 210

4.25% convertible Senior Notes(c) 180 180 68

Pre

aid forward

urchase contracts(b) –14

–

(a) As a result of the net loss from continuing operations for the years ended December 31, 2002 and 2001, all potential dilutive securities were considered anti-

dilutive.

(b) The impact of the minimum number of common shares to be issued upon settlement of the prepaid forward purchase contracts on a weighted-average basis

was 378 and 270 for the years ended December 31, 2003 and 2002, respectively. As of December 31, 2003 and 2002, the minimum number of Nortel

Networks Corporation common shares to be issued upon settlement of the prepaid forward purchase contracts was 164 and 485, respectively. Had the

weighted-average number of prepaid forward purchase contracts been settled as of December 31, 2003 and 2002, an additional nil and 14 Nortel Networks

Corporation common shares, respectively, would have been issued above the minimum number of Nortel Networks Corporation common shares based on

the market price of Nortel Networks Corporation common shares on the respective dates.

F-68

18.

ccumulated other com

rehensive loss

The components of accumulated other comprehensive loss, net of tax, were as follows:

2003 2002 2001

Accumulated foreign currency translation adjustment

Balance at the beginning of the year $(331) $(488) $(354)

Change in foreign currency translation adjustment(a) 529 157 (134)

Balance at the end of the year 198 (331) (488)

Unrealized gain (loss) on investments — net

Balance at the beginning of the year 24 5 44

Change in unrealized gain (loss) on investments 57 19 (39)

Balance at the end of the year(b) 81 24 5

Unrealized derivative gain (loss) on cash flow hedges — net

Balance at the beginning of the year (3) (14) –

Change in unrealized derivative gain (loss) on cash flow hedges(c) 15 11 (14)

Balance at the end of the year 12 (3) (14)

Minimum pension liability(d)

Balance at the beginning of the year (641) (84) –

Change in minimum pension liability (188)(557)(84)

Balance at the end of the year (829) (641) (84)

Accumulated other comprehensive loss $(538) $ (951) $ (581)

(a) The change in the foreign currency translation adjustment was not adjusted for income taxes since it related to indefinite term investments in non-U.S.

subsidiaries.

(b) Certain securities deemed available-for-sale by Nortel Networks were measured at fair value. Unrealized holding gains (losses) related to these securities were

excluded from net earnings (loss) and were included in accumulated other comprehensive loss until realized. Unrealized gain (loss) on investments was net of

tax of nil, nil and $3 for the years ended December 31, 2003, 2002 and 2001, respectively. During the years ended December 31, 2003, 2002 and 2001,

realized (gains) losses on investments of $(6), $(4) and $(32), respectively, were reclassified to other income (expense) — net in the consolidated statements

of o

erations.

(c) During the year ended December 31, 2003, net derivative gains of $32 were reclassified to other income (expense) — net. Unrealized derivative gain (loss) on

cash flow hedges is net of tax of nil, $1 and $6 for the years ended December 31, 2003, 2002 and 2001, respectively. During the year ended December 31,

2002, $18 of net derivative losses were reclassified to other income (expense) — net. Nortel Networks estimates that $12 of net derivative gains

(losses) included in accumulated other comprehensive loss will be reclassified into net earnings (loss) within the next 12 months. Also included $7 (pre-tax

$11) of net derivative losses related to the adoption of SFAS 133 during the year ended December 31, 2001.

(d) Represents non-cash charges to shareholders’ equity related to the increase in the minimum required recognizable liability associated with Nortel Networks

pension plans (see note 9). The change in minimum pension liability amount is presented net of tax of $31, $133 and $26 for the years ended December 31,

2003, 2002 and 2001, respectively.

19. Stock-

ased com

ensation

lans

Stock o

tions

Nortel Networks grants options to purchase Nortel Networks Corporation common shares under two existing stock option plans, Nortel

Networks Corporation 2000 Stock Option Plan (the “2000 Plan”) and Nortel Networks Corporation 1986 Stock Option Plan As Amended

and Restated (the “1986 Plan”). Under these two plans, options to purchase Nortel Networks Corporation common shares may be granted

to employees, and under the 2000 Plan, options may be granted to directors of Nortel Networks that entitle the holders to purchase one

common share at a subscription price of not less than 100 percent of market value on the effective date of the grant. Subscription prices

are stated and payable in U.S. dollars for U.S. options and in Canadian dollars for Canadian options. Generally options granted prior to

2003 vest 33 percent on the anniversary date of the grant for three years. Options granted in 2003 generally vest 25 percent each year

over a four year period on the anniversary date of the grant. The committee of the Board of Directors of Nortel Networks that administers

both plans has the discretion to vary the period during which the holder has the right to exercise options and, in certain circumstances,

may accelerate the right of the holder to exercise options, but in no case shall the exercise period exceed ten years. Nortel Networks will

meet its obligations under both plans either by issuance, or by purchase on the open market, of Nortel Networks Corporation common

shares.

F-69

Options granted under the 2000 Plan and 1986 Plan may be granted with or without a SAR. A SAR entitles the holder to receive payment

of an amount equivalent to the excess of the market value of a common share at the time of exercise of the SAR over the subscription

price of the common share to which the option relates. Options with SARs may be granted on a cancellation basis, in which case the

exercise of one causes the cancellation of the other, or on a simultaneous basis, in which case the exercise of one causes the exercise of

the other.

As of December 31, 2003, the maximum number of common shares authorized by the shareholders and reserved for issuance by the

Board of Directors of Nortel Networks under the 1986 Plan and 2000 Plan is as follows:

(number of common shares in thousands) Maximum

1986 Plan(a)

Issuable to employees(b) 469,718

2000 Plan(a)

Issuable to non-employee directors 500

Issuable to em

ees 94,000

(a) In January 1995, a key contributor stock option program (the “Key Contributor Program”) was established. Under the terms of the Key Contributor Program,

participants are granted an equal number of initial options and replacement options. The initial options generally vest after five years and expire after ten years. The

replacement options are granted concurrently with the initial options and also expire after ten years. No Key Contributor Program options were granted for the years

ended December 31, 2003 and 2002, respectively, under both stock option plans.

(b) As of December 31, 2003, the maximum number of Nortel Networks Corporation common shares with respect to which options may be granted in any given year

under the 1986 Plan is three percent of Nortel Networks Corporation common shares issued and outstanding at the commencement of the year, subject to certain

adjustments.

During the year ended December 31, 2003, approximately 892,475 Nortel Networks Corporation common shares were issued pursuant to

the exercise of stock options granted under the 1986 Plan and 13,501 Nortel Networks Corporation common shares were issued pursuant

to the exercise of stock options granted under the 2000 Plan.

Nortel Networks assumed stock options plans in connection with the acquisition of various companies and granted options to purchase

Nortel Networks Corporation common shares. The vesting periods for these assumed plans may differ from the 2000 Plan and 1986 Plan,

but are not considered to be significant to Nortel Networks overall use of stock-based compensation.

On June 20, 2001, Nortel Networks commenced a voluntary stock option exchange program (the “Exchange Program”) for Nortel

Networks employees allowing employees to exchange certain outstanding stock options for new stock options, based on a prescribed

formula. The terms of the Exchange Program required that the new grants of options would be made at least six months and a day from

the cancellation date of the options tendered for exchange, which was July 27, 2001. Nortel Networks then Board of Directors and its

then board appointed officers were not eligible to participate in the Exchange Program.

F-70

The following is a summary of the total number of outstanding stock options and the maximum number of stock options available for

grant:

Weighted-

Outstanding average Available

options exercise for grant

(thousands)

rice (thousands)

Balance at December 31, 2000 325,380 $32.06 114,223

Granted options under all stock option plans(a) 55,565 $ 29.45 (55,565)

Options exercised (20,836) $ 6.53 –

Options cancelled(b) (56,793) $ 35.60 41,372

Options cancelled under the stock option exchange program(c) (93,416) $ 51.64 93,416

Balance at December 31, 2001 209,900 $ 23.86 193,446

Granted options under all stock option plans(c) 120,335 $7.08 (120,316)

Options exercised (3,269) $ 1.81 –

Options cancelled(b) (70,093) $ 26.48 55,036

Balance at December 31, 2002 256,873 $ 15.52 128,166

Granted options under all stock option plans 74,924 $2.40 (74,924)

Options exercised (1,550) $ 1.99 –

Options cancelled (41,849) $ 17.94 34,755

Balance at December 31, 2003 288,398 $ 12.27 87,997

(a) Included options granted in relation to various acquisitions during the year ended December 31, 2001 of approximately 1,313.

(b) Included ad

ustments to assumed stock o

tion

lans.

(c) Approximately 93,416 stock options were tendered for exchange and cancelled. On January 29, 2002, Nortel Networks granted approximately 52,700 new stock

options in connection with the Exchange Program with exercise prices in the range of U.S. $7.16 to U.S. $7.78 or Canadian $11.39 per common share.

The following table summarizes information about stock options outstanding as of December 31, 2003:

Options outstanding Options exercisable

Weighted-

average

remaining Weighted- Weighted-

Number contractual average Number average

outstanding life exercise exercisable exercise

Range of exercise prices (thousands) (in years) price (thousands) price

$0.0084 -$2.3900 58,476 9.1 $2.32 1,148 $1.49

$2.3901 - $3.5852 19,088 8.9 $ 2.57 1,042 $ 2.71

$3.5853 -$5.3779 11,970 5.9 $4.80 6,671 $4.60

$5.3780 - $8.0670 82,156(a) 6.5 $ 6.50 49,888 $ 6.67

$8.0671 -$12.1006 43,880(a) 3.8 $9.50 41,186 $9.57

$12.1007 - $18.1510 18,220 3.7 $ 15.23 16,580 $ 15.18

$18.1511 -$27.2267 25,602 5.0 $23.20 25,026 $23.28

$27.2268 - $40.8402 9,185 5.3 $ 34.74 8,058 $ 34.25

$40.8403 -$61.2605 13,455 4.5 $51.60 12,987 $51.88

$61.2606 - $91.8900 6,366 4.7 $ 72.50 6,337 $ 72.49

288,398 6.30 $12.27 168,923(b) $17.79

(a) Included approximately 41,069 stock options granted under the Exchange Program.

(b) Total number of exercisable options for the years ended December 31, 2002 and 2001 were 156,632 and 132,969, respectively.

Restricted stock unit

lan

The Nortel Networks Limited Restricted Stock Unit Plan is a long-term incentive plan that generally provides executive officers and

certain senior management with the opportunity to receive RSUs over a specified period of time if assigned performance thresholds are

achieved and the joint leadership resources committee of the Boards of the Directors of Nortel Networks and NNL (the “Committee”)

determines, in its discretion, to issue and settle all or a portion of the allocated RSUs. Each RSU issued entitles the holder to receive one

common share of Nortel Networks Corporation

F-71

purchased on the open market, or at the discretion of the Committee, or at the election of the holder in certain circumstances, cash in lieu

of shares.

The number of RSUs (in millions) allocated as of December 31, 2003, 2002 and 2001 was approximately 20, 2 and 2, respectively.

The RSUs allocated in 2003 may be issued and settled in four tranches at the discretion of the Committee. The Committee’s discretion is

to be based, among other things, on the achievement of four performance thresholds over a three year term ending December 31, 2005.

The performance criteria for each of the four performance thresholds are distinct and incremental “Return on Sales before Tax”

percentage targets, calculated on a rolling four-quarter basis. In order to receive payout, the recipient must have continued employment

until the date the allocated RSUs are issued and settled. Once the Committee determines that a threshold has been achieved, the

Committee uses its discretion to determine whether additional factors should be considered in determining the number of allocated RSUs

to be issued and settled. Such additional factors may include the performance of competitors and other relevant business, financial,

competitive, political and other criteria deemed appropriate by the Committee. In the third quarter of 2003, Nortel Networks issued and

settled approximately 7 million units of the RSUs allocated in 2003 (see note 23).

The RSUs allocated in 2001 were issued at the discretion of the Committee based, among other things, on the achievement of five

performance targets over a two year term ended March 31, 2003. Once the Committee determined whether the five performance targets

had been achieved, it used its discretion to determine the number of allocated RSUs to be issued and settled. On May 29, 2003, Nortel

Networks issued and settled approximately 1.5 million units in respect of the RSUs allocated in 2001.

Directors’ deferred share com

ensation

lans

Under the Nortel Networks Corporation Directors’ Deferred Share Compensation Plan and the Nortel Networks Limited Directors’

Deferred Share Compensation Plan, non-employee directors can elect to receive all or a portion of their compensation for services

rendered as a director of Nortel Networks Corporation or NNL, any committees thereof, and as board or committee chairperson, in the

form of share units, instead of cash. The share units are settled a specified number of trading days following the release of Nortel

Networks financial results after the director ceases to be a member of the applicable board, and each share unit entitles the holder to

receive one common share of Nortel Networks Corporation purchased on the open market. As of December 31, 2003 and 2002, the

number of share units issued (in millions) was 1 and 1, respectively.

ee stock

urchase

lans

Nortel Networks has ESPPs to facilitate the acquisition of common shares of Nortel Networks Corporation at a discount and the retention

of such common shares by eligible employees (see note 23). The ESPPs have four offering periods each year, with each offering period

beginning on the first day of each calendar quarter. Eligible employees may have up to 10 percent of their eligible compensation

deducted from their pay during each offering period to contribute towards the purchase of Nortel Networks Corporation common shares.

The Nortel Networks Corporation common shares are purchased by an independent broker through the facilities of the TSX and/or

NYSE, and held by a custodian on behalf of the plan participants.

For North American eligible employees, Nortel Networks Corporation common shares are purchased at a purchase price of 85 percent of

the market price of the Nortel Networks Corporation common shares on the last trading day of the offering period. For non-North

American eligible employees, common shares are purchased at a purchase price equal to the greater of:

(i) 85 percent of the average of the high and low prices of common shares on the first trading day of the offering period; and

(ii) 71.5 percent of the market price of the common shares on the last trading day of the offering period; or

(iii) if the market price on the last trading day is equal to or less than the average of the high and low on the first trading day, the

purchase price shall be 85 percent of the market price on the last trading day of the offering period.

The purchases under the ESPPs for the years ended December 31 are shown below:

iscontinued o

erations

During the year ended December 31, 2003, Nortel Networks continued to wind down its access solutions operations and there was no

change to the initial disposal strategy or intent to exit the business which was approved by the Nortel Networks Board of Directors on

June 14, 2001. However, the prolonged deterioration in industry and market conditions during 2002 and 2003 delayed certain disposal

activities beyond the original planned timeframe of one year. In particular, actions involving negotiations with customers, who were also

affected by industry conditions, took longer than expected. Although disposal activities continued beyond the one-year period generally

contemplated under APB 30, Nortel Networks continues to present the access solutions operations as discontinued operations in the

consolidated financial statements. As of December 31, 2003, Nortel Networks had substantially completed the wind down of its

discontinued operations.

Pursuant to APB 30, the revenues, costs and expenses, assets and liabilities and cash flows of Nortel Networks access solutions

operations have been segregated in the consolidated statements of operations, consolidated balance sheets and consolidated statements of

cash flows, and are reported as “discontinued operations”. The following consolidated financial results for discontinued operations are

presented as of December 31 for the consolidated balance sheets and for the years ended December 31 for the consolidated statements of

operations and consolidated statements of cash flows:

Consolidated statements of o

erations:

Consolidated balance sheets:

(number of shares in thousands) 2003 2002 2001

Nortel Networks Corporation common shares purchased(a) 11,532 38,824 14,648

Weighted-average price of shares purchased $ 3.10 $ 1.31 $ 8.50

(a) Compensation expense was recognized for Nortel Networks portion of the contributions. Nortel Networks contributed an amount equal to the difference between the

market price and the purchase price.

2003 2002 2001

Revenues $14 $158 $1,071

Net earnings (loss) from discontinued operations — net of tax(a) $–$–$(498)

Net gain (loss) on disposal of operations — net of tax(b) 184 (101)(1,969)

Net earnin

s (loss) from discontinued o

erations — net of tax $ 184 $ (101) $ (2,467)

(a) Net earnings (loss) from discontinued operations was net of applicable income tax benefit of $96 for the year ended December 31, 2001.

(b) Net gain (loss) on disposal of operations was net of an applicable income tax expense (benefit) of $1, $(16) and $(367) for the years ended December 31, 2003, 2002

and 2001, respectively.

F-72

2003 2002

Deferred income taxes $26 $144

Other current assets(a) 265

Total current assets of discontinued operations(b) 28 209

Other long-term assets(b)(c) 4127

Total assets of discontinued operations $32 $336

Current liabilities(b)(d) $6$63

Long-term liabilities(b) 1 1

Total liabilities of discontinued operations $7$64

(a) Included accounts receivable of nil and $20, which was net of provisions of $5 and $53, as of December 31, 2003 and 2002, respectively. Included inventories of

nil, which was net of provisions of $75 and $102, as of December 31, 2003 and 2002, respectively.

(b) Current assets, other long-term assets, current liabilities and long-term liabilities of discontinued operations were included in other current assets, other assets, other

accrued liabilities and other liabilities, respectively, on the consolidated balance sheets.

(c) Included customer financing receivables of $4 and $37, which was net of provisions of $55 and $470, as of December 31, 2003 and 2002, respectively.

Consolidated statements of cash flows:

(d) Included accruals of $6 and $63 as of December 31, 2003 and 2002, respectively. The accruals consisted of future contractual obligations and estimated liabilities of

nil and $14 and accruals of $6 and $49 during the planned period of disposition as of December 31, 2003 and 2002, respectively.

2003 Activity

Nortel Networks recorded net earnings from discontinued operations — net of tax, of $184 in 2003. The significant items included in net

earnings are summarized below.

During the year ended December 31, 2003, Nortel Networks reassessed its remaining provisions for discontinued operations and recorded

a net gain of $68, consisting of changes in estimates of $149 for liabilities, offset by additional provisions for both short-term and long-

term receivables of $81.

On December 17, 2003, Nortel Networks entered into an agreement to settle an outstanding $21 note receivable from one of its

customers, which was previously provisioned, for total cash proceeds of approximately $17. A gain of $17 was recorded as a result of

this transaction.

On December 23, 2003, Nortel Networks sold certain plant and equipment, inventory, patent and other intellectual property related to its

fixed wireless access operations, to Airspan Networks Inc. (“Airspan”). Nortel Networks received cash proceeds of $13. The majority of

the assets transferred to Airspan had previously been written off by Nortel Networks as part of its discontinued operations. As a result of

this transaction, Nortel Networks recorded a gain of $14 during the year ended December 31, 2003.

On March 24, 2003, Nortel Networks sold 8 million common shares of Arris Group back to Arris Group for cash consideration of $28

pursuant to a March 11, 2003 agreement, which resulted in a gain of $12. Following this transaction, Nortel Networks interest in Arris

Group was reduced to 18.8 percent, and it ceased equity accounting for the investment. As a result, Nortel Networks now classifies its

remaining ownership interest in Arris Group as an available-for-sale investment within continuing operations. Nortel Networks continues

to dispose of its interest in Arris Group and the gain or loss on the sale of shares subsequent to the first quarter of 2003 has been included

in other income (expense) — net (see note 10).

On March 18, 2003, Nortel Networks assigned its subordinated redeemable preferred interest (“membership interest”) in Arris

Interactive, L.L.C. (“Arris Interactive”) to ANTEC Corporation, an Arris Group company, for cash consideration of $88. As a result of

this transaction, Nortel Networks recorded a loss of $2. Also in connection with the March 2003 transactions, Nortel Networks received

$11 upon settlement of a sales representation agreement with Arris Group and recorded a gain of $11.

On March 20, 2003, Nortel Networks entered into an agreement with a customer to restructure approximately $465 of trade and customer

financing receivables owed to Nortel Networks, the majority of which was previously provisioned. As a result of the restructuring

agreement, Nortel Networks received consideration including cash of $125, notes receivable and an ownership interest which have been

fully provided for and the mutual release of all other claims between the parties. A gain of $66 was recorded as a result of the transaction.

In addition to the restructuring agreement, a five year equipment and services supply agreement was entered into requiring customer

payment terms of either cash in advance or guarantee by letters of credit in favor of Nortel Networks.

2002 Activity

Nortel Networks recorded a net loss from discontinued operations — net of tax, of $101 in 2002. The significant items included in this

net loss are summarized below.

F-73

2003 2002 2001

Cash flows from (used in) discontinued operations

Operating activities $149 $249 $(363)

Investing activities 241 100 32

Net cash from (used in) discontinued operations $ 390 $ 349 $ (331)

F-74

During the year ended December 31, 2002, Nortel Networks reassessed its remaining provisions for discontinued operations and recorded

a net additional loss of $97. The loss consisted of additional provisions for both short-term and long-term receivables of $157, offset by

gains of $60 due to other changes in estimates.

On June 25, 2002, Arris Group completed a secondary public offering of 15 million common shares held by Nortel Networks. Following

the closing of the offering, Nortel Networks owned 22 million shares, or approximately 27 percent of Arris Group’s common shares. The

cash proceeds received were $67 and a gain of approximately $17 was recorded as a result of this transaction. During the three months

ended March 31, 2002, Nortel Networks recorded a gain of approximately $13 due to the reduction of Nortel Networks ownership interest

in Arris Group, received for Nortel Networks original interest in Arris Group, from approximately 49 percent to approximately 46 percent

as a result of Arris Group’s issuance of common shares in connection with its acquisition of another company.

In addition, during the year, as a result of negotiation with Arris Group, Nortel Networks reduced the carrying value of its membership

interest in Arris Interactive and recorded a loss of $14.

On April 21, 2002, Nortel Networks entered into an agreement with Aastra Technologies Limited to sell certain assets, which were

included in discontinued operations, associated with Nortel Networks prior acquisition of Aptis Communications, Inc. (“Aptis”). The

transaction was completed during the three months ended June 30, 2002. The consideration primarily consisted of approximately $16 in

cash, as well as contingent cash consideration of up to $60 over four years based on the achievement of certain revenue targets by the

business. Nortel Networks recorded a loss of approximately $44 on the transaction.

On March 5, 2002, Nortel Networks divested its approximately 46 percent ownership interest in Elastic Networks Inc. (“Elastic

Networks”) to Paradyne Networks, Inc. (“Paradyne”) in exchange for an approximately 8 percent ownership interest in Paradyne. Nortel

Networks recorded a gain of approximately $7 on the transaction. The investment in Paradyne has been classified within continuing

operations.

On February 6, 2002, Nortel Networks divested its 68.5 percent interest in Netgear, Inc. in exchange for cash proceeds of $5, a

subordinated, unsecured, convertible, promissory note receivable of $20, and the assumption of certain liabilities. Nortel Networks

recorded a gain of approximately $7 on this transaction. Subsequent to 2002, Nortel Networks received cash of $20 relating to the

repayment of the subordinated, unsecured, convertible, promissory note receivable.

2001 Activity

On June 14, 2001, Nortel Networks Board of Directors approved a plan to discontinue Nortel Networks access solutions operations

consisting of all of Nortel Networks narrowband and broadband access solutions, including copper, cable and fixed wireless solutions, as

well as Nortel Networks then consolidated membership interest in Arris Group and equity investment in Elastic Networks. Also affected

by the decision were Nortel Networks prior acquisitions of Sonoma Systems (“Sonoma”), Promatory Communications, Inc.

(“Promatory”), Aptis and Broadband Networks Inc.

In connection with the decision to discontinue the access solutions operations on June 14, 2001, Nortel Networks recorded a pre-tax loss

on disposal of the access solutions operations of $2,173 in the three months ended June 30, 2001, which reflected the estimated costs

directly associated with Nortel Networks plan of disposition. The loss reflected: goodwill write-off of $755 associated with the acquisition

of Sonoma and Promatory; provisions for both short-term and long-term receivables of $423; a provision for inventories of $621; other

asset write-offs totaling $102; future contractual obligations and estimated liabilities of $123; estimated operating losses during the

planned period of disposition of $127; and estimated workforce reduction costs of $22.

In the three months ended June 30, 2001, Nortel Networks also reassessed the carrying value of certain investments totaling $41. Based on

this assessment, the fair value of these assets was nil, and the write-off of $41 was included in net earnings (loss) from discontinued

operations, net of tax of nil.

During the six months ended December 31, 2001, Nortel Networks reassessed its remaining provisions for discontinued operations and

recorded an additional pre-tax loss of $261. The loss consisted mainly of additional provisions for customer financing receivables and

equity losses on investments.

On August 24, 2001, Nortel Networks completed a transaction with Zhone Technologies, Inc. to sell the AccessNode ABM and CDS shelf

products and the Universal Edge 9000 digital loop carrier shelf and remote access shelf products for cash proceeds of $8, which resulted in

alossof$9.

F-75

On August 3, 2001, Nortel Networks announced the completion of the previously announced transfer of its ownership interest in Arris

Interactive to Arris Group, ANTEC Corporation’s new parent company. As a result, as of December 31, 2001, Nortel Networks owned a

49.2 percent non-controlling interest in Arris Group, compared to the previous 81.25 percent controlling interest in Arris Interactive,

including a subordinate redeemable preferred interest in Arris Interactive. Nortel Networks recorded a pre-tax gain of $113 on the

transaction.

On July 25, 2001, Nortel Networks completed a transaction with GE Industrial Systems Technology Management Inc., a division of

General Electric Company, to sell the Lentronics JungleMUX SONET multiplexer and TN-1U SDH multiplexer products for cash

proceeds of $13, which resulted in a gain of $13.

elated

art

transactions

In the ordinary course of business, Nortel Networks engages in transactions with certain of its equity-owned investees that are under or

are subject to Nortel Networks significant influence and with joint ventures of Nortel Networks. These transactions are sales and

purchases of goods and services under usual trade terms and are measured at their exchange amounts.

Transactions with related parties for the years ended December 31 are summarized as follows:

2003 2002 2001

Revenues $1$8$–

Purchases $–$–$16

As at December 31, 2003 and 2002, receivables from and payable to related parties were insignificant.

In 2001, Nortel Networks completed the sale of substantially all of the assets in the Cogent Defence Systems (“CDS”) business to EADS

Telecom. At that time, Nortel Networks held a 41 percent ownership interest in EADS Telecom and EADS held the remaining

59 percent. Under the terms of the agreement, Nortel Networks sold substantially all of its assets in the CDS business including: fixed

assets; accounts receivable; inventory; intellectual property; and licenses (but excluding cash on hand as at the closing date) for

consideration of approximately $143, comprised of a loan note due in 2002 and a call option to acquire an additional approximate

7 percent ownership interest in NNF beginning in 2004. Nortel Networks recorded a gain on the sale of approximately $37 which was

included in (gain) loss on sale of businesses and assets, and a deferred gain of $26, which is amortized into (gain) loss on sale of

businesses and assets over the life of the assets sold to EADS Telecom. In 2002, in connection with negotiations with EADS, the loan

note and call option were cancelled and a new loan note was issued to satisfy the remaining consideration owing in 2003. As a result,

Nortel Networks recorded an additional gain on the sale of approximately $30, which was included in (gain) loss on sale of businesses

and assets and a further deferred gain of $21, which is amortized into (gain) loss on sale of businesses and assets over the remaining life

of the assets sold to EADS Telecom in 2001. During the years ended December 31, 2003 and 2002, $13 and $11, respectively, of the

deferred gains were amortized into (gain) loss on sale of businesses and assets.

On September 18, 2003 as a result of the sale of Nortel Networks 41 percent interest in EADS Telecom (see note 10), the remaining

unamortized deferred gain of $23 related to the sale of substantially all of the assets in the CDS business during the year ended

December 31, 2001, was recognized and included in (gain) loss on sale of businesses and assets.

2. Contin

encies

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 U.S. District Courts for the Eastern District of

New York, for the Southern District of New York and for the District of New Jersey and the provinces of Ontario, Quebec and British

Columbia in Canada, on behalf of shareholders who acquired Nortel Networks Corporation securities as early as October 24, 2000 and as

late as February 15, 2001, allege, among other things, violations of U.S. federal and Canadian provincial securities laws. These matters

also have been the subject of review by Canadian and U.S. securities regulatory authorities. On May 11, 2001, the defendants filed

motions to dismiss and/or stay in connection with the three proceedings in Quebec primarily based on the factual allegations lacking

substantial connection to Quebec and the inclusion of shareholders resident in Quebec in the class claimed in the

F-76

Ontario lawsuit. The plaintiffs in two of these proceedings in Quebec obtained court approval for discontinuances of their proceedings on

January 17, 2002. The motion to dismiss and/or stay the third proceeding was heard on November 6, 2001 and the court deferred any

determination on the motion to the judge who will hear the application for authorization to commence a class proceeding. On

December 6, 2001, the defendants filed a motion seeking leave to appeal that decision. The motion for leave to appeal was dismissed on

March 11, 2002. On October 16, 2001, an order in the Southern District of New York was filed consolidating twenty-five of the related

U.S. class action lawsuits into a single case, appointing class plaintiffs and counsel for such plaintiffs. The plaintiffs served a

consolidated amended complaint on January 18, 2002. On December 17, 2001, the defendants in the British Columbia action served

notice of a motion requesting the court to decline jurisdiction and to stay all proceedings on the grounds that British Columbia is an

inappropriate forum. The motion has been adjourned at the plaintiffs’ request to a future date to be set by the parties.

A class action lawsuit against Nortel Networks was also filed in the U.S. District Court for the Southern District of New York on behalf

of shareholders who acquired the securities of JDS between January 18, 2001 and February 15, 2001, alleging violations of the same U.S.

federal securities laws as the above-noted lawsuits.

On April 1, 2002, Nortel Networks filed a motion to dismiss both the above consolidated U.S. shareholder class action and the above JDS

shareholder class action complaints on the grounds that they failed to state a cause of action under U.S. federal securities laws. With

respect to the JDS shareholder class action complaint, 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 U.S. class action complaint. Plaintiffs appealed the dismissal of the

JDS shareholder class action complaint. On November 19, 2003, oral argument was held before the Second Circuit on the JDS

shareholders’ appeal of the dismissal of their complaint. On May 19, 2004, the Second Circuit issued an opinion affirming the dismissal

of the JDS shareholder class action complaint and on July 14, 2004 the Second Circuit denied plaintiffs’ motion for rehearing. On

October 12, 2004, the plaintiffs filed a petition for writ of certiorari in the U.S. Supreme Court. On November 12, 2004, the defendants

filed Brief for the Respondents in Opposition, and on November 22, 2004, the plaintiffs filed Reply to Brief in Opposition. With respect

to the consolidated U.S. shareholder class action, the plaintiffs served a motion for class certification on March 21, 2003. On May 30,

2003, the defendants served an opposition to the motion for class certification. Plaintiffs’ reply was served on August 1, 2003. The

District Court held oral arguments on September 3, 2003 and issued an order granting class certification on September 5, 2003. On

September 23, 2003, the defendants filed a motion in the Second Circuit for permission to appeal the class certification decision. The

plaintiffs’ opposition to the motion was filed on October 2, 2003. On November 24, 2003, the Second Circuit denied the motion. On

March 10, 2004, the District Court approved the form of notice to the class which was published and mailed.

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 auditors as defendants. The

factual allegations in the Ontario Claim are substantially similar to the allegations in the consolidated amended complaint filed in the U.S.

District Court described above. The Ontario Claim is on behalf of all Canadian residents who purchased Nortel Networks Corporation

securities (including options on Nortel Networks Corporation securities) between October 24, 2000 and February 15, 2001. The plaintiffs

claim damages of Canadian $5,000, plus punitive damages in the amount of Canadian $1,000, prejudgment and postjudgment interest and

costs of the action. On September 23, 2003, the Court issued an order allowing the plaintiffs to proceed to amend the Ontario Claim and

requiring that the plaintiffs serve class certification materials by December 15, 2003. On September 24, 2003, the plaintiffs filed a notice

of discontinuance of the original action filed in Ontario. On December 12, 2003, plaintiffs’ counsel requested an extension of time to

January 21, 2004 to deliver class certification materials. On January 21, 2004, plaintiffs’ counsel advised the Court that the two

representative plaintiffs in the action no longer wished to proceed, but counsel was prepared to deliver draft certification materials

pending the replacement of the representative plaintiffs. On February 19, 2004, the plaintiffs’ counsel advised the Court of a potential

new representative plaintiff. On February 26, 2004, the defendants requested the Court to direct the plaintiffs’ counsel to bring a motion

to permit the withdrawal of the current representative plaintiffs and to substitute the proposed representative plaintiff. On June 8, 2004,

the Court signed an order allowing a Second Fresh as Amended Statement of Claim that substituted one new representative plaintiff, but

did not change the substance of the prior claim.

A purported class action lawsuit was filed in the U.S. District Court for the Middle District of Tennessee on December 21, 2001, on

behalf of participants and beneficiaries of the Nortel Networks Long-Term Investment Plan (the “Plan”) at any time during the period of

March 7, 2000 through the filing date and who made or maintained Plan investments in Nortel Networks Corporation common shares,

under the Employee Retirement Income Security Act (“ERISA”) for Plan-wide relief and alleging, among other things, material

misrepresentations and omissions to induce Plan participants to continue to invest in and maintain investments in Nortel Networks

Corporation common shares in

F-77

the Plan. A second purported class action lawsuit, on behalf of the Plan and Plan participants for whose individual accounts the Plan

purchased Nortel Networks Corporation common shares during the period from October 27, 2000 to February 15, 2001 and making

similar allegations was filed in the same court on March 12, 2002. A third purported class action lawsuit, on behalf of persons who are or

were Plan participants or beneficiaries at any time since March 1, 1999 to the filing date and making similar allegations, was filed in the

same court on March 21, 2002. The first and second purported class action lawsuits were consolidated by a new purported class action

complaint, filed on May 15, 2002 in the same court and making similar allegations, on behalf of Plan participants and beneficiaries who

directed the Plan to purchase or hold shares of certain funds, which held primarily Nortel Networks Corporation common shares, during

the period from March 7, 2000 through December 21, 2001. On September 24, 2002, plaintiffs in the consolidated action filed a motion

to consolidate all the actions and to transfer them to the U.S. District Court for the Southern District of New York. The plaintiffs then

filed a motion to withdraw the pending motion to consolidate and transfer. The withdrawal was granted by the District Court on

December 30, 2002. A fourth purported class action lawsuit, on behalf of the Plan and Plan participants for whose individual accounts the

Plan held Nortel Networks Corporation common shares during the period from March 7, 2000 through March 31, 2001 and making

similar allegations, was filed in the U.S. District Court for the Southern District of New York on March 12, 2003. On March 18, 2003,

plaintiffs in the fourth purported class action filed a motion with the Judicial Panel on Multidistrict Litigation to transfer all the actions to

the Southern District of New York for coordinated or consolidated proceedings pursuant to 28 U.S.C. section 1407. On June 24, 2003,

the Judicial Panel on Multidistrict Litigation issued a transfer order transferring the Southern District of New York action to the Middle

District of Tennessee (the “Consolidated ERISA Action”). On September 12, 2003, the plaintiffs in all the actions filed a consolidated

class action complaint. On October 28, 2003, the defendants filed a motion to dismiss the complaint and a motion to stay discovery

pending disposition of the motion to dismiss. On March 30, 2004, the plaintiffs filed a motion for certification of a class consisting of

participants in, or beneficiaries of, the Plan who held shares of the Nortel Networks Stock Fund during the period from March 7, 2000

through March 31, 2001. On April 27, 2004, the Court granted the defendants’ motion to stay discovery pending resolution of

defendants’ motion to dismiss. On June 15, 2004, the plaintiffs filed a First Amended Consolidated Class Action Complaint that added

additional current and former officers and employees as defendants and expanded the purported class period to extend from March 7,

2000 through to June 15, 2004.

On March 4, 1997, Bay Networks, Inc. (“Bay Networks”), a company acquired on August 31, 1998, announced that shareholders had

filed two separate lawsuits in the U.S. District Court for the Northern District of California (the “Federal Court”) and the California

Superior Court, County of Santa Clara (the “California Court”), against Bay Networks and ten of Bay Networks’ then current and former

officers and directors purportedly on behalf of a class of shareholders who purchased Bay Networks’ common shares during the period of

May 1, 1995 through October 14, 1996. On August 17, 2000, the Federal Court granted the defendants’ motion to dismiss the federal

complaint. On August 1, 2001, the U.S. Court of Appeals for the Ninth Circuit denied the plaintiffs’ appeal of that decision. On April 18,

1997, a second lawsuit was filed in the California Court, purportedly on behalf of a class of shareholders who acquired Bay Networks’

common shares pursuant to the registration statement and prospectus that became effective on November 15, 1995. The two actions in the

California Court were consolidated in April 1998; however, the California Court denied the plaintiffs’ motion for class certification. In

January 2000, the California Court of Appeal rejected the plaintiffs’ appeal of the decision. A petition for review was filed with the

California Supreme Court by the plaintiffs and was denied. In February 2000, new plaintiffs who allege to have been shareholders of Bay

Networks during the relevant periods, filed a motion for intervention in the California Court seeking to become the representatives of a

class of shareholders. The motion was granted on June 8, 2001 and the new plaintiffs filed their complaint-in-intervention on an

individual and purported class representative basis alleging misrepresentations made in connection with the purchase and sale of

securities of Bay Networks in violation of California statutory and common law. On March 11, 2002, the California Court granted the

defendants’ motion to strike the class allegations. The plaintiffs were permitted to proceed on their individual claims. The intervenor-

plaintiffs appealed the dismissal of their class allegations. On July 25, 2003, the California Court of Appeal reversed the trial court’s

dismissal of the intervenor-plaintiffs’ class allegations. On September 3, 2003, the defendants filed a petition for review with the

California Supreme Court seeking permission to appeal the Court of Appeal decision. On October 22, 2003, the California Supreme

Court denied, without opinion, the defendants’ petition for review. On December 22, 2003, the plaintiffs served their motion for

certification of a class of purchasers of Bay Networks’ common shares from July 25, 1995 through to October 14, 1996. Hearing of the

plaintiffs’ motion for class certification was held on May 4, 2004. On July 27, 2004, the Court entered an Amended Order Denying

Motion of Intervenor Plaintiffs for Class Certification and Setting Further Hearing. On August 9, 2004, the intervenor-plaintiffs obtained

Court approval to dismiss their claims and this action and, on September 30, 2004, the Court entered dismissal with prejudice of the

entire action of all parties and all causes of action.

Subsequent to the March 10, 2004 announcement in which Nortel Networks indicated it was likely that it would need to revise its

previously announced unaudited results for the year ended December 31, 2003, and the results reported in

F-78

certain of its quarterly reports for 2003, and to restate its previously filed financial results for one or more earlier periods, Nortel

Networks and certain of its then current and former officers and directors were named as defendants in 27 purported class action lawsuits.

These lawsuits in the U.S. District Court for the Southern District of New York on behalf of shareholders who acquired Nortel Networks

Corporation securities as early as February 16, 2001 and as late as May 15, 2004, allege, among other things, violations of U.S. federal

securities laws. These matters are also the subject of investigations by Canadian and U.S. securities regulatory and criminal investigative

authorities (see note 23). On June 30, 2004, the Court signed Orders consolidating the 27 class actions and appointing lead plaintiffs and

lead counsel. The plaintiffs filed a consolidated class action complaint on September 10, 2004, alleging a class period of April 24, 2003

through and including April 27, 2004. On November 5, 2004, Nortel Networks Corporation and the Audit Committee Defendants filed a

motion to dismiss the consolidated class action complaint.

On May 18, 2004, a purported class action lawsuit was filed in the U.S. District Court for the Middle District of Tennessee on behalf of

participants and beneficiaries of the Plan at any time during the period of December 23, 2003 through the filing date and who made or

maintained Plan investments in Nortel Networks Corporation common shares, under the ERISA for Plan-wide relief and alleging, among

other things, breaches of fiduciary duty. On September 3, 2004, the Court signed a stipulated order consolidating this action with the

Consolidated ERISA Action described above. On June 16, 2004, a second purported class action lawsuit, on behalf of the Plan and Plan

participants for whose individual accounts the Plan purchased Nortel Networks Corporation common shares during the period from

October 24, 2000 to June 16, 2004, and making similar allegations, was filed in the U.S. District Court for the Southern District of New

York. On August 6, 2004, the Judicial Panel on Multidistrict Litigation issued a conditional transfer order to transfer this action to the

U.S. District Court for the Middle District of Tennessee for coordinated or consolidated proceedings pursuant to 28 U.S.C. section 1407

with the Consolidated ERISA Action described above. On August 20, 2004, plaintiffs filed a notice of opposition to the conditional

transfer order with the Judicial Panel. On December 6, 2004, the Judicial Panel denied the opposition and ordered the action transferred

to the U.S. District Court for the Middle District of Tennessee for coordinated or consolidated proceedings with the Consolidated ERISA

Action described above.

On July 28, 2004, Nortel Networks and NNL, and certain directors and officers, and certain former directors and officers, of Nortel

Networks and NNL, were named as defendants in a purported class proceeding in the Ontario Superior Court of Justice on behalf of

shareholders who acquired Nortel Networks Corporation securities as early as November 12, 2002 and as late as July 28, 2004. This

lawsuit alleges, among other things, breaches of trust and fiduciary duty, oppressive conduct and misappropriation of corporate assets and

trust property in respect of the payment of cash bonuses to executives, officers and employees in 2003 and 2004 under the Nortel

Networks Return to Profitability bonus program and seeks damages of Canadian $250 and an order under the Canada Business

Corporations Act directing that an investigation be made respecting these bonus payments.

On July 30, 2004, a shareholders’ derivative complaint was filed in the U.S. District Court for the Southern District of New York against

certain directors and officers, and certain former directors and officers, of Nortel Networks alleging, among other things, breach of

fiduciary duties owed to Nortel Networks during the period from 2000 to 2003 including by causing Nortel Networks to engage in

unlawful conduct or failing to prevent such conduct; causing Nortel Networks to issue false statements; and violating the law.

Except as otherwise described herein, in each of the matters described above, the plaintiffs are seeking an unspecified amount of

monetary damages.

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

business.

Nortel Networks is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to Nortel Networks of the

above matters which, unless otherwise specified, seek damages from the defendants of material or indeterminate amounts or could result

in fines and penalties. Nortel Networks cannot determine whether these actions, suits, claims and proceedings will, individually or

collectively, have a material adverse effect on the business, results of operations, financial condition and liquidity of Nortel Networks.

Nortel Networks and any named directors and officers of Nortel Networks intend to vigorously defend these actions, suits, claims and

proceedings.

Environmental matters

Nortel Networks operations are subject to a wide range of environmental laws in various jurisdictions around the world. Nortel Networks

seeks to operate its business in compliance with such laws. In 2004, Nortel Networks expects to become subject to new European product

content laws and product takeback and recycling requirements that will require

F-79

full compliance by 2006. It is expected that these laws will require Nortel Networks to incur additional compliance costs. Although costs

relating to environmental matters have not resulted in a material adverse effect on the business, results of operations, financial condition

and liquidity in the past, there can be no assurance that Nortel Networks will not be required to incur such costs in the future. Nortel

Networks has a corporate environmental management system standard and an environmental program to promote such compliance.

Moreover, Nortel Networks has a periodic, risk-based, integrated environment, health and safety audit program.

Nortel Networks environmental program focuses its activities on design for the environment, supply chain and packaging reduction

issues. Nortel Networks works with its suppliers and other external groups to encourage the sharing of non-proprietary information on

environmental research.

Nortel Networks is exposed to liabilities and compliance costs arising from its past and current generation, management and disposal of

hazardous substances and wastes. As of December 31, 2003, the accruals on the consolidated balance sheet for environmental matters

were $33. Based on information available as of December 31, 2003, management believes that the existing accruals are sufficient to

satisfy probable and reasonably estimable environmental liabilities related to known environmental matters. Any additional liability that

may result from these matters, and any additional liabilities that may result in connection with other locations currently under

investigation, are not expected to have a material adverse effect on the business, results of operations, financial condition and liquidity of

Nortel Networks.

Nortel Networks has remedial activities under way at 12 sites which are either currently or previously owned or occupied facilities. An

estimate of Nortel Networks anticipated remediation costs associated with all such sites, to the extent probable and reasonably estimable,

is included in the environmental accruals referred to above in an approximate amount of $33.

Nortel Networks is also listed as a potentially responsible party (“PRP”) under the U.S. Comprehensive Environmental Response,

Compensation and Liability Act (“CERCLA”) at six Superfund sites in the U.S. An estimate of Nortel Networks share of the anticipated

remediation costs associated with such Superfund sites is expected to be de minimis and is included in the environmental accruals of $33

referred to above.

Liability under CERCLA may be imposed on a joint and several basis, without regard to the extent of Nortel Networks involvement. In

addition, the accuracy of Nortel Networks estimate of environmental liability is affected by several uncertainties such as additional

requirements which may be identified in connection with remedial activities, the complexity and evolution of environmental laws and

regulations, and the identification of presently unknown remediation requirements. Consequently, Nortel Networks liability could be

greater than its current estimate.

3. Subse

uent events

Nortel Networks Audit Committee Inde

endent Review

;

restatements

;

related matters

As previously announced by Nortel Networks in October 2003, in late October 2003 the Nortel Networks Audit Committee initiated the

Independent Review of the facts and circumstances leading to the First Restatement and engaged WCPHD to advise it in connection with

the Independent Review.

On March 10, 2004, Nortel Networks announced that as a result of the work done to date in connection with the Independent Review, it

was re-examining the establishment, timing of, support for and release to income of certain accruals and provisions in prior periods.

Further, it was likely that Nortel Networks would need to revise its previously announced unaudited results for the year ended

December 31, 2003, and the results reported in certain of its quarterly reports for 2003, and to restate its previously filed financial results

for one or more earlier periods. Nortel Networks announced on March 15, 2004 that the filing of Nortel Networks and NNL’s annual

reports on Form 10-K for the year ended December 31, 2003 (the “2003 Annual Reports”) would be delayed beyond March 30, 2004.

On April 5, 2004, Nortel Networks announced that the SEC had issued a formal order of investigation in connection with Nortel

Networks previous restatement of its financial results for certain periods, as announced in October 2003, and Nortel Networks

announcements in March 2004 regarding the likely need to revise certain previously announced results and restate previously filed

financial results for one or more earlier periods. The matter had been the subject of an informal SEC inquiry. On April 13, 2004, Nortel

Networks announced that it had received a letter from the staff of the Ontario Securities Commission (“OSC”) advising that there is an

OSC Enforcement Staff investigation into the same matters that are the subject of the SEC investigation.

F-80

On April 28, 2004, Nortel Networks announced that the Independent Review was extended to include the second half of 2003 and it was

determined that the previously announced unaudited results for the year ended December 31, 2003 needed to be revised and that the

financial results reported in each of Nortel Networks quarterly periods of 2003 and for earlier periods including 2002 and 2001 needed to

be restated. Nortel Networks announced that it and NNL were not expected to timely file their first quarter 2004 financial statements and,

in accordance with Canadian securities regulations, their 2003 Canadian GAAP audited financial statements and Annual Information

Form.

In April 2004, Nortel Networks terminated for cause its former president and chief executive officer, former chief financial officer and

former controller and, in August 2004, seven additional senior finance employees with significant responsibilities for Nortel Networks

financial reporting as a whole or for their respective business units and geographic regions in August 2004.

On May 14, 2004, Nortel Networks announced that it had received a Federal Grand Jury Subpoena for the production of certain

documents, including financial statements and corporate, personnel and accounting records, prepared during the period from January 1,

2000 to the date of the subpoena. The materials sought are pertinent to an ongoing criminal investigation being conducted by the U.S.

Attorney’s Office for the Northern District of Texas, Dallas Division.

On May 17, 2004, Nortel Networks announced that the OSC had issued a temporary order that prohibits all trading by directors, officers

and certain current and former employees in the securities of Nortel Networks and NNL, which temporary order was replaced with a final

order issued on May 31, 2004. The final order remains in effect until two full business days following the receipt by the OSC of all

filings required to be made by Nortel Networks and NNL pursuant to Ontario securities laws.

On June 29, 2004, Nortel Networks announced that it did not expect to timely file financial statements for the second quarter of 2004 and

related periodic reports in accordance with U.S. and Canadian securities laws.

On August 16, 2004, Nortel Networks received a letter from the Integrated Market Enforcement Team of the Royal Canadian Mounted

Police (“RCMP”) advising Nortel Networks that the RCMP would be commencing a criminal investigation into Nortel Networks

financial accounting situation.

On August 19, 2004, Nortel Networks announced a new streamlined organizational structure, effective October 1, 2004, that involved,

among other things, combining the businesses of Nortel Networks four segments into two business organizations: (i) Carrier Networks

and Global Operations, and (ii) Enterprise Networks. Further, a focused workforce reduction of approximately 3,250 employees was

announced. In addition, the Audit Committee anticipated that there would be work done, in addition to that portion of the inquiry which

affects Nortel Networks and NNL’s ability to finalize their 2003 audited financial statements, in connection with its Independent Review,

on remedial measures, internal controls and improvements to processes.

On October 27, 2004, Nortel Networks announced that Nortel Networks and NNL did not expect to file their third quarter 2004 financial

statements, and the related periodic reports, by the required deadlines in November 2004 in compliance with certain U.S. and Canadian

securities regulations.

Nortel Networks has terminated for cause 10 individuals, including its former president and chief executive officer, its former chief

financial officer and its former controller. Nortel Networks has demanded repayment by the individuals terminated for cause of payments

made under Nortel Networks bonus plans in respect of 2003.

Subsequent to the March 10, 2004 announcement, numerous class action complaints, including ERISA class action complaints, have

been filed against Nortel Networks in the U.S. and Canada. In addition, a derivative action complaint has been filed against Nortel

Networks. Nortel Networks is subject to significant pending civil litigation which, if decided against Nortel Networks, could result in

substantial damages or other penalties which, in turn, could have a material adverse effect on the business, results of operations, financial

condition and liquidity of Nortel Networks (see note 22).

In January 2005, the Audit Committee reported the findings of the Independent Review, together with its recommendations for governing

principles for remedial measures that were developed for the Audit Committee by WCPHD. Each of Nortel Networks and NNL's Boards

of Directors has adopted those recommendations in their entirety and directed management to develop a detailed plan and timetable for

their implementation, and will monitor their implementation.

Also in January 2005, the Nortel Networks Audit Committee determined to review the facts and circumstances leading to the restatement

of certain revenues for specific transactions identified in the Second Restatement. This review will have a particular emphasis on the

underlying conduct that led to the initial recognition of these revenues. The Audit Committee will develop any appropriate additional

remedial measures, and has engaged WCPHD to advise it in connection with such review.

EDC Su

ort Facilit

On March 10, 2004, Nortel Networks announced that the filing of the 2003 Annual Reports with the SEC would be delayed. On

March 15, 2004, Nortel Networks announced that the filing of the 2003 Annual Reports with the SEC would extend beyond March 30,

2004 and that would result in EDC having the right to terminate its commitments under the EDC Support Facility and to exercise certain

rights against the collateral under the related security agreements (see note 24). NNL obtained a waiver from EDC on March 29, 2004 of

certain defaults under the EDC Support Facility related to the delay in filing the 2003 Annual Reports with the SEC, the trustees under

Nortel Networks and NNL’s public trust indentures and EDC and to permit continued access to the EDC Support Facility in accordance

with its terms while Nortel Networks and NNL completed their filing obligations. The waiver also applied to certain related breaches

under the EDC Support Facility relating to the delayed filings and the planned restatements and revisions to Nortel

F-81

Networks and NNL’s prior financial results (the “Related Breaches”). The waiver was to remain in effect until the earliest of certain

events or May 29, 2004. On March 29, 2004, NNL and EDC also amended the EDC Support Facility to provide that EDC may also

suspend its obligation to issue NNL any additional support if events occur that have a material adverse effect on NNL’s business,

financial position or results of operations and that such amendment would survive the waiver period.

On May 28, 2004, NNL obtained a new waiver from EDC of certain defaults under the EDC Support Facility related to the delay in filing

the 2003 Annual Reports and Nortel Networks and NNL’s quarterly reports on Form 10-Q for the three months ended March 31, 2004

(the “First Quarter Reports”) and the Related Breaches, which waiver was to remain in effect until the earliest of certain events or

August 30, 2004. This waiver reclassified the previously committed $300 revolving small bond sub-facility of the EDC Support Facility

as uncommitted support.

A further waiver was obtained from EDC effective August 20, 2004 (the “August Waiver”) related to the delay in filing the 2003 Annual

Reports, the First Quarter Reports and Nortel Networks and NNL’s quarterly reports on Form 10-Q for the three months ended June 30,

2004 (the “Second Quarter Reports”) and the Related Breaches, which waiver was to remain in effect until the earliest of certain events

or September 30, 2004.

On September 29, 2004, NNL obtained a new waiver from EDC (the “September Waiver”) which replaced the August Waiver on

substantially the same terms as provided in the August Waiver except that the September Waiver was to remain in effect until the earliest

of certain events or October 31, 2004.

On October 29, 2004, NNL obtained a new waiver from EDC (the “October Waiver”) which replaced the September Waiver on

substantially the same terms as the September Waiver except that the October Waiver remained in effect until the earliest of certain

events or November 19, 2004.

A further waiver was obtained from EDC effective November 19, 2004 (the “November Waiver”) related to the delay in filing the 2003

Annual Reports, the First Quarter Reports, the Second Quarter Reports and Nortel Networks and NNL’s quarterly reports on Form 10-Q

for the three months ended September 30, 2004 (the “Third Quarter Reports”, and together with the 2003 Annual Reports, the First

Quarter Reports and the Second Quarter Reports, the “Reports”, and the Third Quarter Reports together with the First Quarter Reports

and Second Quarter Reports, the “Quarterly Reports”) and the Related Breaches, which waiver was to remain in effect until the earliest of

certain events or December 10, 2004.

On December 10, 2004, NNL obtained a new waiver from EDC (the “December Waiver”) which replaced the November Waiver on

substantially the same terms as the November Waiver except that: (i) the December Waiver included an amendment to the EDC Support

Facility to extend the termination date of the EDC Support Facility to December 31, 2006 from December 31, 2005; and (ii) the

December Waiver remains in effect until the earliest of certain events including the date on which Nortel Networks and NNL have filed

all of the Reports or January 15, 2005.

As Nortel Networks and NNL will not have filed all of the Reports by January 15, 2005, EDC will have the right on such date (absent a

further waiver in relation to the delayed filings and the Related Breaches) to: (i) terminate the EDC Support Facility; (ii) exercise certain

rights against collateral; or (iii) require NNL to cash collateralize all existing support.

In addition, the Related Breaches will continue beyond the filing of the Reports. Accordingly, EDC will have the right beginning on

January 15, 2005 (absent a further waiver of the Related Breaches) to terminate or suspend the EDC Support Facility and exercise certain

other rights against collateral notwithstanding the filing of the Reports. While NNL is seeking a permanent waiver from EDC in

connection with the Related Breaches, there can be no assurance that NNL will receive any waiver or as to the terms of any such waiver.

The $300 revolving small bond sub-facility will not become committed support until all of the Reports have been filed with the SEC, the

trustees under Nortel Networks and NNL’s public trust indentures and EDC and NNL obtains a permanent waiver of the Related

Breaches.

Credit facilities and securit

reements

On April 28, 2004, NNL notified the banks under the Five Year Facilities that it was terminating these facilities. Absent such termination,

the banks would have been permitted, upon 30 days’ notice, to terminate their commitments under the Five Year Facilities as a result of

NNL’s inability to file its annual report on Form 10-K for the year ended December 31, 2003 by April 29, 2004. Upon termination, the

Five Year Facilities were undrawn.

F-82

As a result of the termination of the Five Year Facilities, certain foreign security agreements entered into by NNL and various of its

subsidiaries under which shares of certain subsidiaries of NNL incorporated outside of the U.S. and Canada were pledged in favor of the

banks under the Five Year Facilities, EDC and the holders of Nortel Networks and NNL’s outstanding public debt securities also

terminated in accordance with their terms (see note 24). In addition, guarantees by certain subsidiaries of NNL incorporated outside of

the U.S. and Canada terminated in accordance with their terms. Security agreements remain in place under which substantially all of the

assets of NNL located in the U.S. and Canada and those of most of its U.S. and Canadian subsidiaries, including the shares of certain of

NNL’s U.S. and Canadian subsidiaries, are pledged in favor of EDC and the holders of Nortel Networks and NNL’s outstanding public

debt securities. In addition, the guarantees by certain of NNL’s wholly owned subsidiaries, including NNI, most of NNL’s Canadian

subsidiaries, Nortel Networks (Asia) Limited, Nortel Networks (Ireland) Limited and Nortel Networks U.K. Limited, of NNL’s

obligations under the EDC Support Facility and Nortel Networks and NNL’s outstanding public debt securities remain in place.

Debt securities

As a result of the delay in filing the Reports, Nortel Networks and NNL have not been in compliance with their obligations to deliver

their respective SEC filings to relevant parties under Nortel Networks and NNL’s public debt indentures. As of December 31, 2004,

approximately $1,800 of notes of NNL (or its subsidiaries) and $1,800 of convertible debt securities of Nortel Networks were

outstanding.

These delays have not resulted in an automatic event of default and acceleration of the outstanding long-term debt and such default and

acceleration cannot occur unless notice of such non-compliance from holders of 25% of the outstanding principal amount of any relevant

debt securities is provided to Nortel Networks or NNL, as applicable, and Nortel Networks or NNL, as applicable, fail to file and deliver

the relevant report within 90 days after such notice is provided, all in accordance with the terms of the indentures. While such notice

could have been given at any time after March 30, 2004, neither Nortel Networks nor NNL has received a notice to the date of this report.

As a result of the delay in filing certain of the Reports, Nortel Networks and NNL continue not to be in compliance with their obligations

under Nortel Networks and NNL’s public debt indentures as described above. If notice were given and acceleration of Nortel Networks

and NNL’s debt securities were to occur, Nortel Networks may be unable to meet its payment obligations.

Stock-based com

ensation

lans

As a result of Nortel Networks March 10, 2004 announcement, as described above under “Nortel Networks Audit Committee

Independent Review; restatements; related matters”, Nortel Networks suspended as of March 10, 2004: the purchase of Nortel Networks

Corporation common shares under the ESPPs; the exercise of outstanding options granted under the 2000 Plan or 1986 Plan, or the grant

of any additional options under those plans, or the exercise of outstanding options granted under employee stock option plans previously

assumed by Nortel Networks in connection with mergers and acquisitions; and the purchase of units in a Nortel Networks stock fund or

purchase of Nortel Networks Corporation common shares under Nortel Networks defined contribution and investments plans, until such

time, at the earliest, that Nortel Networks is in compliance with U.S. and Canadian regulatory securities filing requirements.

Stock exchan

As a result of the continued delay in filing the Quarterly Reports, Nortel Networks is in breach of the continued listing requirements of

the NYSE and the TSX. The NYSE has granted Nortel Networks and NNL an extension up to March 31, 2005 by which to file the 2003

Annual Reports. To date, neither the NYSE nor the TSX has commenced any suspension or delisting procedures in respect of Nortel

Networks Corporation common shares and other of Nortel Networks and NNL’s listed securities. The commencement of any suspension

or delisting procedures by either exchange remains, at all times, at the discretion of such exchange.

Director

and o

erator services business

On August 2, 2004, Nortel Networks completed the contribution of certain assets and liabilities of its directory and operator services

(“DOS”) business to VoltDelta Resources LLC (“VoltDelta”), a wholly owned subsidiary of Volt Information Sciences, Inc. (“VIS”), in

return for a 24 percent interest in VoltDelta. After a period of two years, Nortel Networks and VIS each have an option to cause Nortel

Networks to sell its VoltDelta shares to VIS for proceeds ranging from $25 to $70. As a result of this transaction, approximately 160

Nortel Networks DOS employees in North Americ

F-83

and Mexico joined VoltDelta. Nortel Networks recorded a gain on sale of businesses and assets of approximately $50 in the third quarter

of 2004.

Evolution of Nortel Networks su

chain strate

On June 29, 2004, Nortel Networks announced an agreement with Flextronics International Ltd. (“Flextronics”), regarding the divestiture

of substantially all of Nortel Networks remaining manufacturing operations, including product integration, testing and repair operations

carried out in Nortel Networks Systems Houses in Calgary and Montreal, Canada and Campinas, Brazil, as well as certain activities

related to these locations, including the management of the supply chain, related suppliers, and third-party logistics. In Europe,

Flextronics has made an offer to purchase similar operations at the Nortel Networks Monkstown, Northern Ireland and Chateaudun,

France Systems Houses, subject to the completion of the required information and consultation process.

Under the terms of the agreement and offer, Flextronics will also acquire Nortel Networks global repair services, as well as certain design

assets in Ottawa and Monkstown related to hardware and embedded software design, and related product verification for certain

established optical products.

Nortel Networks and Flextronics have entered into a four year supply agreement for manufacturing services (whereby Flextronics will

manage approximately $2,500 of Nortel Networks annual cost of sales) and a three year supply agreement for design services. The

portion of the transaction related to the optical design activities in Ottawa and Monkstown was completed on November 1, 2004. The

portions of the transaction related to the manufacturing activities in Montreal and Calgary are expected to close in the first and second

quarters of 2005, respectively. The balance of the transaction is expected to close on separate dates occurring during the first half of

2005. These transactions are subject to customary conditions and regulatory approvals.

The successful completion of the agreement and offer with Flextronics will result in the transfer of approximately 2,500 employees from

Nortel Networks to Flextronics. Nortel Networks expects to receive cash proceeds ranging from approximately $675 to $725, which will

be allocated to each separate closing and, with respect to each closing, will be paid on an installment basis up to nine months thereafter.

Such payments will be subject to a number of adjustments, including potential post-closing date asset valuations and potential post-

closing indemnity payments. Flextronics also has the ability in certain cases to exercise rights to sell back to Nortel Networks certain

inventory and equipment after the expiration of a specified period (of up to fifteen months) following each respective closing date. Nortel

Networks does not expect such rights to be exercised with respect to any material amount of inventory and/or equipment. The cash

proceeds estimate is comprised of approximately $475 to $525 for inventory and equipment and $200 for intangible assets. The cash

proceeds would be partially offset by related estimated transaction costs (including transition, potential severance, and information

technology implementation and real estate costs) of approximately $200.

Other

On January 8, 2004, Nortel Networks renegotiated an agreement with a certain customer and reduced Nortel Networks aggregate

undrawn customer financing commitments from $177 to $69.

On February 3, 2004, Nortel Networks sold approximately 7 million common shares of Entrust Inc. (“Entrust”) for cash consideration of

$33, resulting in a gain of $18. As a result of this transaction, Nortel Networks no longer holds any equity interest in Entrust.

On March 1, 2004, Nortel Networks purchased land and two buildings for $87 that were previously leased by Nortel Networks. As a

result, Nortel Networks extinguished a debt of $87.

On May 7, 2004, Nortel Networks received $80 in proceeds from the sale of certain assets in connection with a customer contract

settlement in Latin America. This resulted in a gain of $78, which will be included in (gain) loss on sale of businesses and assets for the

three months ended June 30, 2004.

In August 2004, Nortel Networks entered into a contract with Bharat Sanchar Nigram Limited to establish a wireless network in India.

Nortel Networks commitments to date for orders received under this contract have resulted in an estimated project loss of approximately

$130, which has been recorded in the third quarter of 2004.

F-84

On October 26, 2004, Nortel Networks entered into an agreement with Foundry Networks, Inc. (“Foundry”) to settle outstanding patent

infringement claims and counterclaims by the parties. As part of the settlement, Nortel Networks granted Foundry a four year license

under certain patents, and Foundry paid $35 to Nortel Networks.

On December 15 and 16, 2004, Nortel Networks sold certain notes receivable and convertible notes receivable that had been received as

a result of the restructuring of a customer financing arrangement for cash proceeds of $116. The net carrying amount of the notes

receivable and convertible notes receivable was $56.

On December 23, 2004, a customer financing arrangement was restructured. The notes receivable that were restructured had a net

carrying amount as of December 31, 2003 of $13, net of provisions for doubtful accounts of $147 ($55 of the provision is included in

discontinued operations). Nortel Networks is currently assessing the value of the restructured notes receivable and expects that an

increase in value from the net carrying amount has occurred.

4. Su

lemental consolidatin

inancial in

ormation

As of December 31, 2003, and as a result of NNL’s credit ratings, various liens, pledges and guarantees were effective under security

agreements entered into by NNL and various of its subsidiaries that pledged substantially all of the assets of NNL in favor of the banks

under the Five Year Facilities, EDC and the holders of Nortel Networks and NNL’s outstanding public debt securities, which debt

securities represent substantially all of Nortel Networks consolidated long-term debt (see notes 11 and 23).

The security agreements were originally entered into in connection with the $1,510 December 2001 364-day credit facilities (which

expired on December 13, 2002). The security became effective April 4, 2002, following Moody’s Investors Service, Inc. (“Moody’s”)

downgrade of NNL’s senior long-term debt rating to below investment grade, in respect of the then existing credit facilities including the

Five Year Facilities. Consequently, on April 4, 2002 and in accordance with the negative pledge covenants in the indentures for all Nortel

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.

As of December 31, 2003, the security provided under the security agreements was comprised of pledges of substantially all of the assets

of NNL and those of most of its U.S. and Canadian subsidiaries and pledges of shares in certain of NNL’s other subsidiaries. In addition,

certain of NNL’s wholly owned subsidiaries 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”) represented either wholly

owned subsidiaries of NNL whose shares were pledged, or were the remaining subsidiaries of NNL which did not provide liens, pledges

or guarantees (see note 23).

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. If both the Five Year Facilities and the EDC Support

Facility are terminated, or expire, the security and guarantees will also be released in full. 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 or arrangements acceptable to EDC) in lieu of the security provided under the security

agreements (see note 11). Accordingly, if the EDC Support Facility is secured by cash or other alternate collateral or arrangements

acceptable to EDC and if the Five Year Facilities are terminated or expire, the security and guarantees will also be released in full (see

note 23 for additional related information including the termination of the Five Year Facilities).

The following supplemental consolidating financial data illustrates, in separate columns, the composition of Nortel Networks

Corporation, NNL, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries, eliminations and the consolidated total as of

December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001 (see note 23).

Investments in subsidiaries are accounted for using the equity method for purposes of the supplemental consolidating financial data. Net

earnings (loss) of subsidiaries are therefore reflected in the investment account and net earnings (loss). The principal elimination entries

eliminate investments in subsidiaries and intercompany balances and transactions. The financial data may not necessarily be indicative of

the results of operations or financial position had the subsidiaries been operating as independent entities.

Supplemental Consolidating Statements of Operations for the year ended December 31, 2003:

F-85

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

Revenues $ – $ 3,182 $7,566 $2,804 $(3,359) $ 10,193

Cost of revenues – 1,995 5,106 2,110 (3,359) 5,852

Gross profit –1,187 2,460 694 –4,341

Selling, general and administrative expense – 430 1,327 182 – 1,939

Research and development expense –814 878 268 –1,960

Amortization of ac

uired technolo

and othe

–

– – 101 – 101

Deferred stock option compensation – – – 16 –16

Special charges – 66 246 (28) – 284

(Gain) loss on sale of businesses and assets – 4 (3)(5) – (4)

Operating earnings (loss) – (127) 12 160 – 45

Other income (expense) — net 24 86 301 34 –445

Interest expense

Long-term debt (83)(68)(4)(26) – (181)

Other – (4) (69) 45 – (28)

Earnings (loss) from continuing operations before income taxes,

minority interests and equity in net loss of associated companies (59)(113)240 213 –281

Income tax benefit (expense) 5 184 (50) (59) – 80

(54)71 190 154 –361

Minority interests — net of tax – – – (28) (35) (63)

Equity in net earnings (loss) of associated companies — net of tax 304 351 404 9(1,104)(36)

Net earnings (loss) from continuing operations 250 422 594 135 (1,139) 262

Net earnings (loss) from discontinued operations — net of tax 184 147 95 37 (279)184

Net earnings (loss) before cumulative effect of accounting change 434 569 689 172 (1,418) 446

Cumulative effect of accounting change — net of tax –(4)(8)

–

–(12)

Net earnings (loss) $ 434 $ 565 $ 681 $ 172 $ (1,418) $ 434

Supplemental Consolidating Statements of Operations for the year ended December 31, 2002:

F-86

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

Revenues $

–

$3,026 $8,557 $2,737 $(3,312) $ 11,008

Cost of revenues – 2,720 5,433 2,262 (3,312) 7,103

Gross

rofit

–

306 3,124 475 –3,905

Selling, general and administrative expense 4593 1,647 309 –2,553

Research and development expense – 870 937 276 – 2,083

Amortization of acquired technology and other – – 20 137 –157

Deferred stock option compensation – – – 110 – 110

Special charges

Goodwill impairment – – 203 392 – 595

Other special charges –346 834 320 –1,500

(Gain) loss on sale of businesses and assets – 16 (8) (29) – (21)

Operating earnings (loss) (4)(1,519)(509)(1,040) – (3,072)

Other income (expense) — net 682 (80)134 (216)(525)(5)

Interest ex

ense

Long-term debt (84)(105) – (31) – (220)

Other – – (53) 1 – (52)

Earnings (loss) from continuing operations before income taxes,

minority interests and equity in net loss of associated companies 594 (1,704)(428)(1,286)(525)(3,349)

Income tax benefit (expense) (2) 330 (49) 189 – 468

592 (1,374)(477)(1,097)(525)(2,881)

Minority interests — net of tax – – – 31 (26) 5

Equity in net earnings (loss) of associated companies — net of tax (3,485)(789)(773)(10)5,040 (17)

Net earnings (loss) from continuing operations (2,893) (2,163) (1,250) (1,076) 4,489 (2,893)

Net earnings (loss) from discontinued operations — net of tax (101)(101)(66)

–

167 (101)

Net earnings (loss) $ (2,994) $ (2,264) $ (1,316) $ (1,076) $ 4,656 $ (2,994)

Supplemental Consolidating Statements of Operations for the year ended December 31, 2001:

F-87

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

Revenues $

–

$5,196 $14,124 $4,970 $(5,390) $ 18,900

Cost of revenues – 4,639 11,044 4,319 (5,390) 14,612

Gross

rofit

–

557 3,080 651 –4,288

Selling, general and administrative expense (21)679 4,499 954 –6,111

Research and development expense – 1,085 1,654 377 – 3,116

In-process research and development expense – – – 15 –15

Amortization of intangibles

Acquired technology and other – – 574 232 –806

Goodwill – 22 1,561 2,475 – 4,058

Deferred stock option compensation –18 (2)232 –248

Special charges

Goodwill impairment – – 1,257 10,169 –11,426

Other s

ecial char

–

505 1,654 1,231 – 3,390

(Gain) loss on sale of businesses and assets –(5)(90)233 –138

eratin

earnin

s (loss) 21 (1,747) (8,027) (15,267) – (25,020)

Other income (expense) — net (21) 306 (354) (57) (380) (506)

Interest expense

Long-term debt (32) (145) 3 (34) – (208)

Other 1(26)(72)(6) – (103)

Earnings (loss) from continuing operations before income taxes,

minority interests and equity in net loss of associated companies (31) (1,612) (8,450) (15,364) (380) (25,837)

Income tax benefit (expense) (4)1,777 309 669 –2,751

(35) 165 (8,141) (14,695) (380) (23,086)

Minority interests — net of tax – – – (8)(26)(34)

Equity in net earnings (loss) of associated companies — net of tax (23,220) (11,171) (4,744) 7 38,978 (150)

Net earnings (loss) from continuing operations (23,255)(11,006)(12,885)(14,696)38,572 (23,270)

Net earnings (loss) from discontinued operations — net of tax (2,467) (1,994) (1,296) (473) 3,763 (2,467)

Net earnings (loss) before cumulative effect of accounting change (25,722)(13,000)(14,181)(15,169)42,335 (25,737)

Cumulative effect of accounting change — net of tax – 15 –

–

–15

Net earnings (loss) $(25,722) $ (12,985) $ (14,181) $ (15,169) $ 42,335 $(25,722)

Supplemental Consolidating Balance Sheets as of December 31, 2003:

F-88

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

ASSETS

Current assets

Cash and cash equivalents $68 $(8) $ 3,164 $773 $ – $ 3,997

Restricted cash and cash equivalents – 25 37 1 – 63

Accounts receivable — net –314 1,671 520 –2,505

Intercompany/related party accounts receivable 50 345 1,053 1,099 (2,547) –

Inventories — net –302 565 323 –1,190

Income taxes recoverable – 13 52 25 – 90

Deferred income taxes — net –67 302

–

–369

Other current assets – 31 178 106 – 315

Total current assets 118 1,089 7,022 2,847 (2,547)8,529

Investments 5,728 1,995 (7,568)285 (196)244

Intercom

advances

–

166 537 1,487 (2,190) –

Plant and equipment — net –475 817 364 –1,656

Goodwill – – 1,962 343 – 2,305

Intangible assets — net –40 145 –86

Deferred income taxes — net – 1,673 1,655 69 – 3,397

Other assets 37 102 60 175 –374

Total assets $ 5,883 $ 5,540 $ 4,486 $ 5,615 $ (4,933) $ 16,591

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities

Notes payable $ – $ 2 $ 3 $ 12 $ – $ 17

Trade and other accounts payable 1 347 406 107 – 861

Intercompany/related party accounts payable 109 (4,071)3,211 3,298 (2,547) –

Payroll and benefit-related liabilities 2 137 479 146 – 764

Contractual liabilities –26 309 195 –530

Restructuring – 52 138 16 – 206

Other accrued liabilities 26 356 1,660 463 –2,505

Long-term debt due within one year – 11 101 7 – 119

Total current liabilities 138 (3,140)6,307 4,244 (2,547)5,002

Long-term debt 1,800 1,549 127 415 –3,891

Deferred income taxes — net – – 173 18 – 191

Other liabilities –930 1,811 204 –2,945

Intercom

advances

–

11 297 1,882 (2,190) –

Total liabilities 1,938 (650)8,715 6,763 (4,737)12,029

Minority interests in subsidiary companies – – – 81 536 617

SHAREHOLDERS’ EQUITY

Preferred shares –536 237 47 (820) –

Common shares 33,674 1,211 6,089 1,560 (8,860) 33,674

Additional paid-in capital 3,341 22,031 1,081 19,342 (42,454)3,341

Deferred stock option compensation – – – (9) 9 –

Accumulated deficit (32,532)(17,066)(12,661)(22,139)51,866 (32,532)

Accumulated other comprehensive income (loss) (538) (522) 1,025 (30) (473) (538)

Total shareholders’ equity 3,945 6,190 (4,229)(1,229)(732)3,945

Total liabilities and shareholders’ equity $ 5,883 $ 5,540 $ 4,486 $ 5,615 $ (4,933) $ 16,591

Supplemental Consolidating Balance Sheets as of December 31, 2002:

F-89

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

ASSETS

Current assets

Cash and cash equivalents $35 $251 $2,392 $1,112 $ – $ 3,790

Restricted cash and cash equivalents – 6 176 67 – 249

Accounts receivable — net –288 1,524 414 –2,226

Intercompany/related party accounts receivable – 4,147 994 713 (5,852) 2

Inventories — net –546 712 248 –1,506

Income taxes recoverable 1 1 51 61 – 114

Deferred income taxes — net 12 178 615 (15) – 790

Other current assets – 146 395 109 – 650

Total current assets 48 5,563 6,859 2,709 (5,852)9,327

Investments 5,124 1,531 (8,055)518 1,119 237

Plant and e

ment — ne

–

425 865 402 – 1,692

Goodwill – – 1,954 245 –2,199

Intangible assets — net – 39 2 98 – 139

Deferred income taxes — net (26)1,077 1,510 21 –2,582

Other assets 36 605 1,278 395 (1,529) 785

Total assets $5,182 $9,240 $4,413 $4,388 $(6,262) $ 16,961

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities

Notes

able $

–

$2$ 3$ 25$ –$30

Trade and other accounts payable –342 391 70 –803

Intercompany/related party accounts payable 289 110 3,052 2,401 (5,852) –

Payroll and benefit-related liabilities –104 298 83 –485

Contractual liabilities (1) 43 536 316 – 894

Restructuring – 78 329 100 –507

Other accrued liabilities 41 540 2,243 433 – 3,257

Long-term debt due within one year –174 14 55 –243

Total current liabilities 329 1,393 6,866 3,483 (5,852) 6,219

Long-term debt 1,800 1,603 166 391 – 3,960

Deferred income taxes — net –263 84 (10) – 337

Other liabilities – 764 2,071 1,455 (1,529) 2,761

Total liabilities 2,129 4,023 9,187 5,319 (7,381)13,277

Minority interests in subsidiary companies – – – 95 536 631

SHAREHOLDERS’ EQUITY

Preferred shares

–

536 342 46 (924) –

Common shares 33,234 1,211 6,129 2,134 (9,474) 33,234

Additional paid-in capital 3,753 22,007 1,432 19,507 (42,946)3,753

Deferred stock option compensation (17) – – (26) 26 (17)

Accumulated deficit (32,966)(17,596)(13,423)(22,565)53,584 (32,966)

Accumulated other comprehensive income (loss) (951) (941) 746 (122) 317 (951)

Total shareholders’ equity 3,053 5,217 (4,774)(1,026)583 3,053

Total liabilities and shareholders’ equity $ 5,182 $ 9,240 $ 4,413 $ 4,388 $ (6,262) $ 16,961

Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2003:

F-90

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

Cash flows from (used in) o

eratin

activities

Net earnings (loss) from continuing operations $ 250 $ 422 $ 594 $ 135 $ (1,139) $ 262

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 – 75 249 217 – 541

Non-cash portion of special charges and related asset write

downs – 9 76 2 – 87

Equity in net loss of associated companies (304) (351) (404) (9) 1,104 36

Current and deferred stock option compensation 15 419 4 – 42

Deferred income taxes 14 5 (82) 13 – (50)

Other liabilities

–

83 74 4 – 161

(Gain) loss on repurchases of outstanding debt securities – (4) –

–

–(4)

(Gain) loss on sale or write-down of investments and businesses –(7)(4)(40) – (51)

Other — net 766 291 (904) (974) 35 (786)

Change in operating assets and liabilities 2190 (741)396 –(153)

Intercompany/related party activity (836) (831) 1,506 161 – –

Net cash from (used in) operating activities of continuing operations (93)(114)383 (91) – 85

Cash flows from (used in) investing activities

Expenditures for plant and equipment –(41)(85)(46) – (172)

Proceeds on disposals of plant and equipment – 7 28 3 – 38

Acquisitions of investments and businesses — net of cash acquired –(60)(6) 8 – (58)

Proceeds on sale of investments and businesses – 6 101

–

–107

Net cash from (used in) investing activities of continuing operations –(88)38 (35) – (85)

Cash flows from (used in) financing activities

Dividends on preferred shares –(35) –

–

35 –

Dividends paid by subsidiaries to minority interests – – –

–

(35) (35)

Increase (decrease) in notes payable — net – – 4 (49) – (45)

Proceeds from long-term debt – – –

–

––

Repayments of long-term debt –(199)(2)(69) – (270)

ments of ca

ital leases

able

–

–(12)

–

–(12)

Issuance of common shares 3 – –

–

– 3

Net cash from (used in) financin

activities of continuin

erations 3 (234) (10) (118) – (359)

Effect of foreign exchange rate changes on cash and cash equivalents 3 2 137 34 –176

Net cash from (used in) continuing operations (87) (434) 548 (210) – (183)

Net cash from (used in) discontinued operations 120 175 224 (129) – 390

Net increase (decrease) in cash and cash equivalents 33 (259) 772 (339) – 207

Cash and cash e

uivalents at be

innin

ear 35 251 2,392 1,112 –3,790

Cash and cash equivalents at end of year $ 68 $ (8) $ 3,164 $ 773 $ – $ 3,997

Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2002:

F-91

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

Cash flows from (used in) o

eratin

activities

Net earnings (loss) from continuing operations $ (2,893) $ (2,163) $ (1,250) $ (1,076) $ 4,489 $ (2,893)

Adjustments to reconcile net earnings (loss) from continuing

operations to net cash from (used in) operating activities, net of

effects from acquisitions and divestitures of businesses:

Amortization and depreciation – 87 402 212 – 701

Non-cash portion of special charges and related asset write

downs –199 464 479 –1,142

Equity in net loss of associated companies 3,485 789 773 10 (5,040) 17

Current and deferred stock option compensation – – – 110 –110

Deferred income taxes 16 (417) (137) 113 – (425)

Other liabilities

–

(4)18 (16) – (2)

(Gain) loss on repurchases of outstanding debt securities – (60) –

–

–(60)

(Gain) loss on sale or write-down of investments and businesses –17 18 (17) – 18

Other — net 64 447 (553) (175) 26 (191)

Change in operating assets and liabilities (202)(578)904 691 –815

Intercompany/related party activity 348 91 (152) (287) – –

Net cash from (used in) operating activities of continuing operations 818 (1,592)487 44 (525)(768)

Cash flows from (used in) investing activities

Expenditures for plant and equipment –(65)(242)(45) – (352)

Proceeds on disposals of plant and equipment – 16 390

–

–406

Acquisitions of investments and businesses — net of cash acquired –(5)(24)

–

–(29)

Proceeds on sale of investments and businesses – 23 33 48 – 104

Investments in subsidiaries (2,287) – –

–

2,287 –

Net cash from (used in) investing activities of continuing operations (2,287) (31) 157 3 2,287 129

Cash flows from (used in) financing activities

Dividends on preferred shares – (26) –

–

26 –

Dividends paid by subsidiaries to minority interests – – –

–

(26)(26)

Decrease in notes payable — net – – (174) (159) – (333)

Proceeds from long-term debt – – 1 32 –33

ments of lon

-term deb

–

(460) (138) (13) – (611)

Repayments of capital leases payable –(3)(13)(1) – (17)

Issuance of common shares 863 2,287 –

–

(2,287) 863

Issuance of prepaid forward purchase contracts 623 – –

–

–623

Stock option fair value increment – – (525)

–

525 –

Net cash from (used in) financing activities of continuing operations 1,486 1,798 (849)(141)(1,762)532

Effect of foreign exchange rate changes on cash and cash equivalents – 13 45 16 – 74

Net cash from (used in) continuing operations 17 188 (160)(78) – (33)

Net cash from (used in) discontinued operations – 104 246 (1) – 349

Net increase (decrease) in cash and cash equivalents 17 292 86 (79) – 316

Cash and cash equivalents at beginning of year 18 (41) 2,306 1,191 – 3,474

Cash and cash equivalents at end of year $35 $251 $2,392 $1,112 $ – $ 3,790

Supplemental Consolidating Statements of Cash Flows for the year ended December 31, 2001:

F-92

Nortel Nortel Non-

Networks Networks Guarantor Guarantor

(millions of U.S. dollars) Corporation Limited Subsidiaries Subsidiaries Eliminations Total

Cash flows from (used in) o

eratin

activities

Net earnings (loss) from continuing operations $ (23,255) $ (11,006) $ (12,885) $ (14,696) $ 38,572 $ (23,270)

Adjustments to reconcile net earnings (loss) from continuing

operations to net cash from (used in) operating activities, net of

effects from acquisitions and divestitures of businesses:

Amortization and depreciation – 191 2,608 2,866 – 5,665

In-process research and development expense – – – 15 –15

Non-cash portion of special charges and related asset write

downs – 88 1,459 11,213 – 12,760

Equity in net loss of associated companies 23,220 11,171 4,744 (7)(38,978)150

Current and deferred stock option compensation – – – 248 – 248

Deferred income taxes (3)(537)(797)(176) – (1,513)

Other liabilities – (73) 85 (21) – (9)

(Gain) loss on sale or write-down of investments and businesses –69 253 184 –506

Other — net (139) (458) (371) (588) 27 (1,529)

Change in operating assets and liabilities 43 522 5,227 1,391 –7,183

Intercompany/related party activity 153 (2,539) 1,788 219 379 –

Net cash from (used in) operating activities of continuing operations 19 (2,572)2,111 648 –206

Cash flows from (used in) investing activities

Expenditures for plant and equipment –(317)(833)(152) – (1,302)

Proceeds on disposals of plant and equipment – 23 185

–

–208

Acquisitions of investments and businesses — net of cash acquired –(13)(76)10 –(79)

Proceeds on sale of investments and businesses – 6 403 195 – 604

Investments in subsidiaries – – –

–

– –

Net cash from (used in) investing activities of continuing operations – (301) (321) 53 – (569)

Cash flows from (used in) financing activities

Dividends on preferred shares (123) (27) –

–

27 (123)

Dividends paid by subsidiaries to minority interests – – –

–

(27)(27)

Increase (decrease) in notes payable — net – 12 (281) 39 – (230)

Proceeds from long-term debt 1,756 1,500 10 20 –3,286

Proceeds from Paren

(1,800) 1,800 –

–

––

Repayments of long-term debt –(250)(12)(208) – (470)

Repayments of capital leases payable – (3) (18) (5) – (26)

Issuance of common shares 146 – –

–

–146

Net cash from (used in) financing activities of continuing operations (21) 3,032 (301) (154) – 2,556

Effect of foreign exchange rate changes on cash and cash equivalents – 1 (7)(4) – (10)

Net cash from (used in) continuin

erations (2) 160 1,482 543 – 2,183

Net cash from (used in) discontinued operations –(108)(200)(23) – (331)

Net increase (decrease) in cash and cash equivalents (2) 52 1,282 520 – 1,852

Cash and cash equivalents at beginning of year 20 (93)1,024 671 –1,622

Cash and cash equivalents at end of year $ 18 $ (41) $ 2,306 $ 1,191 $ – $ 3,474

Quarterly Financial Data (Unaudited)

See notes 4, 7 and 10 to the accompanying consolidated financial statements for the impact of accounting changes, special charges and

acquisitions, divestitures and closures, respectively, that affect the comparability of the above selected financial data. Additionally, the

following significant items were recorded in the fourth quarters of 2003 and 2002:

F-93

4th Quarter 3rd Quarter 2nd Quarter 1st Quarter

(millions of U.S. dollars, except per share amounts) 2003** 2002 2003 2002 2003 2002 2003 2002

Revenues

As previously reported $ 2,525 $ 2,266 $ 2,350 $ 2,338 $ 2,788 $ 2,377 $ 2,906

As reported or restated* $3,266 2,616 2,344 2,322 2,285 2,920 2,298 3,150

Gross

rofit

As previously reported 1,029 1,192 910 1,028 1,013 1,044 819

As reported or restated* 1,434 1,109 1,130 730 882 1,029 895 1,037

Special charges

As previously reported 178 70 1,171 (2) 361 112 463

As reported or restated* 86 269 80 1,089 (22)295 140 442

Other income (expense) — net

As previously reported 15 100 (13)23 (23) 4 (9)

As reported or restated* 143 (34) 148 28 60 101 94 (100)

Net earnings (loss) from continuing operations

As previously reported (167) 130 (1,735) 38 (632) (171) (752)

As reported or restated* 501 (195)88 (1,556)(93)(452)(234)(690)

Net earnin

s (loss) from discontinued o

erations

As previously reported (1)55 2(1) 3 190 16

As reported or restated* 27 (99) 43 5 (8) (62) 122 55

Net earnings (loss) before cumulative effect of accounting

change

As previously reported (168) 185 (1,733) 37 (629) 19 (736)

As reported or restated* 528 (294)131 (1,551)(101)(514)(112)(635)

Cumulative effect of accounting change

As previously reported – –

–

– – (8)

–

As reported or restated* – – –

–

––(12)

–

Net earnings (loss)

As previously reported – (168) 185 (1,733) 37 (629) 11 (736)

As reported or restated* 528 (294)131 (1,551)(101)(514)(124)(635)

Basic earnings (loss) per common share

— from continuing operations

As previously reported (0.04) 0.03 (0.40) 0.01 (0.18) (0.04) (0.23)

As reported or restated* 0.12 (0.05)0.02 (0.36)(0.02)(0.13)(0.06)(0.21)

— from discontinued o

erations

As previously reported 0.00 0.01 0.00 0.00 0.00 0.04 0.00

As reported or restated* 0.00 (0.02) 0.01 0.00 0.00 (0.02) 0.03 0.01

Basic earnings (loss) per common share

As previously reported (0.04) 0.04 (0.40) 0.01 (0.18) 0.00 (0.23)

As reported or restated* 0.12 (0.07)0.03 (0.36)(0.02)(0.15)(0.03)(0.20)

Diluted earnings (loss) per common share

— from continuing operations

As previously reported (0.04) 0.03 (0.40) 0.01 (0.18) (0.04) (0.23)

As reported or restated* 0.12 (0.05)0.02 (0.36)(0.02)(0.13)(0.06)(0.21)

— from discontinued operations

As previously reported 0.00 0.01 0.00 0.00 0.00 0.04 0.00

As reported or restated* 0.00 (0.02) 0.01 0.00 0.00 (0.02) 0.03 0.01

Diluted earnings (loss) per common share

As previously reported (0.04) 0.04 (0.40) 0.01 (0.18) 0.00 (0.23)

As re

orted or restated* 0.12 (0.07)0.03 (0.36)(0.02)(0.15)(0.03)(0.20)

* As discussed in note 3 to the accompanying consolidated financial statements and Management’s Discussions and Analysis of Financial Condition and Results of

Operations — Nortel Networks Audit Committee Independent Review; restatements; related matters, the unaudited quarterly financial data for the first three quarters of

2003 and all of 2002 have been restated. A comparison of previously reported and restated unaudited quarterly financial data is presented in the tables above.

** The fourth quarter ended December 31, 2003 had not been previously reported.

• During the fourth quarter of 2003, revenue of $300 and gross profit of $186 was recorded related to sales of Enterprise Networks products

that had been previously deferred until software revenue recognition criteria were met. The gross profit impact was partially offset by an

incremental Optical Networks inventory provision of $119. Also during the fourth quarter, bad debt recoveries of $69 were recorded as a

reduction to selling, general and administrative expense.

• During the fourth quarter of 2002, bonus and fringe benefit estimates were revised which reduced operating expenses by $33 and $101,

respectively.

REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS

To the Shareholders of Nortel Networks Corporation

We have audited the consolidated financial statements of Nortel Networks Corporation and its subsidiaries (“Nortel Networks”) as of

December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003, and have issued our report thereon dated

January 10, 2005, which report expresses an unqualified opinion and includes explanatory paragraphs relating to the restatement of the

consolidated financial statements as of December 31, 2002 and 2001 and for each of the years then ended and the change in the method of

accounting for stock-based compensation, asset retirement obligations and goodwill; such report is included elsewhere in this Form 10-K. Our

audits also included the consolidated financial statement schedule of Nortel Networks listed in Item 15. This financial statement schedule is the

responsibility of Nortel Networks management. Our responsibility is to express an opinion on this consolidated financial statement schedule

based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated

financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Deloitte & Touche LLP

Independent Registered Chartered Accountants

Toronto, Canada

January 10, 2005

178

Schedule II

Consolidated

NORTEL NETWORKS CORPORATION

Valuation and Qualifying Accounts and Reserves

Provision For Uncollectibles (a)

(millions of U.S. dollars)

179

Additions

Balance at charged Balance at

beginning o

to costs end o

U.S. GAAP year and expenses Deductions(b) year(c)

Year 2003 $1,282 $(180) $ 611 $491

Year 2002(d) $ 1,540 $ 291 $ 549 $ 1,282

Year 2001(d) $809 $1,791 $1,060 $1,540

(a) Excludes Discontinued Operations.

(b) Includes acquisitions and disposals of subsidiaries and divisions and amounts written off, and foreign exchange translation adjustments.

(c) Includes provisions for uncollectibles on long-term accounts receivable of $297, $780, and $761 as of December 31, 2003, 2002, and 2001, respectively.

(d) As restated (see note 3 to the accompanying consolidated financial statements).

In light of the relevance of the findings of the Independent Review to the matters addressed in this Item 9A, this Item 9A first sets forth in full

the “Summary of Findings and of Recommended Remedial Measures of the Independent Review,” submitted to the Audit Committee by

WCPHD and Huron Consulting Services LLC, or the Independent Review Summary. The balance of this Item 9A addresses, among other

matters:

******

113

ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial

Disclosure

NONE

ITEM 9A. Controls and Procedures

• current management’s conclusions concerning our disclosure controls and procedures as at December 31, 2003 and January 10,

2005 and certain earlier dates (see “Current Management Conclusions Concerning Disclosure Controls and Procedures”);

• information relating to the First Restatement, including a discussion of material weaknesses in internal control over financial

reporting identified at the time of the First Restatement (see “Additional Background

—

First Restatemen

”);

• information relating to the Second Restatement, including a discussion of material weaknesses in internal control over financial

reporting identified over the course of the Second Restatement (see “Additional Background

—

Second Restatement”);

• the determination of the Audit Committee to review the facts and circumstances leading to the restatement of revenues, as part of

the Second Restatement, for specific transactions during the periods 1999 through 2002, with particular emphasis on the underlying

conduct that led to the initial recognition of these revenues, which we refer to as the Revenue Independent Review (see “Revenue

Independent Review”);

• the current status of our internal control over financial reporting and expectations as to management conclusions and the

independent auditor attestation required to be included in our fiscal year 2004 Annual Report on Form 10-K, or the 2004 Form 10-

K, pursuant to Section 404 of the Sarbanes-Oxley Act (see “Current Status of Material Weaknesses in Internal Control Over

Financial Reporting and Expectations as to Required Management Conclusions and Independent Auditor Attestation Pursuant to

Section 404 of the Sarbanes-Oxley Act”);

• remedial measures adopted by the Board of Directors pursuant to the recommendations of WCPHD, and remedial measures

identified, developed and begun to be implemented by our current management, including pursuant to recommendations from D&T

(see “Remedial Measures”); and

• changes in internal control over financial reporting (see “Remedial Measures”).

SUMMARY OF FINDINGS AND

OF RECOMMENDED REMEDIAL MEASURES

OF THE INDEPENDENT REVIEW

SUBMITTED TO THE AUDIT COMMITTEE

OF THE BOARDS OF DIRECTORS

OF NORTEL NETWORKS CORPORATION

AND NORTEL NETWORKS LIMITED

114

Wilmer Cutler Pickerin

Hale and Dorr LLP

2445 M Street, N.W.

Washin

ton, D.C. 20037

Huron Consultin

Services LLC

99 Hi

h Street

Boston, Massachusetts 02110

In late October 2003, Nortel Networks Corporation (“Nortel” or the “Company”) announced that it intended to restate approximately $900M of

liabilities carried on its previously reported balance sheet as of June 30, 2003, following a comprehensive internal review of these liabilities

(“First Restatement”). The Company stated that the principal effects of the restatement would be a reduction in previously reported net losses

for 2000, 2001, and 2002 and an increase in shareholders’ equity and net assets previously reported on its balance sheet. Concurrent with this

announcement, the Audit Committees of the Boards of Directors of Nortel Networks Corporation and Nortel Networks Limited (collectively,

the “Audit Committee” and the “Board of Directors” or “Board,” respectively) initiated an independent review of the facts and circumstances

leading to the First Restatement. The Audit Committee wanted to gain a full understanding of the events that caused significant excess

liabilities to be maintained on the balance sheet that needed to be restated, and to recommend that the Board of Directors adopt, and direct

management to implement, necessary remedial measures to address personnel, controls, compliance, and discipline. The Audit Committee

engaged Wilmer Cutler Pickering Hale and Dorr LLP (“WCPHD”) to advise it in connection with its independent review. Because of the

significant accounting issues involved in the inquiry, WCPHD retained Huron Consulting Services LLC (“Huron”) to provide expert

accounting assistance. Huron has been involved in all phases of WCPHD’s work.

The independent review focused initially on events relating to the establishment and release of contractual liability and other related provisions

(also called accruals, reserves, or accrued liabilities) in the second half of 2002 and the first half of 2003, including the involvement of senior

corporate leadership. (The review did not include provisioning activity in the first half of 2002 because it was not expected that any such

activity could have had a material impact on the results of those quarters in light of the significant losses in those periods.) As the review

evolved, its focus broadened to include specific provisioning activities in each of the business units and geographic regions. In light of

concerns raised in the initial phase, the Audit Committee expanded the review to include provisioning activities in the third and fourth quarters

of 2003.

The Audit Committee expressly directed that requested documents be promptly provided and that employees cooperate with requests for

interviews; the Audit Committee instructed senior management to implement these directions throughout the Company. Over the course of the

inquiry, more than 50 current and former Nortel employees were interviewed, some more than once. While the independent inquiry did not

examine the work of Nortel’s external auditor, Deloitte & Touche LLP, several current and former audit engagement partners were

interviewed. Hundreds of thousands of hard copy and electronic documents and emails were collected and reviewed from corporate

headquarters in Brampton, from company servers, and from key employees in the business units and in the regions.

It was beyond the scope of the independent inquiry to audit or otherwise review the substantive accuracy of Nortel’s restated financial

statements. As the inquiry progressed, the Audit Committee directed new corporate management to examine in depth the concerns identified by

WCPHD regarding provisioning activity and to review provision releases in each of the four quarters of 2003, down to a low threshold. That

examination, and other errors identified by management, led to a second restatement of financial results, filed today (the “Second

Restatement”). WCPHD and Huron played no role in management’s restatement efforts. It was also beyond the scope of the independent

inquiry to review other aspects of Nortel’s accounting practices. The Second Restatement addresses a number of these practices.

115

Sco

the Inde

endent Review

WCPHD and Huron reported regularly to the Audit Committee on the progress of the investigation. Most, or all, of the independent and non-

management Board members attended these Audit Committee briefings. The Chairs of the Audit Committee and of the Board of Directors

were briefed between Audit Committee meetings to provide them with a “real time” understanding of the progress of the investigation. At the

direction of the Audit Committee, WCPHD and Huron met regularly with new management and the Company’s external auditors to provide

facts developed through the inquiry, so both would have this information as they proceeded through the Second Restatement. WCPHD and

Huron also briefed Canadian and U.S. regulators on a regular basis. The Audit Committee has reviewed in detail the findings of the

independent review and the recommended remedial measures, and it has adopted those findings and proposed remedial measures in their

entirety. This synopsis summarizes those findings and proposed remedial measures.

The investigation necessarily focused on the financial picture of the Company at the time that decisions were made and actions were taken

regarding provisioning activity. Because of significant changes to financial results reflected in the Second Restatement, the restated financial

results differ from the historical results that formed the backdrop for this inquiry.

In summary, former corporate management (now terminated for cause) and former finance management (now terminated for cause) in the

Company’s finance organization endorsed, and employees carried out, accounting practices relating to the recording and release of provisions

that were not in compliance with U.S. generally accepted accounting principles (“U.S. GAAP”) in at least four quarters, including the third and

fourth quarters of 2002 and the first and second quarters of 2003. In three of those four quarters — when Nortel was at, or close to, break even

— these practices were undertaken to meet internally imposed pro-forma earnings before taxes (“EBT”) targets. While the dollar value of most

of the individual provisions was relatively small, the aggregate value of the provisions made the difference between a profit and a reported loss,

on a pro forma basis, in the fourth quarter of 2002 and the difference between a loss and a reported profit, on a pro forma basis, in the first and

second quarters of 2003. This conduct caused Nortel to report a loss in the fourth quarter of 2002 and to pay no employee bonuses, and to

achieve and maintain profitability in the first and second quarters of 2003, which, in turn, caused it to pay bonuses to all Nortel employees and

significant bonuses to senior management under bonus plans tied to a pro forma profitability metric.

The failure to follow U.S. GAAP with respect to provisioning can be understood in light of the management, organizational structure, and

internal controls that characterized Nortel’s finance organization. These characteristics, discussed below, include:

116

Summar

Findin

the Inde

endent Review

• Management “tone at the top” that conveyed the strong leadership message that earnings targets could be met through application

of accounting practices that finance managers knew or ought to have known were not in compliance with U.S. GAAP and that

questioning these practices was not acceptable;

• Lack of technical accounting expertise which fostered accounting practices not in compliance with U.S. GAAP;

• Weak or ineffective internal controls which, in turn, provided little or no check on inaccurate financial reporting;

• Operation of a complicated “matrix” structure which contributed to a lack of clear responsibility and accountability by business

units and by regions; and

• Lack of integration between the business units and corporate management that led to a lack of transparency regarding provisioning

activity to achieve internal EBT targets.

Nortel posted significant losses in 2001 and 2002 and downsized its work force by nearly two-thirds. The remaining employees were asked to

undertake significant additional responsibilities with no increase in pay and no bonuses. The Company’s former senior corporate management

asserted, at the start of the inquiry, that the Company’s downturn, and concomitant downsizing of operations and workforce, led to a loss of

documentation and a decline in financial discipline. Those factors, in their view, were primarily responsible for the significant excess

provisions on the balance sheet as of June 30, 2003, which resulted in the First Restatement. While that downturn surely played a part in the

circumstances leading to the First Restatement, the root causes ran far deeper.

When Frank Dunn became CFO in 1999, and then CEO in 2001, he drove senior management in his finance organization to achieve EBT

targets that he set with his senior management team. The provisioning practices adopted by Dunn and other finance employees to achieve

internal EBT targets were not in compliance with U.S. GAAP, particularly Statement of Financial Accounting Standards Number 5 (“SFAS

5”). SFAS 5, which governs accounting for contingencies, requires, among other things, a probability analysis for each risk before a provision

can be recorded. It also requires that a triggering event — such as resolution of the exposure or a change in estimate — occur in the quarter to

warrant the release of a provision. Dunn and other finance employees recognized that provisioning activity — how much to reserve for a

particular exposure and when that reserve should be released — inherently involved application of significant judgment under U.S. GAAP.

Dunn and others stretched the judgment inherent in the provisioning process to create a flexible tool to achieve EBT targets. They viewed

provisioning as “a gray area.” They became comfortable with the concept that the value of a provision could be reasonably set at virtually any

number within a wide range and that a provision release could be justified in a number of quarters after the quarter in which the exposure,

which formed the basis for the provision, was resolved. Dunn and others exercised their judgment strategically to achieve EBT targets.

Third quarter, 2002.At the direction of then-CFO Doug Beatty, a company-wide analysis of accrued liabilities on the balance sheet was

launched in early August 2002. The CFO and the Controller, Michael Gollogly, learned that this analysis showed approximately $303M in

provisions that were no longer required and were available for release. The CFO and the Controller, each a corporate officer, knew, or ought to

have known, that excess provisions, if retained on the balance sheet, would cause the Company’s financial statements to be inaccurate and that

U.S. GAAP would have required either that such provisions be released in that period and properly disclosed, or that prior period financial

statements be restated. Instead, they permitted finance employees in the business units and in the regions to release excess accruals into income

over the following several quarters. They acted in contravention of U.S. GAAP by failing to correct the Company’s financial statements to

account for the significant excess accrued liabilities. Neither the CFO nor the Controller advised the Audit Committee and/or the Board of

Directors that significant excess provisions on the balance sheet had been identified and that the Company’s financial statements might be

inaccurate, nor did either suggest such information should be disclosed in the Company’s financial statements.

As a result of this company-wide review, senior finance employees recognized that their respective business unit or region had excess

provisions on Nortel’s balance sheet, and directed other finance employees to track these excess provisions. Nortel finance employees had their

own distinct term for a provision on the balance sheet that was no longer needed — it was “hard.” Each business unit developed, in varying

levels of detail and over varying periods of time, internal “hardness” schedules that identified provisions that were no longer required and were

available for release. Finance employees treated provisions identified on these schedules as a pool from which releases could be made to “close

the gap” between actual EBT and EBT targets in subsequent quarters.

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Fourth quarter, 2002.By mid-2002, employees throughout the Company were being recruited by other companies and morale was low.

Corporate management sought to retain these employees but recognized that other public companies had come under criticism for awarding

“stay” bonuses in the face of enormous losses. At management’s recommendation, the Board determined to reward employees with bonuses

under bonus plans tied to profitability. One plan, the Return to Profitability (“RTP”) bonus, contemplated a one-time bonus payment to every

employee, save 43 top executives, in the first quarter in which the Company achieved pro forma profitability. The 43 executives were eligible

to receive 20% of their share of the RTP bonus in the first quarter in which the Company attained profitability, 40% after the second

consecutive quarter of cumulative profitability, and the remaining 40% upon four quarters of cumulative profitability. In order for the RTP

bonuses to be paid, pro forma profits had to exceed, by at least one dollar, the total cost of the bonus for that quarter. Another plan, the

Restricted Stock Unit (“RSU”) plan, made a significant number of share units available for award by the Board to the same 43 executives in

four installments tied to profitability milestones. Once a milestone was met, the Board had discretion whether to make the award.

Through the first three quarters of 2002, Nortel experienced significant losses, and management reported to the Board that it expected losses

would continue in the fourth quarter. After the initial results for the business units and regions were consolidated, they showed that Nortel

unexpectedly would achieve pro forma profitability in the fourth quarter. Frank Dunn, who had been promoted to CEO in 2001, understood

that profitability had been attained from an operational standpoint but determined that it was unwise to report profitability and pay bonuses in

the fourth quarter because performance for the rest of the year had been poor. He determined that provisions should be taken to cause a loss for

the quarter. Over a two day period late in the closing process, the CFO and the Controller worked with employees in the finance organizations

in the business units, the regions, and in global operations, to identify and record additional provisions totaling more than $175 million. All of

these provisions were recorded “top-side” — that is, by employees in the office of the Controller based on information provided by the

business units, regions and global operations — because of the late date in the closing process on which they were made. Nortel’s results for

the fourth quarter of 2002 turned from an unexpected profit into the loss previously forecasted by management to the Board of Directors.

Neither the CEO, the CFO, nor the Controller advised the Audit Committee and/or the Board of Directors of this concerted provisioning

activity to improperly turn a profit into a loss. Nortel has since determined that many of these provisions were not recorded in compliance with

U.S. GAAP, and has reversed those provisions in the Second Restatement. The loss then reported by Nortel in the fourth quarter meant that no

employee bonuses were paid for that quarter.

First quarter, 2003.While Nortel had announced publicly that it expected to achieve pro forma profitability in the second quarter of 2003,

Dunn told a number of employees that he intended to achieve profitability one quarter earlier, and he established internal EBT targets for each

business unit and for corporate to reach that goal. At Dunn’s direction, “roadmaps” were developed to show how the targets could be achieved.

These roadmaps made clear that the internal EBT targets for the quarter could only be met through release from the balance sheet of excess

provisions that lacked an accounting trigger in the quarter. At the request of finance management in each business unit, finance employees

identified excess, or “hard,” provisions from the balance sheet, and, together, they determined which provisions to release to close the gap and

meet the internal EBT targets. That release activity was supplemented by releases, directed by the CFO and by the Controller, of excess

corporate provisions that had been identified in the third quarter of 2002 as available for release. Releases of provisions by corporate and by

each business unit and region, including excess provisions, totaling $361M, enabled Nortel to show a consolidated pro forma profit in the first

quarter, notwithstanding that its operations were running at a loss. The Finance Vice Presidents of the business units and two of the three

regions, the Asia Controller, the CFO, the Controller, and the CEO knew, or ought to have known, that U.S. GAAP did not permit the release,

without proper justification, of excess provisions into the income statement. Nortel has since determined that many of these releases in this

quarter were not in accordance with U.S. GAAP, and has reversed those releases in the First and Second Restatements and restated the releases

into proper quarters.

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When presenting the preliminary results for the quarter to the Audit Committee, the Controller inaccurately represented that the vast majority

of these releases were “business as usual” and in compliance with U.S. GAAP, and that the remaining releases were one time, non-recurring

events and in compliance with U.S. GAAP. Further, the CFO and the Controller failed to advise the Audit Committee and/or the Board of

Directors that release of excess corporate provisions was required to achieve profitability and make up for the shortfall in operational results;

that such releases were needed to cover the cost of the bonus compensation; that no event in the quarter triggered the releases (as required by

U.S. GAAP); that the releases implicated Staff Accounting Bulletin 99 (relating to materiality) because they turned a loss for the quarter into a

profit; and that they retained a significant amount of excess provisions on the balance sheet to be used, when needed, in a subsequent quarter.

In separate executive sessions held by the Audit Committee with the CFO and the Controller, neither the CFO nor the Controller raised quality

of earnings issues nor questioned the payment of the RTP bonus. Based on management’s representations, the Audit Committee approved the

quarterly results, and the Board approved the award of the RTP bonus.

Second quarter, 2003.Seeking to continue to show profitability in the second quarter and meet the first RSU milestone and the second

tranche of the RTP bonus, senior corporate management developed internal EBT targets to achieve pro forma profitability. As was the case in

the first quarter, it became clear during the quarter that operational results would be a loss. At the request of finance management in each

business unit, finance employees again identified “hard” provisions from the balance sheet, and, together, they determined which provisions to

release to close the gap and achieve the internal EBT targets. Nortel has since determined that many of these releases were not in accordance

with U.S. GAAP, and has reversed those releases in the First and Second Restatements and restated the releases into proper quarters. In both

the first and second quarters of 2003, the dollar value of many individual releases was relatively small, but the aggregate value of the releases

made the difference between a pro forma loss and profit in each quarter.

The CEO, the CFO and the Controller failed to advise the Audit Committee or the Board of Directors that operations of the business units were

running at a loss during the second quarter and that the validity of many of the numerous provision releases, totaling more than $370 million,

could be questionable. Based on management’s representations, the Audit Committee approved the quarterly results, and the Board approved

payment of the second tranche of the RTP bonus and awarded restricted stock under the RSU plan.

Third and fourth quarters, 2003.In light of concerns raised by the inappropriate accounting judgments outlined above, the Audit

Committee expanded its investigation to determine whether excess provisions were released to meet internal EBT targets in each of these two

quarters. No evidence emerged to suggest an intent to release provisions strategically in those quarters to meet EBT targets. Given the

significant volume of provision releases in these two quarters, the Audit Committee directed management to review provision releases, down to

a low threshold, using the same methods used to evaluate the releases made in the first half of the year. This review has resulted in additional

adjustments for these quarters, which are reflected in the Second Restatement.

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Governing Principles for Remedial Measures

The Audit Committee asked WCPHD to recommend governing principles, based on its independent inquiry, to prevent recurrence of the

inappropriate accounting conduct, to rebuild a finance environment based on transparency and integrity, and to ensure sound financial

reporting and comprehensive disclosure. The recommendations developed by WCPHD and provided to the Audit Committee were directed at:

These recommendations were grouped into three categories — people, processes and technology — and are discussed below:

An effective “tone at the top” requires effective policies and procedures, but these alone are not sufficient. Those who manage and lead the

Company, and are its officers, must exercise the highest fiduciary duties to the Company and shareholders and must be accountable, both to

corporate management and the Board, for accurately reporting financial results.

Based on periodic reports by WCPHD on the progress of the independent inquiry, the Audit Committee recommended, and the Board of

Directors approved, termination for cause of the CEO, the CFO, the Controller, and seven additional senior finance employees. The Board of

Directors determined that each of these individuals had significant responsibilities for Nortel’s financial reporting as a whole, or for their

respective business units and geographic regions, and that each was aware, or ought to have been aware, that Nortel’s provisioning activity,

described above, did not comply with U.S. GAAP. Nortel has formally demanded the return of all bonus compensation paid to each of these

individuals in 2003. Once the Board receives responses to this demand, it should determine the appropriate course of action to pursue with each

of these ten former employees.

Senior corporate officers, including the four Presidents of the business units during the period covered by this inquiry, the four Presidents of

the regions, and the President of Global Operations, now recognize that inappropriate activity involving provisioning occurred “on their

watch.” While they lacked an understanding that certain provisioning activities in their respective business units were not in compliance with

U.S. GAAP, they now recognize that such conduct was instrumental in achieving the reported results in the fourth quarter of 2002 and the first

and second quarters of 2003. To demonstrate personal commitment to the governing principles stated above and to lead the Company forward,

each of these officers has volunteered to return to the Company the entire RTP bonus that he or she was awarded, net of taxes already paid, and

to disclaim any opportunity to receive the third and fourth installments of the RSU bonus, which the Board has accepted. In light of the Board’s

expectation that senior employees of the Company will lead by example, the Board should decline to award the third and fourth tranches of the

RSU plan to the remaining eligible employees, irrespective of whether the profitability metrics for such bonuses are met as a result of the

Second Restatement.

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• Establishing standards of conduct to be enforced through appropriate discipline;

• Infusing strong technical skills and experience into the finance organization;

• Requiring comprehensive, on-going training on increasingly complex accounting standards;

• Strengthening and improving internal controls and processes;

• Establishing a compliance program throughout the Company which is appropriately staffed and funded;

• Requiring management to provide clear and concise information, in a timely manner, to the Board to facilitate its decision-making;

and

• Implementing an information technology platform that improves the reliability of financial reporting and reduces the opportunities

for manipulation of results.

• People

The Board of Directors must make clear that it has not tolerated, and will not in the future tolerate, accounting conduct that involves the

misapplication of U.S. GAAP. It must further communicate its expectation that every Nortel employee will adhere to the highest ethical

standards; will have training and experience commensurate with his or her job responsibilities; and will be held accountable for his or her

actions and decisions. The Board of Directors and management should continue to address the issues associated with the inappropriate use of

provisions.

Recent experience has shown that the Nortel finance organization lacks sufficient technical accounting expertise. Many finance employees are

“career” Nortel employees and learned accounting at Nortel. Whatever basic accounting knowledge is resident within Nortel is largely

knowledge of Canadian GAAP, not U.S. GAAP. Nortel reported in accordance with Canadian GAAP until 2000, when it switched to reporting

in accordance with U.S. GAAP. High quality finance employees are critical to the soundness of the Company’s financial reporting systems and

controls so that the results of operations are reported accurately and in a timely manner. The Board of Directors should direct management to

recruit, from outside Nortel, individuals with strong accounting and financial reporting skills and a proven record of integrity and ethical

behavior to fill key finance positions. The Board should also direct management to review the training and experience of Nortel mid-level

finance employees and to supplement this expertise, where appropriate, by hiring individuals from outside Nortel with strong accounting

training and background.

Nortel has long had an internal “technical accounting group” to which finance employees were supposed to turn for resolution of difficult

accounting questions and for technical accounting interpretations. While this practice is a sound one, the practical application has fallen short.

Finance employees did not regularly turn to this group for resolution of an issue, and it was far from clear that this group had the “last word”

on such issues. That technical accounting group should be led by a very senior finance executive with in-depth knowledge of, and experience

in applying, U.S. GAAP. Management should be directed to conduct a benchmarking study to evaluate whether the technical accounting group

is properly organized; its personnel component is consistent with other similar companies; its staff has appropriate and current expertise; and

its authority to resolve accounting issues and technical interpretations is clearly defined within the organization.

Notwithstanding the enormous time and resources that the Company has devoted to restatement activities for the past year, many employees

appear to lack a clear understanding of the accounting issues that gave rise to the restatements. That is perhaps not surprising in light of the

lack of basic U.S. GAAP training and expertise in the finance organization. Management has taken significant steps to remedy this deficit by

requiring mandatory training, developed by external consultants, and taught by knowledgeable finance employees. These remedial training

programs are an important first step, but much more must be done to ensure that the finance organization is fluent in governing accounting

standards and principles. Widespread training, by outside experts, at all levels of the finance organization, must continue so that all finance

employees receive comprehensive training in U.S. GAAP and in the consequences of failing to follow U.S. GAAP. Going forward,

management should develop in depth, on-going continuing education programs that explain continuously evolving complex accounting

standards. Management should assess the staffing of its training organization, and the adequacy of its trainers. Every Nortel employee,

including each finance employee, must now acknowledge annually, in writing, that he or she has read Nortel’s code of conduct and will adhere

to that code. The certification for each finance employee should be expanded to include an acknowledgement that each such employee is

familiar with all applicable U.S. GAAP requirements. In addition, the Board should consider whether each finance employee should be

required to complete a certain number of hours of continuing professional education each year.

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A basic component of sound corporate oversight is the control structure. Internal controls — the Company’s accounting policies,

organizational structure, systems, processes, employees, leadership, and culture — working together, foster accurate financial reporting and

sound disclosure in a timely manner. While management has recognized weaknesses in existing processes and controls, and has taken steps to

remedy these deficiencies, more needs to be done.

Nortel is a multi-national organization that has changed organizational structure over the past several years. One legacy of this changing

structure is a matrix organization in which there is no clear assignment of responsibility for assessing the adequacy and usage of contractual

liability provisions; even where responsibility is clear, it is unlikely that sufficient monitoring is in place to make sure that provisioning activity

is in accord with U.S. GAAP. The need for the matrix organization must be re-examined in light of the risks that it poses to financial discipline

and accountability and, if a matrix structure continues to be used, clear accountability must be established.

Historically, finance employees responsible for meeting EBT targets had authority to record and release provisions. That practice must end

immediately. The control organization must have sole authority to make these decisions and record these entries. The Board of Directors must

insist that the re-engineering of the control organization be a management priority. In addition, the Controller and the control organization,

working with the General Counsel, must develop standards of transparency in financial reporting that meet both the letter and the spirit of legal

requirements.

Nortel’s written accounting policies must be reviewed and, where necessary, rewritten to ensure strict adherence to U.S. GAAP and provide

numerous “real life” examples of practical applications. Procedures must be adopted to identify evolving interpretations of accounting

standards and best practices under U.S. GAAP and to develop and conform Nortel’s policies in a timely manner. Employees charged with

responsibility for Nortel’s accounting policies must have substantial knowledge of the strengths and weaknesses of the financial organization

and knowledge of best practices in similarly situated companies and ensure that accounting practices follow Nortel’s policies. These policies

must be communicated to finance and control employees, and management must stress the importance of adherence to the policies and impose

sanctions if they are not followed.

The internal audit function must be strengthened and must provide an independent check on the integrity of financial reporting. Historically,

Nortel’s internal auditor focused solely on “operational” reviews and had no role in determining whether Nortel’s accounting policies were in

compliance with U.S. GAAP or in evaluating whether these policies were properly applied. The Audit Committee has already established new

priorities for the internal auditor relating to the evaluation of risk exposures for financial reporting. Internal audit should continue its practice of

proposing an annual work plan, and should ensure that the work plan focuses on the new priorities set by the Audit Committee. The Company

is currently conducting a search to fill the vacant position of internal auditor. The internal audit function requires a leader with substantial

experience in applying U.S. GAAP in a similarly-situated company and great familiarity in applying professional standards issued by the

Institute of Internal Auditors. The internal auditor should report to the CEO to remove any potential threat to independence. The internal

auditor should continue to have direct and regular access to the Board and the Audit Committee. Staffing of internal audit must be consistent

with its mandate.

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•Processes

These governing principles are an effort to forge a framework for rebuilding the Nortel finance environment. Equally important, the Board, the

CEO, and the CFO must continue to promote high ethical standards throughout the Company. Words announcing adherence to the highest

standard of integrity are relatively easy to express, but it is actions, not words, that count. The Board has established the position of a Chief

Ethics and Compliance Officer. The Board has also adopted a code of ethical conduct and business practices which outlines principles to guide

ethical decision-making and provides practical answers to ethics questions regularly asked in the workplace. The Board should direct

management to enhance significantly the existing compliance program. Together, the code and a strengthened compliance program set the tone

and the standards of behavior that the Company expects from its employees. Employees must be convinced of the Company’s commitment to

an ethical climate, and of the central role that they play in ensuring that the Company’s code is followed. They must view compliance with the

Company’s code of conduct, standards, and control systems as a central priority, and understand they will be rewarded for ethical behavior,

even if it uncovers some problem that others might prefer to remain undisclosed. On a regular basis, the Board should review the activities of

the compliance office, the strength of the compliance program, and the risks it has addressed.

The Board must receive from management, in sufficient time prior to meetings, all materials necessary for it to monitor and act on business

risks affecting Nortel and information relating to decisions the Board is being asked to make. The Audit Committee needs clear and concise

information relating to Nortel’s financial reporting. The Board should implement a process whereby management would provide a quarterly

assessment of the overall quality and transparency of Nortel’s financial reporting and suggestions for improvements in form and content, which

the external auditors would review and comment. The Board’s practice of receiving all information respecting Nortel’s financial performance

on a consolidated basis, and of each of its business units, only from the CFO should change. The heads of each business unit should be

expected to take full responsibility for the financial results of their respective businesses and to provide quarterly presentations to the Board

with the senior finance employee in that business unit. Periodically, the Audit Committee should have separate, executive sessions with the

chief operations and finance employees for each business unit to discuss issues specific to their businesses.

Management has announced that it intends to acquire and install a SAP information technology platform to facilitate production of accurate

financial results in a timely and cost effective manner. The objectives of any technology platform implemented by Nortel should include

identification of existing control procedures that are redundant or inefficient; prevention/detection and correction of errors on a timely basis;

prevention or detection of fraud; simplification of systems and increased productivity; reduction of opportunities for manual intervention;

ability to trace transactions from start to finish; improved operation of controls; and substantive analysis of results, including both operating

and financial metrics. In sum, those responsible for implementing SAP should have a strong focus on re-engineering existing processes so that

the control elements intrinsic to the SAP system are effective.

******

After thorough consideration, the Audit Committee has recommended, and the Board of Directors has approved, adoption of each of these

recommendations. The Board of Directors has directed management to develop a detailed plan and timetable for the implementation of these

recommendations and intends to monitor the implementation of these principles by management.

******[EndofIndependentReviewSummary]

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• Technology

Current Management Conclusions Concerning Disclosure Controls and Procedures

In January 2005, we carried out an evaluation under the supervision and with the participation of management, including the current CEO and

current CFO, pursuant to Rule 13a-15 under the Exchange Act, of the effectiveness of our disclosure controls and procedures as at

December 31, 2003 (the end of the period covered by this report) and as at January 10, 2005. The CEO and CFO were appointed to such

positions as at April 28, 2004, with the CFO having served in such capacity on an interim basis since March 15, 2004.

In making this evaluation, the CEO and CFO considered, among other matters:

Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and procedures, as at December 31, 2003 and

January 10, 2005, were not effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit

under the Exchange Act is recorded, processed, summarized and reported as and when required.

In light of this conclusion and as part of the extensive work undertaken in connection with the Second Restatement, we have applied

compensating procedures and processes as necessary to ensure the reliability of our financial reporting. Accordingly, management believes,

based on its knowledge, that (i) this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to

make the statements made, in light of the circumstances under which they were made, not misleading with respect to the period covered by this

report and (ii) the financial statements, and other financial information included in this report, fairly present in all material respects our

financial condition, results of operations and cash flows as at, and for, the periods presented in this report.

The Second Restatement and other matters listed above have also resulted in the re-evaluation, in January 2005, of the effectiveness of our

disclosure controls and procedures as at December 31, 2002, March 31, 2003, June 30, 2003 and September 30, 2003. Based on these

evaluations and in consideration of the Second Restatement and other matters listed above, the CEO and CFO have concluded that our

disclosure controls and procedures, as at December 31, 2002, March 31, 2003, June 30, 2003 and September 30, 2003, were not effective to

provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded,

processed, summarized and reported as and when required.

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• the Second Restatement and the revisions to our preliminary unaudited results for the year ended December 31, 2003;

• the findings of the Independent Review summarized above in the Independent Review Summary;

• the terminations for cause of our former president and chief executive officer, former chief financial officer, former controller and

seven additional senior finance employees during the course of the Independent Review and the reasons therefor as described in the

Independent Review Summary;

• the material weaknesses in our internal control over financial reporting that we and our external auditor, D&T have identified (as

more fully described below);

• the measures we have identified, developed and begun to implement beginning in November 2003 to remedy those material

weaknesses (as more fully described below);

• our omission of 1999 and 2000 selected financial data from this report, and our decision not to amend our 2002 Form 10-K/A and

our 2003 quarterly reports (as more fully described below); an

• the decision of the Audit Committee to undertake the Revenue Independent Review (as more fully described below).

These new conclusions are in contrast to conclusions reached as a result of previous evaluations carried out under the supervision and with the

participation of management, including the former chief executive officer and former chief financial officer. In particular, these conclusions

differ from the conclusions stated in our 2002 Annual Report on Form 10-K and Quarterly Reports on Form 10-Q for the quarters ended

March 31, 2003 and June 30, 2003 that our disclosure controls and procedures were so effective as at December 31, 2002, March 31, 2003 and

June 30, 2003, respectively. They also differ from the conclusions based upon the re-evaluations carried out in December 2003 under the

supervision and with the participation of management, including the former president and chief executive officer and former chief financial

officer, as stated in our amended 2002 Annual Report on Form 10-K/A, or the 2002 Form 10-K/A, and amended Quarterly Reports on Form

10-Q for the quarters ended March 31, 2003 and June 30, 2003, or the 2003 Form 10-Q/As, that our disclosure controls and procedures were so

effective as at December 31, 2002, March 31, 2003 and June 30, 2003, respectively, after taking into account the First Restatement and the

identification of certain material weaknesses. These new conclusions also differ from the conclusions stated in our Quarterly Report on Form

10-Q for the quarter ended September 30, 2003 that our disclosure controls and procedures were so effective as at September 30, 2003, after

taking into account the First Restatement and the identification of certain material weaknesses.

******

dditional Background

This section provides additional information with respect to the identified material weaknesses and other deficiencies, as well as certain

additional background information regarding the First Restatement and the Second Restatement.

In this report, unless otherwise indicated, the terms “material weakness” and “reportable condition” have the meanings as formerly set forth

under standards established by the AICPA, which were applicable with respect to 2003. The AICPA then defined a (i) “reportable condition”

as a matter that comes to an auditor’s attention that represents a significant deficiency in the design or operation of internal control that could

adversely affect an entity’s ability to initiate, record, process and report financial data consistent with the assertions of management in the

financial statements and (ii) “material weakness” as a reportable condition in which the design or operation of one or more of the internal

control components does not reduce to a relatively low level the risk that misstatements caused by error or fraud in amounts that would be

material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal

course of performing their assigned functions.

In May 2003, we commenced certain balance sheet reviews at the direction of certain members of former management that led to the

Comprehensive Review, which resulted in the First Restatement. Each of the former members of management terminated for cause had

responsibility for their respective positions at the time of the Comprehensive Review and First Restatement. As disclosed in our Quarterly

Report on Form 10-Q for the quarter ended June 30, 2003, the Comprehensive Review was initiated “[I]n light of a period of unprecedented

industry adjustment and subsequent restructuring actions, including workforce reductions and asset write-downs . . . . The amounts under

review were recorded when our balance sheet

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First Restatemen

Overview

and income statement were much larger. Specifically, what would have been relatively minor amounts in prior periods may be considered to be

material to current periods.” As noted in the Independent Review Summary, “Nortel posted significant losses in 2001 and 2002 and downsized

its work force by nearly two-thirds. The remaining employees were asked to undertake significant additional responsibilities with no additional

increase in pay and no bonuses. The Company’s former senior corporate management asserted, at the start of the inquiry, that the Company’s

downturn, and concomitant downsizing of operations and workforce, led to a loss of documentation and a decline in financial discipline. Those

factors, in their view, were primarily responsible for the significant excess provisions on the balance sheet as at June 30, 2003, which resulted

in the First Restatement. While that downturn surely played a part in the circumstances leading to the First Restatement, the root causes ran far

deeper.” The root causes of the First Restatement, as identified in the Independent Review, are more fully discussed in the Independent Review

Summary.

The Comprehensive Review purported to (i) identify balance sheet accounts that, as at June 30, 2003, were not supportable and required

adjustment; (ii) determine whether such adjustments related to the third quarter of 2003 or prior periods; and (iii) document certain account

balances in accordance with our accounting policies and procedures. The Comprehensive Review, as supplemented by additional procedures

carried out between July 2003 and November 2003 to quantify the effects of potential adjustments in the relevant periods and review the

appropriateness of releases of certain contractual liability and other related provisions (also called accruals, reserves or accrued liabilities)in

the six fiscal quarters ending with the fiscal quarter ended June 30, 2003, formed the basis for the adjustments made to the financial statements

in the First Restatement.

On December 23, 2003, we filed with the SEC the 2002 Form 10-K/A and the 2003 Form 10-Q/As reflecting the First Restatement. As

disclosed in those reports, the net effect of the First Restatement adjustments was a reduction in accumulated deficit of $497 million,

$178 million and $31 million as at December 31, 2002, 2001 and 2000, respectively. The following were the principal adjustments of the First

Restatement:

In 2003, we, together with D&T, identified a number of deficiencies in our internal control over financial reporting.

On July 24, 2003, D&T first informed the Audit Committee that deficiencies in documentary support for certain accruals and provisions on our

balance sheet as at June 30, 2003 constituted a reportable condition, but not a material weakness, in our internal control over financial

reporting. In particular,

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• Approximately $935 million and $514 million of certain liabilities (primarily accruals and provisions) carried on our previously

reported consolidated balance sheet as at December 31, 2002 and 2001, respectively, were released to income in prior periods.

• We determined to correct certain known errors previously not recorded because the amount of the errors was not material to the

consolidated financial statements. Specifically, among other items, we made certain revenue adjustments to reflect revenue that

should have been deferred instead of recognized in a particular period.

• We made adjustments to correct errors related to deferred income tax assets and foreign currency translation accounts and made

reclassification adjustments within the consolidated balance sheet to better reflect the underlying nature of certain items. These

reclassifications did not impact our net assets as at the end of any period.

aterial Weaknesses and Other Deficiencies in Internal Control over Financial Reporting Identified at the Time of the First

estatemen

D&T concluded, in respect of this reportable condition, that it was unclear, due to the lack of documentation regarding support for certain

provisions and accruals, the passage of time and the turnover of personnel, as to what adjustments, if any, should have been made in prior

years. D&T noted that its assessment was based on such information as was available at the date of its communication to the Audit Committee

and the materiality of the underlying amounts in the context of 2003 reported results. This conclusion was initially disclosed in our Quarterly

Report on Form 10-Q for the quarter ended June 30, 2003.

On November 18, 2003, as part of the communications by D&T to the Audit Committee with respect to D&T’s interim audit procedures for the

year ended December 31, 2003, D&T informed the Audit Committee that there were two reportable conditions, each of which constituted a

material weakness in our internal control over financial reporting. No other reportable conditions were communicated by D&T to the Audit

Committee at the time of the First Restatement. These reportable conditions were as follows:

The foregoing material weaknesses contributed to the need for the First Restatement. Upon completion of our assessment of our internal

control over financial reporting as at December 31, 2004 pursuant to Section 404(a) of the Sarbanes-Oxley Act of 2002 and related SEC rules,

or SOX 404, we currently expect to conclude that these material weaknesses continue to exist as at December 31, 2004, and we continue to

identify, develop and begin to implement remedial measures to address them, as described below.

In late October 2003, the Audit Committee initiated the Independent Review in order to, as noted in the Independent Review Summary, “gain a

full understanding of the events that caused significant excess liabilities to be maintained on the balance sheet that needed to be restated, and to

recommend that the Board of Directors adopt, and direct management to implement, necessary remedial measures to address personnel,

controls, compliance and discipline.” As noted in the Independent Review Summary, “[t]he [Independent Review] focused initially on events

relating to the establishment and release of contractual liability and other related provisions . . . in the second half of 2002 and the first half of

2003, including the involvement of senior corporate leadership. . . . As the [Independent Review] evolved, its focus broadened to include

specific provisioning activities in each of the business units and geographic regions. In light of concerns raised in the initial phase of the

[Independent Review], the Audit Committee expanded the review to include provisioning activities in the third and fourth quarters of 2003.”

As discussed more fully above in the Independent Review Summary, the Independent Review concluded that “[i]n summary, former corporate

management (now terminated for cause) and former finance management (now terminated for cause) in the Company’s finance organization

endorsed, and employees carried out, accounting practices relating to the recording and release of provisions that were not in compliance with

[U.S. GAAP] in at least four quarters, including the third and fourth quarters of 2002 and the first and second quarters of 2003. In three of

those four quarters — when Nortel was at, or close to, break even — these practices were undertaken to meet internally imposed pro-forma

earnings before taxes

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• lack of compliance with established Nortel Networks procedures for monitoring and adjusting balances related to certain accruals

and provisions, including restructuring charges; and

• lack of compliance with established Nortel Networks procedures for appropriately applying U.S. GAAP to the initial recording of

certain liabilities, including those described in SFAS No. 5, and to foreign currency translation as described in SFAS No. 52.

Second Restatemen

ndependent Review

... targets. While the dollar value of most of the individual provisions was relatively small, the aggregate value of the provisions made the

difference between a profit and a reported loss, on a pro forma basis, in the fourth quarter of 2002 and the difference between a loss and a

reported profit, on a pro forma basis, in the first and second quarters of 2003.”

As noted in the Independent Review Summary, “[a]s the [Independent Review] progressed, the Audit Committee directed new corporate

management to examine in-depth the concerns identified by WCPHD regarding provisioning activity and to review provision releases in each

of the four quarters of 2003, down to a low threshold. That examination, and other errors identified by management, led to [the Second

Restatement]....”

In addition to this examination of provisioning activity, management, including our new CFO, undertook various initiatives aimed at ensuring

the reliability and integrity of the audited consolidated financial statements included in this report. As part of these efforts, our new CFO

encouraged employees across our finance organization to raise any questions or concerns regarding other potential accounting errors that

should be reviewed for possible adjustment in the Second Restatement. In addition, as management identified individual customer contracts

and transactions for re-examination of the establishment and release of provisions, management also undertook a review of many of those

contracts and transactions more generally to understand the broader nature of the original accounting for the contract or transaction. This

individual contract and transaction review also identified additional accounting issues. As a result of these initiatives, management, with the

assistance of outside consultants, then undertook further detailed reviews of our significant accounting policies, specific transactions and

communications and other documents relating to the identified issues. As a result, the Second Restatement included adjustments to correct

errors relating to a number of accounting issues other than provisioning.

In particular, management identified various errors involving recognition of revenues. To identify, assess and remedy these errors,

management, assisted by outside consultants, reviewed a substantial number of individual transactions as well as significant accounting

policies across all of our major product lines and geographical regions. As part of our review of individual contracts, we analyzed the relevant

contractual provisions (such as delivery and acceptance terms), delivery and other data from our logistics systems, characteristics of the

particular products and customers and the manner in which revenue recognition policies were applied. We also utilized databases within our

accounting systems to identify additional contracts that might raise revenue recognition issues. In light of the increasing magnitude of the total

revenue adjustments identified by the beginning of November 2004, the Board of Directors directed management to conduct additional focused

revenue reviews in selected periods in order to test the conclusions we had reached and identify any potential additional revenue adjustments.

Management has completed these reviews.

Overall in the Second Restatement, as a result of adjustments to correct errors related to revenue recognition, we increased revenues by an

aggregate of $1,492 million in 2001 and $439 million in 2002. We also increased previously announced 2003 revenues by an aggregate of

$386 million. Most of these adjustments constituted the recognition of revenues that had previously been improperly recognized in prior years

and should have been deferred (often over a number of years). This also had the effect of reducing previously reported revenues in 1998, 1999

and 2000 by approximately $158 million, $355 million and $2,866 million, respectively. Of these adjustments identified in the Second

Restatement, approximately $750 million of revenues has been deferred to years after 2003, while approximately $250 million of revenues was

permanently reversed, as described below.

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Second Restatement Process

In light of the total magnitude of these revenue adjustments, we present below an overview of the principal revenue adjustments required in the

Second Restatement to correct accounting errors related to revenue recognition and the general circumstances that gave rise to them. In

addition, as described under “Revenue Independent Review”, the Audit Committee has determined to review the facts and circumstances

leading to the restatement of these revenues for specific transactions identified in the Second Restatement. The Revenue Independent Review

will have a particular emphasis on the underlying conduct that led to the initial recognition of these revenues, and will consider any appropriate

additional remedial measures, including those involving internal controls and processes.

Of this amount, we made adjustments of approximately $870 million in 2001 and $200 million in 2002 to correct errors relating to passage of

product title or risk of loss. Both employee input and our review of the broader original accounting treatment of certain individual contracts

identified a specific customer contract as warranting re-examination of the timing of revenue recognition relative to the timing of passage of

product title. Following a detailed review, we determined that revenues had been recorded erroneously before title had passed. We also

reviewed other similar contracts and determined that corrections were also required where title or risk of loss had not passed. These corrections

principally impacted North American contracts in our Optical and Wireline businesses.

Some of the adjustments related to title and risk of loss issues described above resulted in a permanent reversal of revenues, rather than a

deferral of revenues to later periods. In certain cases, revenues were recognized in error in a particular period (before title had passed and the

criteria for revenue recognition had been met) and a bad debt expense was subsequently recorded due to collectibility issues. In such cases,

both entries were reversed. Following those corrections, if title in fact never passed or the other criteria were never met, and the customer failed

to pay, the revenues were not recognized in subsequent periods but instead permanently reversed. We permanently reversed a total of

approximately $150 million of revenues in 2000 and $25 million in 2001 as a result of title and risk of loss adjustments.

We also identified errors related to title and delivery issues in connection with arrangements known as “bill and hold” transactions, in which

revenue is recognized before actual delivery of the product. Corrections of these errors resulted in the deferral of revenue into later periods,

which had the effect of a net increase to revenues of approximately $760 million in 2001 and $10 million in 2002. Our scrutiny of this issue

was similarly prompted by employee input. In this situation, we determined that the relevant accounting policy had been incorrectly applied to

a number of contracts, and revenues were recognized where the relevant criteria had not been fully met. In reviewing individual contracts, we

examined, among other things: whether significant product returns had occurred in later periods, the accounts receivable history, whether better

pricing was provided for the particular purchase order to incent a customer to enter into a bill and hold arrangement, whether purchase orders

were eventually placed by the customer and whether third-party corroboration was available as to whether the arrangement was at the request

of the customer or Nortel Networks. As a result of our consideration of these factors, we deferred all revenues associated with bill and hold

arrangements to subsequent periods. We no longer recognize revenue on bill and hold arrangements before delivery occurs and all other criteria

of revenue recognition are fully met.

Another area of review prompted by our review of the broader original accounting treatment of certain individual contracts was related to

certain optical product transactions where revenues related to undelivered product elements were erroneously recognized. In these cases,

revenues for customer orders

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•Title and deliver

— An increase of $1,624 million in 2001 and $211 million in 2002.

•Undelivered elements and liquidated damages — A decrease of $190 million in 2001 and an increase of $45 million in 2002 and

$204 million in 2003.

were recognized upon delivery of interim product solutions pending the availability of the later generation optical product that the customer

had ordered. In this circumstance, revenues for the order should have been deferred until the undelivered element was delivered as we did not

have evidence supporting the fair value of the undelivered element. Accordingly, we restated the recorded revenues, deferring recognition to

subsequent periods, which had the effect of a net decrease to revenues of approximately $40 million in 2001 and an increase to revenues of

approximately $190 million in 2002 and $25 million in 2003.

We also focused on accounting for software revenue recognition more generally, particularly in our Optical business. In Fall 2004, we sought

the views of the SEC’s Office of the Chief Accountant, or OCA, on one issue with respect to our historical and continuing accounting

treatment under U.S. GAAP of revenues recognized on sales of certain optical products containing embedded software. We advised the OCA

that we believed our historical accounting treatment of these optical products was appropriate, and we were fully supported in this conclusion

by D&T. We, in consultation with D&T, nevertheless decided to obtain the views of the OCA on our analysis and conclusions due to the

udgments involved in the applicable accounting analysis and the significant impact a different conclusion could have had on our reported

revenues (namely, the deferred recognition of substantial revenues over a number of subsequent years). Following discussions with us, the

OCA did not approve or disapprove our accounting in this area, and we concluded that we would not make any adjustments to our accounting

treatment of the sales of these optical products as part of the Second Restatement.

We also considered revenue recognition policies related to post-contract support, or PCS, with respect to all business lines, and identified

certain Enterprise products that presented issues. For these products, we recognized revenues at the time of delivery of the product but before

completion of PCS or other future services agreed to in the contract. Because in some cases we did not have vendor specific objective evidence

of fair value for those services (for example, where we made available free software upgrades on our website), U.S. GAAP requires the

revenues to be recognized over the PCS period. Accordingly, we corrected this error and deferred the revenues to subsequent periods, resulting

in a net decrease to revenues of approximately $140 million in 2001 and $155 million in 2002 and a net increase of approximately $170 million

in 2003.

As a result of our focus on accounting for software revenue recognition more generally as described above, we identified a specific contract for

which revenue for sales had been recognized but the criteria for revenue recognition had not been met, including the criteria that contract fees

be either fixed or determinable. Accordingly, we corrected this error and deferred the revenues to subsequent periods when customer payments

became due and all criteria for revenue recognition were met.

As a result of employee input, we determined that a certain reseller lacked economic substance apart from Nortel Networks at the time of the

relevant transaction. In such a case, we should have deferred revenues and recognized them only upon the reseller’s sale of the products to an

end customer. Accordingly, we corrected this error and deferred the revenues to subsequent periods.

In our review of a particular contract in connection with other issues described above, we determined that it also involved a reciprocal

arrangement with the customer. Instead of recognizing the full amount of

130

•Fixed or determinable

ees—An increase o

$133 million in 2002.

•

eseller transactions—An increase of $151 million in 2001.

•

eci

rocal arran

ements—A decrease of approximately $55 million in 2000 and $20 million in 2001.

revenues we received on the sale of products or services, the amounts we paid the customer under the reciprocal arrangement should have been

treated as a reduction of revenues. Through our review of a substantial number of individual contracts, as noted above, we also identified a

limited number of other reciprocal arrangements, which were recorded as permanent reductions in revenue.

As we continued to review the application of our accounting policies, as well as specific contracts, we discovered errors related principally to

the incorrect application of percentage of completion accounting for certain transactions. Our review also included an analysis of the

accounting for product credits, liquidated damages and other incentives. We corrected these errors, which resulted in both deferrals of revenues

to subsequent periods and movement of revenues to earlier periods.

Other accounting practices that management examined and adjusted as part of the Second Restatement included, among other things, the

following (as described in more detail below):

In sum, the key components of the Second Restatement process were as follows:

As discussed above under “Current Management Conclusions Concerning Disclosure Controls and Procedures”, as a result of the extensive

work undertaken in connection with the Second Restatement, management believes, based on its knowledge, that (i) this report does not

contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the

circumstances under which they were made, not misleading with respect to the period covered by this

131

•

pplication of SOP 81-1 and other revenue recognition items—A decrease of approximately $40 million in 2001 and an increase of

approximately $80 million in 2002 and $140 million in 2003.

• our foreign exchange accounting, as part of the plan to address the identified material weakness related to foreign currency

translation described above;

• intercompany balances that did not eliminate upon consolidation and related provisions;

• the accounting treatment of the February 2001 acquisition of the 980 NPLC business from JDS and the related OEM Purchase and

Sale Agreement;

• special charges relating to goodwill, inventory impairment, contract settlement costs and other charges; and

• the accounting treatment of certain elements of discontinued operations.

• involvement and oversight by current senior finance personnel, with regular communications to the global finance organization to

monitor progress and ensure consistency, and open and regular dialogue with our external auditors;

• maintenance of a restatement database to track issues and adjustments;

• establishment of a process to evaluate certain potential provisions and releases that may not have been fully addressed in the First

Restatement, including a review of all First Restatement processes, and enhanced balance sheet reviews at the business unit,

regional and statutory entity levels;

• establishment of processes to evaluate certain potential restatement items related to our revenue recognition policies and practices

and other accounting issues;

• validation processes, including detailed review of supporting documentation to ensure adjustments were appropriately

substantiated; and

• identification, development and initial implementation of remedial actions, as further described under “Remedial Measures” below.

report and (ii) the financial statements, and other financial information included in this report, fairly present in all material respects our

financial condition, results of operations and cash flows as at, and for, the periods presented in this report.

The following are the principal Second Restatement adjustments:

The principal adjustments primarily relate to the following matters (each of which reflects a number of related adjustments that have been

aggregated for disclosure purposes):

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Principal Adjustments

• An increase of $386 million in previously announced revenues and a decrease of $298 million in previously announced net earnings

for the year ended December 31, 2003, with the following adjustments on a quarterly basis:

• a decrease of $79 million in previously reported revenues and $135 million in previously reported net earnings for the first

quarter of 2003, resulting in our reporting a net loss rather than net earnings for the period;

• a decrease of $53 million in previously reported revenues and $138 million in previously reported net earnings for the second

quarter of 2003, resulting in our reporting a net loss rather than net earnings for the period;

• an increase of $78 million in previously reported revenues and a decrease of $54 million in previously reported net earnings for

the third quarter of 2003; and

• an increase of $440 million in previously announced revenues and $29 million in previously announced net earnings for the

fourth quarter of 2003.

• An increase of $439 million in previously reported revenues and a reduction of $272 million in previously reported net loss for the

year ended December 31, 2002, with the following adjustments on a quarterly basis:

• an increase of $244 million in previously reported revenues and a decrease of $101 million in previously reported net loss for

the first quarter of 2002;

• an increase of $132 million in previously reported revenues and a decrease of $115 million in previously reported net loss for

the second quarter of 2002;

• a decrease of $28 million in previously reported revenues and $182 million in previously reported net loss for the third quarter

of 2002; and

• an increase of $91 million in previously reported revenues and $126 million in previously reported net loss for the fourth

quarter of 2002.

• An increase of $1,492 million in previously reported revenues and a reduction of $1,433 million in previously reported net loss for

the year ended December 31, 2001.

• Adjustments to revenues and cost of revenues to address various aspects of our revenue recognition policies and practices increased

revenues by a total of $439 million in 2002 and $1,492 million in 2001, and increased cost of revenues by a total of $305 million in

2002 and $598 million in 2001. The revenue matters adjusted are discussed in detail above under “Second Restatement Process”.

• Foreign exchange adjustments increased our pre-tax loss by a total of $63 million in 2002 and $132 million in 2001. These

adjustments resulted from the re-examination of the determination of the functional currency for certain entities and the incorrect

treatment of significant long-term inter-company positions, and the incorrect classification of certain foreign exchange gains and

losses.

For additional information concerning adjustments made in the Second Restatement, see notes 3 and 23 to the accompanying audited

consolidated financial statements and “—Developments in 2004—Restatements” in the MD&A section of this report.

As described above, two material weaknesses in our internal control over financial reporting were identified at the time of the First

Restatement. During the Second Restatement process, a number of additional material weaknesses in our internal control over financial

reporting were identified, as described below. Due to, among other factors, these material weaknesses, the significant turnover in our finance

personnel, changes in accounting systems, documentation weaknesses and the passage of time generally, the Second Restatement involved the

efforts of hundreds of our finance personnel and a number of outside consultants and advisors. As described above, the process required the

review and verification of a substantial number of documents and communications, and related accounting entries, over multiple fiscal periods.

In addition, the review of accruals and provisions and the application of accounting literature to certain matters in the Second Restatement,

including revenue recognition, foreign exchange, special charges and discontinued operations, was complicated by the passage of time, the lack

of availability of supporting records and the turnover of finance personnel noted above. As a result of this complexity, estimates and

assumptions that impact both the quantum of the various recorded adjustments and the fiscal period to which they were attributed were

required in the determination of certain of the Second Restatement

133

• Correction of certain inter-company balances that did not properly eliminate upon consolidation and related provisions resulted in a

decrease of $36 million and an increase of $42 million to pre-tax loss for 2002 and 2001, respectively.

• Adjustments to previously recorded special charges relating to goodwill, inventory impairment, contract settlement costs and other

charges resulted in a total decrease to special charges of $78 million in 2002 and $845 million in 2001. These adjustments consisted

primarily of the following:

• goodwill impairment and amortization charges were reduced, and cost of revenues were increased, as a result of the re-

examination of the accounting for the deferred consideration associated with our acquisition of the 980 NPLC business from

JDS;

• goodwill recorded from certain acquisitions was reduced due to corrections to purchase accounting allocations, which in turn

reduced the subsequent goodwill impairment charges and amortization that were a component of special charges;

• inventory impairments incorrectly classified as special charges were reclassified to cost of revenues; and

• contract settlement costs and other items were adjusted primarily due to changes in estimates and/or assumptions that were

previously recorded in the incorrect period.

• Corrections to various accruals, provisions or other transactions, primarily due to the incorrect application of U.S. GAAP to the

initial recording of such liabilities, or the failure to subsequently adjust such liabilities in the correct period, resulted in a decrease o

$314 million and an increase of $59 million in our net loss in 2002 and 2001, respectively.

• Adjustments to the accounting treatment of certain components of discontinued operations, initially recorded by us in June 2001,

resulted in an increase of $121 million and a decrease of $529 million to the net loss from discontinued operations — net of tax in

2002 and 2001, respectively.

Use of Estimates in Financial Reporting; Omission of 1999 and 2000 Selected Financial Data; Decision Not to Amend Certain

Previous Filin

adjustments. We believe the procedures followed in determining such estimates were appropriate and reasonable using the best available

information.

Also as a result of the above factors, as well as a likely inability to obtain third party corroboration in certain cases due to the substantial

industry adjustment in the telecommunications industry beginning in 2001, we believe that extensive additional efforts over an extended period

of time would be required to restate our 1999 and 2000 selected financial data. We also believe that selected financial data for these periods

would not be meaningful to investors due to this industry adjustment, which significantly impacted our financial results in 2001 and subsequent

periods and limits the relevance of financial results in periods prior to 2001 for purposes of analysis of trends in subsequent periods. Given the

long delay in filing the Reports, we believed that investor understanding would be better aided by the dedication of our resources to the

preparation of the current financial and other information included in this and future reports. As a result, except for the selected balance sheet

data as at December 31, 2000, financial data for the years ended December 31, 1999 and 2000 has not been restated or presented in the

“Selected Financial Data (Unaudited)” section of this report. This omitted data is normally required to be included in an Annual Report on

Form 10-K.

A number of our and NNL’s past filings with the SEC remain subject to ongoing review by the SEC’s Division of Corporation Finance (which

could result in the need to amend this or our other filings). In addition, the Second Restatement involved the restatement of our consolidated

financial statements for 2001 and 2002 and the first, second and third quarters of 2003. Amendments to our prior filings with the SEC would be

required in order for us to be in full compliance with our reporting obligations under the Exchange Act. However, for the same reasons

discussed above, we do not believe that it would be feasible for us to amend our 2002 Form 10-K/A. In addition, we believe that amended

disclosure in the 2002 Form 10-K/A, 2003 Form 10-Q/As and 2003 Form 10-Q would in large part repeat the disclosure in this report and

expected to be contained in the 2004 Form 10-Qs. Accordingly, we do not plan to amend our 2002 Form 10-K/A, 2003 Form 10-Q/As or 2003

Form 10-Q. We believe that we have included in this report all information needed for current investor understanding and will take similar

steps in our 2004 Form 10-Qs.

Over the course of the Second Restatement process, we, together with D&T, identified a number of reportable conditions, each constituting a

material weakness, in our internal control over financial reporting as at December 31, 2003. In September 2004, management first notified the

Audit Committee of the possibility of additional material weaknesses. Over the remainder of the Second Restatement process, management and

D&T identified a total of six material weaknesses. On January 10, 2005, D&T confirmed to the Audit Committee that it had identified these six

material weaknesses. No other reportable conditions were identified by us or D&T at the time of the Second Restatement. The material

weaknesses identified were:

134

aterial Weaknesses in Internal Control over Financial Re

ortin

Identi

ied Durin

the Second Restatemen

• lack of compliance with written Nortel Networks procedures for monitoring and adjusting balances related to certain accruals and

provisions, including restructuring charges and contract and customer accruals;

• lack of compliance with Nortel Networks procedures for appropriately applying applicable GAAP to the initial recording of certain

liabilities, including those described in SFAS No. 5, and to foreign currency translation as described in SFAS No. 52;

The foregoing material weaknesses contributed to the need for the Second Restatement. Upon completion of our assessment of our internal

control over financial reporting as at December 31, 2004 pursuant to SOX 404, we currently expect to conclude that the first five of these six

material weaknesses continue to exist as at December 31, 2004, and we continue to identify, develop and begin to implement remedial

measures to address them, as described below.

******

Current Status of Material Weaknesses in Internal Control Over Financial Reporting and Expectations as to Required Management

Conclusions and Independent Auditor Attestation Pursuant to Section 404 of the Sarbanes-Oxley Act

As noted in “MD&A — Risk factors/Forward looking statements”, our 2004 Form 10-K must comply with SOX 404, which requires

management to assess the effectiveness of our internal control over financial reporting annually and to include in our Annual Report on Form

10-K a management report on that assessment, together with an attestation by our independent registered public accounting firm. As noted

above, upon completion of our assessment of our internal control over financial reporting as at December 31, 2004, we currently expect to

conclude that the first five of the six material weaknesses in our internal control over financial reporting described immediately above continue

to exist as at December 31, 2004 (and also constitute “material weaknesses” as now defined under standards established by the Public

Company Accounting Oversight Board). Accordingly, management expects to conclude that our internal control over financial reporting as at

December 31, 2004 is ineffective, and D&T has advised us that they expect their report on management’s assessment of internal control over

financial reporting also to indicate that internal control over financial reporting is ineffective.

******

evenue Independent Review

As more fully described above, over the course of the Second Restatement process, management identified certain accounting practices that it

determined should be adjusted as part of the Second Restatement. In particular, management identified certain errors related to revenue

recognition and undertook a process of revenue reviews. In light of the resulting adjustments to previously reported revenues, the Audit

Committee has determined to review the facts and circumstances leading to the restatement of these revenues for specific transactions

identified in the Second Restatement. The

135

• lack of sufficient personnel with appropriate knowledge, experience and training in U.S. GAAP and lack of sufficient analysis and

documentation of the application of U.S. GAAP to transactions, including, but not limited to, revenue transactions;

• lack of a clear organization and accountability structure within the accounting function, including insufficient review and

supervision, combined with financial reporting systems that are not integrated and which require extensive manual interventions;

• lack of sufficient awareness of, and timely and appropriate remediation of, internal control issues by Nortel Networks personnel;

and

• an inappropriate ‘tone at the top’, which contributed to the lack of a strong control environment. As reported in the Independent

Review Summary included above, there was a “Management ‘tone at the top’ that conveyed the strong leadership message that

earnings targets could be met through application of accounting practices that finance managers knew or ought to have known were

not in compliance with U.S. GAAP and that questioning these practices was not acceptable”.

Revenue Independent Review will have a particular emphasis on the underlying conduct that led to the initial recognition of these revenues.

The Audit Committee will seek a full understanding of the historic events that required the revenues for these specific transactions to be

restated and will consider any appropriate additional remedial measures, including those involving internal controls and processes. The Audit

Committee has engaged WCPHD to advise it in connection with the Revenue Independent Review.

******

emedial Measures

At the recommendation of the Audit Committee, the Board of Directors adopted all of the recommendations for remedial measures contained

in the Independent Review Summary. The Board of Directors has directed management to develop a detailed plan and timetable for the

implementation of these recommendations and will monitor their implementation. In addition, we have identified, developed and begun to

implement a number of measures to strengthen our internal control over financial reporting and address the material weaknesses identified

above, including pursuant to recommendations from D&T. These measures are in the process of being reviewed in light of the

recommendations of the Independent Review and certain of these measures may be superseded by the plans for the implementation of the

recommendations of the Independent Review. A summary of these measures, as well as previously announced personnel actions, follows.

136

• Personnel Actions in Response to the First Restatement and Independent Review.

• We terminated for cause our former president and chief executive officer, former chief financial officer and former controller

in April 2004 (the former chief financial officer and former controller having been placed on paid leaves of absence in

March 2004).

• We terminated for cause seven additional senior finance employees with significant responsibilities for our financial reporting

as a whole or for their respective business units and geographic regions in August 2004.

• Renewed Commitment to Best Corporate Practices and Ethical Conduct.

• In August 2004, we adopted a new strategic plan that includes a renewed commitment to best corporate practices and ethical

conduct, including the establishment of the office of a chief ethics and compliance officer (which has been filled on an interim

basis pending the permanent appointment of Susan E. Shepard, as now announced).

• Over the course of the Second Restatement, our current CEO and current CFO have communicated to employees the

importance of the Second Restatement process, reliable and transparent financial reporting and ethical conduct. Those

communications included formal presentations as part of our annual executive conference in November 2004.

• In June 2004 management recommended, the joint leadership resources committee recommended and the Board of Directors

subsequently approved that financial accountability be included as a key qualitative factor in the individual leadership

performance objectives for determination of incentive cash awards under our annual incentive plan.

• Extended Balance Sheet Reviews.

• We have developed a plan to extend our balance sheet reviews through the implementation of enhanced review procedures to:

• require greater frequency of timely statutory and segment balance sheet reviews,

• clarify responsibilities within Nortel Networks for organizing balance sheet

As noted above, we continue to identify, develop and begin to implement remedial measures, including the development of a detailed plan and

timetable for the implementation of the recommendations of the Independent Review. As part of the Revenue Independent Review, the Audit

Committee will also consider any appropriate additional remedial measures, including those involving internal controls and processes.

The above mentioned changes in internal control over financial reporting materially affected our internal control over financial reporting, and

these changes and expected changes as a result of remedial measures to be developed and implemented are reasonably likely to materially

affect our internal control over financial reporting in the future. We intend to continue to make ongoing assessments of our internal controls

and procedures periodically and as a result of the recommendations of the Independent Review and any additional recommendations of the

Revenue Independent Review.

137

reviews, and

• establish minimum documentation requirements with respect to balance sheet entries.

• As part of the initial development of this plan, in the first quarter of 2004, we increased our focus on the review of specific

balance sheet accounts.

• Review of Finance Department Organizational Structure. We announced, and began to implement, plans to transform our finance

organization, which include a renewed commitment to transparency as a fundamental goal. Measures we have begun to implement

include:

• In the first quarter of 2004, we began to enhance our global technical accounting group and establish global contract review

and global finance governance teams.

• We engaged Accenture, a global management consulting and technology services firm, in the third quarter of 2004 to assess

the finance organization’s structure, processes and systems, with an expected assessment completion date of March 2005.

• We established a global corporate finance Sarbanes-Oxley compliance group beginning in the third quarter of 2004.

• We have hired additional full-time finance personnel (with a focus on qualified accounting professionals) as part of an

initiative introduced by the CFO and controller in March 2004.

• Training Initiatives.

• We re-established our formal training group (led by the global finance governance team described above) to implement

ongoing training programs for finance personnel globally. The group’s focus includes training with respect to SFAS No. 5;

accounting for hedging and derivatives; revenue recognition, accruals and provisions; and SFAS No. 52.

• Internal Audi

• In the first quarter of 2004, we modified the mandate of our Internal Audit function to place a greater emphasis on the

adequacy of, and compliance with, procedures relating to internal control over financial reporting.

• In October 2004, we engaged outside consultants to conduct a strategic performance review of the internal audit function. The

objective of this review is to ensure that internal audit continues to meet professional internal audit standards and moves

towards audit best practices.

• Manual Journal Entry Processes.

• In the fourth quarter of 2003, we began to modify our manual journal entry processes by implementing new procedures, with

a focus on approvals of manual journal entries, more stringent documentation processes and reduction of user access to

manual journal entry functions.

Directors of the registrant

Directors are elected at the annual meeting of shareholders, except that we can appoint directors in certain circumstances between annual

meetings. Each person who is appointed or elected to the board of directors will hold that position until the earliest of: (i) the close of the next

annual meeting of shareholders; (ii) the date he or she ceases to be a director by operation of law; or (iii) the date he or she resigns.

The committee on directors and the board of directors of the Company remain committed to ensuring an orderly succession, continuity and

renewal. This process was commenced in 2003 and resulted in the appointment of Dr. Bischoff and Mr. Manley in the second quarter of 2004.

On January 10, 2005, the committee on directors advised the board of directors that five of the current directors have decided not to stand for

re-election at our next annual and special meeting of shareholders to be held as soon as practicable after the completion and filing of the 2004

and 2003 audited annual financial statements (the “AGM”). These directors and the year of their initial election to the board of directors are:

Mr. Wilson (1991), Mr. Fortier (1992), Mr. Smith (1994), Mrs. Saucier (1997) and Mr. Blanchard (1997). All of the current members of the

board of directors who will not be standing for re-election at the next AGM are committed to continuing in their current roles until the next

AGM. The committee on directors has identified two additional candidates not listed below, who the board of directors expects will be

nominated at the next AGM for election as directors. The board of directors of the Company today appointed Mr. McCormick and Mr. Pearce

directors of the Company effective immediately after the filing with the United States Securities and Exchange Commission of this Annual

Report on Form 10-K of the Company for the year ended December 31, 2003. The board of directors of Nortel Networks Limited also

appointed Mr. McCormick and Mr. Pearce directors of Nortel Networks Limited, effective immediately after the filing with the United States

Securities and Exchange Commission of the Annual Report on Form 10-K of Nortel Networks Limited for the year ended December 31, 2003.

Set out below is certain information concerning the individuals who currently have been nominated to be elected as directors of the

Company at our next AGM and certain information concerning the five of our current directors who will not be standing for re-election at the

AGM.

138

ITEM 10. Directors and Executive Officers of the Re

istran

Name A

ePosition with the Com

Dr. Manfred Bischoff 62 Director

The Hon. James Johnston Blanchard 62 Director (not standing for re-election)

Robert Ellis Brown 59 Director

John Edward Cleghorn 63 Director

L. Yves Fortier 69 Director (not standing for re-election)

Robert Alexander Ingram 62 Director

John A. MacNaughton 59 Nominee

The Hon. John Manley 55 Director

Richard D. McCormick 64 Nominee

William Arthur Owens 64 President and Chief Executive Officer and Director

Harry J. Pearce 62 Nominee

Guylaine Saucier 58 Director (not standing for re-election)

Sherwood H. Smith, Jr. 70 Director (not standing for re-election)

Lynton Ronald Wilson 64 Chairman (non-executive) and Director (not standing for re-

election)

139

DR. MANFRED BISCHOFF, 62, Starnberg, Federal Republic of Germany, was appointed as a director of

the Company and Nortel Networks Limited on April 29, 2004. Dr. Bischoff has been Chairman of the Board

of European Aeronautic Defence and Space Company EADS N.V., an aerospace company, since July 2000

and Delegate for Aerospace at DaimlerChrysler AG since January 2004. Dr. Bischoff was a member of the

board of management of DaimlerChrysler AG, an automotive manufacturing company, from May 1995 to

December 2003 and President and Chief Executive Officer of DaimlerChrysler Aerospace AG from

May 1995 to March 2000. He is also a member of the Supervisory Board of Bayerische Hypo-und

Vereinsbank AG, Fraport AG, Gerling-Konzern Versicherungs-Beteiligungs-AG, J.M. Voith AG, Lagardère

SCA and Royal KPN N.V.

ROBERT ELLIS BROWN, 59, Westmount, Québec, Canada, has been a director of the Company since

March 7, 2000 and of Nortel Networks Limited since April 27, 2000. Mr. Brown has been President and Chief

Executive Officer of CAE Inc., a flight training, services and equipment company, since August 2004 and has

been a director of ACE Aviation Holdings Inc., the parent holding company under which the reorganized Air

Canada is held, since October 2004. After being appointed a director of Air Canada, a commercial airline

company, in March 2003, he was appointed Vice-Chairman of the Board from April 2003 to May 2003 and

Chairman of the Board from May 2003 to September 2004. On April 1, 2003, Air Canada obtained an initial

order from the Ontario Superior Court of Justice providing creditor protection under the Companies Creditors

rrangement Ac

, such order being subsequently amended in connection with the proceedings. On April 1,

2003, Air Canada also made a concurrent petition for recognition and ancillary relief under Section 304 of the

United States Bankruptcy Code. Air Canada successfully completed its restructuring process and emerged

from creditor protection in September 2004. Mr. Brown served as a Director and Chairman of the Board of

Air Canada during its restructuring. Mr. Brown has been the Chairman of Vanguard Response Systems Inc.

since November 2003. Mr. Brown was the President and Chief Executive Officer of Bombardier Inc. from

February 1999 to December 2002.

JOHN EDWARD CLEGHORN, O.C., F.C.A., 63, Toronto, Ontario, Canada, has been a director of the

Company and of Nortel Networks Limited since May 24, 2001. Mr. Cleghorn was Chairman and Chief

Executive Officer of the Royal Bank of Canada from January 1995 to July 2001. He is also Chairman of the

Board of SNC-Lavalin Group Inc., an engineering and construction company, and a director of Canadian

Pacific Railway Company, Canadian Pacific Railway Limited, Finning International Inc. and Molson Inc. He

is Chancellor Emeritus of Wilfrid Laurier University, Member of the Faculty of Management International

Advisory Board, McGill University and is the Immediate Past Chairman and a director of the Historica

Foundation of Canada.

ROBERT ALEXANDER INGRAM, 62, Durham, North Carolina, United States, has been a director of the

Company since March 7, 2000 and of Nortel Networks Limited since April 29, 1999. Mr. Ingram has been

Vice-Chairman Pharmaceuticals of GlaxoSmithKline plc, a corporation involved in the research,

development, manufacturing and sale of pharmaceuticals, since January 2003. Mr. Ingram was the Chief

Operating Officer and President, Pharmaceutical Operations of GlaxoSmithKline plc from January 2001 to

January 2003. He was Chief Executive of Glaxo Wellcome plc from October 1997 to December 2000 and

Chairman of Glaxo Wellcome Inc., Glaxo Wellcome plc’s United States subsidiary, from January 1999 to

December 2000. Mr. Ingram is also non-executive Chairman of the Board of OSI Pharmaceuticals, Inc., a

biotechnology company, and a director of Edwards Lifesciences Corporation, Lowe’s Companies, Inc., Misys

plc, VALEANT Pharmaceuticals International and Wachovia Corporation.

140

JOHN A. MacNAUGHTON, C.M., 59, Toronto, Ontario, Canada, has been nominated for election as a

director of the Company and Nortel Networks Limited for the first time. Mr. MacNaughton has served since

September 1999 as President and Chief Executive Officer of the Canada Pension Plan Investment Board, a

Crown Corporation created by an Act of Parliament in 1997 to invest the assets of the Canada Pension Plan.

He is due to retire from that position on January 14, 2005. Prior to September 1999, he served as President of

Nesbitt Burns Inc., the investment banking arm of Bank of Montreal, from September 1994 to March 1999.

Mr. MacNaughton is a Trustee of the University Health Network, an academic health science centre. He is a

Governor of CCAF-FCVI Inc., a research and education foundation focused on governance, accountability,

management and audit in the public sector.

THE HON. JOHN MANLEY, 55, Ottawa, Ontario, Canada, was appointed as a director of the Company

and Nortel Networks Limited on May 26, 2004. Mr. Manley has been a senior counsel at the law firm of

McCarthy Tétrault LLP since May 2004. Mr. Manley was previously the Member of Parliament for Ottawa

South from November 1988 to June 2004 and Chairman of the Ontario Power Generation Review Committee,

which was responsible for reviewing the state of the energy system of Ontario, from December 2003 to

March 2004. As a Member of Parliament, Mr. Manley also held various positions in the Canadian federal

government, including Deputy Prime Minister of Canada from January 2002 to December 2003, Minister of

Finance from June 2002 to December 2003, Chair of the Cabinet Committee on Public Security and Anti-

Terrorism from October 2001 to December 2003, Minister of Foreign Affairs from October 2000 to

January 2002 and Minister of Industry prior thereto.

RICHARD D. McCORMICK, 64, Denver, Colorado, United States, served as Chairman of US WEST, Inc.,

a telecommunications company, from June 1998 until his retirement in May 1999. He was chairman, president

and chief executive officer of US WEST, Inc. from 1992 until 1998. He is also a director of HealthTrio Inc.,

United Technologies Corporation, Unocal Corporation and Wells Fargo and Company. From 1994 to 2003,

Mr. McCormick was also a director of UAL Corporation, the parent holding company and sole shareholder of

United Air Lines, Inc. On December 9, 2002, UAL Corporation, United Air Lines, Inc. and 26 direct and

indirect wholly owned subsidiaries of UAL Corporation filed voluntary petitions to reorganize their

businesses under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for

the Northern District of Illinois, Eastern Division.

WILLIAM ARTHUR OWENS, 64, Kirkland, Washington, United States, has been a director of the

Company and of Nortel Networks Limited since February 28, 2002. Mr. Owens has been President and Chief

Executive Officer of the Company and of Nortel Networks Limited since April 2004. Mr. Owens was

Chairman and Chief Executive Officer of Teledesic LLC, a satellite communications company, from

December 2001 to April 2004, after having served as Vice Chairman and Co-Chief Executive Officer from

August 1998 to December 2001. Mr. Owens was Vice-Chairman of the Board of Directors of Science

Applications International Corporation (or SAIC), a research and engineering firm representing the largest

employee-owned high technology company in the United States, from March 1996 to August 1998, and

served as SAIC’s President and Chief Operating Officer from December 1996 to August 1998 and Vice-

President from March 1996 to December 1996. Prior to joining SAIC, Mr. Owens was Vice Chairman of the

Joint Chiefs of Staff, the second-ranking military officer in the United States. As part of his role with the Joint

Chiefs of Staff, he had responsibility for the reorganization and restructuring of the armed forces in the post-

Cold War era. Mr. Owens is also a director of DaimlerChrysler AG. Mr. Owens was the Chairman and

founder of a private five-state wireless telecommunication venture. Mr. Owens was also a director of IFusion

Com Corporation, a company involved in developing Internet services and systems, for approximately one

year, his tenure ending in March 1997. On March 28, 1997, IFusion Com Corporation filed a voluntary

petition to reorganize its businesses under Chapter 11 of the United States Bankruptcy Code in the United

States Bankruptcy Court for the Southern District of New York, United States.

We would like to acknowledge the many years of contribution and service to the Company and Nortel Networks Limited by Messrs. Lynton

Ronald Wilson, L. Yves Fortier, Sherwood H. Smith, Jr., Mrs. Guylaine Saucier and the Honorable James Johnston Blanchard.

Mr. Wilson has been a director of the Company since March 7, 2000 and of Nortel Networks Limited since April 25, 1991 and non-

executive Chairman of the Board of the Company and of Nortel Networks Limited since February 2002. Mr. Wilson was executive Chairman

of the Board of the Company and of Nortel Networks Limited from November 2001 to February 2002. He was non-executive Chairman of the

Board of the Company and of Nortel Networks Limited from April 2001 to November 2001. Mr. Wilson was Chairman of the Board of

Directors of BCE Inc., a telecommunications company, from May 1998 to April 2000, serving in a non-executive capacity from January 1999.

He is Chairman of the Board of CAE Inc., a flight training, services and equipment company, and a director of DaimlerChrysler AG and

DaimlerChrysler Canada Inc.

Mr. Fortier has been a director of the Company since March 7, 2000 and Nortel Networks Limited since April 30, 1992. He also serves on

the pension fund policy committee of Nortel Networks Limited. He is a senior partner and Co-Chairman of the law firm of Ogilvy Renault.

Mr. Fortier was Canada’s Ambassador to the United Nations from 1988 to 1992. Since 2001, he has been a Trustee of the International

Accounting Standards Committee Foundation. He is also Chairman of the Board of Alcan Inc., Governor (Chairman of the Board) of Hudson’s

Bay Company, and a director of NOVA Chemicals Corporation and Royal Bank of Canada.

Mr. Smith, having reached the age of retirement and the term limit under the Company’s corporate governance guidelines, will not be

standing again for re-election at the AGM. Mr. Smith has been a director of the Company since March 7, 2000 and of Nortel Networks Limited

since April 28, 1994. He serves on the audit committee and the joint leadership resources committee of the Company, and on the audit

committee, the joint leadership resources committee and the pension fund policy committee (Chairman) of Nortel Networks Limited.

Mr. Smith is Chairman Emeritus of the Board at CP&L. He is also a trustee of Northwestern Mutual Life Insurance Company, Chairman of the

Triangle Universities Center for Advanced Studies and Vice-Chairman of the Research Triangle Foundation.

Mrs. Saucier has been a director of the Company since March 7, 2000 and of Nortel Networks Limited since May 1, 1997. Mrs. Saucier was

Chair of the Joint Committee on Corporate Governance, which was established by the Canadian Institute of Chartered Accountants, the

Canadian Venture Exchange, and the Toronto Stock Exchange in 2000 to review the state of corporate governance in Canada and make

recommendations thereon. She was also Chair of The Canadian Institute of Chartered Accountants from June 1999 to June 2000. Mrs. Saucier

was Chairman of the Board and a director of the Canadian Broadcasting Corporation, a public broadcaster, from April 1995 to December 2000.

She is also a director of Altran Technologies SA, AXA Assurances Inc., Bank of Montreal, Petro-Canada and Tembec Inc.

Mr. Blanchard has been a director of the Company since March 7, 2000 and of Nortel Networks Limited since May 1, 1997. Mr. Blanchard

has been a partner in the law firm of Piper Rudnick LLP (now DLA Piper Rudnick Gray Cary) since October 2002 and prior to October 2002

was a shareholder in the law firm of Verner, Liipfert, Bernhard, McPherson and Hand, Chartered since April 1996. He was previously United

States Ambassador to Canada, Governor of the State of Michigan and a member of the United States House of Representatives. Mr. Blanchard

is also a director of Bennett Environmental, Inc., Brascan Corporation, Enbridge Inc., LDMI Communications, Inc. and Teknion Corporation.

Shareholders who wish to have the committee on directors of the board of directors of the Company consider the nomination of any person

for director should communicate with the Company’s corporate secretary at the Company’s principal executive offices at 8200 Dixie Road,

Suite 100, Brampton, Ontario, L5T 5P6.

141

HARRY J. PEARCE, 62, Bloomfield Hills, Michigan, United States, was Chairman of the Board of Hughes

Electronics Corporation (now The DIRECTV Group, Inc.), a company engaged in digital television

entertainment, broadband satellite and network services as well as global video and data broadcasting, from

June 2001 to January 2004. He was a director and Vice-Chairman of General Motors Corporation from

January 1996 to June 2001. Mr. Pearce is also a director of Marriott International, Inc. and MDU Resources

Group, Inc.

Executive officers and certain other non-executive board appointed officers of the Registrant

The executive officers and certain other non-executive board appointed officers of the Company are appointed, and may be removed, by the

Board of Directors of the Company. Generally, executive officers and other non-executive officers hold their offices until a successor is

appointed or until the officer resigns. As of December 31, 2004, the names of the executive officers and non-executive board appointed officers

of the Company, their ages, offices currently held and year of appointment thereto were as follows:

All the above-named executive officers and non-executive board appointed officers of the Company have been employed in their current

position or other senior positions with Nortel Networks during the past five years, except as follows:

142

Year of

Name and a

eOffice and

osition currentl

held A

ointment

Martha Helena Bejar (42) President, CALA 2004

Chahram Bolouri (50) President, Global Services 2004

Malcolm Kevin Collins (44) President, Enterprise Networks 2002

Tracy Sarah Jane Connelly McGilley (33)* Assistant Secretary and Counsel

—

Securities 2004

Gordon Allan Davies (42)* Assistant General Counsel — Securities and Corporate Secretary 2004

Pascal Debon (57) President, Carrier Networks 2004

Nicholas John DeRoma (57) Chief Legal Officer 2000

William John Donovan (47) Senior Vice-President, Human Resources 2000

John Marshall Doolittle (41)* Vice-President, Tax 2002

John Joseph Giamatteo (37) President, Asia Pacific 2003

Albert Roger Hitchcock (39) Chief Information Officer 2002

Dion Constandino Joannou (39) Chief Strategy Officer 2004

William Robert Kerr (50) Chief Financial Officer 2004

Richard Stephen Lowe (54) President, CDMA 2004

Peter David MacKinnon (42) President, GSM/UMTS 2004

Robert Yu Lang Mao (61) President and Chief Executive Officer, Greater China 2003

William F. McCauley** (73) Chief Ethics and Compliance Officer 2004

Brian William McFadden (51) Chief Technology Officer 2004

Donald Gregory Mumford (58) Special Advisor 2004

William Arthur Owens (64) President and Chief Executive Officer 2004

MaryAnne Elisabeth Pahapill (43) Controller 2004

Stephen Charles Pusey (43) President, Europe, Middle East and Africa 2001

Ralph Edward Clenton Richardson (43) Chief Marketing Officer 2004

Charles Raymond Saffell, Jr. (58) President, Federal Network Solutions 2004

Steven Leo Schilling (48) President, Enterprise Accounts 2002

Stephen Francis Slattery (45) President, Wireline/Optical 2004

Karen Elizabeth Sledge (43)* Assistant Controller 2003

Susan Louise Spradley (43) President, Global Operations 2004

Katharine Berghuis Stevenson (42) Treasurer 2000

Masood Ahmad Tariq (54) President, Global Alliances 2003

Tracey Lynn Vickruck* ** (46) Assistant Treasurer 2004

*Non-executive board appointed officers

** Appointed on an interim basis

• T.S.J. Connelly McGilley, prior to her appointment as Assistant Secretary effective in December 2004, held the position of Counsel —

Securities in the Nortel Networks Limited legal department;

• J.M. Doolittle was, prior to returning to Nortel Networks in September 1999, Vice President, Finance of The Bank of Montreal, a

Canadian chartered bank, from August 1997 and Director, Treasury, Europe and Asia, Nortel Networks, prior thereto;

Subsequent appointment

Susan E. Shepard, 61, will succeed Mr. W.F. McCauley in the position of Chief Ethics and Compliance Officer effective February 21, 2005.

Mr. McCauley will work with Ms. Shepard to transition the position of Chief Ethics and Compliance Officer. Over the course of her career,

Ms. Shepard has served in a number of positions specifically related to ethics and compliance. Ms. Shepard has been a Commissioner for the

New York State Ethics Commission since May 2003. In addition, prior to becoming engaged in private practice in 1997, Ms. Shepard was

Commissioner of Investigation for New York City (1990 to 1994), Chief Counsel to the New York State Commission of Investigation (1986 to

1990) and an Assistant United States Attorney for the Eastern District of New York (1976 to 1986).

143

• W.R. Kerr, prior to returning to Nortel Networks as Chief Financial Officer in March 2004, held various senior finance positions with

Nortel Networks from January 1999 (and prior thereto) until his retirement in December 2001. He has also served as a director of Bank

of China (Canada) since June 1, 1997;

• R.Y.L. Mao was, prior to returning to Nortel Networks in January 2003, Chairman and Chief Executive Officer of Foxconn (Beijing)

Precision Component Industries, Ltd., a manufacturer of mobile communication terminal devices, from November 2002 to December

2002, and Chief Executive Officer, Nortel China, prior thereto;

• W.F. McCauley was a consultant prior to his appointment as Chief Ethics and Compliance Officer of Nortel Networks effective October

28, 2004. Mr. McCauley was engaged in consulting on various matters in a variety of industries during the period from 1998 until his

appointment with Nortel Networks, except from September 1999 to June 2001 when he was a director of the Kyle Foundation, a non-

profit enterprise engaged in causes associated with child cancer care. From August 2004 until his appointment as Chief Ethics and

Compliance Officer, he acted as an independent consultant to Nortel Networks on matters related to the ethics and compliance function

of the Company and its subsidiaries. In addition, Mr. McCauley is currently a member of the respective advisory committees of

Actuarial Consulting Group, a pension planning and execution enterprise, and High-Tech Engineering, a specialty steel and titanium

manufacturing company, as well as the Ship Systems Advisory Committee of Northrop Grumman Corp., a company engaged in ship

building, primarily for the U.S. Navy. He is also a director, and member of the investment and audit committees, of Pacific Specialty

Insurance Group, a property and casualty insurance enterprise, a foundation trustee of the U.S. Naval Academy and a board trustee of

Scripps Foundation, an organization engaged in the oversight of six hospitals in southern California;

• W.A. Owens was, prior to his appointment as President and Chief Executive Officer in April 2004, Chairman and Chief Executive

Officer of Teledesic LLC, a satellite communications company, from December 2001 to April 2004, after having served as Vice

Chairman and Co-Chief Executive Officer from August 1998 to December 2001. Mr. Owens was Vice-Chairman of the Board of

Directors of Science Applications International Corporation (or SAIC), a research and engineering firm representing the largest

employee-owned high technology company in the United States, from March 1996 to August 1998, and served as SAIC’s President and

Chief Operating Officer from December 1996 to August 1998 and Vice-President from March 1996 to December 1996. Prior to joining

SAIC, Mr. Owens was Vice Chairman of the Joint Chiefs of Staff, and the second-ranking military officer in the United States. As part

of his role with the Joint Chiefs of Staff, he had responsibility for the reorganization and restructuring of the armed forces in the post-

Cold War era. Mr. Owens is also a director of DaimlerChrysler AG. Mr. Owens was the Chairman and founder of a private five-state

wireless telecommunication venture. Mr. Owens has been a director of the Company and Nortel Networks Limited since February 2002;

• R.E.C. Richardson was, prior to his appointment as Chief Marketing Officer effective October 1, 2004, Vice President, Global

Marketing Enterprise Networks from April 2004 to September 2004. Mr. Richardson was a consultant from April 2003 to March 2004

and prior thereto was Chief Sales and Marketing Officer, and member of the board of directors, at T-Mobile UK, the UK wireless unit of

Deutsche Telekom AG, from April 2001 to March 2003. Prior to that, Mr. Richardson was Vice President Worldwide Developer

Relations and Worldwide Solutions Marketing, Apple Computer, a company engaged in the desktop and notebook computer industry as

well as the production of operating systems and professional applications, from December 1997 to March 2001;

• C.R. Saffell, Jr. was, prior to his appointment as President, Federal Network Solutions in October, 2004, Senior Vice President for

National Security Solutions, Titan Corporation, a technology developer and systems integrator that provides a range of systems solutions

primarily for the Department of Defense, the Department of Homeland Security, intelligence and other U.S. government agencies, from

December 1988 to March 2004;

• K.E. Sledge, prior to her appointment as Assistant Controller in July 2003, held various finance positions with Nortel Networks; and

• T.L. Vickruck was, prior to returning to Nortel Networks in August 2004, Team Leader, Corporate Treasury, Financial Controls Office

of Royal Bank of Canada, a Canadian chartered bank, from September 2003 to June 2004. She was Director, Global Treasury Centre,

Nortel Networks from September 2000 to June 2002 and prior thereto was Director, Treasury Operations, Americas Nortel Networks

from January 1999 to September 2000.

Section 16(a) beneficial ownership reporting compliance

Section 16(a) of the United States Securities Exchange Act of 1934 requires directors and executive officers of the Company to file reports

concerning their ownership of Company equity securities with the United States Securities and Exchange Commission, the New York Stock

Exchange, and the Company. Based solely on a review of the information received and written representations from the persons subject to

Section 16(a), we believe that all of the Company’s directors and executive officers filed their required reports on a timely basis during 2004

and 2003.

Audit committee financial expert

The boards of directors of the Company and Nortel Networks Limited have determined that Mr. J.E. Cleghorn meets the criteria required by

the United States Securities and Exchange Commission for an “audit committee financial expert” (United States GAAP). Mr. Cleghorn is

“independent” under the requirements for the “independence” of audit committee members under the New York Stock Exchange (or NYSE)

corporate governance listing standards.

Audit committee

The Company and Nortel Networks Limited have audit committees in accordance with Section 3(a)(58)(A) of the United States Securities

Exchange Act of 1934, as amended. The audit committees have identical memberships. The members of both audit committees are J.E.

Cleghorn (Chairman), M. Bischoff, R.E. Brown, R.A. Ingram, G. Saucier, and S.H. Smith, Jr.

Code of ethics and other corporate governance matters

The Company and Nortel Networks Limited have adopted a code of business conduct and ethics, known as “Living the Values: A Guide to

Ethical Business Practices at Nortel Networks”, which applies to the chief executive officer, chief financial officer and controller, and other

persons performing similar functions, as well as to directors and all other employees. Certain waivers under the Guide if granted by the boards

of directors or any committee thereof to directors of the Company or Nortel Networks Limited or officers will be posted on our website at

www.nortel.com, in accordance with applicable law and the requirements of the stock exchanges on which the Company or Nortel Networks

Limited securities are listed and of securities regulatory authorities as adopted or amended and in force from time to time.

The audit committees of the Company and Nortel Networks Limited have each adopted a charter, known as the “Audit Committee

Mandate”. The committee on directors of the Company acts as the nominating committee and makes corporate governance recommendations

to the board of directors of the Company. The committee on directors has adopted a charter, known as the “Committee on Directors Mandate”.

The joint leadership resources committee acts as the compensation committee of Nortel Networks. The joint leadership resources committee

has adopted a charter, known as the “Joint Leadership Resources Committee Mandate”. The Company and Nortel Networks Limited have

adopted corporate governance guidelines, known as the “Statement of Governance Guidelines”.

144

The Guide to Ethical Business Practices, the Audit Committee Mandates, the Committee on Directors Mandate, the Joint Leadership

Resources Mandate, and the Statement of Governance Guidelines, as well as any future amendments to these documents, are available free of

charge on our website at www.nortel.com or by writing to the corporate secretary at Nortel Networks Corporation, 8200 Dixie Road,

Suite 100, Brampton, Ontario L6T 5P6.

The following tables are presented in accordance with the rules of the United States Securities and Exchange Commission.

Summary compensation table

The following tables set forth the compensation awarded to, earned by, or paid to each of the Company’s named executive officers for

services rendered by them to the Company and its subsidiaries in (1) 2004, 2003 and 2002, and (2) 2003, 2002 and 2001, respectively.

145

ITEM 11. Executive Com

ensation

2004

146

Long Term

Compensation

Awards Payouts

Annual Compensation Securities

Name Other Annual Underlying LTIP All Other

And Principal Salary Bonus Compensation Options Payouts Compensation

Position Year ($) ($)(1) ($) (#) (#) ($)

W.A. Owens*

President and Chief

Executive Officer

2004

2003

2002

681,818

–

70,298(2)

–

P. Debon**

President, Carrier

Networks

2004

2003

2002

590,000

537,143

–

743,400(6)

1,475,000(8)(9)

–

10,445(3)

–

250,000

–

90,000(7)

745,000(10)

–

85,577(4)(5)

92,346(4)(5)

125,875(4)(5)(11)

B.W. McFadden**

Chief Technology Officer

2004

2003

2002

530,000

501,667

458,545

–

528,675(6)

1,291,000(8)(9)

–

250,000

–

90,000(7)

745,000(10)

–

38,601(12)(13)

65,430(12)(13)

16,503(12)(13)

S.L. Spradley**

President, Global

Operations

2004

2003

2002

530,000

496,667

354,275

–

609,325(6)

1,285,000(8)(9)

–

291,999(15)

–

575,000(10)

–

6,500(14)

6,000(14)

5,500(14)

N.J. DeRoma

Chief Legal Officer

2004

2003

2002

526,000

–

524,685(6)

1,315,000(8)(9)

–

24,038(13)(16)

–

250,000

–

135,000(7)

535,000(10)

–

31,960(12)(13)

54,494(12)(13)

17,885(12)(13)

F.A. Dunn*

Former President and

Chief Executive Officer

2004

2003

2002

417,043(17)

868,750

825,000

–

–(18)

3,540,000(8)(19)

–

750,000(20)

–

225,000(7)

745,000(10)(19)

–

9,138(12)(13)

26,145(12)(13)

24,747(12)(13)

*On April 27, 2004, Mr. Dunn’s employment as President and Chief Executive Officer of the Company and Nortel Networks Limited was terminated for cause and

Mr. Owens was a

ointed President and Chief Executive Officer of the Com

and Nortel Networks Limited.

** Prior to the change in positions effective October 1, 2004 in accordance with the corporate reorganization announced by the Company on August 19, 2004, Messrs. Debon

and McFadden and Ms. Spradley held, respectively, the positions of: President, Wireless Networks; President, Optical Networks; and President, Wireline Networks.

(1) Incentive cash awards for each fiscal year under the Nortel Networks Limited SUCCESS Incentive Plan (or SUCCESS Plan), including payments made in connection with

the “Return to Profitability” bonus program component of that plan, in respect of each of the fiscal years, whether or not deferred by the named executive officer. On

April 27, 2004, the Company and Nortel Networks Limited terminated for cause the employment of each of its then president and chief executive officer, chief financial

officer and controller. On August 19, 2004, the Company announced that seven individuals with, or who had, significant responsibilities for financial reporting at the line

of business and regional levels were terminated for cause. Nortel Networks has demanded from these individuals repayment of any payments made under bonus plans in

respect of 2003, including any awards under the SUCCESS Plan. See footnotes (8) and (19) below.

(2) Represents contributions under the Nortel Networks Long-Term Investment Plan ($1,038), expatriate expenses related to Mr. Owens’ responsibilities as President and

Chief Executive Officer of the Company and Nortel Networks Limited ($43,588) and fees earned as a non-employee director prior to being appointed as President and

Chief Executive Officer of the Company and Nortel Networks Limited ($25,672). See “Compensation of directors”.

147

(3) Represents a tax reimbursement payment in connection with certain permanent transfer expenses.

(4) Certain payments paid in euros have been converted to United States dollars and included in this amount. Payments have been converted using the average of the exchange

rates in effect during each year equal to US$1.00 = .8027 euros for 2004, US$1.00 = .8830 euros for 2003 and US$1.00 = 1.0615 euros for 2002.

(5) Represents contributions under the Nortel Networks Long-Term Investment Plan or Nortel Networks (UK) Pension Plan, as applicable ($3,268 in 2004, $7,200 in 2003

and $8,467 in 2002), and expatriate, permanent transfer and other similar expenses related to Mr. Debon’s global responsibilities as President, Wireless Networks ($82,309

in 2004, $85,146 in 2003 and $117,408 in 2002).

(6) Represents a SUCCESS Plan annual incentive award. Nortel Networks has demanded that the individuals described in footnote (1) whose employment was terminated for

cause re

ments made under bonus

lans in res

ect of 2003, includin

SUCCESS Plan annual incentive awards.

(7) Represents the number of restricted stock units issued and settled in respect of restricted stock units allocated under the 2001 program of the Nortel Networks Limited

Restricted Stock Unit Plan (or RSU Plan). Restricted stock units allocated in 2001 had a two year performance period that was divided into five shorter performance

segments. The performance criteria included resizing activity targets for the first segment, and corporate performance objectives under the incentive plan for the remaining

four segments. Although the joint leadership resources committee determined that certain of the distinct performance objectives were not achieved, it exercised its

discretion in May 2003 to authorize the issuance and settlement in the form of common shares of the Company (net of withholding taxes) of 90 percent of the restricted

stock units allocated under the 2001 program based on its consideration of the improved financial performance of the Company during the two-year performance period

and the Company’s overall performance over that period as compared to its key competitors. The total before tax value of the restricted stock units that were issued and

settled, using the purchase price of our common shares on the date of purchase, was: Cdn$945,293 ($672,902) for Mr. Dunn; $274,050 for Mr. Debon; Cdn$378,117

($269,161) for Mr. McFadden, and Cdn$567,176 ($403,741) for Mr. DeRoma. Amounts have been converted using the exchange rates listed in footnote (13) below.

(8) Represents a Return to Profitability program award under the SUCCESS Plan. Nortel Networks has demanded that the individuals described in footnote (1) whose

employment was terminated for cause repay any payments made under bonus plans in respect of 2003, including any Return to Profitability program awards. See footnotes

(1), (9) and (19).

(9) Mr. Debon, Mr. McFadden, Ms. Spradley and Mr. DeRoma have voluntarily undertaken to pay to the Company over a three year period an amount equal to their Return to

Profitability program bonus awarded in 2003 (net of any taxes deducted at the source). The following additional current members of senior management have similarly

voluntarily agreed to pay their respective Return to Profitability program bonus awards: Messrs. Bolouri, Collins, Donovan, Giamatteo, Joannou, Mao, Mumford and

Pusey. See “Voluntary undertaking: Return to Profitability bonus program and 2003 restricted stock unit program”.

(10) Represents the number of restricted stock units issued and settled in respect of restricted stock units allocated under the 2003 program of the RSU Plan. Each unit entitled

the holder to receive one common share of the Company or, subject to certain conditions, a cash payment equal to the common share value. In respect of payments made

under the 2003 program of the RSU Plan, each named executive officer, other than Mr. Dunn, received in July 2003 restricted stock units in connection with the

achievement of the first performance threshold as at the end of the second fiscal quarter of 2003 (100% in the form of common shares) and in February 2004 restricted

stock units in connection with the achievement of the second performance threshold as at the end of the third fiscal quarter of 2003 (50% in the form of common shares

and 50% in the form of cash). These individuals continue to hold the common shares received as a result of the settlement of their restricted stock units. Mr. Dunn received

in July 2003 restricted stock units in connection with the achievement of the first performance threshold (100% in the form of common shares) but did not receive

restricted stock units in connection with the achievement of the second performance threshold. The before tax total value of restricted stock units issued and settled was:

Cdn$2,983,204 ($2,123,579) for Mr. Dunn; $3,783,743 for Mr. Debon; $2,920,339 for Ms Spradley; Cdn$5,085,873 ($3,620,354) for Mr. McFadden; and Cdn$3,652,271

($2,599,851) for Mr. DeRoma. Restricted stock units are valued using the purchase price of the common shares on the date of purchase (for share settlement) and on the

average price for the specified 20 day trading period for cash settlement (where applicable). Amounts have been converted using the exchange rates listed in footnote (13)

below. See “Long-term incentive plans — awards in last two fiscal years — 2003” for a description of the applicable performance criteria. See footnote (19) below.

(11) Certain payments paid in United Kingdom pounds have been converted to United States dollars and included in this amount. Payments have been converted using the

avera

e of the exchan

e rates in effect e

ual to US$1.00 = UK

0.6661 for 2002.

148

(12) Represents contributions made under the Nortel Networks Limited Investment Plan for Employees — Canada.

(13) Represents the United States dollar equivalent of payments actually earned or paid in Canadian dollars. Amounts have been converted using the average of the exchange

rates in effect during each year equal to US$1.00 = CDN$1.2978 for 2004, US$1.00 = Cdn$1.4048 for 2003 and US$1.00 = Cdn$1.5708 for 2002.

(14) Represents contributions under the Nortel Networks Long-Term Investment Plan.

(15) In June 2001, the Company commenced a voluntary stock option exchange program whereby eligible employees could exchange certain then outstanding stock options for

new options based on a prescribed formula. In January 2002, new stock options were granted to eligible employees who participated in the stock option exchange

program, with exercise prices at the fair market value of the Company’s common shares on the date of grant. Prior to Ms. Spradley’s appointment as an officer of the

Company, she was an employee eligible to participate in the voluntary stock option exchange program. As a result, 41,999 of the stock options granted toMs.Spradleyin

2002 were granted pursuant to the voluntary stock option exchange program.

(16) Amounts paid to reimburse Mr. DeRoma for income taxes payable by him in accordance with his employment agreement. Mr. DeRoma’s employment agreement is

described below under “Certain employment arrangements”.

(17) Includes Cdn$151,898 base salary for accrued vacation paid as required in accordance with corporate policy and applicable law as a result of the termination of

employment for cause.

(18) Mr. Dunn did not receive any annual incentive bonus under the SUCCESS Plan with respect to 2003. See footnotes (1), (8) and (19).

(19) As a result of the termination of Mr. Dunn’s employment for cause on April 27, 2004, the Company and Nortel Networks Limited have demanded repaymentofthe

Return to Profitability program bonus award under the SUCCESS Plan of $3,540,000 and the 745,000 restricted stock units issued and settled in respect of restricted stock

units allocated under the 2003 program of the RSU Plan. See footnotes (8) and (10).

(20) These options terminated and expired automatically upon the termination of Mr. Dunn’s employment for cause on April 27, 2004.

2003

149

Long Term

Compensation

Annual Compensation Awards Payouts

Name

And Principal

Position Year

Salary

($)

Bonus

($)(1)

Other Annual

Compensation

($)

Securities

Underlying

Options

(#)

LTIP

Payouts

(#)

All Other

Compensation

($)

F.A. Dunn* 2003 868,750 –(2) – – 225,000(3) 26,145(4)(5)

President and Chief 3,540,000(6)(7) 745,000(7)(8)

Executive Officer 2002 825,000 – – 750,000(9) –24,747(4)(5)

2001 564,833 – – 1,500,000(9)(10) –16,806(4)(5)

P. Debon** 2003 590,000 743,400(11) – – 90,000(3) 92,346(12)(13)

President, Wireless 1,475,000(6)(14) 745,000(8)

Networks 2002 537,143 – – 250,000 –125,875(12)(13)(15)

2001 440,417 –68,713(15)(16) 650,000 –332,020(13)(15)

S.L. Spradley** 2003 496,667 609,325(11) – – 575,000(8) 6,000(17)

President, Wireline 1,285,000(6)(14)

Networks 2002 354,275 – – 291,999(18) –5,500(17)

2001 269,026 – – –(19) –5,100(17)

C. Bolouri** 2003 510,000 589,050(11) – – 135,000(3) 63,404(4)(5)

President, Global 1,275,000(6)(14) 535,000(8)

Operations 2002 510,000 – – 250,000 –18,358(4)(5)

2001 459,000 – – 700,000 –27,440(4)(5)

N.J. DeRoma 2003 526,000 524,685(11) – – 135,000(3) 54,494(4)(5)

Chief Legal Officer 1,315,000(6)(14) 535,000(8)

2002 526,000 –24,038(5)(20) 250,000 –17,885(4)(5)

2001 493,750 –62,921(5)(20) 650,000 –27,642(4)(5)

* On April 27, 2004, Mr. Dunn’s employment as President and Chief Executive Officer of the Company and Nortel Networks Limited was terminated for cause and

Mr. W.A. Owens was appointed President and Chief Executive Officer of the Company and Nortel Networks Limited. The compensation for his successor Mr. W.A.

Owens, President and Chief Executive Officer of the Company and Nortel Networks Limited, is described below under “Certain employment arrangements”.

** In accordance with the corporate reorganization announced by the Company on August 19, 2004, effective October 1, 2004, Messrs. Debon and Bolouri and Ms. Spradley

were, respectively, appointed to the positions of: President, Carrier Networks; President, Global Services; and President, Global Operations.

(1) Incentive cash awards for each fiscal year under the Nortel Networks Limited SUCCESS Incentive Plan (or SUCCESS Plan), including payments made in connection with

the “Return to Profitability” bonus program component of that plan, in respect of each of the fiscal years, whether or not deferred by the named executive officer. On

April 27, 2004, the Company and Nortel Networks Limited terminated for cause the employment of each of their then president and chief executive officer, chief financial

officer and controller. On August 19, 2004, the Company announced that seven individuals with, or who had, significant responsibilities for financial reporting at the line

of business and regional levels were terminated for cause. Nortel Networks has demanded from these individuals repayment of any payments made under bonus plans in

respect of 2003, including any awards under the SUCCESS Plan. See footnotes (6) and (7) below.

(2) Mr. Dunn did not receive an

annual incentive bonus under the SUCCESS Plan with res

ect to 2003. See footnotes (1), (6) and (7).

(3) Represents the number of restricted stock units issued and settled in respect of restricted stock units allocated under the 2001 program of the Nortel Networks Limited

Restricted Stock Unit Plan (or RSU Plan). Restricted stock units allocated in 2001 had a two year performance period that was divided into five shorter performance

segments. The performance criteria included resizing activity targets for the first segment, and corporate performance objectives

150

under the incentive plan for the remaining four segments. Although the joint leadership resources committee determined that certain of the distinct performance objectives

were not achieved, it exercised its discretion in May 2003 to authorize the issuance and settlement in the form of common shares of the Company (net of withholding

taxes) of 90 percent of the restricted stock units allocated under the 2001 program based on its consideration of the improved financial performance oftheCompany

during the two-year performance period and the Company’s overall performance over that period as compared to its key competitors. The total before tax value of the

restricted stock units that were issued and settled, using the purchase price of our common shares on the date of purchase, was: Cdn$945,293 ($672,902) for Mr. Dunn;

$274,050 for Mr. Debon; Cdn$567,176 ($403,741) for Mr. Bolouri; and Cdn$567,176 ($403,741) for Mr. DeRoma. Amounts have been converted using the exchange

rates listed in footnote (5) below.

(4) Represents contributions made under the Nortel Networks Limited Investment Plan for Employees — Canada.

(5) Represents the United States dollar equivalent of payments actually earned or paid in Canadian dollars. Amounts have been converted using the average of the exchange

rates in effect during each year equal to US$1.00 = Cdn$1.4048 for 2003, US$1.00 = Cdn$1.5708 for 2002 and US$1.00 = Cdn$1.5489 for 2001.

(6) Represents a Return to Profitability program award under the SUCCESS Plan. Nortel Networks has demanded that the individuals described in footnote (1) whose

employment was terminated for cause repay any payments made under bonus plans in respect of 2003, including any Return to Profitability program awards. See footnotes

(1), (7) and (14).

(7) As a result of the termination of Mr. Dunn’s employment for cause on April 27, 2004, the Company and Nortel Networks Limited have demanded repayment of the

Return to Profitability program bonus award under the SUCCESS Plan of $3,540,000 and the 745,000 restricted stock units issued and settled in respect of restricted stock

units allocated under the 2003 program of the RSU Plan. See footnotes (6) and (8).

(8) Represents the number of restricted stock units issued and settled in respect of restricted stock units allocated under the 2003 program of the RSU Plan. Each unit entitled

the holder to receive one common share of the Company or, subject to certain conditions, a cash payment equal to the common share value. In respect of payments made

under the 2003 program of the RSU Plan, each named executive officer, other than Mr. Dunn, received in July 2003 restricted stock units in connection with the

achievement of the first performance threshold as at the end of the second fiscal quarter of 2003 (100% in the form of common shares) and in February 2004 restricted

stock units in connection with the achievement of the second performance threshold as at the end of the third fiscal quarter of 2003 (50% in the form of common shares

and 50% in the form of cash). These individuals continue to hold the common shares received as a result of the settlement of their restricted stock units. Mr. Dunn received

in July 2003 restricted stock units in connection with the achievement of the first performance threshold (100% in the form of common shares) but did not receive

restricted stock units in connection with the achievement of the second performance threshold. The before tax total value of restricted stock units issued and settled was:

Cdn$2,983,204 ($2,123,579) for Mr. Dunn; $3,783,743 for Mr. Debon; $2,920,339 for Ms Spradley; Cdn$3,652,271 ($2,599,851) for Mr. Bolouri; and Cdn$3,652,271

($2,599,851) for Mr. DeRoma. Restricted stock units are valued using the purchase price of the common shares on the date of purchase (for share settlement) and on the

average price for the specified 20 day trading period for cash settlement (where applicable). Amounts have been converted using the exchange rates listed in footnote (5)

above. See “Long-term incentive plans — awards in last two fiscal years — 2003” for a description of the applicable performance criteria. See footnote (7) above.

(9) These options terminated and expired automatically upon the termination of Mr. Dunn’s employment for cause on April 27, 2004.

(10) This amount has been reduced from the previously reported amount to reflect Mr. Dunn’s voluntary return for immediate cancellation in June 2003 of 250,000 stock

options that were originally granted in 2001.

(11) Represents a SUCCESS Plan annual incentive award. Nortel Networks has demanded that the individuals described in footnote (1) whose employment was terminated for

cause repay any payments made under bonus plans in respect of 2003, including any SUCCESS Plan annual incentive awards.

(12) Certain payments paid in euros have been converted and included in this amount. Payments have been converted using the average of the exchange rates in effect during

each year equal to US$1.00 = .8830 euros for 2003 and US$1.00 = 1.0615 euros for 2002.

Annual cash incentive awards

Annual cash bonus awards under the SUCCESS Plan are based on achieving corporate and individual performance objectives for a calendar

year. The joint leadership resources committee retains full discretion in determining whether, and the extent to which, corporate performance

objectives have been met and whether, and to what extent, an annual award under the SUCCESS Plan will be made. An annual award is

determined as a percentage of annual base salary by reference to individual job scope, complexity and responsibilities, and by individual

performance and contribution, as well as corporate performance.

The joint leadership resources committee recommended the corporate performance objectives for 2004, which were approved by the boards

of directors of the Company and Nortel Networks Limited in January 2004. The corporate performance objectives for 2004 were revenue,

earnings, cash flow and leadership (which included customer engagement, technology leadership and market perception). The joint leadership

resources committee also have discretion to consider other business factors in making a final determination of corporate performance for 2004.

In June 2004, management recommended, and the joint leadership resources committee and the boards of directors of the Company and Nortel

Networks Limited subsequently approved, that financial accountability be included as a key quantitative factor in the individual leadership

performance objectives for determination of incentive cash awards under the SUCCESS Plan. The financial accountability objective includes,

among other things: (i) compliance with financial reporting obligations under United States and Canadian securities laws and the requirements

of the Sarbanes-Oxley Act of 2002; (ii) an assessment of training with respect to financial reporting responsibilities and understanding of

general accepted accounting principles across Nortel Networks; and (iii) progress on the implementation of process and system improvements

related to accounting and management information systems across Nortel Networks. As of the date of this report, no annual cash bonus awards

have been made with respect to the fiscal year ended December 31, 2004.

Voluntary undertaking: Return to Profitability bonus program and 2003 restricted stock

unit program

In a letter, dated January 10, 2005 to Mr. Lynton (Red) Wilson, the Chairman of the board of directors of the Company, the members of the

core executive leadership team of Nortel Networks (each, a “Member”) affirmed their voluntary, unilateral and unconditional undertaking to (i)

pay to the Company over a three year period an amount equal to the entire Return to Profitability (“RTP”) bonus paid to each such Member in

2003 (net of any taxes deducted at the source) regardless of whether the profitability metrics associated with the RTP were met on a restated

basis and (ii) not accept, and accordingly disclaim, any potential award of either the third of fourth tranches of 2003 restricted stock units

(regardless whether applicable financial targets for these bonuses were achieved). The Members indicated in their letter that, while they did not

engage in the improper accounting activities identified by the Independent Review, they share the board of directors’ deep disappointment in

these actions and events and are determined to make clear to Nortel Networks employees, investors and others that such activities are

unacceptable to them.

The following table sets forth the amount of the RTP bonus (the “RTP Amount”) to be paid by each Member:

Option grants in 2004 and 2003

No options were granted to any of the named executive officers for 2004 during the fiscal year ended December 31, 2004 and no options

were granted to any of the named executive officers for 2003 during the fiscal year ended December 31, 2003.

(13) Represents contributions under the Nortel Networks Long-Term Investment Plan or Nortel Networks (UK) Pension Plan, as applicable ($7,200 in 2003, $8,467 in 2002

and $6,068 in 2001), and expatriate, permanent transfer and other similar expenses related to Mr. Debon’s global responsibilities as President, Wireless Networks ($85,146

in 2003, $117,408 in 2002 and $325,952 in 2001).

(14) Mr. Debon, Mr. Bolouri, Ms. Spradley and Mr. DeRoma have voluntarily undertaken to pay to the Company over a three year period an amount equal to their Return to

Profitability program bonus awarded in 2003 (net of any taxes deducted at the source). The following additional current members of senior management have similarly

voluntarily agreed to pay their respective Return to Profitability program bonus awards: Messrs. Collins, Donovan, Giamatteo, Joannou, Mao, McFadden, Mumford and

Pusey. See “Voluntary undertaking: Return to Profitability bonus program and 2003 restricted stock unit program”.

(15) Certain payments paid in United Kingdom pounds have been converted and included in this amount. Payments have been converted using the average of the exchange

rates in effect durin

each

ear e

ual to US$1.00 = UK

0.6661 for 2002 and US$1.00 = UK

0.6909 for 2001.

(16) Mr. Debon’s responsibilities during 2001 as President, Wireless Networks were global in nature and his offices and personal residences spanned several geographies. As a

result, transportation services and benefits (automobile benefits, commercial air travel, train and car services) for Mr. Debon totaled $48,010 in 2001.

(17) Represents contributions under the Nortel Networks Long-Term Investment Plan.

(18) In June 2001, the Company commenced a voluntary stock option exchange program whereby eligible employees could exchange certain then outstanding stock options for

new options based on a prescribed formula. In January 2002, new stock options were granted to eligible employees who participated in the stock option exchange

program, with exercise prices at the fair market value of the Company’s common shares on the date of grant. Prior to Ms. Spradley’s appointment as an officer of the

Company, she was an employee eligible to participate in the voluntary stock option exchange program. As a result, 41,999 of the stock options granted toMs.Spradleyin

2002 were

ranted

ursuant to the voluntar

stock o

tion exchan

ram.

(19) All of Ms. Spradley’s options that were granted in 2001 were cancelled in connection with her participation in the voluntary stock option exchange program. See footnote

(18) above.

(20) Amounts paid to reimburse Mr. DeRoma for income taxes payable by him in accordance with his employment agreement. Mr. DeRoma’s employment agreement is

described below under “Certain employment arrangements”.

Member RTP Amount (Net)

Chahram Bolouri Cdn. $891,697

Malcolm Kevin Collins GBP

395,409

Pascal Debon U.S. $1,078,963

Nicholas John DeRom

Cdn. $953,747

William John Donovan U.S. $640,271

John Joseph Giamatteo U.S. $259,875

Dion Constandino Joannou U.S. $328,412

Robert Yu Lang Mao U.S. $627,500

Brian William McFadden Cdn. $899,630

Donald Gregory Mumford Cdn. $921,500

Stephen Charles Pusey GBP

473,173

Susan Louise Spradley U.S. $967,694

Aggregate option exercises in 2004 and 2003 and year-end option values

No options were exercised by any named executive officers for 2004 during the fiscal year ended December 31, 2004 and no options were

exercised by any named executive officers for 2003 during the fiscal year ended December 31, 2003. The following tables set forth: (i) the

value of unexercised options held by named executive officers for 2004 as at December 31, 2004; and (ii) the value of unexercised options held

by named executive officers for 2003 as at December 31, 2003, respectively.

2004

151

Common

Shares Acquired

On Exercise

(#)

Number of Securities

Underlying

Unexercised Options at Fiscal

Year-End (#)(1)(2)(3)(4)

Value of Unexercised

In-the-Money

Options at Fiscal Year-End ($)(4)

Value

Realized ($)

Name Exercisable Unexercisable Exercisable Unexercisable

W.A. Owens – – – – – –

P. Debon – – 1,358,666(5) 243,334 – –

B.W. McFadden – – 1,133666(Cdn) 163,334(Cdn) – –

S.L. Spradley – – 238,665(6) 83,334 – –

N.J. DeRoma – – 1,290,000(Cdn)(5)

80,000

243,334(Cdn) – –

F.A. Dunn* –

–

–(7) – (Cdn)(7)

–(7)

– –

152

* On April 27, 2004, Mr. Dunn’s employment as President and Chief Executive Officer of the Company and Nortel Networks Limited was terminated for cause.

(1) As adjusted to reflect the two-for-one stock split of Nortel Networks Limited’s common shares effective at the close of business on January 7, 1998, the stock dividend of

one common share on each issued and outstanding common share of Nortel Networks Limited effective at the close of business on August 17, 1999, and the two-for-one

stock split of the Company’s common shares effective at the close of business on May 5, 2000, where applicable.

(2) Includes the following number of “replacement options”: 160,000 for Mr. Debon; 80,000 for Mr. McFadden (which will expire in January 2009 and which are unavailable

for exercise pursuant to the terms of the replacement option program); and 160,000 for Mr. DeRoma. Mr. Dunn had also received 120,000 replacement options, which he

subsequently voluntarily returned for immediate cancellation in June 2003. See also footnote (6) below. Replacement options are granted pursuant to the key contributor

stock option program. Under that program, a participant is granted concurrently an equal number of initial options and replacement options. The initial options and the

replacement options expire ten years from the date of grant. The initial options have an exercise price equal to the market value of common shares on the date of grant and

the replacement options have an exercise price equal to the market value of common shares on the date all of the initial options are fully exercised, provided that in no

event will the exercise price be less than the exercise price of the initial options. Replacement options are generally exercisable commencing 36 months after the date all of

the initial options are fully exercised, provided that the participant beneficially owns a number of common shares at least equal to the number of common shares subject to

the initial o

tionslessan

common shares sold to

for o

tions costs, a

licable taxes, and brokera

e costs associated with the exercise of the initial o

tions.

(3) As the Company grants both United States dollar and Canadian dollar stock options, the options are listed separately for each currency, where applicable. Unless otherwise

stated, all options are United States dollar options.

(4) As at December 31, 2004, none of the outstanding exercisable or unexercisable United States dollar or Canadian dollar stock options held by the named executive officers

had an exercise price that exceeded the closing price of the Company’s common shares on the last trading day of the year on, respectively, the New York Stock Exchange

for United States stock options and on the Toronto Stock Exchange for Canadian stock options. On December 31, 2004, the closing price of the Company’s common shares

on the New York Stock Exchange and the Toronto Stock Exchange was $3.47 and Cdn$4.16, respectively. The weighted average exercise price of the outstanding

exercisable and unexercisable United States dollar and Canadian dollar stock options as at December 31, 2004 was: $14.51 for options held by Mr. Debon; $6.30 for

options held by Ms. Spradley; Cdn$24.32 for options held by Mr. McFadden; and Cdn$25.18 for Mr. DeRoma’s Canadian dollar stock options and $11.29 for his United

States dollar stock options. Where applicable, weighted average price has been calculated assuming that replacement options that currently do not have set exercise prices

will have exercise

rices e

ual to the exercise

rices of the corres

ondin

initial o

tions. See footnote (2) above.

(5) The remaining two thirds of the performance accelerated stock options previously granted to Messrs. Debon, McFadden and DeRoma vested and became exercisable in

January 2004, the other one third having vested and became exercisable in December 2003.

(6) Prior to Ms. Spradley’s appointment as an officer of the Company, she was an employee eligible to participate in the voluntary stock option exchange program. As a result,

2003

153

41,999 of the stock options granted to Ms. Spradley in 2002 were granted pursuant to the voluntary stock option exchange program. All of those options were

exercisable as of December 31, 2004.

(7) As a result of the termination of Mr. Dunn’s employment for cause on April 27, 2004, all United States dollar and Canadian dollar options held by Mr. Dunn terminated

and expired automatically on April 27, 2004, including all performance accelerated stock options.

Number of Securities

Underlying

Unexercised Options at Fiscal

Year-End (#)(1)(2)(3)(4)

Common

Shares Acquired

On Exercise

(#)

Value of Unexercised

In-the-Money

Options at Fiscal Year-End ($)(4)

Value

Realized ($)

Name Exercisable Unexercisable Exercisable Unexercisable

F.A. Dunn –

–

750,000(Cdn) (5)(6) 1,500,000(Cdn)(5)

–(7)

– –

P. Debon – – 891,999 (6) 710,001 – –

S.L. Spradley – – 148,665 (8) 173,334(8) – –

C. Bolouri – – 931,332(Cdn) (6) 686,668(Cdn) – –

N.J. DeRoma – – 663,333(Cdn)

80,000

(6) 870,001(Cdn) – –

(1) As adjusted to reflect the two-for-one stock split of Nortel Networks Limited’s common shares effective at the close of business on January 7, 1998, the stock dividend of

one common share on each issued and outstanding common share of Nortel Networks Limited effective at the close of business on August 17, 1999, and the two-for-one

stock split of the Company’s common shares effective at the close of business on May 5, 2000, where applicable.

(2) Includes the following number of previously granted “replacement options”: 160,000 for Mr. Debon; 120,000 for Mr. Bolouri; and 160,000 for Mr. DeRoma. Mr. Dunn

had also been granted 120,000 replacement options, which he subsequently voluntarily returned for immediate cancellation in June 2003. See also footnotes (5) and

(7) below. Replacement options are granted pursuant to the Company’s key contributor stock option program. Under that program, a participant is granted concurrently an

equal number of initial options and replacement options. The initial options and the replacement options expire ten years from the date of grant. The initial options have an

exercise price equal to the market value of common shares of the Company on the date of grant and the replacement options have an exercise price equal to the market

value of common shares on the date all of the initial options are fully exercised, provided that in no event will the exercise price be less than the exercise price of the initial

options. Replacement options are generally exercisable commencing 36 months after the date all of the initial options are fully exercised, provided that the participant

beneficially owns a number of common shares at least equal to the number of common shares subject to the initial options less any common shares sold to pay for options

costs, applicable taxes, and brokerage costs associated with the exercise of the initial options.

(3) As the Company grants both United States dollar and Canadian dollar stock options, the options are listed separately for each currency, where applicable. Unless otherwise

stated, all options are United States dollar options.

(4) As at December 31, 2003, all of the outstanding exercisable or unexercisable United States dollar or Canadian dollar stock options held by the named executive officers

had an exercise price that exceeded the closing price of the Company’s common shares on the last trading day of the year on, respectively, the New York Stock Exchange

for United States stock options and on the Toronto Stock Exchange for Canadian stock options. On December 31, 2003, the closing price of the Company’s common shares

on the New York Stock Exchange and the Toronto Stock Exchange was $4.23 and Cdn$5.49, respectively. The weighted average exercise price of the outstanding

exercisable and unexercisable United States dollar and Canadian dollar stock options as at December 31, 2003 was: Cdn$8.95 for options held by Mr. Dunn; $14.51 for

options held by Mr. Debon; $6.30 for options held by Ms. Spradley; Cdn$37.06 for options held by Mr. Bolouri; and Cdn$25.18 for Mr. DeRoma’s Canadian dollar stock

options and $11.29 for his United States dollar stock options. Where applicable, weighted average price has been calculated assuming that replacement options that

currently do not have set exercise prices will have exercise prices equal to the exercise prices of the corresponding initial options. See footnote (2) above.

Long-term incentive plans — awards in last two fiscal years

No long-term incentives were granted under any long-term incentive plan to any of the named executive officers for 2004 during the fiscal

year ended December 31, 2004.

The following table sets forth certain information concerning the allocation of restricted stock units to the named executive officers for 2003

under the Nortel Networks Limited Restricted Stock Unit Plan (or RSU Plan) during the fiscal year ended December 31, 2003.

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(5) As a result of the termination of Mr. Dunn’s employment for cause on April 27, 2004, all options held by Mr. Dunn terminated and expired automaticallyonApril27,

2004, including all performance accelerated stock options. Previously, in June 2003, Mr. Dunn voluntarily returned for immediate cancellation 934,668 previously granted

Canadian dollar stock options, comprised of 851,334 exercisable plus 83,334 unexercisable options as well as 120,000 exercisable replacement options referenced in

footnote (2) above. See also footnote (7) below.

(6) One third of the performance accelerated stock options previously granted to Messrs. Dunn, Debon, Bolouri and DeRoma in 2001 vested and became exercisable in

December 2003. Other than Mr. Dunn, who did not have any additional performance accelerated stock options accelerated, the remaining two thirds of the performance

accelerated stock options held by Messrs. Debon, Bolouri and DeRoma vested and became exercisable in January 2004.

(7) In June 2003, Mr. Dunn voluntarily turned in for immediate cancellation 200,000 unexercisable United States dollar stock options originally granted in July 1999.

(8) Prior to Ms. Spradley’s appointment as an officer of the Company, she was an employee eligible to participate in the voluntary stock option exchange program. As a result,

41,999 of the stock options granted to Ms. Spradley in 2002 were granted pursuant to the voluntary stock option exchange program. Of those options, 35,332 were

exercisable as of December 31, 2003.

PerformanceorOther

Period Until

Maturation or Payout

(2)

Estimated Future Payouts Under Non-Share

Price Based Plans

Number of Shares,

Units or Other Rights

(#)(1)(2)

Name Threshold(#) Target(#) Maximum(#)

(2)

F.A. Dunn 2,980,000(3) 2003 to 2005 0 0 2,980,000(3)

P. Debon 1,490,000 2003 to 2005 0 0 1,490,000

S.L. Spradley 1,150,000 2003 to 2005 0 0 1,150,000

C. Bolouri 1,070,000 2003 to 2005 0 0 1,070,000

N.J. DeRoma 1,070,000 2003 to 2005 0 0 1,070,000

(1) When issued and settled, a restricted stock unit entitles the holder to receive one common share of the Company or, in the discretion of the joint leadership resources

committee or at the election of the holder in certain circumstances, cash in lieu thereof.

(2) The 2003 program has a three-year performance period ending December 31, 2005. The three-year performance period includes four performance thresholds that may be

achieved at any time during the performance period. The performance criteria for each of the four thresholds are distinct “Return on Sales before Tax” (or ROSBT)

percentage targets, calculated on a rolling four-quarter basis. The joint leadership resources committee assesses the Company’s performance on a quarterly basis against

each of these thresholds and further considers the Company’s performance as compared to its competitors and certain business, financial, competitive, political and other

relevant criteria in determining, in the committee’s discretion, whether any or a portion of the allocated restricted stock units will be issued and settled to participants. In

respect of 2003, the committee exercised its discretion to authorize the issuance of restricted stock units to the named executive officers based, among other things, on the

achievement of two performance thresholds. On January 10, 2005, the joint leadership resources committee exercised the discretion reserved to it with respect to the 2003

program of the RSU Plan and determined, and the boards of directors of the Company and Nortel Networks Limited confirmed and approved, that no additional restricted

stock units will be issued with respect to the 2003 program (including in connection with the achievement of the third and fourth ROSBT performance targets or otherwise)

and that all unissued restricted stock units under the 2003 program are immediately terminated and cancelled in their entirety. Information regarding restricted stock units

issued and settled under the 2003 program of the RSU Plan is disclosed in the “Summary Compensation Table — 2003” above under “Long Term Compensation —

Payouts”. On April 27, 2004, the Company and Nortel Networks Limited terminated for cause the employment of each of their then chief financial officer and controller.

Retirement plans

The Company has several pension plans. The following descriptions relate to pension plans to which the named executive officers for 2004

and the named executive officers for 2003 are eligible to participate.

The non-contributory defined benefit pension plans (or base plans) in Canada and in the United States are generally available to employees

and executives who were participants prior to May 1, 2000. There is also the Nortel Networks Supplementary Executive Retirement Plan

which is available to eligible executives. The benefit calculated under the Supplementary Executive Retirement Plan is reduced by the pension

benefits payable under the registered/qualified defined benefit pension plans and the non-qualified/excess plans. Effective January 1, 2000, the

Supplementary Executive Retirement Plan was closed to new participants.

Defined Benefit Pension Plan —Canada

A defined benefit pension plan, the Nortel Networks Limited Managerial and Non-Negotiated Pension Plan, is maintained for eligible

employees and executives in Canada. This plan has two different formulas, called Part I and Part II.

The Part I formula provides a monthly benefit at retirement based on years of service and a pension accrual of 1.3 percent of the average

annual earnings of the best three consecutive years. An early retirement reduction applies for retirement prior to age 60. Eligible earnings

include base salary and, where applicable, overtime, off-shift differentials and an individual sales commission factor. Effective January 1,

1999, the Part I defined benefit formula was closed to new participants.

The Part II formula was introduced January 1, 1999. Employees who were participants in Part I could continue to participate in Part I, or

move to the new Part II formula, at their election. Part II provides a benefit based on pension credits and the average annual earnings for the

highest three consecutive years in the last ten years prior to retirement or other termination of employment. Pension credits are earned during

each year of participation based on the participant’s age attained in the year and on years of service. Eligible earnings include base salary and,

where applicable, incentive awards or bonuses, if any, paid under the Nortel Networks Limited SUCCESS Incentive Plan (or SUCCESS Plan),

overtime, off-shift differentials and sales commissions. Effective May 1, 2000, the Part II defined benefit formula was closed to new

participants.

The Part II benefit can be paid in a lump sum or as an actuarially equivalent annuity. Under the annual income option, there are reductions

for retirement prior to normal retirement age of 65. Certain grandfathering rules exist for employees and executives who were participating in

the pension plan as at December 31, 1998.

The Income Tax Act (Canada) (or ITA) limits the amount of pension that may be paid under a registered pension plan. Pension benefits

within the ITA limit are funded by a pension trust that is separate from the general assets of Nortel Networks Limited. Pension benefits that

exceed the ITA limits are paid from an excess plan, and are funded from Nortel Networks Limited’s general assets and the general assets of

Nortel Networks Technology Corporation (or NNTC), an affiliate of the Company.

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The Company and Nortel Networks Limited have demanded repayment from the chief financial officer and controller of the restricted stock units issued and settled in

July 2003 with respect to the achievement of the first performance threshold and, with respect to the controller, the restricted stock units issued and settled in January 2004

with respect to the achievement of the second performance threshold. All restricted stock units allocated to the chief financial officer and the controller that were not issued

have been forfeited. See footnote (3) regarding restricted stock units allocated to the president and chief executive officer.

(3) As a result of the termination of Mr. Dunn’s employment for cause on April 27, 2004, Mr. Dunn’s allocated but unissued restricted stock units were automatically

forfeited. With respect to the restricted stock units issued to him and settled in July 2003 with respect to the achievement of the first performance threshold, the Company

and Nortel Networks Limited have demanded repayment as noted in the “Summary Compensation Table” above.

Defined Benefit Pension Plan —United States

A defined benefit pension plan, the Nortel Networks Retirement Income Plan, is maintained for eligible employees and executives in the

United States. Benefits are paid to plan participants under one of two formulas, depending on elections made by the plan participant: the

Pension Service Plan (or PSP) formula or the Cash Balance Plan formula.

The PSP formula is available for participants who are employees of Nortel Networks Inc. (or NNI) or other Nortel Networks subsidiaries

located in the United States who enrolled in the plan prior to May 1, 2000, and who elected prior to May 1, 2000 to be covered by the PSP

formula. As of May 1, 2000, the PSP formula under the Nortel Networks Retirement Income Plan was closed to new participants. The PSP

formula provides a benefit based on pension credits and average earnings for the highest 1,095 consecutive calendar days of compensation out

of the last 3,650 days prior to retirement or other termination of employment. Pension credits are earned during each year of participation based

on the participant’s age attained in the year and on years of service. Eligible earnings include base salary and, where applicable, incentive

awards or bonuses, if any, paid under the SUCCESS Plan, overtime, off-shift differentials and sales commissions.

A new defined benefit pension formula, the Cash Balance Plan, was established, effective May 1, 2000, based on pay credits and interest

credits. Employees who were participants in the PSP could continue to participate in the PSP, or move to the new Cash Balance Plan, or elect

to opt out of the pension plan. The Cash Balance Plan formula provides a monthly credit equal to 4% of eligible earnings, with interest being

credited monthly based on the month’s starting balance. Eligible earnings include base salary and, where applicable, incentive awards or

bonuses, if any, paid under the SUCCESS Plan, overtime, off-shift differentials and sales commissions earned prior to retirement or other

termination of employment.

The PSP and Cash Balance Plan benefits can be paid in a lump sum or as an actuarially equivalent annuity.

Certain grandfathering rules exist for employees and executives who were participating in the pension plan as at December 31, 1998.

Federal laws place limitations on compensation amounts that may be included under a qualified pension plan ($205,000 in 2004) as well as

limitations on the total benefit that may be paid from such plans. Pension benefits within the limit are funded by a pension trust that is separate

from the general assets of NNI. Pension benefits applicable to compensation that exceeds federal limitations and pension benefits in excess of

the limitations on total benefits are paid from a restoration (excess) plan, and are funded from NNI’s general assets.

Supplementary Executive Retirement Plan

Eligible executives in Canada and the United States also participate in the Supplementary Executive Retirement Plan (or SERP). Effective

January 1, 2000, the SERP was closed to new participants and there are only 19 executives who remain eligible to participate in the SERP.

For Canadian executives participating in the SERP as at December 31, 1998 who elected, effective January 1, 1999, to remain in Part I of

the pension plan, the SERP formula provides a benefit based on years of service and a pension accrual of 1.3 percent of the final average

earnings of the best three consecutive years. An early retirement reduction of seven percent a year prior to age 60 applies in the case of

retirement prior to this age. The maximum total annual retirement benefit cannot exceed 60 percent of an executive’s final average earnings at

retirement. Eligible earnings include base salary plus the incentive award or bonus, if any, paid under the SUCCESS Plan, and commissions,

however a bonus or commissions will not be included in a given year to the extent that it exceeds 60 percent of a participant’s base salary for

that calendar year.

New SERP plan provisions, which became effective January 1, 1999 and are applicable to Part II members participating in the Canadian

plan and to US PSP formula members, provide a benefit based on pension credits and final average earnings for the highest three consecutive

years in the last ten years prior to retirement, to a maximum benefit of 550 percent of final average earnings. Pension credits are earned during

each year of participation based on the participant’s age attained in the year and on years of service. Eligible earnings include base salary plus

the incentive award or bonus, if any, paid under the SUCCESS Plan, and commissions, however a bonus or commissions will not be included

in a given year to the extent that it exceeds 60 percent of a participant’s base salary for that calendar year.

All participating executives at December 31, 1998 have their benefits protected under the pre-1999 grandfathered SERP formula.

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Pension benefits from the SERP are funded from the general assets of, respectively, Nortel Networks Limited and NNTC in Canada and

Nortel Networks Inc. in the United States.

The following tables show the aggregate approximate annual retirement benefits for an eligible executive officer for certain compensation

and years of service categories assuming retirement at age 65, and assuming grandfathering provisions do not apply.

Table I estimates the total retirement benefit (including the SERP) for all participating United States executives (PSP formula members),

and for participating Canadian executives who elected and continue to participate in Part II of the Nortel Networks Limited Managerial and

Non-Negotiated Pension Plan. It estimates the benefit payable as a life annuity with a 60 percent survivor pension.

The approximate benefits for the service of Messrs. Debon, McFadden and DeRoma (named executive officers in 2004) and Mr. Bolouri (a

named executive officer in 2003, along with Messrs. Debon and DeRoma) are shown in Table I. The approximate total eligible earnings and

years of credited pensionable service at December 31, 2004 was: $808,525 and 4.92 years of United States service for Mr. Debon; $708,816

and 27.50 years of Canadian service for Mr. McFadden; and $823,931 and 5.58 years of Canadian pensionable service for Mr. DeRoma.

Mr. DeRoma is also eligible to receive additional credited pensionable service, up to a maximum of 8.125 years, under the terms of his

employment agreement. See “Certain Employment Arrangements”. The approximate total eligible earnings and years of credited pensionable

service for Mr. Bolouri at December 31, 2003 was $696,984 and 22 years of Canadian service.

Table I

Table II estimates the benefits calculated under the United States Cash Balance Plan formula under the Nortel Networks Retirement Income

Plan for participating employees and executives, payable as a straight life annuity.

The approximate benefits for Mr. Owens and Ms. Spradley’s service are shown in Table II. The approximate total eligible earnings and

years of credited service at December 31, 2004 for Mr. Owens was $680,328 and .75 years of United States service and $1,139,325 and

16.67 years of United States service for Ms. Spradley. As Mr. Owens and Ms. Spradley are in the Cash Balance Plan, eligible earnings for

2004 reflect 2004 base salary and for Ms. Spradley it also included the one-time award paid during 2004 under the SUCCESS Plan. Mr. Owens

is also eligible for a Special Pension Arrangement. See “Certain Employment Arrangements”.

157

Years of Service

Total Earnings 15 20 25 30 35

$600,000 $138,578 $169,034 $207,612 $235,023 $273,602

700,000 161,674 197,206 242,215 274,194 319,202

800,000 184,770 225,379 276,817 313,365 364,802

900,000 207,866 253,551 311,419 352,535 410,403

1,000,000 230,963 281,724 346,021 391,706 456,003

1,100,000 254,059 309,896 380,623 430,876 501,603

1,200,000 277,155 338,068 415,225 470,047 547,203

1,300,000 300,251 366,241 449,827 509,217 592,804

1,400,000 323,348 394,413 484,429 548,388 638,404

1,500,000 346,444 422,585 519,031 587,558 684,004

1,600,000 369,540 450,758 553,633 626,729 729,605

1,700,000 392,636 478,930 588,235 665,900 775,205

1,800,000 415,733 507,102 622,837 705,070 820,805

1,900,000 438,829 535,275 657,439 744,241 866,406

2,000,000 461,925 563,447 692,042 783,411 912,006

Table II

On April 27, 2004, the Company and Nortel Networks Limited terminated for cause the employment of each of their then president and

chief executive officer, chief financial officer and controller. On August 19, 2004, the Company announced that seven individuals with, or who

had, significant responsibilities for financial reporting at the line of business and regional levels were terminated for cause and that Nortel

Networks will demand repayment of payments made under bonus plans in respect of 2003. As a result, where applicable and permitted under

applicable law, the pension benefits for the terminated executives were recalculated to include base salary only in 2003.

As a result of the termination of Mr. Dunn’s employment for cause on April 27, 2004, he was no longer eligible for any SERP benefit that

would have otherwise applied as a result of his past election to remain in Part I of the pension plan. Upon the termination of his employment

for cause, Mr. Dunn received Cdn$2,416,517.18 representing the commuted value of the pension benefits accrued pursuant to the Nortel

Networks Limited Managerial and Non-Negotiated Pension Plan. The payment was calculated based on Mr. Dunn’s 27.92 years of service in

accordance with the Part I formula described under “Defined Benefit Pension Plan — Canada”.

Certain employment arrangements

On August 31, 2004, the Company and Nortel Networks Limited entered into an employment agreement with William A. Owens

confirming Mr. Owens’ appointment as President and Chief Executive Officer of the Company and Nortel Networks Limited as of April 27,

2004. The agreement provides that Mr. Owens will receive a base salary of $1,000,000 and will be eligible for a targeted annual bonus of

170% of base salary under the Nortel Networks Limited SUCCESS Incentive Plan. Under the agreement, Mr. Owens will receive a special

pension benefit that will accrue ratably over the first five years of his employment as President and Chief Executive Officer. Assuming

retirement at the end of such five years, Mr. Owens will receive an estimated monthly pension benefit of $33,540, payable over the five year

period following his retirement.

Mr. Owens is based at the registrant’s offices in Ontario, Canada. In connection with his relocation to Ontario, Mr. Owens will be eligible

for certain benefits under the Nortel Networks-International Assignment Relocation program, in accordance with the generally applicable terms

of such program and consistent with his senior executive position.

Mr. DeRoma entered into an employment agreement in April 1997, prior to commencing employment as Vice-President and Deputy

General Counsel. Pursuant to the agreement, the Company agreed to make a gross-up payment to Mr. DeRoma for calendar years 1997 through

2000. The gross-up payment was intended to place Mr. DeRoma in the same after-tax position with respect to his base salary and any annual

incentive award as if he were a resident of the State of Connecticut and a taxpayer in the United States. After June 2000, this gross-up was

subject to annual review by the joint

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Years of Service

Total Earnings 510 15 20 25 30 35

$600,000 $10,330 $20,659 $30,989 $41,318 $51,648 $61,978 $72,308

700,000 12,051 24,102 36,153 48,204 60,256 72,307 84,359

800,000 13,773 27,546 41,318 55,091 68,864 82,637 96,411

900,000 15,494 30,989 46,483 61,977 77,472 92,967 108,462

1,000,000 17,216 34,432 51,648 68,863 86,080 103,296 120,513

1,100,000 18,938 37,875 56,813 75,750 94,688 113,626 132,565

1,200,000 20,659 41,318 61,977 82,636 103,296 123,956 144,616

1,300,000 22,381 44,762 67,142 89,522 111,904 134,285 156,667

1,400,000 24,103 48,205 72,307 96,409 120,512 144,615 168,719

1,500,000 25,824 51,648 77,472 103,295 129,120 154,945 180,770

1,600,000 27,546 55,091 82,636 110,181 137,728 165,274 192,821

1,700,000 29,267 58,534 87,801 117,068 146,336 175,604 204,873

1,800,000 30,989 61,978 92,966 123,954 154,944 185,933 216,924

1,900,000 32,711 65,421 98,131 130,840 163,552 196,263 228,975

2,000,000 34,432 68,864 103,296 137,727 172,160 206,593 241,027

leadership resources committee of the boards of directors of the Company and Nortel Networks Limited, and was not renewed subsequent to

March 2002. Under the terms of the agreement, Mr. DeRoma is also eligible for the Nortel Networks Limited Special Pension Credit Program

which covered new executive hires older than age 35. Mr. DeRoma will be credited, for pension purposes, with additional years and months

equal to one half of the years between the age of 35 and Mr. DeRoma’s age at the time of hire, if he retires after the age of 60, to a maximum of

8.125 years.

Other than Mr. Dunn, each of the named executive officers and certain other executive officers of the Company, including the current

President and Chief Executive Officer, currently participate in the Nortel Networks Corporation Executive Retention and Termination Plan (or

ERTP). The ERTP provides that if a participant’s employment is terminated without cause within a period commencing 30 days prior to the

date of a change in control of the Company and ending 24 months after the date of a change in control of the Company, or the participant

resigns for good reason (including, among other things, a reduction in overall compensation, geographic relocation or reduction in

responsibility, in each case without the consent of the participant) within 24 months following the date of a change in control of the Company,

the participant will be entitled to certain payments and benefits, including (i) the payment of an amount equal to three times (in the case of the

chief executive officer) and two times (in the case of the other named executive officers) of the participant’s annual base salary; (ii) the

payment of an amount equal to 300 percent (in the case of the chief executive officer) and 200 percent (in the case of the other named

executive officers) of the participant’s target annual incentive bonus; (iii) accelerated vesting of all or substantially all stock options; and

(iv) the “pay-out” at target of any restricted stock units under the Nortel Networks Limited Restricted Stock Unit Plan.

For purposes of the ERTP, a change in control is deemed to occur if:

Until June 30, 2003, each of the named executive officers (other than Mr. Dunn) and certain other executive officers of the Company were

eligible to participate in the Nortel Networks Corporation Special Retention Plan (or SRP). The SRP provided that if a participant’s

employment was terminated by the participant for good reason or by the Company without cause during the period from November 1, 2001 to

June 30, 2003, that participant would have been entitled to certain payments and benefits. Other than payments made in accordance with the

SRP in March 2003 in connection with a former executive officer’s previously announced termination of employment, no amounts were paid

or became payable in 2003 to any executive officer prior to June 30, 2003.

159

(i) any party or group acquires beneficial ownership of securities of the Company representing more than 20 percent of the outstanding

securities entitled to vote in the election of directors of the Company;

(ii) the Company participates in a business combination, including, among other things, a merger, amalgamation, reorganization, sale

of all or substantially all of its assets, or plan of arrangement, unless the business combination only involves the Company and/or its

affiliates or, following the completion of the business combination, the Company’s common shareholders beneficially own, directly

or indirectly, more than 50 percent of the then-outstanding voting shares of the entity resulting from the business combination (or of

an entity which ultimately controls such entity) and a majority of the members of the board of directors of the entity resulting from

the business combination (or the entity ultimately controlling such entity) were members of the board of directors of the Company

when the business combination was approved or the initial agreement in connection with the business combination was executed;

(iii) the persons who were directors of the Company on the effective date of the ERTP cease (for reasons other than death or disability)

to constitute at least a majority of the Company’s board of directors; provided, that any person who was not a director on the

effective date of the ERTP shall be deemed to be an incumbent director if such person was elected or appointed to the Company’s

board of directors by, or on the recommendation of or with the approval of, at least two-thirds of the directors who then qualify as

incumbent directors unless such election, appointment, recommendation or approval was the result of any actual or publicly

threatened proxy contest for the election of directors; or

(iv) any other event occurs which the Company’s board of directors determines in good faith could reasonably be expected to give rise

to a change in control.

Compensation of directors

Effective January 1, 2002, each non-employee director of the Company and Nortel Networks Limited elected to receive all compensation

for services rendered as a member of the board of directors of the Company and Nortel Networks Limited, any committees thereof, and as

board or committee chairperson, in the form of share units, instead of cash, under the Directors’ Deferred Share Compensation Plans

maintained by the Company and Nortel Networks Limited. The share units are settled a specified number of trading days following the release

of the Company’s financial results after the director ceases to be a member of the applicable board, and each share unit entitles the holder to

receive one common share of the Company. Effective January 1, 2004, each non-employee director of the Company and Nortel Networks

Limited was entitled to elect to receive fees in cash, in share units under the Directors’ Deferred Share Compensation Plans or in a combination

of cash and share units.

The compensation of directors is considered on a combined basis in light of the overall governance structure of the Company and Nortel

Networks Limited. Director compensation is set solely on an annual fee basis (paid quarterly in arrears) and fees are not paid for board or

committee meeting attendance. From January 1, 2002 to December 31, 2003, directors of the Company and Nortel Networks Limited, who

were not salaried employees of the Company or any of its subsidiaries, received an annual Nortel Networks Limited board retainer of $50,000,

an annual committee membership retainer of $12,500 (or $6,250 each for membership on the same committee of the boards of the Company

and Nortel Networks Limited) and, except as noted below, an annual committee chairperson fee of $7,500 (or $3,750 each for chairing the

same committee of the boards of the Company and Nortel Networks Limited). Effective July 25, 2002, the fee for the audit committee

chairperson was increased to $17,500 (or $8,750 for each audit committee of the Company and Nortel Networks Limited) in recognition of the

significant responsibilities assumed by the audit committee chairperson.

Annual directors’ fees were initially increased effective January 1, 2004, after having been essentially unchanged for the previous two year

period, as described above. However, in light of the challenges subsequently faced by the Company and Nortel Networks Limited, the boards

of directors in July 2004 decreased the annual directors’ fees back to the fees in effect prior to January 1, 2004. The boards of directors also

determined that the directors’ fees to be paid during the remainder of 2004 would be reduced so that the total amount of the directors’ fees paid

for 2004 would equal the amount of fees that would have been paid under the 2003 directors’ fee schedule. Accordingly, the net effect of these

determinations was that the directors’ fees paid to non-employee directors remain essentially unchanged since January 1, 2002.

Between January 1, 2004 to June 30, 2004, directors of the Company and Nortel Networks Limited, who were not salaried employees of the

Company or any of its subsidiaries, received an annual Nortel Networks Limited board retainer of $60,000 and an annual committee

membership retainer and, except as described below, an annual committee chairperson retainer of $12,500 (or $6,250 each for membership on

or chairing the same committee of the boards of the Company and Nortel Networks Limited). The fee for the audit committee chairperson was

$27,500 or $13,750 for each audit committee, in recognition of the significant responsibilities assumed by the audit committee chairperson.

The Company maintains, at its cost, life insurance for directors, who are not salaried employees of the Company and Nortel Networks

Limited. Such insurance is in an amount of Cdn$100,000 while a director and in an amount of Cdn$75,000 following retirement at or after age

65 or, at any lesser age after ten years of board membership (including Nortel Networks Limited board membership).

Directors entitled to the above remuneration are also reimbursed for reasonable travel and living expenses properly incurred by them in

attending any meetings of the boards of directors of the Company and Nortel Networks Limited or their committees or for performing services

as directors.

Effective January 1, 2004, amended share ownership guidelines adopted by the boards of directors of the Company and Nortel Networks

Limited require each non-chairman director to own, directly or indirectly, common shares of the Company having a fair market value of at

least $300,000 within five years from the earlier of the date he or she was first elected or appointed to the boards of directors of the Company

or Nortel Networks Limited. Share ownership guideline compliance must thereafter be maintained during an individual’s tenure as a director.

The chairman of the board must own, directly or indirectly, common shares of the Company having a fair market value of at least $1,600,000

within five years from the earlier of the date he or she was first appointed as chairman of the boards of directors of the Company or Nortel

Networks Limited. A newly elected director is required to elect to receive at least 50 percent of his or her annual compensation for serving as a

director of the Company and Nortel Networks Limited or, in the case of a newly appointed chairman of the board of directors, at least

50 percent of his or her annual compensation for serving as a director and as

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chairman of the board of directors of the Company and Nortel Networks Limited, in the form of share units until such time as the share

ownership guidelines are met. Share units credited under the Directors’ Deferred Share Compensation Plans are included in the calculation of

the number of common shares of the Company owned by a director for this purpose. Messrs. Bischoff and Manley have been prevented under

applicable securities laws from participating in the Directors Deferred Share Compensation Plans due to the delay in the filing of the restated

financial statements and related periodic reports of the Company and Nortel Networks Limited.

Retirement benefits are not paid to non-employee directors of the Company or to non-employee directors of Nortel Networks Limited

elected after January 1, 1996. Non-employee directors of Nortel Networks Limited elected prior to January 1, 1996 are entitled to receive

retirement benefits equal to 75 percent of the greater of $27,500 and the annual retainer paid to each director at retirement, indexed to reflect

approximately half of the increase in directors’ retainers after retirement. The benefits are payable for a maximum of ten years.

From his appointment in April 2001 to December 31, 2003, Mr. Wilson’s additional compensation for serving as non-executive chairman of

the board of directors of the Company and Nortel Networks Limited from each of the Company and Nortel Networks Limited was $45,000 per

fiscal quarter. As with the directors’ annual fees, Mr. Wilson’s additional compensation for serving as non-executive chairman of the board of

the Company and of Nortel Networks Limited was initially increased to $50,000 per fiscal quarter from each of the Company and Nortel

Networks Limited for the period from January 1, 2004 to June 30, 2004. Effective July 1, 2004, his additional compensation for serving as non-

executive chairman of the board of directors of the Company and of Nortel Networks Limited was reduced back to the $45,000 per fiscal

quarter that was being paid prior to January 1, 2004 by each of the Company and Nortel Networks Limited. The boards of directors also

determined that the amount of additional compensation for serving as non-executive chairman paid to Mr. Wilson from July 1, 2004 to

December 31, 2004 would be reduced so that the total amount of additional compensation to be paid to Mr. Wilson in 2004 for serving as non-

executive Chairman would equal his pre-2004 compensation. The net effect of these determinations was that the additional fees paid to

Mr. Wilson for serving as non-executive Chairman remain unchanged since his original appointment.

Compensation committee interlocks and insider participation

The joint leadership resources committee of the boards of directors of the Company and Nortel Networks Limited is comprised of members

from the boards of directors of the Company and Nortel Networks Limited. The members of the joint committee are Messrs. R.E. Brown

(chairman), S.H. Smith, Jr., and L.R. Wilson. Mr. Owens served as a member of the joint committee until April 27, 2004, but resigned from the

committee prior to being appointed President and Chief Executive Officer of the Company and Nortel Networks Limited. No other changes to

the membership of the joint committee have occurred during 2004 or 2003. No member of the joint committee was an officer (within the

meaning of applicable United States securities rules) or employee of the Company or any of its subsidiaries at any time during 2004 or 2003.

No executive officer of the Company serves on the board of directors or compensation committee of any other entity that has or has had one

or more of its executive officers serving as a member of the Company’s board of directors.

Security ownership of certain beneficial owners

We are not aware of any person who, as of December 31, 2004, beneficially owned or exercised control or direction over more than five

percent of the Company’s common shares.

Security ownership of directors and management

The following table shows the number of common shares of the Company and Bookham Technology plc beneficially owned, as of

January 7, 2005 (unless otherwise noted), by each of the Company’s directors, nominees for directors and the individuals named in the 2004

and 2003 summary compensation tables set forth above under “Executive Compensation”, as well as by the directors and executive officers as

a group, with the exception that common shares held under Canadian and U.S. investment plans and common shares subject to stock options

are as of December 31, 2004. Bookham Technology plc was an affiliate of the Company as of December 31, 2004.

161

ITEM 12. Securit

Ownershi

of Certain Beneficial Owners and Mana

emen

A person is deemed to be a beneficial owner of a common share if that person has, or shares, the power to direct the vote or investment of

the common share. Under applicable United States securities laws, a person is also deemed to be a beneficial owner of a common share if such

person has the right to acquire the share within 60 days (whether or not, in the case of a stock option, the current market price of the underlying

common share is below the stock option exercise price). More than one person may be deemed a beneficial owner of a common share and a

person need not have an economic interest in a share to be a beneficial owner.

162

Amount and Nature of

Name of Beneficial Owner Title of Class of Security Beneficial Ownership (1)

M. Bischoff* Common shares of the Company

–

J.J. Blanchard Common shares of the Company

Share units

19,392

114,395

(2)

(3)

R.E. Brown Common shares of the Company

Share units

417,281

123,254

(4)

(3)

J.E. Cleghorn Common shares of the Company

Share units

29,000

132,249

(5)

(3)

L.Y. Fortier Common shares of the Company

Share units

22,585

132,889

(6)

(3)

R.A. Ingram Common shares of the Company

Share units

10,756

133,243

(7)

(3)

J.A. MacNaughton** Common shares of the Company

Share units

42,804,520

–

(8)

J. Manle

*Common shares of the Com

–

R.D. McCormick** Common shares of the Company 100,000

W.A. Owens Common shares of the Company

Share units

–

103,917 (3)

H.J. Pearce** Common shares of the Company 10,000

G. Saucier Common shares of the Company

Share units

28,673

129,397

(9)

(3)

S.H. Smith, Jr. Common shares of the Company

Share units

131,192

157,173

(10)

(3)

L.R. Wilson Common shares of the Company

Share units

1,201,871

564,470

(11)

(3)

F.A. Dunn*** Common shares of the Com

793,510 (12)

P. Debon Common shares of the Com

1,958,167 (13)

B.W. McFadden Common shares of the Company 1,718,388 (14)

S.L. Spradley Common shares of the Company 615,255 (15)

C. Bolouri**** Common shares of the Company 1,909,380 (16)

N.J. DeRoma Common shares of the Company 1,919,233 (17)

Directors and executive officers as a group

(consisting of 36 persons, comprised of the current

directors and current executive officers)

Common shares of the Company

Share units

Common shares of Bookham Technology plc

23,396,591

1,590,987

–

(18)

(3)

* Messrs. Bischoff and Manley were each appointed a director of the Company and of Nortel Networks Limited on April 29, 2004 and May 26, 2004, respectively.

Messrs. Bischoff and Manley have been prevented under applicable securities laws from participating in the Directors’ Deferred Share Compensation Plans due to the

delay in the filing of the restated financial statements and related periodic reports of the Company and Nortel Networks Limited and, since May 31, 2004, have been subject

to an Ontario Securities Commission management cease trade order prohibiting trading by directors, officers and certain current and former employees in securities of the

Company until after the filing of the restated financial statements and related periodic reports of the Company and Nortel Networks Limited.

** Nominee for election as a director of the Company and Nortel Networks Limited for the first time.

163

*** Mr. Dunn ceased to be President and Chief Executive Officer of the Company and Nortel Networks Limited on April 27, 2004 and ceased to be a director of the Company

and Nortel Networks Limited on May 21, 2004.

**** A named executive officer in 2003 only.

(1) Except as set forth below, each person has sole investment and voting power with respect to the common shares beneficially owned by such person. Includes common

shares subject to stock options exercisable by December 31, 2004 or that become exercisable within 60 days from December 31, 2004 (whether or not the market price of

the underlying common shares is below the stock option exercise price). As of December 31, 2004, each director and named executive officer individually, and the

directors and executive officers as a group, beneficially owned less than 1.0 percent of the outstanding common shares of the Company.

(2) Includes 8,000 common shares sub

ect to stock o

tions.

(3) Share units issued under the Nortel Networks Corporation Directors’ Deferred Share Compensation Plan and the Nortel Networks Limited Directors’ Deferred Share

Compensation Plan. Each share unit represents the right to receive one common share of the Company. Those plans are described under “Compensation of Directors”.

(4) Includes 8,000 common shares subject to stock options. Excludes 94 common shares beneficially owned by Mr. Brown’s son residing with Mr. Brown and 671 common

shares beneficially owned by Mr. Brown’s spouse. Mr. Brown disclaims beneficial ownership of those excluded shares.

(5) Includes 4,000 common shares subject to stock options.

(6) Includes 8,000 common shares subject to stock options. Excludes 5,000 common shares beneficially owned by Mr. Fortier’s spouse. Mr. Fortier disclaims beneficial

ownershi

of those excluded shares.

(7) Includes 8,000 common shares subject to stock options and 1,800 common shares as to which Mr. Ingram shares investment and voting power with his spouse.

(8) Represents common shares beneficially owned as of December 31, 2004 by the Canada Pension Plan Investment Board of which Mr. MacNaughton is the President and

Chief Executive Officer. He is due to retire from that position on January 14, 2005. Mr. MacNaughton disclaims beneficial ownership of these shares.

(9) Includes 8,000 common shares subject to stock options and 20,673 common shares beneficially owned by a corporation that is wholly-owned by Mrs. Saucier.

(10) Includes 8,000 common shares subject to stock options. Excludes 1,600 common shares beneficially owned by Mr. Smith’s spouse. Mr. Smith disclaims beneficial

ownership of those excluded shares.

(11) Includes 38,000 common shares subject to stock options and 1,157,855 common shares beneficially owned by a corporation that is wholly-owned by Mr. Wilson.

Excludes 2,204 common shares beneficially owned by Mr. Wilson’s spouse. Mr. Wilson disclaims beneficial ownership of those excluded shares.

(12) Includes 5,000 common shares beneficially owned by Mr. Dunn’s son as to which Mr. Dunn shares investment power. Excludes 10,000 common shares beneficially

owned by Mr. Dunn’s spouse and daughter residing with Mr. Dunn. Mr. Dunn disclaims beneficial ownership of those 15,000 included and excluded shares. As Mr. Dunn

was no longer an insider of the Company effective May 21, 2004, the number of common shares reported as part of his holdings is based on information in our corporate

records and Mr. Dunn’s filings on the Canadian insider reporting system, the System for Electronic Disclosure by Insiders, as at May 12, 2004 and reports filed pursuant

to Section 16(a) of the U.S. Securities Exchange Act of 1934.

(13) Includes 1,442,000 common shares subject to stock options.

(14) Includes 1,217,000 common shares subject to stock options.

(15) Includes 321,999 common shares subject to stock options.

(16) Includes 1,498,000 common shares subject to stock options.

Equity compensation plan information

2004

The table below provides information as of December 31, 2004 with respect to common shares of the Company that may be issued under

the following equity compensation plans:

The table does not provide information with respect to equity compensation plans that have expired or are no longer in effect. The Company

and its subsidiaries maintain other equity compensation plans that permit awards to directors, officers and other employees to be paid in

common shares of the Company that are not issued from treasury but are purchased on the open market for immediate delivery to plan

participants. Such plans are not dilutive to shareholders and information with respect to such plans is not required to be included in the table.

2003

The table below provides information as of December 31, 2003 with respect to common shares of the Company that may be issued under

the following equity compensation plans:

164

(17) Includes 1,453,334 common shares subject to stock options and 397,127 common shares as to which Mr. DeRoma shares investment and voting power with his spouse.

(18) Includes 15,124,239 common shares subject to stock options. Also includes 420,920 common shares as to which investment and voting power is sharedwithoneor

more other persons. Excludes 52,854 common shares as to which beneficial ownership is disclaimed.

• Nortel Networks Corporation 2000 Stock Option Plan (the “2000 Stock Option Plan”); and

• Nortel Networks Corporation 1986 Stock Option Plan as amended and restated (the “1986 Stock Option Plan” and, collectively

with the 2000 Stock Option Plan, the “Stock Option Plans”).

Plan category A B C

Number of common

shares to be issued

upon exercise of

outstanding options,

warrants and rights

Weighted average

exercise price of

outstanding

options, warrants

and rights

Number of common shares

remaining available for future

issuance under equity compensation

plans (excluding common shares

reflectedincolumnA)

Equity compensation plans approved by shareholders (1) 278,710,155 $10.87 73,062,123

Equity compensation plans not approved by shareholders (2) – – –

Total (3) 278,710,155 $10.87 73,062,123

(1) Consists of the Stock Option Plans.

(2) None. Except for the plans noted in footnote (3) below, all equity compensation plans involving the issuance of common shares from treasury have received

shareholder approval.

(3) This table does not include information on any options, warrants or rights outstanding under plans that have been assumed by the Company and its subsidiaries in

connection with merger, consolidation or other acquisition transactions (the “Assumed Stock Option Plans”). As of December 31, 2004, 20,278,215 common shares of

the Company were issuable upon the exercise of outstanding options under the Assumed Stock Option Plans. The weighted average exercise price of such outstanding

options is $23.11 per common share. No additional options may be granted under the Assumed Stock Option Plans.

• Nortel Networks Corporation 2000 Stock Option Plan (the “2000 Stock Option Plan”); and

The table does not provide information with respect to equity compensation plans that have expired or are no longer in effect. The Company

and its subsidiaries maintain other equity compensation plans that permit awards to directors, officers and other employees to be paid in

common shares of the Company that are not issued from treasury but are purchased on the open market for immediate delivery to plan

participants. Such plans are not dilutive to shareholders and information with respect to such plans is not required to be included in the table.

ITEM 13. Certain Relationships and Related Transactions

The Company and its subsidiaries paid the law firm of Ogilvy Renault, of which Mr. Fortier is a senior partner and Co-Chairman, fees for

legal services with respect to several matters in 2003 and 2004 and are expected to continue to pay fees for legal services in 2005.

The Company and its subsidiaries paid the law firm of Piper Rudnick LLP, of which Mr. Blanchard is a partner, fees for legal services with

respect to several matters in 2003 and 2004 and are expected to continue to pay fees for legal services in 2005.

The Company and its subsidiaries paid the law firm of McCarthy Tétrault LLP fees for legal services in 2003 and 2004. In May 2004,

Mr. Manley became a senior counsel of the law firm of McCarthy Tétrault LLP, serving as an independent consultant but not a partner.

McCarthy Tétrault LLP represents a former executive of Nortel Networks in connection with matters related to his former association with

Nortel Networks, including certain civil proceedings commenced in 2001, the fees for which are being paid by the Company pursuant to

indemnification provisions of applicable law.

Indebtedness of management

The Company provides relocation assistance to employees who are requested to relocate that is designed to minimize the financial exposure

to employees as a result of the move. In the past, the assistance has included housing loans, advances on real estate equity, and payments on

behalf of employees of direct costs associated with the move. The assistance offered is specific to each employee and is structured to be

competitive in the area to which the employee is relocated, subject

165

• Nortel Networks Corporation 1986 Stock Option Plan as amended and restated (the “1986 Stock Option Plan” and, collectively

with the 2000 Stock Option Plan, the “Stock Option Plans”).

Plan category A B C

Number of common

shares to be issued

upon exercise of

outstanding options,

warrants and rights

Weighted average

exercise price of

outstanding

options, warrants

and rights

Number of common shares

remaining available for future

issuance under equity compensation

plans (excluding common shares

reflectedincolumnA)

Equity compensation plans approved by shareholders (1) 270,793,165 $11.52 87,996,421

Equity compensation plans not approved by shareholders (2) – – –

Total (3) 270,793,165 $11.52 87,996,421

(1) Consists of the Stock Option Plans.

(2) None. Except for the plans noted in footnote (3) below, all equity compensation plans involving the issuance of common shares from treasury have received

shareholder approval.

(3) This table does not include information on any options, warrants or rights outstanding under plans that have been assumed by the Company and its subsidiaries in

connection with merger, consolidation or other acquisition transactions (the “Assumed Stock Option Plans”). As of December 31, 2003, 22,109,241 common shares of

the Company were issuable upon the exercise of outstanding options under the Assumed Stock Option Plans. The weighted average exercise price of such outstanding

options is $25.52 per common share. No additional options may be granted under the Assumed Stock Option Plans.

to the overall relocation policy. Effective July 30, 2002, and in accordance with the United States Sarbanes-Oxley Act of 2002, the Company

no longer offers its executive officers housing loans as part of their relocation assistance.

No loans have been extended by the Company or its subsidiaries to any director or executive officer of the Company since January 1, 2003.

Neither the Company nor its subsidiaries have given any guarantee, support agreement, letter of credit, or similar arrangement or

understanding, to any other entity in connection with indebtedness of current and former directors or executive officers since January 1, 2003.

As at December 31, 2004, approximately $3.6 million of indebtedness was owed by current and former employees to the Company and its

subsidiaries. Except for the indebtedness previously owed by a recently appointed executive officer as set out in the table below, no current or

former director or executive officer had any loans outstanding since January 1, 2003.

Table of Indebtedness of Directors and Executive Officers

ITEM 14. Principal Accountant Fees and Services

Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (or, collectively, the Deloitte

Entities) are the principal independent accountants of the Company and Nortel Networks Limited.

In accordance with applicable laws and the requirements of stock exchanges and securities regulatory authorities, the audit committees of

the Company and Nortel Networks Limited pre-approve all audit and non-audit services to be provided by the Deloitte Entities. In addition, in

April 2002, the audit committees of the Company and Nortel Networks Limited recommended for approval, and the boards of directors of the

Company and Nortel Networks Limited approved, a policy that thereafter the Company’s and Nortel Networks Limited’s auditors would be

retained solely to provide audit and audit-related services and advice with respect to tax matters, and that the auditors would not be retained to

provide consulting services, such as information technology services. The boards’ policy applies to new engagements and did not affect limited

term engagements in effect at the time the policy was approved.

Certain services in each fee category below were not subject to the audit committee pre-approval requirements as the fees related to

engagements for services prior to the audit committee pre-approval requirements coming into effect. Five percent of the fees billed for 2003 are

for engagements that were undertaken prior to the pre-approval requirements coming into effect and were primarily for tax compliance

services. Services for which the fees were less than one percent of the total fees billed by the Deloitte Entities for 2003 were inadvertently not

pre-approved by the audit committees but were promptly brought to the attention of the audit committees and, in accordance with applicable

laws and the requirements of securities regulatory authorities, were approved prior to the completion of the services associated with those fees.

Audit Fees

The Company and Nortel Networks Limited prepare financial statements in accordance with United States generally accepted accounting

principles (or US GAAP) and Canadian generally accepted accounting principles (or Canadian GAAP). Deloitte Entities billed to date the

Company and its subsidiaries $14.3 million for 2004 for the following audit services: (i) interim audit work related to the audit of the annual

consolidated financial statements of the Company and Nortel Networks Limited for the year ended December 31, 2004; (ii) reviews of the

financial statements of the Company and Nortel Networks Limited included as comparative financial statements in Forms 10-Q for the periods

ended March 31, 2004 and June 30, 2004; and (ii) audit of internal controls over financial reporting as required under the United States

Sarbanes-Oxley Act of 2002. Deloitte Entities billed to date the Company and its subsidiaries $55.0 million and $8.1 million for 2003 and

166

Name and Principal

Position

Involvement of

Company or Subsidiary

Largest Amount Outstanding

January 1, 2003 -

December 31, 2004 ($)

Amount Outstanding

as at December 31, 2004 ($)

Martha H. Bejar (1)

President, CALA Lender 200,000 0

(1) A subsidiary of the Company extended a housing loan to Ms. Bejar in 2001 in connection with a relocation. The loan was for a period of 10 years, interest-free and secured

against Ms. Bejar’s residence. The full amount of this indebtedness was repaid by Ms. Bejar prior to her appointment as an executive officer effective October 1, 2004.

2002, respectively, for the following audit services: (i) audits of the annual consolidated financial statements of the Company and Nortel

Networks Limited included in annual reports on Form 10-K and annual reports to shareholders for the fiscal years ended December 31, 2003

and 2002; (ii) reviews of the interim financial statements of the Company and Nortel Networks Limited included in quarterly reports on Form

10-Q and quarterly reports to shareholders for the periods ended March 31, June 30 and September 30, 2003 and 2002 (and in a Nortel

Networks Limited amended Form 10-Q/A for the period ended September 30, 2003); (iii) audits and reviews of the restated financial

statements of the Company and Nortel Networks Limited included in their respective amended annual reports on Form 10-K/A for the fiscal

year ended December 31, 2002 and amended quarterly reports on Form 10-Q/A for the periods ended March 31 and June 30, 2003; (iv) audits

and reviews of the restated financial statements of the Company and Nortel Networks Limited included as comparative financial statements in

their respective Form 10-K for the fiscal year ended December 31, 2003; (v) audits of individual subsidiary statutory financial statements; and

(vi) comfort letters, attest services, statutory and regulatory audits, consents and other services related to United States Securities and Exchange

Commission matters.

Audit-Related Fees

Deloitte Entities billed to date the Company and its subsidiaries $2.8 million, $3.1 million and $1.1 million for 2004, 2003 and 2002,

respectively, for the following audit-related services: (i) audit of pension plan financial statements; (ii) financial accounting and reporting

consultations; (iii) information system reviews; (iv) advisory services related to the United States Sarbanes-Oxley Act of 2002; (v) accounting

consultations and audits in connection with dispositions; (vi) internal control reviews; and (vii) accounting consultations regarding financial

accounting standards for various local business-related transactions.

Tax Fees

Deloitte Entities billed the Company and its subsidiaries $7.1 million, $14.6 million and $13.7 million for 2004, 2003 and 2002,

respectively for tax compliance services. Tax compliance services are services rendered based upon facts already in existence or transactions

that have already occurred to document, compute and obtain government approval for amounts to be included in tax filings and consisted of:

(i) assistance in filing tax returns in various jurisdictions; (ii) sales and use, property and other tax return assistance; (iii) research and

development tax credit documentation and analysis for purposes of filing amended returns; (iv) transfer pricing documentation; (v) requests for

technical advice from taxing authorities; (vi) assistance with tax audits and appeals; and (vii) preparation of expatriate tax returns.

All Other Fees

Deloitte Entities billed the Company and its subsidiaries $0, $0 and $1.7 million for 2004, 2003 and 2002, respectively, for the following

services: (i) non-financial information systems design and implementation; (ii) financial information systems design and implementation; (iii)

immigration services; and (iv) review of import/export and social security requirements/reports. Approximately $1.0 million of the above

services billed by Deloitte Entities in 2002 were for services provided by Deloitte Consulting.

167

PART IV

All other schedules are omitted because they are inapplicable or not required.

Individual financial statements of entities accounted for by the equity method have been omitted because no such entity constitutes a

“significant subsidiary” requiring such disclosure at December 31, 2003.

Nortel Networks Corporation filed a Current Report on Form 8-K dated October 24, 2003 related to its financial results for the third quarter of

2003.

Nortel Networks Corporation filed a Current Report on Form 8-K dated November 13, 2003 related to a press release announcing the expected

timing for the filing of its Form 10-Q for the fiscal year of 2003.

Nortel Networks Corporation filed a Current Report on Form 8-K dated December 23, 2003 relating to a press release announcing the

confirmation of the filing of a Form 10-K/A for 2002, a Form 10-Q/A for the first quarter of 2003 and a Form 10-Q/A for the second quarter of

2003.

Nortel Networks Corporation filed a Current Report on Form 8-K dated January 29, 2004 concerning its financial results for the fourth quarter

of 2003 and full year 2003.

Nortel Networks Corporation filed a Current Report on Form 8-K dated March 10, 2004 related to a press release announcing the delay of

filing of its financial results for the third quarter of 2003.

Nortel Networks Corporation filed a Current Report on Form 8-K dated March 15, 2004 related to a press release announcing the appointments

of a new Chief Financial Officer and Controller on an interim basis.

Nortel Networks Corporation filed a Current Report on Form 8-K dated March 30, 2004 related to a press release announcing the waiver from

Export Development Canada and update regarding the timing of the first quarter 2004 results announcement and Annual Shareholders’

Meeting.

Nortel Networks Corporation filed a Current Report on Form 8-K dated April 5, 2004 related to a press release updating the status of the

Securities and Exchange Commission inquiry.

168

ITEM 15. Exhibits

Financial Statement Schedules and Re

orts on Form 8-K

1. Financial Statements

The index to the Consolidated Financial Statements appears on page •.

2. Financial Statement Schedules

Page

Quarterly Financial Data (Unaudited) F-93

Report of Independent Registered Chartered Accountants 178

II — Valuation and Qualifying Accounts and Reserves, Provision for Uncollectibles 179

Audited Financial Statements and the notes thereto of Nortel Networks S.A., prepared in accordance with

United States generally accepted accounting principles, for the three years ended December 31, 2003 180

3. Re

orts on Form 8-K

Nortel Networks Corporation filed a Current Report on Form 8-K dated April 14, 2004 related to a press release updating the status of Ontario

Securities Commission inquiry.

Nortel Networks Corporation filed a Current Report on Form 8-K dated April 28, 2004 related to a press release announcing the appointment

of William A. Owens as President and Chief Executive Officer, other management changes and an update on a number of matters, including

the status of certain prior year financial statements.

Nortel Networks Corporation filed a Current Report on Form 8-K/A dated April 28, 2004 amending debt securities information contained in a

press release dated March 10, 2004.

Nortel Networks Corporation filed a Current Report on Form 8-K dated April 29, 2004 related to a press release announcing the appointment

of Dr. rer. Pol. Manfred Bischoff to the Nortel Networks Board of Directors.

Nortel Networks Corporation filed a Current Report on Form 8-K dated May 14, 2004 related to a press release announcing Nortel Networks

receipt of a federal grand jury subpoena from the U.S. Attorney’s Office for the production of certain documents.

Nortel Networks Corporation filed a Current Report on Form 8-K dated May 18, 2004 related to a press release announcing a temporary cease

trade order issued by the Ontario Securities Commission.

Nortel Networks Corporation filed a Current Report on Form 8-K dated May 25, 2004 related to the resignation of Frank Andrew Dunn as a

director effective May 21, 2004.

Nortel Networks Corporation filed a Current Report on Form 8-K dated May 26, 2004 related to a press release announcing the appointment of

TheHon.JohnManleytotheNortelNetworksBoardofDirectors.

Nortel Networks Corporation filed a Current Report on Form 8-K dated May 31, 2004 related to a press release announcing that Nortel

Networks Limited had obtained a new waiver from Export Development Canada.

Nortel Networks Corporation filed a Current Report on Form 8-K dated June 2, 2004 related to a press release providing a status update on its

financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated June 15, 2004 related to a press release providing a status update on its

financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated June 23, 2004 related to a press release announcing court approval for

extending the time for calling the 2004 Annual Shareholders’ Meeting.

Nortel Networks Corporation filed a Current Report on Form 8-K dated June 24, 2004 related to a letter received from the Toronto Stock

Exchange advising of a breach of its financial statements filing requirements.

Nortel Networks Corporation filed a Current Report on Form 8-K dated June 29, 2004 related to a press release providing a status update on its

financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated July 6, 2004 related to an agreement reached with Flextronics

International Ltd.

Nortel Networks Corporation filed a Current Report on Form 8-K dated July 13, 2004 related to a press release providing a status update on its

financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated July 27, 2004 related to a press release providing a status update on its

financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated August 10, 2004 related to a press release providing a status update on

its financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated August 17, 2004 related to a press release providing a status update of

the RCMP review.

169

Nortel Networks Corporation filed a Current Report on Form 8-K dated August 19, 2004 related to a press release providing a status update on

its financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated August 20, 2004 related to a press release announcing a new waiver

from Export Development Canada.

Nortel Networks Corporation filed a Current Report on Form 8-K dated September 2, 2004 related to a press release providing a status update

on its financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated September 2, 2004 related to an employment agreement with William

Owens, President and Chief Executive Officer.

Nortel Networks Corporation filed a Current Report on Form 8-K dated September 16, 2004 related to a press release providing a status update

on its financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated September 30, 2004 related to a press release providing a status update

on its financial restatement process and announcing that Nortel Networks Limited had obtained a new waiver from Export Development

Canada.

Nortel Networks Corporation filed a Current Report on Form 8-K/A dated September 30, 2004 amending details of its previously announced

work plan contained in a press release dated August 19, 2004.

Nortel Networks Corporation filed a Current Report on Form 8-K dated October 14, 2004 related to a press release providing a status update on

its financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K/A dated October 18, 2004 amending certain information concerning the

timing and implementation of certain matters under the existing agreement with Flextronics International Ltd. contained in a press release

dated June 29, 2004.

Nortel Networks Corporation filed a Current Report on Form 8-K dated October 27, 2004 related to a press release providing a status update on

its financial restatement process and other matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated November 2, 2004 related to a press release announcing a new waiver

from Export Development Canada.

Nortel Networks Corporation filed a Current Report on Form 8-K dated November 12, 2004 related to a press release providing a status update

on its financial restatement process and other matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated November 19, 2004 related to a press release announcing a new waiver

from Export Development Canada.

Nortel Networks Corporation filed a Current Report on Form 8-K dated November 24, 2004 related to a press release providing a status update

on its financial restatement process and other matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated November 30, 2004 updating certain information concerning on the

Corporation’s Annual Shareholders’ Meeting.

Nortel Networks Corporation filed a Current Report on Form 8-K dated December 8, 2004 related to a press release providing a status update

on its financial restatement process and other matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated December 10, 2004 related to a press release announcing a new waiver

from Export Development Canada.

Nortel Networks Limited filed a Current Report on Form 8-K dated December 16, 2004 related to a press release providing limited estimated

unaudited financial results for the third quarter of 2004, and updated limited estimated unaudited results for the first and second quarters of

2004 and for the years 2001, 2002 and 2003.

170

Nortel Networks Corporation filed a Current Report on Form 8-K dated December 22, 2004 related to a press release providing a status update

on its financial restatement process and other related matters.

Nortel Networks Corporation filed a Current Report on Form 8-K dated January 4, 2005 related to a press release advising that the New York

Stock Exchange has granted a three month extension to file the 2003 Annual Reports on Form 10-K with the Securities and Exchange

Commission.

Nortel Networks Corporation filed a Current Report on Form 8-K dated January 7, 2005 related to a press release providing a status update on

its financial restatement process and other related matters.

171

The items listed as Exhibits 10.2 to 10.7, 10.27 to 10.45 and item 10.49 relate to management contracts or compensatory plans or

arrangements.

Exhibit

172

4. Exhibit Index

Number Description

*2. Amended and Restated Arrangement Agreement involving BCE Inc., Nortel Networks Corporation, formerly known as New

Nortel Inc., and Nortel Networks Limited, formerly known as Nortel Networks Corporation, made as of January 26, 2000, as

amended and restated March 13, 2000 (including Plan of Arrangement under Section 192 of the Canada Business Corporations

) (filed as Exhibit 2.1 to Nortel Networks Corporation’s Current Report on Form 8-K dated May 1, 2000).

*3.1 Restated Certificate and Articles of Incorporation of Nortel Networks Corporation (filed as Exhibit 3 to Nortel Networks

Corporation’s Current Report on Form 8-K dated October 18, 2000).

*3.2 By-Law No. 1 of Nortel Networks Corporation (filed as Exhibit 3.2 to Nortel Networks Corporation’s Annual Report on Form 10-

K for the year ended December 31, 2000).

*4.1 Shareholders Rights Plan Agreement dated as of March 13, 2000 between Nortel Networks Corporation and Montreal Trust

Company of Canada, which includes the Form of Rights Certificate as Exhibit A thereto, as amended by the Registration

Statement on Form 8-A/A filed on May 1, 2000, as further amended and restated by Registration Statement dated February 14,

2003 (filed as Exhibit 3 to Nortel Networks Corporation’s Registration Statement on Form 8-A/A filed on April 25, 2003).

*4.2 Indenture dated as of November 30, 1988, between Nortel Networks Limited and The Toronto-Dominion Bank Trust Company,

as trustee, related to debt securities authenticated and delivered thereunder, which comprised the 6% Notes due September 1,

2003, and the 6 7/8% Notes due September 1, 2023 issued by Nortel Networks Limited (filed as Exhibit 4.1 to Nortel Networks

Corporation’s Annual Report on Form 10-K for the year ended December 31, 1999).

*4.3 Indenture dated as of February 15, 1996, among Nortel Networks Limited, as issuer and guarantor, Nortel Networks Capital

Corporation, formerly Northern Telecom Capital Corporation, as issuer, and The Bank of New York, as trustee, related to debt

securities and guarantees authenticated and delivered thereunder, which comprised the 7.40% Notes due 2006 and the 7.875%

Notes due 2026 (filed as Exhibit 4.1 to Registration Statement on Form S-3 (No. 333-1720) of Nortel Networks Limited and

Nortel Networks Capital Corporation).

*4.4 Indenture dated as of December 15, 2000 among Nortel Networks Limited, as issuer and guarantor, Nortel Networks Capital

Corporation, as issuer, and Citibank, N.A., as trustee, related to debt securities authenticated and delivered thereunder (filed as

Exhibit 4.1 to Registration Statement on Form S-3 (No. 333-51888) of Nortel Networks Limited and Nortel Networks Capital

Corporation).

*4.5 First Supplemental Indenture dated as of February 1, 2001 to Indenture dated as of December 15, 2000 among Nortel Networks

Limited, as issuer and guarantor, Nortel Networks Capital Corporation, as issuer, and Citibank, N.A., as trustee, related to 6.125%

Notes due 2006 (filed as Exhibit 4.1 to Nortel Networks Limited’s Current Report on Form 8-K dated February 2, 2001).

173

Number Description

*4.6 Instrument of Resignation, Appointment and Acceptance entered into as of December 19, 2002, effective as of January 2, 2003,

among Nortel Networks Limited, as issuer and guarantor, Nortel Networks Capital Corporation, as issuer, Citibank, N.A. and

Deutsche Bank Trust Company Americas, with respect to the Indenture dated as of December 5, 2000, as supplemented by a First

Supplemental Indenture dated as of February 1, 2001 related to debt securities (filed as Exhibit 4.6 to Nortel Networks

Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002).

*4.7 Indenture dated as of August 15, 2001 between Nortel Networks Corporation, Nortel Networks Limited, as guarantor, and

Bankers Trust Company, as trustee, related to convertible debt securities and guarantees authenticated and delivered thereunder,

which comprised the 4.25% Convertible Senior Notes due 2008 (filed as Exhibit 4 to Nortel Networks Corporation’s Quarterly

Report on Form 10-Q for the quarter ended September 30, 2001).

*10.1 Third Amended and Restated Reciprocal Credit Agreement dated as of December 19, 2002 between Nortel Networks Corporation,

Nortel Networks Limited and the other parties who have executed the agreement (filed as Exhibit 10.1 to Nortel Networks

Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002).

*10.2 Nortel Networks Supplementary Executive Retirement Plan, as amended effective October 18, 2001 and October 23, 2002 (filed

as Exhibit 10.2 to Nortel Networks Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002).

*10.3 Agreement dated April 29, 1997 related to the remuneration of the Chief Legal Officer (filed as Exhibit 10.3 to Nortel Networks

Corporation’s Annual Report on Form 10-K for the year ended December 31, 2001).

*10.4 Acknowledgement effective as of June 1, 2000 related to the remuneration of the Chief Legal Officer (filed as Exhibit 10.4 to

Nortel Networks Corporation’s Annual Report on Form 10-K for the year ended December 31, 2001).

*10.5 Statement describing the retirement arrangements of the former President and Chief Executive Officer (filed as Exhibit 10.5 to

Nortel Networks Corporation’s Annual Report on Form 10-K for the year ended December 31, 2001).

*10.6 Nortel Networks Corporation Executive Retention and Termination Plan, as amended and restated, effective from June 26, 2002

(filed as Exhibit 10.1 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30,

2002).

*10.7 Nortel Networks Corporation Special Retention Plan effective August 1, 2001 and expired on June 30, 2003 (filed as Exhibit 10.3

to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).

*10.8 Purchase Contract and Unit Agreement dated as of June 12, 2002 among Nortel Networks Corporation, Computershare Trust

Company of Canada, as purchase contract agent, and Holders (as defined therein) from time to time (filed as Exhibit 10.1 to

Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).

*10.9 Five Year Credit Agreement dated as of April 12, 2000, among Nortel Networks Limited, as borrower, various banks, as lenders,

Royal Bank of Canada and Toronto Dominion Bank, as co-syndication agents, and J.P. Morgan Canada, as administrative agent

(filed as Exhibit 10.4 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001).

*10.10 Five Year Credit Agreement dated as of April 12, 2000, among Nortel Networks Limited, as guarantor, Nortel Networks Inc., as

borrower, various banks, as lenders, ABN AMRO Bank N.V., Bank of America N.A. and Citibank N.A., as co-syndication agents,

and Morgan Guaranty Trust Company of New York, as administrative agent (which terminated on April 28, 2004) (filed as

Exhibit 10.5 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001).

174

Number Description

*10.11 U.S. Guarantee and Security Agreement dated as of the first day of the “Collateral Period” (as defined therein) among Nortel

Networks Limited, Nortel Networks Inc. and certain of their subsidiaries and JPMorgan Chase Bank, as Collateral Agent (filed as

Exhibit 99.1 to Nortel Networks Corporation’s Current Report on Form 8-K dated January 18, 2002).

*10.12 Amendment No. 1 dated as of December 12, 2002 to the U.S. Guarantee and Security Agreement dated as of April 4, 2002 among

Nortel Networks Limited, Nortel Networks Inc., the Subsidiary Lien Grantors party thereto and JPMorgan Chase Bank, as

Collateral Agent (filed as Exhibit 99.2 to Nortel Networks Corporation’s Current Report on Form 8-K dated December 13, 2002).

*10.13 Canadian Guarantee and Security Agreement dated as of the first day of the “Collateral Period” (as defined therein) among Nortel

Networks Limited and certain of its subsidiaries and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 99.1 to Nortel

Networks Corporation’s Current Report on Form 8-K dated February 4, 2002).

*10.14 Amendment No. 1 dated as of December 12, 2002 to the Canadian Guarantee and Security Agreement dated as of April 4, 2002

among Nortel Networks Limited, Nortel Networks Inc., the Subsidiary Guarantors party thereto and JPMorgan Chase Bank, as

Collateral Agent (filed as Exhibit 99.3 to Nortel Networks Corporation’s Current Report on Form 8-K dated December 13, 2002).

*10.15 Form of Nortel Networks Limited Foreign Subsidiary Guarantee dated as of April 4, 2002 and schedule thereto listing the specific

foreign subsidiary guarantees which are not attached as exhibits (filed as Exhibit 10.8 to Nortel Networks Corporation’s Quarterly

Report on Form 10-Q for the quarter ended March 31, 2002).

*10.16 Amendment No. 1 dated as of December 12, 2002 to certain Foreign Subsidiary Guarantees dated as of April 4, 2002 among

Nortel Networks (Ireland) Limited, Nortel Networks UK Limited, Nortel Networks (Asia) Limited and JPMorgan Chase Bank, as

Collateral Agent (filed as Exhibit 99.4 to Nortel Networks Corporation’s Current Report on Form 8-K dated December 13, 2002).

*10.17 Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, the Subsidiary Guarantors party thereto and

JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 10.9 to Nortel Networks Corporation’s Quarterly Report on Form 10-

Q for the quarter ended March 31, 2002).

*10.18 Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, Nortel Networks International Corporation

and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 10.10 to Nortel Networks Corporation’s Quarterly Report on

Form 10-Q for the quarter ended March 31, 2002).

*10.19 Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Inc. and JPMorgan Chase Bank, as Collateral Agent

(filed as Exhibit 10.11 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).

*10.20 Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, Nortel Networks International Finance & Holding

B.V., Nortel Networks S.A., and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 10.12 to Nortel Networks

Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).

*10.21 Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks International Finance & Holding B.V., Nortel

Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase Bank, as Collateral Agent, together with

(a) the Supplementing Pledge Agreement dated as of April 4, 2002 among Nortel Networks International Finance & Holding,

B.V. and JPMorgan Chase Bank, as Collateral Agent, (b) the Pledge Agreement Supplement dated as of April 4, 2002 between

Nortel Networks Limited and JPMorgan Chase Bank, as Collateral Agent, and (c) the Pledge Agreement Supplement dated as of

April 4, 2002 between Nortel Networks U.K. Limited and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 10.13 to

Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).

175

Number Description

*10.22 Foreign Pledge Agreement dated as of April 4, 2002 between Nortel Networks International Finance & Holding B.V. and

JPMorgan Chase Bank, as Collateral Agent, together with (a) the Pledge Agreement Supplement, dated as of April 4, 2002

between Nortel Networks Optical Components Limited and JPMorgan Chase Bank, as Collateral Agent, and (b) the Pledge

Agreement Supplement dated as of April 4, 2002 between Nortel Networks International Finance & Holding B.V., Nortel

Networks Optical Components Limited and JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 10.14 to Nortel Networks

Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).

*10.23 Pledge Agreement Supplement dated as of May 20, 2002 between Nortel Networks Mauritius Ltd and JPMorgan Chase Bank, as

Collateral Agent supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks International

Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase Bank, as

Collateral Agent (filed as Exhibit 10.5 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended

June 30, 2002).

*10.24 Pledge Agreement Supplement dated as of May 15, 2002 between Nortel Networks International Finance & Holding B.V. and

JPMorgan Chase Bank, as Collateral Agent, supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among Nortel

Networks International Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB and

JPMorgan Chase Bank, as Collateral Agent (filed as Exhibit 10.6 to Nortel Networks Corporation’s Quarterly Report on Form 10-

Q for the quarter ended June 30, 2002).

*10.25 Pledge Agreement Supplement dated as of June 4, 2002 between Nortel Networks Singapore Pte Ltd, and JPMorgan Chase Bank,

as Collateral Agent, supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks International

Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase Bank, as

Collateral Agent (filed as Exhibit 10.7 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended

June 30, 2002).

*10.26 Pledge Agreement Supplement dated as of May 15, 2002 between Nortel Networks Limited and JPMorgan Chase Bank, as

Collateral Agent, supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, the

Subsidiary Guarantors party thereto and JP Morgan Chase Bank, as Collateral Agent (filed as Exhibit 10.8 to Nortel Networks

Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).

*10.27 Nortel Networks Limited SUCCESS Plan as amended and restated on July 28, 2003 with effect from January 1, 2003 (filed as

Exhibit 10.1 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).

*10.28 Supplementary Pension Credits Arrangement (filed as Exhibit 10.14 to Nortel Networks Corporation’s Registration Statement on

Form S-1 (No. 2-71087)).

*10.29 Statements describing the right of certain executives in Canada to defer all or part of their short-term and long-term incentive

awards (filed as Exhibit 10.4 to Nortel Networks Limited’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000).

*10.30 Statement describing eligibility for the Group Life Insurance Plan for directors who are not salaried employees of Nortel

Networks Corporation (filed as Exhibit 10.30 to Nortel Networks Corporation’s Annual Report on Form 10-K for the year ended

December 31, 2002).

10.31 Resolutions of the Board of Directors of Nortel Networks Corporation dated December 18, 2003, related to the remuneration of

the chairman of the board, directors and chairman of the audit committee, effective January 1, 2004.

10.32 Resolutions of the Board of Directors of Nortel Networks Limited dated December 18, 2003, related to the remuneration of the

chairman of the board, directors and chairman of the audit committee, effective January 1, 2004.

176

Number Description

*10.33 Resolutions of the Board of Directors of Nortel Networks Limited dated December 17, 1993, as amended by resolutions of the

Board of Directors of Nortel Networks Limited dated February 29, 1996, providing for retirement compensation of directors who

are not salaried employees of Nortel Networks Limited or its subsidiaries (filed as Exhibit 10.33 to Nortel Networks Corporation’s

Annual Report on Form 10-K for the year ended December 31, 2002).

*10.34 Agreement between a director of Nortel Networks Corporation and Nortel Networks Limited and the respective companies dated

June 22, 2001 setting forth the arrangements with respect to serving as non-executive chairman of each of the board of directors of

Nortel Networks Corporation and Nortel Networks Limited (filed as Exhibit 10.1 to Nortel Networks Corporation’s Quarterly

Report on Form 10-Q for the quarter ended June 30, 2001).

*10.35 Amended General description of cash bonus for employees and executives of Nortel Networks Corporation and Nortel Networks

Limited as originally filed as Exhibit 10.5 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended

September 30, 2002 (filed as Exhibit 10.01 to the Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter

ended June 30, 2003).

*10.36 Nortel Networks Limited Restricted Stock Unit Plan dated as of January 30, 1997, as amended effective April 29, 1999,

September 1, 1999, February 15, 2000, May 1, 2000, November 15, 2000 and January 23, 2003 (filed as Exhibit 10.1 to Nortel

Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003).

10.37 Nortel Networks Corporation Directors’ Deferred Share Compensation Plan effective January 1, 2002 as amended and restated

May 29, 2003, as amended and restated December 18, 2003 effective January 1, 2004.

10.38 Nortel Networks Limited Directors’ Deferred Share Compensation Plan effective June 30, 1998 as amended and restated May 1,

2000, as further amended and restated effective January 1, 2002, as amended and restated May 29, 2003, as amended and restated

December 18, 2003 effective January 1, 2004.

*10.39 Nortel Networks Corporation 1986 Stock Option Plan as Amended and Restated, as amended effective April 30, 1992, April 27,

1995, December 28, 1995, April 8, 1998, February 25, 1999, April 29, 1999, September 1, 1999, December 16, 1999, May 1,

2000 and January 31, 2002 (filed as Exhibit 10.1 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter

ended March 31, 2002).

*10.40 Nortel Networks Corporation 2000 Stock Option Plan as amended effective May 1, 2000 and January 31, 2002 (filed as

Exhibit 10.2 to Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).

*10.41 Nortel Networks NA Inc., formerly known as Bay Networks, Inc., 1994 Stock Option Plan as Amended and Restated, as amended

effective May 1, 2000 (filed as Exhibit 4.3 to Post-Effective Amendment No. 2 on Form S-8 to Nortel Networks Corporation’s

Registration Statement on Form S-4 (No. 333-9066)).

*10.42 Nortel Networks/BCE 1985 Stock Option Plan (Plan of Arrangement 2000) (filed as Exhibit 10.5 to Nortel Networks

Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2000).

*10.43 Nortel Networks/BCE 1999 Stock Option Plan (Plan of Arrangement 2000) (filed as Exhibit 10.6 to Nortel Networks

Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2000).

*10.44 Assumption Agreement between Nortel Networks Corporation and Nortel Networks Limited dated March 5, 2001, regarding the

assumption and agreement by Nortel Networks Corporation to perform certain covenants and obligations of Nortel Networks

Limited under the Nortel Networks Limited Executive Retention and Termination Plan (filed as Exhibit 10.25 to Nortel Networks

Corporation’s Annual Report on Form 10-K for the year ended December 31, 2000).

*10.45 Nortel Networks U.S. Deferred Compensation Plan (filed as Exhibit 4.3 to Post-Effective Amendment No. 1 to Nortel Networks

Corporation’s Registration Statement on Form S-8 (No. 333-11558)).

177

Number Description

*10.46 Master Facility Agreement dated as of February 14, 2003 between Nortel Networks Limited and Export Development Canada

(filed as Exhibit 99.2 to Nortel Networks Corporation’s Current Report on Form 8-K dated February 14, 2003).

*10.47 Master Indemnity Agreement dated as of February 14, 2003 between Nortel Networks Limited and Export Development Canada

(filed as Exhibit 99.3 to Nortel Networks Corporation’s Current Report on Form 8-K dated February 14, 2003).

*10.48 Amending Agreement No. 1 dated as of July 10, 2003 to the Master Facility Agreement dated as of February 14, 2003 between

Nortel Networks Limited and Export Development Canada (filed as Exhibit 99.2 to Nortel Networks Corporation’s Current

Report on Form 8-K dated July 10, 2003).

*10.49 Letter dated June 23, 2003 from the former, President and Chief Executive Officer of Nortel Networks, to the Joint Leadership

Resources Committee of the Board of Directors of Nortel Networks Corporation and Nortel Networks Limited regarding the

voluntary return for cancellation of certain stock options to purchase common shares of Nortel Networks Corporation (filed as

Exhibit 10.4 to the Nortel Networks Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).

21. Subsidiaries of the Registrant (see page • ).

23.1 Consent of Deloitte & Touche LLP.

23.2 Consent of Deloitte & Associes.

24. Power of Attorney of certain directors and officers.

31.1 Rule 13a — 14(a)/15d — 14(a) Certification of the President and Chief Executive Officer.

31.2 Rule 13a — 14(a)/15d — 14(a) Certification of the Chief Financial Officer.

32. Certification of the President and Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as

adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

NORTEL NETWORKS S.A.

(A Subsidiary of Nortel Networks Limited)

For the three years ended December 31, 2003

180

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors of Nortel Networks S.A.

We have audited the accompanying consolidated balance sheets of Nortel Networks S.A., a subsidiary of Nortel Networks Limited, and its

subsidiaries as of December 31, 2003 and 2002 and the related consolidated statements of operations, shareholders’ equity and cash flows for

each of the three years in the period ended December 31, 2003 (all expressed in Euros). These financial statements are the responsibility of

Nortel Networks S.A. management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those

standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An

audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall

financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Nortel Networks S.A. and

its subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the

period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.

As described in note 3 to the consolidated financial statements, the accompanying consolidated financial statements of Nortel Networks S.A. as

of December 31, 2002, and for each of the two years in the period then ended have been restated.

As described in note 4 to the consolidated financial statements, effective January 1, 2003, Nortel Networks S.A. changed its method of

accounting for stock-based compensation in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for

Stock-based Compensation — Transition and Disclosure”. Also, as described in note 4, effective January 1, 2002, Nortel Networks S.A.

changed its method of accounting for goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”.

Deloitte & Associés

(formerly Deloitte Touche Tohmatsu)

SociétédeCommissairesauxComptes

/s/ Nicholas L.E. ROLT

Neuilly, France

January 10, 2005

181

NORTEL NETWORKS S.A.

(a Subsidiary of Nortel Networks Limited)

Consolidated Statements of Operations for the years ended December 31

*Seenote3

The accompanying notes are an integral part of these financial statements

182

(thousands of Euros) 2003 2002 2001

As restated* As restated*

Revenues — external 344,008 356,316 767,713

—

arties 515,478 458,918 439,072

859,486 815,234 1,206,785

Cost of revenues 657,128 600,367 1,116,766

Gross profit 202,358 214,867 90,019

Selling, general and administrative expense 70,274 69,482 175,433

Research and development expense 236,967 264,275 249,603

Amortization of intangibles

Acquired technology and other 255 – –

Goodwill – – 3,434

Special charges

Goodwill impairment ––20,607

Other special charges 24,563 83,427 74,772

(Gain) loss on sale of businesses and assets 13,883 16,171 (10,243)

Operating earnings (loss) (143,584)(218,488)(423,587)

Other income (expense) — net 2,015 23,038 53,998

Forei

nexchan

ain (loss) 1,043 (5,531)(1,710)

Interest expense (3,221) (9,885) (11,286)

Earnin

s (loss) before income taxes and minorit

interes

(143,747)(210,866)(382,585)

Minority interest (756) 3,052 8,973

Income tax benefit 5,614 1,640 34,073

Net earnings (loss) (138,889) (206,174) (339,539)

NORTEL NETWORKS S.A.

(a Subsidiary of Nortel Networks Limited)

Consolidated Balance Sheets as at December 31

*Seenote3

The accompanying notes are an integral part of these financial statements

183

(thousands of Euros) 2003 2002

As restated*

ASSETS

Current assets

Cash and cash equivalents 74,352 150,419

Accounts receivable (less provisions of 19,324 for 2003, 32,499 for 2002) 113,411 83,955

Inventories — net 66,197 80,070

Receivables from related parties 254,697 234,071

Other current assets 17,469 106,364

Total current assets 526,126 654,879

Long-term receivable from related party

–

140,010

Investments at cost

–

16,176

Plant and equipment — net 184,169 218,121

Goodwill 19,683 –

Intangible assets — net 8,929 3,454

Deferred income taxes — net 47,510 43,268

Other assets

–

Total assets 786,417 1,075,914

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities

Note payable to related party 160 –

Trade and other accounts payable 141,799 91,151

Payables to related parties 32,002 89,326

roll and benefi

-related liabilities 68,960 50,809

Contractual liabilities 23,822 37,818

Restructuring 9,224 13,346

Other accrued liabilities 105,739 174,260

Long-term debt due within one year 3,241 3,073

Total current liabilities 384,947 459,783

Other liabilities 9,615 2,837

Long-term deferred income 18,092 17,231

Long-term debt 73,217 76,457

Long-term note payable to related party 70,000 220,000

Total liabilities 555,871 776,308

Minority interest

–

9,757

Commitments (note 13)

SHAREHOLDERS’ EQUITY

Common shares, 0.005 par value — Authorized shares: unlimited;

Issued and outstanding: 91,308,951 for 2003 and 61,308,951 for 2002 456,544 306,544

Additional paid-in capital (26,417) 43,997

Accumulated deficit (199,581)(60,692)

Total shareholders’ equity 230,546 289,849

Total liabilities and shareholders’ equity 786,417 1,075,914

NORTEL NETWORKS S.A.

(a Subsidiary of Nortel Networks Limited)

Consolidated Statements of Shareholders’ Equity

*Seenote3

A Statement of Other Comprehensive Income (Loss) has not been presented as there are no other comprehensive income (loss) items.

The accompanying notes are an integral part of these financial statements

184

Additional Retained Total

Common

aid-in earnin

s shareholders’

(thousands of Euros) shares capital (deficit) equity

Balance at December 31, 2000 as restated* 35,762 202,171 148,039 385,972

Payment of dividends

–

– (35,773) (35,773)

Net earnings (loss)

–

–(339,539)(339,539)

Balance at December 31, 2001 as restated* 35,762 202,171 (227,273) 10,660

Common shares issued 485,363 – – 485,363

Capital restructuring (214,581) (158,174) 372,755

–

Net earnings (loss)

–

–(206,174)(206,174)

Balance at December 31, 2002 as restated* 306,544 43,997 (60,692) 289,849

Common shares issued 150,000 – – 150,000

Stock based compensation

–

1,333 – 1,333

Acquisition of Northern Telecom France

–

(83,800) – (83,800)

Acquisition of Nortel Networks France

–

(31,017) – (31,017)

Gain on related party transactions

–

43,070 –43,070

Net earnings (loss)

–

– (138,889) (138,889)

Balance at December 31, 2003 456,544 (26,417)(199,581)230,546

NORTEL NETWORKS S.A.

(a Subsidiary of Nortel Networks Limited)

Consolidated Statements of Cash Flows for the years ended December 31

*Seenote3

The accompanying notes are an integral part of these financial statements

185

(thousands of Euros) 2003 2002 2001

As restated* As restated*

Cash flows from (used in) operating activities

Net loss (138,889) (206,174) (339,539)

Adjustments to reconcile net loss to net cash from (used in) operating activities:

Amortization and depreciation 63,536 45,964 50,060

Non-cash

ortion of s

ecial char

es and related assets write down

–

20,607

Deferred income taxes (4,242) (3,728) (37,249)

(Gain) loss on disposal of assets 13,883 16,171 5,997

(Gain) loss on disposal of investments –

–

(16,240)

Current and deferred stock option compensation 1,333

–

Changes in operating assets and liabilities:

Accounts receivable (29,456)22,451 124,235

Receivables from related parties 27,947 246,248 24,699

Inventories 13,873 31,612 40,672

Accounts payable and accrued liabilities (17,843) (25,908) (179,972)

Payables to related parties (57,165)(437,236)257,754

Income taxes 4 (161) (27,416)

Other o

eratin

assets and liabilities 89,510 (36,488)44,679

Net cash used in operating activities (37,509) (347,249) (31,713)

Cash flows from (used in) investing activities

enditures for

lant and e

men

(41,246) (57,631) (108,601)

Expenditure for investments (154,192)(2,490)(9,296)

Proceeds on disposal of investments 58,940 9,909 23,834

Proceeds on disposal of plant and equipment 596 754 8,855

Divestiture of investments & businesses — net cash divested –

–

(6,614)

Increase (decrease) in other financial assets 9,147 (7,147)

–

Net cash used in investing activities (126,755) (56,605) (91,822)

Cash flows from (used in) financing activities

Issuance of common shares – 204,363

–

(Increase) decrease in receivables from related parties — net 91,437 (142,329)2,319

Increase (decrease) in notes payable to related parties — net – 320,000 181,000

(Increase) decrease in long-term receivables –

–

531

Increase (decrease) in notes payable (3,240) (3,295) 4,750

Dividend paid –

–

(29,736)

Net cash from financing activities 88,197 378,739 158,864

Net increase (decrease) in cash and cash equivalents (76,067)(25,115)35,329

Cash and cash equivalents, beginning of year 150,419 175,534 140,205

Cash and cash equivalents, end of year 74,352 150,419 175,534

NORTEL NETWORKS S.A.

(a Subsidiary of Nortel Networks Limited)

Notes to Consolidated Financial Statements

(thousands of euros, unless otherwise stated)

186

ortel Networks S.A.

All of the shares of Nortel Networks S.A. are owned by Nortel Networks Limited (“Nortel Networks”) and Nortel Networks International

Finance & Holding B.V. (“NNIF&H B.V.”), which is an indirect wholly owned subsidiary of Nortel Networks. Nortel Networks S.A.

(formerly known as Nortel Matra Cellular SCA) is a French société anonyme (limited liability company) established in 1992. Nortel

Networks S.A. develops wireless network equipment for Nortel Networks customers. This includes the engineering, configuration and

implementation of various Nortel Networks products for wireless network applications.

On June 24, 2003, Nortel Networks S.A. acquired the outstanding shares of Northern Telecom France S.A. (“Northern Telecom France”)

from Nortel Networks Inc. (“NNI”), a subsidiary of Nortel Networks (see note 9). Northern Telecom France is a holding company that

was then holding interests of 17.8 percent in Nortel Networks France S.A.S. (“Nortel Networks France”) and 13.2 percent in EADS

Telecom S.A.S., formerly EADS Defence and Security Networks S.A.S. (“EADS Telecom”).

On December 18, 2003, through a series of transactions Nortel Networks S.A. acquired all outstanding shares of Nortel Networks France

not already under its control from Nortel Networks and from NNIF&H B.V. (see note 9). Nortel Networks France primarily distributes

Wireline, Optical and Enterprise products of Nortel Networks in France either directly or through various distribution channels.

.Si

icant accountin

olicies

Basis of

resentation

The consolidated financial statements of Nortel Networks S.A. have been prepared in accordance with accounting principles generally

accepted in the United States (“U.S.”) (“GAAP”) and the rules and regulations of the U.S. Securities and Exchange Commission (the

“SEC”) for the preparation of financial statements.

Nortel Networks S.A. and certain affiliates entered into a series of complex transactions during the periods presented that constituted a

reorganization and transfers of share ownership of entities under common control (see note 9). The transactions have been accounted for

at historical cost in a manner similar to a pooling of interest, and in accordance with Statement of Financial Accounting Standards

(“SFAS”) No. 141 “Business Combinations” (“SFAS 141”) all prior period financial statements presented have been restated as if the

reorganization took place at the beginning of such periods.

As described in note 3, the consolidated statements of operations, shareholders’ equity and cash flows for the years ended December 31,

2002 and 2001 and the consolidated balance sheet as of December 31, 2002, including the applicable notes, were restated.

These financial statements have been prepared on the basis that Nortel Networks S.A. is a going concern. Nortel Networks S.A. has

received a pledge of support from Nortel Networks.

(a)

rinci

les o

consolidation

The financial statements of entities which are controlled by Nortel Networks S.A. through voting equity interests, referred to as

subsidiaries, are consolidated. Entities which are jointly controlled, referred to as joint ventures, and entities which are not

controlled but over which Nortel Networks S.A. has the ability to exercise significant influence, referred to as associated

companies, are accounted for using the equity method. Variable Interest Entities (“VIEs”) (which include, but are not limited to,

special purpose entities, trusts, partnerships, certain joint ventures and other legal structures), as defined by the Financial

Accounting Standards Board (“FASB”) in FASB Interpretation (“FIN”) No. 46 (Revised 2003), “Consolidation of Variable Interest

Entities — an Interpretation of Accounting Research Bulletin No. 51” (“FIN 46R”), are entities in which equity investors do not

have the characteristics of a “controlling financial interest” or there is not sufficient equity at risk for the entity to finance its

activities without additional subordinated financial support. VIEs are consolidated by Nortel Networks S.A. when it is determined,

that it will, as the primary beneficiary, absorb the majority of the VIEs expected losses and/or

187

expected residual returns. Intercompany accounts and transactions are eliminated upon consolidation and unrealized intercompany

gains and losses are eliminated when accounting under the equity method.

(b) Use o

estimates

Nortel Networks S.A. makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of

contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and

expenses during the reporting period. Actual results may differ from those estimates. Estimates are used when accounting for items

and matters such as revenue recognition, allowances for uncollectible accounts receivable and customer financing, receivables

sales, inventory obsolescence, product warranty, amortization, asset valuations, impairment assessments, employee benefits, taxes,

restructuring and other provisions, stock-based compensation and contingencies.

The functional currency of Nortel Networks S.A. is the euro.

Transactions and financial statement items denominated in a currency other than the euro are translated into euros at the exchange

rates in effect at the balance sheet dates for monetary assets and liabilities, and at historical exchange rates for non-monetary assets

and liabilities. Revenue and expenses are translated at average rates for the period, except for amortization and depreciation which

are translated on the same basis as the related assets. Resulting translation gains or losses are reflected in net earnings (loss).

(d)

evenue reco

nition

Nortel Networks S.A. products and services are generally sold as part of a contract and the terms of the contracts, taken as a whole,

determine the appropriate revenue recognition methods.

Depending upon the terms of the contract and types of products and services sold, Nortel Networks S.A. recognizes revenue under

American Institute of Certified Public Accountants Statement of Position (“SOP”) 81-1, “Accounting for Performance of

Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”), SOP 97-2, “Software Revenue Recognition” (“SOP 97-

2”), and SEC Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition” (“SAB 104”), which was preceded by SAB 101,

“Revenue Recognition in Financial Statements” (“SAB 101”). Revenue is recognized net of cash discounts and allowances.

Effective July 1, 2003, for contracts involving multiple deliverables, where the deliverables are governed by more than one

authoritative accounting standard, Nortel Networks S.A. generally applies the FASB Emerging Issues Task Force (“EITF”) Issue

No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”), and evaluates each deliverable to determine

whether it represents a separate unit of accounting based on the following criteria: (a) whether the delivered item has value to the

customer on a standalone basis, (b) whether there is objective and reliable evidence of the fair value of the undelivered item(s), and

(c) if the contract includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s)

is considered probable and substantially in the control of Nortel Networks S.A. If objective and reliable evidence of fair value exists

for all units of accounting in the contract, revenue is allocated to each unit of accounting or element based on relative fair values. In