UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Commission file number 000-30758

Nortel Networks Limited

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

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

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

Title of each class:   Common Shares without nominal or par value

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

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

At March 31, 2005, 1,460,978,638 common shares of Nortel Networks Limited were issued and outstanding, all of which were held by Nortel Networks Corporation. The common shares of the registrant are not traded on any stock exchange.

TABLE OF CONTENTS

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

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PART I

ITEM 1.	BUSINESS

Overview

Nortel Networks Limited is a recognized leader in delivering communications capabilities that enhance the human experience, ignite and power global commerce, and secure and protect the world’s most critical information. We offer converged multimedia networks that use innovative packet, wireless, voice and optical technologies and are underpinned by high standards of security and reliability. For both service providers and enterprises, these networks help to drive increased profitability and productivity by reducing costs and enabling new business and consumer services opportunities. Our networking solutions consist of hardware, software and services. 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 making strategic investments in research and development. This focus forms a core strength and is a factor that we believe differentiates us from many of our competitors. We believe our acknowledged strength is strong customer loyalty as a result of providing value to our customers through high reliability networks, a commitment to ongoing support and an evolution of solutions as technology advancements in the products are made.

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 2004, our business was organized into 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 streamlined organizational structure that included, among other things, combining the businesses of our four reportable segments into two business organizations: (i) Carrier Networks and Global Operations, and (ii) Enterprise Networks. We have reviewed the impact of these changes on our reportable segments and concluded that, although certain structural changes were made to reflect this reorganization effective October 1, 2004, we did not meet the accounting criteria to change our reportable segments for the 2004 fiscal year.

These two business organizations include four operating segments. The four operating segments are Carrier Packet Networks, which is substantially an amalgamation of our previous Wireline Networks and Optical Networks businesses; CDMA Networks, which was previously part of Wireless Networks; GSM and UMTS Networks which was also previously part of Wireless Networks; and Enterprise Networks, which remains substantially unchanged from the previous organization. For the first quarter of 2005 these four operating segments will become our reportable segments.

For financial information by reporting segment and product category, see “Segment information” in note 5 of the accompanying consolidated financial statements and “Results of operations — continuing operations — Segment revenues” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A.

The Company’s principal executive offices are located at 8200 Dixie Road, Suite 100, Brampton, Ontario, Canada, L6T 5P6, telephone number (905) 863-0000. The Company was incorporated in Canada as the Northern Electric Company, Limited on January 5, 1914. The Company participated in a corporate amalgamation with two of its wholly owned subsidiaries on January 14, 1982. The Company changed its name to

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Northern Telecom Limited on March 1, 1976, to Nortel Networks Corporation on April 29, 1999, and to Nortel Networks Limited on May 1, 2000. On May 1, 2000, the Company participated in a Canadian court-approved plan of arrangement with Nortel Networks Corporation, previously known as New Nortel Inc., and BCE Inc., the largest shareholder of the Company prior to the plan of arrangement, and changed its name to Nortel Networks Limited, or NNL. In connection with the plan of arrangement, the Company became the principal operating subsidiary of Nortel Networks Corporation.

Where we say “we”, “us”, “our” or “Nortel”, we mean Nortel Networks Limited or Nortel Networks Limited and its subsidiaries, as applicable. References to “the Company” mean Nortel Networks Limited without its subsidiaries. Where we refer to the “industry”, we mean the telecommunications industry.

The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports available free of charge under “Investor Relations” on our website at www.nortel.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. Information contained on our website is not incorporated by reference into this or any other report filed with or furnished to the SEC.

Developments in 2004 and 2005

Business environment

In 2004, there was increased spending in the industry compared to 2003 by both service provider and enterprise customers as certain service provider customers began to expand and upgrade their existing networks, including next generation wireless technologies and Voice over Internet Protocol, or IP, solutions. This increase in industry spending was strongest with the build-out of new technologies in both established and emerging markets and with the build-out of traditional technologies in emerging markets. In 2005, we expect that these trends will continue; however, the rate of increase may be slower.

Although there was increased spending in the industry by both service provider and enterprise customers in 2004, we experienced a decline in revenue compared to 2003. There was decreased spending on our traditional technologies as customers continued to transition to next generation technologies. This decreased spending on traditional technologies outpaced the increased spending on new technologies with many of our customers realigning capital spending with their current levels of earnings in order to maximize their return on invested capital. 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. However, based on current customer orders in emerging markets, particularly in Asia and the Caribbean and Latin America region, or CALA, increased deployments of Voice over IP and next generation wireless technologies, including Universal Mobile Telecommunications System, or UMTS, we believe that we are well positioned to grow our revenues in 2005. For example, throughout 2004 and into 2005 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 and new network build outs were started in emerging markets.

In 2005, we expect increased consolidation of certain service providers in the industry, particularly in the U.S. We expect this trend to result in a net reduction in customer spending as these service providers focus on improving the efficiency of their combined networks rather than network expansion. Competition in the industry remains strong and our traditional large competitors, newer competitors, particularly from China and certain smaller niche competitors continue to increase their market share. We and our competitors remain focused on certain key factors such as customer relationships, installed networks, innovative and reliable products, services and price.

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For 2005, we expect overall revenue growth over 2004 primarily due to:

	•		continued growth in our voice over packet technologies and our third generation wireless technologies;
	•		expansion and enhancement of existing networks by our customers due to subscriber growth and competitive pressures;
	•		build out of the Bharat Sanchar Nigram Limited, or BSNL, contract in the Asia Pacific region;
	•		anticipated growth in our Enterprise Networks business, particularly in our converged networks products;
	•		expected continued growth in metro optical and carrier Voice over IP; and
	•		expected focus on new product areas, such as, Wireless Local Area Networks, or WLAN, and carrier routing.

Revenue growth generated from spending by our customers in the above areas of our business is expected to be partially offset by revenue declines from customers limiting their investments in mature technologies as they focus on maximizing return on invested capital. In addition, we expect to continue to experience pricing pressures on sales of certain of our products as a result of increased competition, particularly from low cost suppliers. We also anticipate declines in revenue due to consolidation of service providers which may reduce overall spending on telecom equipment. Further, while customer support generally remains strong, the ongoing restatement activities and the internal restructuring and realignment programs initiated in August 2004 had an adverse impact on business performance in 2004 and will continue to have an adverse impact into 2005.

Nortel 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 our and NNC’s Boards of Directors, or the Audit Committee, initiated an independent review of the facts and circumstances leading to the First Restatement, or the Independent Review, and engaged the law firm now known as Wilmer Cutler Pickering Hale & Dorr LLP, or WCPHD, to advise it in connection with the Independent Review. The Audit Committee sought to gain a full understanding of the events that caused significant excess liabilities to be maintained on the balance sheet that needed to be restated, and to recommend that our Board of Directors adopt, and direct management to implement, necessary remedial measures to address personnel, controls, compliance and discipline. In January 2005, the Audit Committee reported the findings of the Independent Review, together with its recommendations for governing principles for remedial measures that were developed for the Audit Committee by WCPHD. Each of our and NNC’s Boards of Directors has adopted these recommendations in their entirety and directed our management to develop a detailed plan and timetable for their implementation, and will monitor their implementation.

As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns identified by WCPHD regarding provisioning activity and to review certain provision releases. That examination, and other errors identified by management, led to the restatement of our financial statements for the years ended December 31, 2002 and 2001 and the quarters ended March 31, 2003 and 2002, June 30, 2003 and 2002 and September 30, 2003 and 2002, or the Second Restatement, and our revision of previously announced unaudited results for the year ended December 31, 2003. The need for the Second Restatement resulted in delays in filing our and NNC’s 2003 Annual Reports on Form 10-K for the year ended December 31, 2003, or the 2003 Annual Reports, our and NNC’s 2004 Annual Report on Form 10-K for the year ended December 31, 2004, or the 2004 Annual Reports, and our and NNC’s Quarterly Reports on Form 10-Q for the first, second and third quarters of 2004, or the 2004 Quarterly Reports, and is expected to result in a delay in filing our and NNC’s Quarterly Reports on Form 10-Q for the first quarter of 2005, or the 2005 First Quarter Reports beyond the SEC’s required filing dates. We refer to the 2003 Annual Reports, the 2004 Annual Reports, and the 2004 Quarterly Reports together as the Reports.

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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 is reviewing the facts and circumstances leading to the restatement of these revenues for specific transactions identified in the Second Restatement. This review has a particular emphasis on the underlying conduct that led to the initial recognition of these revenues. The Audit Committee is seeking 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:

•		Over the course of the Second Restatement process, we and our independent auditors identified a number of material weaknesses in our internal control over financial reporting (all but one of which continued to exist as of December 31, 2004). See the “Controls and Procedures” section of this report. Further, 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 areas 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’s financial accounting situation. In addition, numerous class action complaints have been filed against Nortel, including class action complaints under the Employee Retirement Income Security Act, or ERISA. In addition, a derivative action complaint has been filed against Nortel. See “Contingencies” in note 20 in the accompanying consolidated financial statements.
•		As a result of the delayed filing of our Reports, we and NNC were not in compliance with our obligations to deliver the Reports under our and NNC’s public debt indentures and were required to seek waivers from Export Development Corporation, or EDC, under the EDC Support Facility. The waivers also applied to certain related breaches under the EDC Support Facility, or the Related Breaches. If we and NNC fail to file the 2005 First Quarter Reports by May 31, 2005, EDC will have the right (absent a further waiver) to terminate the EDC Support Facility, exercise certain rights against collateral or require us to cash collateralize all existing support. In addition, the Related Breaches will continue beyond the filing of the 2004 Annual Reports and the 2005 First Quarter Reports. With the filing of the 2004 Annual Reports with the SEC and the delivery of the 2004 Annual Reports to the trustees under our and NNC’s public debt indentures, we and NNC will be in compliance with our delivery obligations under the indentures. However, as a result of the expected delay in filing the 2005 First Quarter Reports, we and NNC may not be in compliance with our obligations to deliver the 2005 First Quarter Reports to the trustees under our and NNC’s public debt indentures if such reports are filed after May 25, 2005. 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 “Developments in 2004 and 2005” and “Liquidity and capital resources” in the MD&A section of this report.

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•		The OSC issued an order prohibiting all trading by directors, officers and certain current and former employees in the securities of Nortel Networks Corporation and NNL. The order remains in effect until two full business days following the receipt by the OSC of all filings required to be made by us and NNC pursuant to Ontario securities laws. Because such filings would require amendments to each of the quarterly periods of 2003 and for earlier periods including 2002 and 2001, which we do not believe to be feasible for the same reasons mentioned in the “Controls and Procedures” section of this report with respect to the restatement of 2000 selected financial data, we and NNC plan to apply to the OSC to have this order revoked once we and NNC have become current with our filing obligations for 2005 under Ontario securities laws. The OSC may, in its discretion, revoke the order where in its opinion to do so would not be prejudicial to the public interest.
•		We postponed our 2004 Annual Shareholders’ Meeting due to the delay in filing our 2003 financial statements. A combined 2004/2005 Annual Shareholders’ Meeting is scheduled to be held on June 29, 2005.
•		As a result of the delayed filing of certain of the Reports, NNC is in breach of the continued listing requirements of the Toronto Stock Exchange, or TSX, and the New York Stock Exchange, or NYSE. We and NNC continue to co-operate with the NYSE and the TSX concerning our and NNC’s delay in filing our financial reports. As of 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 and other of our or NNC’s listed securities. The commencement of any suspension or delisting procedure by either exchange remains, at all times, at the discretion of such exchange, and would be publicly announced by the exchange.
•		We suspended as of March 10, 2004: the purchase of Nortel Networks Corporation common shares under the stock purchase plans for eligible employees in eligible countries that facilitate the acquisition of Nortel Networks Corporation common shares; the exercise of outstanding options granted under Nortel Networks Corporation 2000 Stock Option Plan, or the 2000 Plan, and the Nortel Networks Corporation 1986 Stock Option Plan as amended and restated, or the 1986 Plan, or the grant of any additional options under those plans, or the exercise of outstanding options granted under employee stock option plans previously assumed by us in connection with mergers and acquisitions; and the purchase of units in a Nortel Networks stock fund or purchase of Nortel Networks Corporation common shares under our defined contribution and investment plans, until such time as, at the earliest, we are in compliance with U.S. and Canadian regulatory securities filing requirements.
•		On April 28, 2004, Standard and Poor’s, or S&P, downgraded its ratings on NNL, including its long-term corporate credit ratings from “B” to “B-” and its preferred shares ratings from “CCC” to “CCC-”. At the same time, it revised its outlook to developing from negative. On April 28, 2004, Moody’s Investor’s Service, Inc. changed its outlook to potential downgrade from uncertain. See “Liquidity and capital resources — Credit ratings” in the MD&A section of this report.

Strategic plan

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

	•		a renewed commitment to best corporate practices and ethical conduct, including the establishment of the office of a chief ethics and compliance officer;
	•		a streamlined organizational structure to reflect alignment with carrier converged networks;

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	•		an increased focus on the enterprise market and customers;
	•		optimized research and development programs for highly secure, available and reliable converged networks;
	•		the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;
	•		the establishment of a chief marketing officer to drive overall marketing strategy;
	•		the strategic review of embedded services to assess opportunities in the professional services business; and
	•		a distinct focus on government and defense customers.

We provided further details concerning the strategic plan on September 30, 2004 and December 14, 2004.

Our strategic plan also includes a work plan involving focused workforce reductions, including a voluntary retirement program, of 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. Our workforce actions are focused to disproportionately protect customer and sales facing roles as well as continue our focus on new innovative solutions. We anticipate cost savings of approximately $500 million in 2005 related to this work plan partially offset by planned investments in certain strategic areas such as the finance organization.

In 2005, we are focusing on regions and networking solutions that we believe will be areas of potential growth and importance to our customers. On a regional basis, we see potential significant growth opportunities in emerging markets such as China and India. Evidence of our focus on these emerging market opportunities include our contract with BSNL to establish a wireless network in India, our investment in Sasken Communication Technologies Ltd. of India to develop new software and deploy our networking equipment and our planned joint venture with China Putian Corporation. Globally, we believe security and reliability for service provider networks are increasingly important to governments, defense interests and enterprises around the world.

Other business developments

We engaged in a number of activities in 2004 and into 2005, 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:

	•		announcing the planned divestiture of substantially all of our remaining manufacturing operations to Flextronics International Ltd., or Flextronics;
	•		contributing certain assets and liabilities of our directory and operator services business in return for a 24% interest in VoltDelta, Resources LLC;
	•		entering into a memorandum of understanding with LG Electronics to establish a joint venture for providing high quality, leading edge telecommunications equipment and networking solutions to Korea and other markets globally; and
	•		announcing that Nortel Networks Inc., our wholly owned subsidiary had entered into an agreement with PEC Solutions, Inc., or PEC, providing for the acquisition of all of the outstanding shares of PEC subject to certain conditions, including the successful completion of a tender offer and regulatory approvals.

For information on these and other developments in 2004, see “Special charges” in note 6, “Acquisitions, divestitures and closures” in note 9, “Long-term debt, credit and support facilities” in note 10 and “Subsequent events” in note 21 of the accompanying consolidated financial statements and “Developments in 2004 and 2005” in the MD&A section of this report.

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Networking solutions

Networking

In our industry, networking refers to:

	•		the connecting of two or more communications devices, such as telephones and personal computers, across short or long distances to create a “network”;
	•		the connecting of two or more networks; or
	•		the connecting of equipment used in a network.

Network components

A telecommunications network generally consists of equipment and software that enable network access, core networking and network services. Network access equipment and software enables information to enter or exit a network, and resides with or near an end-user of the network. Network access can be obtained through the use of either wireline cable (such as fiber optic, copper wire or coaxial) or wireless radio signals.

Core networking equipment and software direct, route or “switch” the data, voice and multimedia communications signals from one part of the network to another. Core network equipment and software also transport communications signals to and from network access equipment and other core networking equipment located in another location. These functions are carried out primarily through the use of routers, circuit and packet switches, and fiber optic technologies.

Network services consist of various user capabilities that are enabled through the use of software elements in a network. User capabilities may be configured to extend throughout the network and include features such as location-based services, security services, calling features and multimedia services. Network services can be personalized to suit the user’s needs and to support various applications.

Networking solutions

Our networking solutions include network equipment, software and other technologies that enable communications between two or more points defining a network through the use of data, voice and multimedia networking. Our networking solutions may consist of a combination of products and services provided by our four reportable segments consisting of Wireless Networks, Enterprise Networks, Wireline Networks and Optical Networks. For a discussion of our recent establishment of a new organizational structure that includes, among other things, combining the businesses of our four segments into two business organizations, see “Business — Overview”.

Networking solutions can be circuit-based or packet-based. Our circuit-based networking solutions consist of technologies that require a separate network circuit to be maintained for each communications signal for the duration of the transmission. Our packet-based networking solutions consist of technologies which involve the conversion of a data, voice or multimedia communications signal into pieces, or “packets”, that are directed or routed through the network independently and then re-assembled at the destination. This enables large numbers of communications signals to be directed or routed simultaneously and more efficiently than in circuit networking. Our data networking solutions consist of products and services designed to enable the transportation of data information across a network. Our security solutions consist of products and services designed to ensure that information can be securely transported across a network and to prevent unauthorized users from being able to disrupt the network.

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Wireless Networks includes network access and core networking solutions for voice and data communications that span second and third generation wireless technologies and most major global standards for mobile networks. Enterprise Networks includes circuit and packet voice solutions, and data networking and security solutions used by our enterprise customers. Wireline Networks includes circuit and packet voice solutions, and data networking and security solutions used by our service provider customers. Optical Networks includes metropolitan, regional and long-haul optical transport and switching solutions and managed broadband services. Within each of our reportable segments, our networking solutions also consist of related professional services which may include: strategic planning, network design and engineering; network optimization; network operations planning and consulting; and installation and ongoing technical support.

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

Wireless Networks

Products

Wireless networking, also known as mobility networking, refers to communications networks that enable end-users to be mobile while they send and receive voice and data communications using wireless devices, such as cellular telephones, personal digital assistants and other computing and communications devices. These networks use specialized network access equipment and specialized core networking equipment that enable an end-user to be connected and identified when not in a fixed location. The technology for wireless communications networks has evolved and continues to evolve, through various technology “generations”.

Our existing wireless solutions span second and third generation wireless technologies and most major global digital standards for mobile networks. The majority of wireless communications networks existing today are still based on second generation, or 2G, wireless technologies, which consist of circuit switching technology with modest data transmission capabilities. However, third generation, or 3G, networks have been launched in several regions. 3G wireless technologies consist of packet networking technology with high-speed data, voice and multimedia transmission capabilities.

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

	•		Time Division Multiple Access, or TDMA, is a 2G wireless standard supported mainly in the United States, Canada and 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.
	•		UMTS is now a commercial standard for 3G networks based on Wideband CDMA, or WCDMA, technology. UMTS combines WCDMA-based radio access with packet switching technology to yield high capacity, high speed wireless networks for data, voice and multimedia communications.

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

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Network access

Radio network access equipment uses radio waves to provide wireless access to the subscriber’s device, enabling the wireless subscriber to connect to the network to send and receive data, voice and multimedia communications. The key network elements in radio access are base station transceivers or access points and base station/radio network controllers. We offer our customers a wide range of base station transceivers and base station controllers for all of the standards that we support.

Core networking

Core networking equipment directs, routes or “switches” communications signals within a service provider’s wireless communications network. The key network elements in the core part of a wireless communications network are mobile switching centers, home location registers and packet data serving nodes.

	•		Mobile switching centers direct or “switch” data, voice and multimedia communications signals from one network circuit to another and also support advanced voice services like 3-way calling, calling party number/name delivery, call holding and call redirection.
	•		A home location register is a database that contains subscriber data, such as provisioning and service information, and dynamic information, such as the wireless handset’s current location.
	•		Packet data serving nodes are hardware and software network equipment elements that aggregate and manage data communications between wireless subscriber devices and public/private data networks, such as the Internet. Packet data serving nodes deliver valuable network services including content-based billing, security, virtual private networks and quality of service.

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

Product development

Our wireless networking products in development include the next evolution of our CDMA 3G, GSM/GPRS/EDGE, WLAN and UMTS products.

	•		Our CDMA 3G 1xRTT products are generally available and have been deployed in several commercial networks in all our geographic regions. Our CDMA 3G 1xEV-DO product is currently being deployed by several large operators in the United States and Brazil and is generally available for commercial deployment. We are currently working with the various standards bodies to finalize the specifications for CDMA 3G 1xEV-DV.
	•		There are several GSM/GPRS/EDGE products that are being developed to allow GSM operators to offer higher data rates on existing GSM spectrum allocations. We have successfully completed customer trials of Adaptive MultiRate, or AMR, base station transceivers. AMR allows service providers to use the radio spectrum allocated to them more efficiently to support more customers on the same network.
	•		The enhanced version of our GSM base station controller, the GSM BSC 3000 (formerly, the BSCe3), became generally available for commercial deployment in 2003. Our EDGE base station transceivers, including both hardware and software, are generally available and are being deployed by several customers in the United States and Europe.
	•		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.

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	•		We are working at establishing strategic relationships with other companies for research, development and manufacture of equipment that conforms to the Chinese 3G TD-SCDMA standard.
	•		We continue to work on developing access technologies such as UMTS-HSDPA, or High Speed Downlink Packet Access, 1x-EV, or single channel Evolution, OFDM, or Orthogonal Frequency Division Multiplexing, and MIMO, or Multiple Input Multiple Output, antenna technologies to increase the speed and efficiency of broadband wireless access from 3G networks deployed today.
	•		Our Wireless Mesh Network solution, designed to allow our customers to reduce the costs of high-speed wireless data transport from wireless access networks to wired broadband networks, is now generally available and has been deployed in the United States and Asia Pacific.
	•		Our enterprise grade WLAN access products are generally available for commercial deployment by our wireless service provider customers.

Markets

We anticipate that demand for wireless networking equipment will be driven by continued subscriber and traffic growth, and the effectiveness of 2.5G and 3G wireless networking systems. There are two key aspects to the migration from 2G wireless communications technologies to 2.5G and 3G wireless communications technologies. The first is that all current 3G technologies, including CDMA 3G and UMTS, are based on spread spectrum technology. The second is that the migration from 2G to 2.5G and 3G technologies is largely based on a transition from circuit switching technologies in 2G core networks to packet-based networking technologies in 3G core networks. We believe that our extensive experience in deploying CDMA wireless communications networks, combined with our expertise in packet-based networking for wireline networks, will be a competitive strength during the migration from 2G wireless communications networks to 2.5G and 3G wireless communications networks.

Commercial CDMA 3G networks have been launched in the United States, Canada, CALA and the Asia Pacific region. CDMA networks operating in the 450 MHz radio spectrum are also expanding into Central and Eastern Europe. GPRS and UMTS networks have already been launched in EMEA, the Asia Pacific 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

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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’s consolidated revenues in 2004.

Competition

Our major competitors in the global wireless infrastructure business have traditionally included Telefonaktiebolaget LM Ericsson, Nokia Corporation, Siemens Aktiengesellschaft, Motorola, Inc. and Lucent Technologies Inc. Nokia and Siemens compete in the sale of GSM and UMTS equipment, whereas Lucent competes in the sale of CDMA and UMTS equipment. Motorola is a competitor in the sale of GSM, UMTS and CDMA equipment. Ericsson competes in the sale of equipment for all of the major wireless communications technologies. More recently, Samsung Electronics Co., Ltd. has emerged as a competitor in the sale of CDMA systems, and Huawei Technologies Co., Ltd. and ZTE Corporation have emerged as competitors for GSM, CDMA and UMTS systems in China and many other developing countries. NEC Corporation and Fujitsu Limited have emerged as competitors for UMTS equipment.

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

	•		technology leadership, product features and availability;
	•		product quality and reliability;
	•		conformity to existing and emerging regulatory and industry standards;
	•		warranty and customer support;
	•		price and cost of ownership;
	•		interoperability with other networking products;
	•		network management capabilities;
	•		traditional supplier relationships, particularly in EMEA and the Asia Pacific region;
	•		regulatory certification; and
	•		provision of customer financing.

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

Enterprise Networks

Products

Our Enterprise Networks solutions portfolio provides data, voice and multimedia communications solutions for our enterprise customers. We also provide our enterprise customers with related professional services.

Circuit and packet voice solutions

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

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	•		Our communications servers and remote gateway products provide converged data, voice and multimedia communications systems, using Voice over IP, or session initiation protocol, or SIP, for service providers and enterprises. SIP is a standard protocol for initiating an interactive user session that involves multimedia elements such as video, voice, chat, gaming and virtual reality. Our enterprise solutions can be used by customers building new networks and customers who want to transform their existing communications network into a more cost effective, packet-based network supporting data, voice and multimedia communications.
	•		Our customer premises-based circuit and packet telephone switching systems are designed for small, medium and large commercial enterprises and government agencies. These systems provide or can be configured with multiple applications, including voice communications features, such as voice messaging, call waiting and call forwarding, as well as advanced voice services, converged multimedia applications and other networking capabilities.
	•		Our customer contact center, messaging and interactive voice and web service solutions are advanced communications tools designed to work with our customer premises-based solutions. These tools enable employees to efficiently and productively communicate with business contacts and other employees regardless of where they are located, the applicable time zone or whether they choose to interact over the telephone or the Internet.

Data networking and security solutions

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

	•		Our data switches, secure routers and associated security products provide data switching designed to allow our customers to provide Internet data security and IP services including IP routing, virtual private networks, deep packet inspection, firewall applications, policy management and data traffic flow management. These products also enable our customers to manage and prioritize the Internet content that is provided to end-users and balance the amount of communications traffic on multiple Internet servers.
	•		Our Ethernet switch portfolio is a series of high performance packet switches for our enterprise customers’ small to large local area networks that use the Ethernet, a standard computer networking protocol for local area networks.
	•		Our multi-protocol routers offer high-speed, high-capacity and medium-capacity data switching to support a wide range of data communications technologies, including multi-protocol label switching, asynchronous transfer mode, IP and frame relay services. Our Ethernet routing switches deliver IP routing and switching.
	•		Our portfolio of WLAN service switching products is designed to provide secure and efficient transmission of WLAN data and voice traffic for mobile users. Our WLAN voice products integrate with our communications servers and gateway products to provide a wireless Voice over IP solution for our customers.
	•		Our portfolio of optical network switching products is designed to extend the range of storage area networks to enable our customers to consolidate their data servers. Our products enable enterprises to deploy these storage area networks in alternate locations, providing geographic redundancy as part of their business continuity strategy.

Product development

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

•

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

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	•		Additions to the applications in our communications server products to allow integration of Voice over IP, voice extensible markup language, new operating systems and servers, and voice recognition speech products.
	•		New developments in data networking products that will deliver resiliency, enable increased data network traffic and provide suitable service levels and network connectivity and power to devices over the same line.
	•		The development of the next generation web platform, which will feature higher performance, scalability (that is, the ability to grow a service or capability with incremental cost) and integrated applications.
	•		Enhancements to our security portfolio including the new secure sockets layer, or SSL, and switching products and a new high-end secure router product. In addition, we have entered into and continue to pursue strategic relationships that enhance our end-to-end security solutions.
	•		Updates to our customer premises-based telephone systems to support our software that enables those systems to function entirely as a packet-based system or as a hybrid packet and circuit switching system.

Markets

We offer Enterprise Networks products to enterprises around the world. With the growth of data, voice and multimedia communications over the public telephone network, the public Internet and private voice and data communications networks, there is an increasing opportunity to converge disparate networks towards a single, high performance network that can support various types of communications traffic and applications.

We believe that in order to meet the growing demand for increased capacity at lower per-minute rates, enterprises will transition their circuit-based voice communications to more cost effective packet-based technologies. As a result, 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 is increasing.

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 traditional 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, as well as system integrators, also act as distribution channels for our Enterprise Networks sales. None of our Enterprise Networks customers represented more than 10% of Nortel’s consolidated revenues in 2004.

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Competition

Our principal competitors in the sale of our Enterprise Networks solutions are Cisco Systems, Inc., Avaya Inc., Siemens, Alcatel S.A., and NEC Corporation. Avaya is our largest competitor in the sale of voice equipment while Cisco is our largest competitor in the sale of data networking equipment to enterprises. We also compete with smaller companies that address specific niches, such as Juniper Networks, Inc., 3Com Corporation, Foundry Networks, Inc., Extreme Networks, Inc. and Enterasys Networks, Inc. in data networking; and Mitel Networks Corporation in Internet-based voice communications solutions. We expect competition to remain intense as enterprises look for ways to maximize the effectiveness of their existing networks while reducing ongoing capital expenditures and operating costs.

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

	•		technology leadership, product features and availability;
	•		product quality and reliability;
	•		conformity to existing and emerging regulatory and industry standards;
	•		sales distribution and channel marketing strategy;
	•		warranty and customer support;
	•		price and cost of ownership;
	•		interoperability with other networking products;
	•		installed base of product;
	•		alternative solutions offered to enterprises by service providers;
	•		the leveraging of existing customer-supplier relationships; and
	•		the availability of distribution channels.

Wireline Networks

Products

Our Wireline Networks portfolio addresses the demand by our service provider customers for cost efficient data, voice and multimedia communications solutions. Our wireline solutions, including related professional services, simplify network architectures by bringing data, voice, multimedia and emerging broadband applications for revenue generating services together on one packet network.

Circuit and packet voice solutions

We are a leader in the development and deployment of highly scalable circuit switched and secure voice over packet solutions such as Voice over IP for wireline and wireless service providers around the world. Our voice over packet solutions offer service providers opportunities for new revenue sources and sustainable operating and capital cost reduction, as well as high levels of reliability and network resiliency. Our solutions include the following:

•

Our wireline voice over packet network solutions for service providers, which include softswitches and media gateways. The portfolio provides the complete range of voice over packet solutions, including local, toll, long-distance and international gateway capabilities, and enables voice applications to run on the new multi-service 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 as well as call control and call management services. The portfolio consists of a SIP-based application server that can enable an interactive user session involving multimedia elements. For example, users are provided with the flexibility 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.

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•

Our portfolio of digital, circuit-based telephone switches provides local, toll, long-distance and international gateway capabilities for service providers. These systems enable service providers to connect end-users making local and long-distance telephone calls. These 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 our digital, circuit-based telephone switch portfolios with third party vendors including infrastructure and application companies.

•

Our Converged Multimedia Services (CMS) solution comprised of a new portfolio of networking equipment compliant with the emerging IP Multimedia Subsystem (IMS) standard. Available for GSM/UMTS customers in the second half of 2005, the solution is designed to enable fixed, mobile and cable operators to create a converged core network and rapidly deploy a wide variety of new services. The CMS solution currently is in trial in multiple countries in Europe.

These solutions work alone or in combination with each other to provide traditional voice services, advanced packet voice services and enhanced multimedia services to service providers around the world.

Data networking and security solutions

We offer a wide range of data networking (packet switching and routing) solutions to our service provider customers. Our wide area network, or WAN, solutions and IP service routers enable our service provider customers to offer connectivity solutions and high value services to both enterprises and residential customers. Connectivity solutions include packet services such as: frame relay; Asynchronous Transfer Mode, or ATM; Ethernet; and IP access for digital subscriber line and cable users. High-value services, such as IP virtual private networks, enable an enterprise to connect with other enterprise sites and remote users and to securely connect with business partners. These high-value services also provide enhanced network capabilities, such as network security, network address translation and class of service, that enable service providers to offer a wide range of networking services beyond basic connection to the network. In 2004, we announced a new multiservice provider edge networking device that allows service providers to converge multiple networks at the network edge to enable the delivery of voice, data, multimedia and wireless services over a single, converged network. When we refer to the network edge, we are referring to the point at which access networks meet the core network.

Product development

Research and development investments are focused on creating new and improving existing, packet-based residential and business services for wireline and wireless service providers. Also, we continue to develop products that support the evolution of data, voice and multimedia communications systems toward converged or combined voice and data networks, including:

•

Enhancements to our voice over packet solutions that will allow service providers to connect any business telephone system, using standard Voice over IP protocols, into a common dialing plan with connectivity to the public switched telephone network. Additional enhancements to our packet voice solutions will continue to focus on interoperability with other manufacturers’ equipment, including gateway and integrated access device manufacturers, as well as on meeting the needs of the Asian and European markets. We continue to make improvements to our softswitch portfolio by utilizing the latest commercial technology to provide our customers with converged wireline and wireless service support, superior application choices, integrated network management and linear scalable capacity.

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•

Enhancements to 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 multimedia communications applications.

•

Additions to the digital, circuit-based telephone switch portfolio that will allow service providers to offer and manage IP voice and multimedia (Centrex IP) services to those businesses that use traditional business telephones as well as businesses that use next generation telephones designed for use in IP networks.

•

Enhancements to our IP services router that enable an increase in the number of residential subscribers and virtual private network sites that can be supported, and the amount of bandwidth that can be applied to an enterprise site. Development will also focus on enhancing the ability of our service provider customers to provide additional revenue-generating services.

•

A focus on cable standards compliance to enhance our solutions for the cable operator markets in the United States, Canada and EMEA, including support for the open cable standard protocol for cable media gateways.

•

Enhancements to our WAN switch portfolio to improve interoperability with other vendors’ products. In addition, development will focus on enhancing the migration to converged networks which simultaneously support data, voice and multimedia.

•

Continued development of a multiservice provider edge networking device designed to converge multiple communications services operating at the IP or multi-protocol label switching network edge. This device is currently undergoing customer trials and is not yet generally available. As well, we continue to develop enhancements to our existing line of WAN switch and IP service router products that are intended to efficiently aggregate different types of data traffic at the network edge.

•

Continued integration of a service provider core network router into our voice over packet portfolio to enable us to provide a complete end-to-end solution.

Markets

With the growth of data, voice and multimedia communications over the public telephone network, the public Internet and private voice and data communications networks, there is an increasing opportunity to converge disparate networks towards a single, high performance packet network that can support most 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-enabled 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 traditional 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. As a result of this increased competitive pressure as well as regulatory changes, the pace of consolidation among service providers in the United States has increased.

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The market for our Wireline Networks products is global. Service providers are expected over the long term to continue to modernize with packet-based networks and converge voice and data communications networks in order to deploy new revenue-generating service offerings. We anticipate an increased emphasis by service providers towards end-user networks in addition to their efforts to modernize the inter-connection of those networks. In EMEA, we also continue to see market demand for certain networking products, including equipment for Voice over IP and equipment for virtual private networking. In EMEA, we anticipate continued opportunities with alternate operators, cable operators and wireless operators and anticipate new opportunities in emerging markets.

In the Asia Pacific region, we continue to see market demand for certain networking products, including equipment for Voice over IP and multimedia services and equipment for virtual private networking. Deregulation in China has created opportunities for new entrants who are building out their networks with packet-based technologies. In CALA, service providers are also focused on implementing Voice over IP technology to enable opportunities for additional growth, network efficiency and revenue-generating services. There is also a growing demand for voice over IP technology among cable operators in CALA.

Customers

We offer our Wireline Networks products and services to a wide range of service providers including local and long distance telephone companies, wireless and cable operators, as well as other communication 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’s consolidated revenues in 2004.

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:

•

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.

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Competition remains intense as a result of reduced investment in existing traditional networks by service providers, the continued consolidation in the service provider industry, and the continued focus by suppliers on growing revenue in new broadband and IP technologies.

Optical Networks

Products

Our Optical Networks solutions portfolio addresses the varying optical communication needs of service providers and enterprises. Optical networks transport data, voice and multimedia communications within and between cities, countries or continents by transmitting communications signals in the form of light waves through fiber optic cables. Optical networking is the most common method for transporting communications signals between the various locations within a service provider’s network and is unmatched for delivering vast amounts of data reliably and cost-effectively with service and bandwidth flexibility and scalability.

Our optical networking solutions are designed to provide metropolitan, regional and long-haul, high-capacity transport and switching of data, voice and multimedia communications signals. These solutions include photonic Coarse/Dense Wavelength Division Multiplexing, or C/DWDM, transmission solutions, synchronous optical transmission solutions, optical switching solutions and network management and intelligence software. We also offer our customers a variety of related professional services. Our solutions include the following:

•

Our photonic networking C/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 wavelength division multiplexing, or WDM, series provides networking solutions within a city or region for up to 600 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, CALA 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.

Our Optical Networks solutions enable customers to enhance and transform their networks towards a scalable and reliable network for delivering diverse high speed data and voice communication services. Such network transformation is expected to increase deployment of managed broadband services, such as:

•

Optical Ethernet solutions that combine the strengths of the Ethernet network computing protocol with those of optical communications. Optical Ethernet solutions transport communications signals carrying Ethernet packets in the form of light waves through fiber optic cables between locations within a city or between cities.

•

Optical storage connectivity solutions, which allow the interconnection of data centers for the efficient preservation and sharing of business-critical data to ensure business continuity and disaster recovery.

•

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

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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 C/DWDM systems and our optical long-haul and regional line and terminal solutions. We have:

•

introduced advanced metro optical network products enabling the convergence of multiple platforms onto a single architecture, lowering network costs, enhancing functionality and delivering consistent service quality and scalability to meet varying enterprise needs;

•

enhanced the capabilities of our existing metro optical network products to enable new storage area solutions that address emerging enterprise business continuity requirements;

•

implemented mesh restoration capabilities on the optical switching platform; and

•

introduced a new regional/long-haul product that utilizes photonic networking DWDM technology, which assists customers in lowering their network costs by providing improved optical performance.

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

•

enhancing our optical Ethernet portfolio by introducing new Ethernet switching and transport capabilities designed to improve the productivity of our enterprise customers and the services offered by our service provider customers;

•

providing flexibility, simplicity and automation enhancements to our common photonic layer product that facilitate the deployment and operation of regional and long-haul optical links;

•

offering solutions which enhance value from optical solutions for end users, i.e. in our metro edge and metro access solutions; and

•

investing in improving the density, capacity and flexibility of our optical transmission systems.

We also continue to invest in core technologies, such as efficient service adaptation, aggregation, switching and management, that enable our customers worldwide to deploy innovative optical networking services 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.

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The market for our Optical Networks solutions is global. In the United States and Canada, new networks are not currently being built by service providers in anticipation of market demand, but are instead being built to more closely align with actual end-user demand. Several service providers in the United States have announced plans to deploy optical fiber networks to allow access to these networks by residential end-users. Within EMEA, the building of pan-European optical networks by service providers is now mature and many service providers have begun to focus on building their metropolitan and regional optical networks. We expect that the increased usage of broadband wireless data provided by 3G networks may eventually drive the increased deployment of optical networks. The demand for additional and enhanced services by enterprises is increasing in Europe and may also encourage service providers to invest in the creation of networks that offer services such as optical Ethernet and storage connectivity. In EMEA, European government-sponsored service providers and networking equipment suppliers enjoy favorable positions within many European countries.

In the Asia Pacific region, the industry is continuing to develop and may provide a significant market for new optical networking equipment over the next several years. As a result, there has been an increased focus on the Asia Pacific region by virtually all suppliers of optical networking equipment. Similar to what is occurring in Europe within the EMEA region, the Asia Pacific region may experience increased demand for additional and enhanced services by enterprises which may encourage service providers to invest in the creation of networks that offer services such as optical Ethernet and storage connectivity. In CALA, where a few service providers account for a significant percentage of the industry, the building of national optical network infrastructures is largely complete.

Customers

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

We are also focused on enterprises and we continue to provide optical solutions for private enterprise networking and also for service providers to build and operate custom dedicated and shared networks for enterprises. We leverage numerous distribution 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’s consolidated revenues in 2004.

Competition

Our major competitors in the sale of optical networking equipment include Alcatel, Lucent, Siemens, Fujitsu Limited, Marconi plc, Cisco, Huawei, NEC, Ciena and ADVA International Inc. Market position in the global market for optical networking equipment can fluctuate significantly on a quarter-by-quarter basis. However, we continue to be a leading global provider of optical networking equipment. No one competitor is dominant in the optical networking equipment market.

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

•

technology leadership, product features and availability;

•

product quality and reliability;

•

conformity to existing and emerging regulatory and industry standards;

•

warranty and customer support;

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•

price and cost of ownership;

•

interoperability with other networking products;

•

network management capabilities;

•

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

•

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

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

Sales and distribution

All of our reportable segments use the Nortel direct sales force to market and sell to customers around the world. The Nortel 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 $4.1 billion as of December 31, 2004. 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 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.”

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The operations of our service provider customers are subject to extensive country-specific telecommunications regulations. In the United States, on February 20, 2003, the FCC announced a decision in its triennial review proceeding of the agency’s rules regarding unbundled network elements. The text of the FCC’s order and reasons for the decision were released on August 21, 2003. The FCC decision, subsequent judicial review of the decision, FCC adoption of interim rules and subsequent adoption of new unbundling rules with an effective date of March 11, 2005 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’s 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. The transfer of the optical design operations and related assets in Ottawa, Canada and Monkstown, Northern Ireland closed in the fourth quarter of 2004. In the first quarter of 2005, we completed the portion of the transaction related to the manufacturing activities in Montreal, Canada. We previously reported that the portion of the transaction related to the manufacturing activities in Calgary, Canada is expected to close in the second quarter of 2005 and that the balance of the transaction is expected to close on separate dates occurring during the first half of 2005. We and Flextronics are currently discussing the timing of these transactions in order to optimize the business transition between the companies. As a result of these discussions, it is now expected that the balance of the transaction relating to the manufacturing operations in Chateaudun, France, Calgary and Monkstown will close by the end of the first quarter in 2006. As a result, we and Flextronics intend to enter into an amendment agreement to extend the term of the original agreement and offer to reflect this updated schedule. These transactions are subject to customary conditions and regulatory approvals. For recent developments in the evolution of our supply chain strategy, see “Developments in 2004 and 2005 — Evolution of our supply chain strategy” 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, 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.

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Through our existing manufacturing model, we are generally able to obtain sufficient materials and components from global sources to meet the needs of our four reportable segments. In each of our reportable segments, we:

•

make significant purchases of electronic components and assemblies, optical components, original equipment manufacturer, or OEM, products, software products, outsourced assemblies and other materials and components from many domestic and foreign sources;

•

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

•

occasionally maintain special inventories of components internally or request that they be maintained by suppliers to satisfy customer demand or to minimize effects of possible market shortages.

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 13 of the accompanying consolidated financial statements and “Developments in 2004 and 2005” and “Liquidity and capital resources — Uses of liquidity — Contractual cash obligations” in the MD&A section of this report.

Seasonality

In 2004, 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. Revenues in all of our segments in the fourth quarter of 2004 were highest compared to the other quarters in 2004. The quarterly profile of our business results in 2005 is not expected to be consistent across all of our reportable segments. We expect a seasonal decline in revenue in the first quarter of 2005 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” 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. As the information technology and communications markets converge, we expect that our rate of forming strategic alliances will increase in order to fill the need for complimentary technology and network integration skills.

While we did not make any material acquisitions 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.

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Our investment activity remained at a low level 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 2004 and 2005 — Other business developments” 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, 2004, we employed approximately 12,890 regular full-time research and development employees (excluding employees on notice of termination) including approximately:

•

5,000 regular full-time research and development employees in Canada;

•

4,550 regular full-time research and development employees in the United States;

•

2,140 regular full-time research and development employees in EMEA; and

•

1,200 regular full-time research and development employees in other countries.

In August and September 2004, we announced a strategic plan that included 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:

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Intellectual property

Our intellectual property is fundamental to Nortel and the business of each of our four reportable segments. In particular, our success is dependent upon our proprietary technology. We generate, maintain, utilize and enforce a substantial portfolio of intellectual property rights, including trademarks, and an extensive portfolio of patents covering significant innovations arising from research and development activities. In all of our reportable segments, we use our intellectual property rights to protect our investments in research and development activities, to strengthen our leadership positions, to protect our good name, to promote our brand name recognition, to enhance our competitiveness and to otherwise support our business goals and objectives. However, our intellectual property rights may be challenged, invalidated or circumvented, or fail to provide us with significant competitive advantages. See “Risk factors/forward looking statements” in the MD&A section of this report. The duration and level of protection of our intellectual property rights are dependent upon the laws and requirements of the jurisdictions providing or controlling those rights.

As of December 31, 2004, we and our parent, Nortel Networks Corporation, had on a consolidated basis, approximately:

•

3,500 United States patents;

•

2,200 patents in other countries; and

•

5,600 pending patent applications worldwide.

We were granted 520 United States patents in 2004.

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 trademarks and trade names, Nortel and Nortel Networks, are two of our most valuable assets. We sell our products primarily under the Nortel and Nortel Networks brand names. We have registered the Nortel and Nortel Networks trademarks, and many of our other trademarks, in countries around the world. As of December 31, 2004, we and our parent, Nortel Networks Corporation, owned on a consolidated basis approximately 100 registered trademarks in the United States, and approximately 1,985 registered trademarks in other countries. In addition, as of December 31, 2004, we had approximately 130 pending trademark registrations worldwide.

Employee relations

At December 31, 2004, we employed approximately 33,990 regular full-time employees (excluding employees on notice of termination), including approximately:

•

12,120 regular full-time employees in the United States;

•

8,990 regular full-time employees in Canada;

•

7,430 regular full-time employees in EMEA; and

•

5,450 regular full-time employees in other countries.

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

As part of our resizing activities to further reduce our cost structure and streamline operations, we notified for termination and provisioned for the exit of approximately 1,800 regular full-time employees during 2004. As well, divestitures and outsourcing affecting non-core businesses completed or entered into in 2004 resulted in additional reductions. On June 29, 2004, we announced that we had reached an agreement

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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 employees would transfer to Flextronics. Approximately 170 employees located in Ottawa and Monkstown were transferred in connection with the closing of the optical design business in the fourth quarter of 2004. Approximately 910 employees located in Montreal were transferred in connection with the completion of the transaction related to the manufacturing activities in Montreal in the first quarter of 2005. The timing for the transfer of the remaining employees to Flextronics is under review.

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 6 of the accompanying consolidated financial statements and “Results of operations — continuing operations — Consolidated operating expenses — Special charges” in the MD&A section of this report.

At December 31, 2004, labor contracts covered approximately five percent of our employees worldwide. At the same date, five labor contracts covered approximately twelve percent of our employees in Canada including:

•

one labor contract covering approximately seven percent of Canadian unionized employees which expires in February, 2006;

•

one labor contract covering less than one percent of Canadian unionized employees which expires in August 2006;

•

one labor contract covering approximately nine percent of Canadian unionized employees which expires in 2014;

•

one labor contract covering approximately 68% of Canadian unionized employees which was renewed, ratified and became effective April 13, 2004; and

•

one labor contract covering approximately 15% of Canadian unionized employees which expires in 2008.

At December 31, 2004, 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. As the market continues to improve, we believe it will become increasingly important to our future success to recruit and retain skilled employees. During 2004, approximately 2,400 regular full-time employees were hired. See “Risk factors/forward looking statements” in the MD&A section of this report.

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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. Nortel is subject to new European 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 20 of the accompanying consolidated financial statements.

Financial information by operating segment and product category

For financial information by operating segment and product category, see “Segment information” in note 5 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 5 of the accompanying consolidated financial statements and “Results of operations — continuing operations - Geographic revenues” in the MD&A section of this report.

Working capital

For a discussion of our working capital practices, see “Long-term debt, credit and support facilities” in note 10 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.

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ITEM 2. Properties

At December 31, 2004, we operated 189 sites around the world occupying approximately 13.3 million square feet. The following table sets forth additional information regarding these sites:

*		Indicates the primary use of the site. A number of our sites are mixed-use facilities.
**		Excludes approximately 6.5 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, 2004 approximately 2.8 million square feet of such property was sub-leased.

At December 31, 2004, our facilities were primarily used, on a consolidated basis, approximately as follows:

•

20% by Wireless Networks;

•

10% by Enterprise Networks;

•

10% by Wireline Networks;

•

5% by Optical Networks;

•

25% by global operations; and

•

30% by one or more of our reporting segments and/or corporate facilities.

In 2004, 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. 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 6 and “Long-term debt, credit and support facilities” in note 10 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 10, “Subsequent events” in note 21 and “Supplemental consolidating financial information” in note 23 of the accompanying consolidated financial statements and “Developments in 2004 and 2005 — Credit facilities and security agreements” and “Liquidity and capital resources — Sources of liquidity — Available support facility” in the MD&A section of this report.

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ITEM 3.

Legal Proceedings

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

A class action lawsuit against NNC was also filed in the U.S. District Court for the Southern District of New York on behalf of shareholders who acquired the securities of JDS between January 18, 2001 and February 15, 2001, alleging violations of the same U.S. federal securities laws as the above-noted lawsuits.

On April 1, 2002, NNC filed a motion to dismiss both the above consolidated U.S. shareholder class action and the above JDS shareholder class action complaints on the grounds that they failed to state a cause of action under U.S. federal securities laws. With respect to the JDS shareholder class action complaint, NNC also moved to dismiss on the separate basis that JDS shareholders lacked standing to sue NNC. On January 3, 2003, the District Court granted the motion to dismiss the JDS shareholder class action complaint and denied the motion to dismiss the consolidated U.S. class action complaint. Plaintiffs appealed the dismissal of the JDS shareholder class action complaint. On November 19, 2003, oral argument was held before the U.S. Court of Appeals for 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. On January 10, 2005, the U.S. Supreme Court denied the petition for writ of certiorari. 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 NNC, certain of its current and former officers and directors and its auditors as defendants. The factual allegations in the Ontario Claim are substantially similar to the allegations in the consolidated amended complaint filed in the U.S. District Court described above. The Ontario Claim is on behalf of all Canadian residents who purchased Nortel Networks Corporation securities (including options on Nortel Networks Corporation securities) between October 24, 2000 and February 15, 2001. The plaintiffs claim damages of Canadian $5,000, plus punitive damages in the amount of Canadian $1,000, prejudgment and postjudgment interest and costs of the action. On September 23, 2003, the Court issued an order allowing the plaintiffs to proceed to amend the Ontario Claim and requiring that the plaintiffs serve class certification materials by December 15, 2003. On September 24, 2003, the plaintiffs filed a notice of discontinuance of the original action filed in Ontario. On December 12, 2003, plaintiffs’ counsel requested an extension of time to January 21, 2004 to deliver class certification materials. On January 21, 2004, plaintiffs’ counsel advised the Court that the two representative plaintiffs in the action no longer wished to proceed, but

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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 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 U.S. District Court for 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 U.S. District Court for the Middle District of Tennessee (the “Consolidated ERISA Action”). On September 12, 2003, the plaintiffs in all the actions filed a consolidated class action complaint. On October 28, 2003, the defendants filed a motion to dismiss the complaint and a motion to stay discovery pending disposition of the motion to dismiss. On March 30, 2004, the plaintiffs filed a motion for certification of a class consisting of participants in, or beneficiaries of, the Plan who held shares of the NNC Stock Fund during the period from March 7, 2000 through March 31, 2001. On April 27, 2004, the Court granted the defendants’ motion to stay discovery pending resolution of defendants’ motion to dismiss. On June 15, 2004, the plaintiffs filed a First Amended Consolidated Class Action Complaint that added additional current and former officers and employees as defendants and expanded the purported class period to extend from March 7, 2000 through to June 15, 2004.

On March 4, 1997, Bay Networks, Inc. (“Bay Networks”), a company acquired on August 31, 1998, announced that shareholders had filed two separate lawsuits in the U.S. District Court for the Northern District of California (the “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

30

Court of Appeal reversed the trial court’s dismissal of the intervenor-plaintiffs’ class allegations. On September 3, 2003, the defendants filed a petition for review with the California Supreme Court seeking permission to appeal the Court of Appeal decision. On October 22, 2003, the California Supreme Court denied, without opinion, the defendants’ petition for review. On December 22, 2003, the plaintiffs served their motion for certification of a class of purchasers of Bay Networks’ common shares from July 25, 1995 through to October 14, 1996. Hearing of the plaintiffs’ motion for class certification was held on May 4, 2004. On July 27, 2004, the Court entered an Amended Order Denying Motion of Intervenor Plaintiffs for Class Certification and Setting Further Hearing. On August 9, 2004, the intervenor-plaintiffs obtained Court approval to dismiss their claims and this action and, on September 30, 2004, the Court entered dismissal with prejudice of the entire action of all parties and all causes of action.

Subsequent to the March 10, 2004 announcement in which NNC indicated it was likely that it and Nortel would need to revise their previously announced unaudited results for the year ended December 31, 2003, and the results reported in certain of their quarterly reports for 2003, and to restate their previously filed financial results for one or more earlier periods, NNC and certain of its then current and former officers and directors were named as defendants in 27 purported class action lawsuits. These lawsuits in the U.S. District Court for the Southern District of New York on behalf of shareholders who acquired Nortel Networks Corporation securities as early as February 16, 2001 and as late as May 15, 2004, allege, among other things, violations of U.S. federal securities laws. These matters are also the subject of investigations by Canadian and U.S. securities regulatory and criminal investigative authorities. 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 January 18, 2005, the lead plaintiffs, NNC, and the Audit Committee Defendants reached an agreement in which NNC would withdraw its motion to dismiss and plaintiffs would dismiss Count II of the complaint which asserts a claim against the Audit Committee Defendants.

On April 5, 2004, NNC announced that the SEC had issued a formal order of investigation in connection with NNC’s previous restatement of its financial results for certain periods, as announced in October 2003, and NNC announcements in March 2004 regarding the likely need to revise certain previously announced results and restate previously filed financial results for one or more periods. The matter had been the subject of an informal SEC inquiry. On April 13, 2004, NNC announced that it had received a letter from the staff of the Ontario Securities Commission (“OSC”) advising that there is an OSC Enforcement Staff investigation into the same matters that are the subject of the SEC investigation.

On May 14, 2004, NNC announced that it had received a federal grand jury subpoena for the production of certain documents, including financial statements and corporate, personnel and accounting records, in connection with an ongoing criminal investigation being conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division.

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 individuals who were 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 January 3, 2005, this action was received in the U.S. District Court for the Middle District of Tennessee and consolidated with the Consolidated ERISA Action described above.

On July 28, 2004, Nortel and NNC, and certain directors and officers, and certain former directors and officers, of Nortel and NNC, were named as defendants in a purported class proceeding in the Ontario Superior Court of Justice on behalf of shareholders who acquired Nortel Networks Corporation securities as early as November 12, 2002 and as late as July 28, 2004. This lawsuit alleges, among other things, breaches of trust and fiduciary duty, oppressive conduct and misappropriation of corporate assets and trust property in respect of the payment of cash bonuses to executives, officers and employees in 2003 and 2004 under the NNC Return to Profitability bonus program and seeks damages of Canadian $250 and an order under the Canada Business Corporations Act directing that an investigation be made respecting these bonus payments.

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On July 30, 2004, a shareholders’ derivative complaint was filed in the U.S. District Court for the Southern District of New York against certain directors and officers, and certain former directors and officers, of NNC alleging, among other things, breach of fiduciary duties owed to NNC during the period from 2000 to 2003 including by causing NNC to engage in unlawful conduct or failing to prevent such conduct; causing NNC to issue false statements; and violating the law. On February 14, 2005, the defendants filed a motion to dismiss the derivative complaint.

On August 16, 2004, NNC received a letter from the Integrated Market Enforcement Team of the Royal Canadian Mounted Police (“RCMP”) advising NNC that the RCMP would be commencing a criminal investigation into Nortel’s financial accounting situation.

On February 16, 2005, a motion for authorization to institute a class action on behalf of residents of Québec, who purchased NNC securities between January 29, 2004 and March 15, 2004, was filed in the Québec Superior Court naming NNC as a defendant. The motion alleges that NNC made misrepresentations about 2003 financial results.

On March 9, 2005, Nortel and NNC, and certain of its current and former officers and directors and its auditors were named as defendants in a purported class action proceeding filed in the Ontario Superior Court of Justice, Commercial List, on behalf of all Canadian residents who purchased Nortel Networks Corporation securities from April 24, 2003 to April 27, 2004. This lawsuit alleges, among other things, negligence, misrepresentations, oppressive conduct, insider trading and violations of Canadian corporation and competition laws in connection with NNC’s 2003 financial results and seeks damages of Canadian $3,000, plus punitive damages in the amount of Canadian $1,000, prejudgment and postjudgment interest and costs of the action.

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

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

Nortel is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to Nortel 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 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. Nortel, or NNC, as applicable, and any named directors and officers of Nortel, or NNC, as applicable, intend to vigorously defend these actions, suits, claims and proceedings. Nortel will continue to cooperate fully with all authorities in connection with the regulatory and criminal investigations.

Environmental matters

Nortel’s operations are subject to a wide range of environmental laws in various jurisdictions around the world. Nortel seeks to operate its business in compliance with such laws. In 2004, Nortel became 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 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 will not be required to incur such costs in the future. Nortel has a corporate environmental management system standard and an environmental program to promote such compliance. Moreover, Nortel has a periodic, risk-based, integrated environment, health and safety audit program.

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Nortel’s environmental program focuses its activities on design for the environment, supply chain and packaging reduction issues. Nortel works with its suppliers and other external groups to encourage the sharing of non-proprietary information on environmental research.

Nortel 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, 2004, the accruals on the consolidated balance sheet for environmental matters were $31. Based on information available as of December 31, 2004, 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.

Nortel has remedial activities under way at 12 sites which are either currently or previously owned or occupied facilities. An estimate of Nortel’s 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 $31.

Nortel 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’s 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 $31 referred to above.

Liability under CERCLA may be imposed on a joint and several basis, without regard to the extent of Nortel’s involvement. In addition, the accuracy of Nortel’s 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’s liability could be greater than its current estimate.

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PART II

ITEM 5.

Market for the Registrant’s Common Equity and Related Stockholder Matters

The common shares of the Company are no longer listed and posted for trading on any stock exchange. Nortel Networks Corporation is the sole holder of 100% of the issued and outstanding common shares of the Company. The common shares of Nortel Networks Corporation are listed and posted for trading on the New York Stock Exchange in the United States and on the Toronto Stock Exchange in Canada.

Securities authorized for issuance under equity compensation plans

Not applicable.

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PART II

ITEM 6.	Selected Financial Data

The selected financial data presented below was derived from Nortel Networks Limited’s (“Nortel”) 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, 2002, 2001 and 2000 and summarized results of operations data for the year ended December 31, 2001. Readers should note the following information regarding the selected financial data presented below.

As reported in its 2003 Annual Report on Form 10-K, Nortel restated its 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. Except for selected balance sheet data as of December 31, 2000, financial data for the year ended December 31, 2000 has not been restated or presented in the selected financial data presented below. Due to the identified material weaknesses in Nortel’s internal control over financial reporting, significant turnover in Nortel’s 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 has determined that extensive additional efforts over an extended period of time would have been required to restate its 2000 selected financial data. See Controls and Procedures — Second Restatement — Use of Estimates in Financial Reporting; Omissions of 2000 Selected Financial Data” section of this report. Nortel also believes that selected financial data for this period would not be meaningful to investors due to the significant industry adjustment in the telecommunications industry beginning in 2001, which significantly impacted Nortel’s 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 should not be relied upon.

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See notes 3, 6 and 9 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.

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ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations — Table of Contents

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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. A number of our and Nortel Networks Corporation’s past filings with the United States Securities and Exchange Commission, or SEC, remain subject to ongoing review by the SEC’s Division of Corporation Finance. 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 factors/forward looking statements”. All dollar amounts in this MD&A are in millions of United States, or U.S., dollars unless otherwise stated.

Where we say “we”, “us”, “our” or “Nortel”, we mean Nortel Networks Limited or Nortel Networks Limited and its subsidiaries, as applicable, and where we refer to the “industry”, we mean the telecommunications industry.

Business overview

Our business

Nortel 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 Internet Protocol, or VoIP, multimedia services and applications, and wireless broadband solutions designed to help people solve the world’s greatest challenges. Our networking solutions consist of hardware, software and services. 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 making strategic investments in 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 believe our acknowledged strength is strong customer loyalty as a result of providing value to our customers through high reliability networks, a commitment to ongoing support and an evolution of solutions as technology advancements in the products are made.

We are the principal direct operating subsidiary of Nortel Networks Corporation, or NNC. NNC holds all of our outstanding common shares but none of our outstanding preferred shares. NNC’s common shares are publicly traded on the New York Stock Exchange, or NYSE, and Toronto Stock Exchange, or TSX under the symbol “NT”. Our cumulative Redeemable Class A Preferred Shares Series 5 and Non-cumulative Redeemable Class A Preferred Shares Series 7 are traded on the TSX under the symbols NTL.PR.F and NTL.PR.G, respectively. Acquisitions involving any share consideration are completed by NNC, while acquisitions involving only cash consideration are generally completed by Nortel.

Our segments

During 2004, our operations were organized into four reportable segments as follows:

	•		Wireless Networks — Our Wireless Networks segment provides communications network solutions that enable our wireless service provider customers to offer their customers, the subscribers for wireless communication services, the ability 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 segment consists of Code Division Multiple Access, or CDMA, Global System for Mobile communications, or GSM, Time Division Multiple Access, or TDMA, and Universal Mobile Telecommunications Systems, or UMTS, products.
	•		Enterprise Networks — Our Enterprise Networks segment provides data, voice and multimedia communications solutions to 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. Our Enterprise Networks segment consists of: (i) circuit and packet voice solutions and (ii) data networking and security solutions.

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	•		Wireline Networks — Our Wireline Networks segment provides data, voice and multimedia communications solutions to service providers that operate wireline networks. Our service provider customers include local and long distance telephone companies, wireless service providers, cable operators and other communication service providers. Our Wireline Networks segment consists of: (i) circuit and packet voice solutions and (ii) data networking and security solutions.
	•		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 customers include local and long-distance telephone companies, wireless service providers, cable operators and other communications service providers. Our Optical Networks segment consists of long-haul and metropolitan optical products.

Commencing in the second quarter of 2004, the primary financial measure used by the chief executive officer, or CEO, in assessing performance and allocating resources to the segments was management earnings (loss) before income taxes, or Management EBT. This measure includes the cost of revenues, selling, general and administrative, or SG&A, expense, 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.

Effective October 1, 2004, we established a new streamlined organizational structure that included, among other things, combining the businesses of our four reportable segments into two business organizations: (i) Carrier Networks and Global Operations, and (ii) Enterprise Networks. We have reviewed the impact of these changes on our reportable segments and concluded that, although certain structural changes were made to reflect this reorganization effective October 1, 2004, we did not meet the criteria to change our reportable segments under Statement of Financial Accounting Standards, or SFAS, No. 131, “Disclosures about Segments of an Enterprise and Related Information” for the 2004 fiscal year. Our operating results on a segmented basis for the new business organizations were not available for review by our chief operating decision maker, as a significant amount of our finance resources were allocated to our restatement activity discussed in greater detail under “Developments in 2004 and 2005”.

These two business organizations include four operating segments. The four operating segments are Carrier Packet Networks, which is substantially an amalgamation of our previous Wireline Networks and Optical Networks businesses; CDMA Networks, which was previously part of Wireless Networks; GSM and UMTS Networks which was also previously part of Wireless Networks; and Enterprise Networks, which remains substantially unchanged from the previous organization. For the first quarter of 2005 these four operating segments will become our reportable segments.

Our business environment

In 2004, there was increased spending in the industry compared to 2003 by both service provider and enterprise customers as certain service provider customers began to expand and upgrade their existing networks, including next generation wireless technologies and VoIP solutions. This increase in industry spending was strongest with the build-out of new technologies in both established and emerging markets and with the build-out of traditional technologies in emerging markets. In 2005, we expect that these trends will continue; however, the rate of increase may be slower.

Although there was increased spending in the industry by both service provider and enterprise customers in 2004, we experienced a decline in revenue compared to 2003. There was decreased spending on our overall traditional technologies as customers continued to transition to next generation technologies. This decreased spending on traditional technologies outpaced the increased spending on new technologies with many of our customers realigning capital spending with their current levels of earnings in order to maximize their return on invested capital. 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. However, based on current customer orders in emerging markets, particularly in Asia and the Caribbean and Latin America region, or CALA, and increased deployments of VoIP and next generation wireless technologies, including UMTS, we believe that we are well positioned to grow our revenues in 2005. For example, throughout 2004 and into 2005 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 and new network build-outs were started in emerging markets.

In 2005, we expect increased consolidation of certain service providers, particularly in the U.S. We expect this trend to result in a net reduction in customer spending as these service providers focus on improving the efficiency of their combined networks rather than network expansion. Competition in the industry remains strong and our traditional large competitors, newer competitors, particularly from China, and certain smaller niche competitors continue to increase their market share and create pricing and margin pressures. We and our competitors remain focused on certain key factors such as customer relationships, installed networks, innovative and reliable products, services and price.

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As first announced on August 19, 2004, we put in place a new strategic plan that recognizes our business environment and the evolution of the converged network (see “Business overview — Our strategic plan and outlook”). We are currently in a challenging transitional period as we implement the new strategic plan. 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.

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 International Ltd., or Flextronics, regarding the divestiture of substantially all of our remaining manufacturing operations. 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 revenues, 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.

In May 2003, we commenced certain balance sheet reviews at the direction of certain members of former management that led to a comprehensive review and analysis of our assets and liabilities, or the Comprehensive Review, which resulted in the restatement (effected in December 2003) of our consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the quarters ended March 31, 2003 and June 30, 2003, or the First Restatement. In late October 2003, the Audit Committees of our and NNC’s Boards of Directors, or the Audit Committee, initiated an independent review of the facts and circumstances leading to the First Restatement, or the Independent Review, and engaged the law firm now known as Wilmer Cutler Pickering Hale & Dorr LLP, or WCPHD, to advise it in connection with the Independent Review. The Audit Committee sought to gain a full understanding of the events that caused significant excess liabilities to be maintained on the balance sheet that needed to be restated, and to recommend that our Board of Directors adopt, and direct management to implement, necessary remedial measures to address personnel, controls, compliance and discipline. In January 2005, the Audit Committee reported the findings of the Independent Review, together with its recommendations for governing principles for remedial measures that were developed for the Audit Committee by WCPHD. Each of our and NNC’s Boards of Directors has adopted these recommendations in their entirety and directed our management to develop a detailed plan and timetable for their implementation, and will monitor their implementation. The “Summary of Findings and of Recommended Remedial Measures of the Independent Review” is set forth in full in Item 9A of our and NNC’s 2003 Annual Reports on Form 10-K, or the 2003 Annual Reports.

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 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 the 2003 Annual Reports, our and NNC’s 2004 Annual Reports on Form 10-K for the year ended December 31, 2004, or the 2004 Annual Reports, and our and NNC’s Quarterly Reports on Form 10-Q for the first, second and third quarters of 2004, or the 2004 Quarterly Reports, and is expected to result in a delay in filing our and NNC’s Quarterly Reports on Form 10-Q for the first quarter of 2005, or the 2005 First Quarter Reports, beyond the SEC’s required filing dates. We refer to the 2003 Annual Reports, the 2004 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 is reviewing the facts and circumstances leading to the restatement of these revenues for specific transactions identified in the Second Restatement. This review has a particular emphasis on the underlying conduct that led to the initial recognition of these revenues. The Audit Committee is seeking 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.”

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Over the course of the Second Restatement process, we and our independent auditors identified a number of material weaknesses in our internal control over financial reporting (all but one of which continued to exist as of December 31, 2004). See the “Controls and Procedures” section of this report. 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 have made a number of recent appointments that are intended to enhance and complement our senior executive team. These appointments included the new roles of chief operating officer, chief marketing officer, chief strategy officer, chief ethics and compliance officer and chief research officer and a new chief technology officer to lead the strategic vision for our product and technology portfolio.

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 are driving our business forward on a platform of integrity with a focus on cash, costs and revenues as strategic goals. We remain committed to our business strategy of technology and solutions evolution in helping our customers transform their networks and implement new applications and services to drive improved productivity, reduced costs and revenue growth.

The principal components of the strategic plan are:

	•		a renewed commitment to best corporate practices and ethical conduct, including the establishment of the office of a chief ethics and compliance officer;
	•		a streamlined organizational structure to reflect alignment with carrier converged networks;
	•		an increased focus on the enterprise market and customers;
	•		optimized R&D programs for highly secure, available and reliable converged networks;
	•		the establishment of a chief strategy officer to drive partnerships, new markets and acquisitions;
	•		the establishment of a chief marketing officer to drive overall marketing strategy;
	•		the strategic review of embedded services to assess opportunities in the professional services business; and
	•		a distinct focus on government and defense customers.

Our strategic plan also includes a work plan involving focused workforce reductions, including a voluntary retirement program, of 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. Our workforce actions are focused to disproportionately protect customer and sales facing roles as well as continue our focus on new innovative solutions. We anticipate cost savings of approximately $500 in 2005 related to this work plan, partially offset by planned investments in certain strategic areas such as the finance organization.

For further information related to our work plan, see “Results of operations — Continuing operations — Consolidated operating expenses — Special charges”.

In 2005, we are focusing on regions and networking solutions that we believe will be areas of potential growth and importance to our customers. On a regional basis, we see potential significant growth opportunities in emerging markets such as China and India. Evidence of our focus on these emerging market opportunities includes our contract with Bharat Sanchar Nigram Limited, or BSNL, to establish a wireless network in India, our investment in Sasken Communication Technologies Ltd. of India to develop new software and deploy our networking equipment and our planned joint venture with China Putian Corporation. Globally, we believe security and reliability for service provider networks are increasingly important to governments, defense interests and enterprises around the world.

In 2005, we expect our Management EBT to increase as compared to 2004 primarily due to expected higher revenues, the

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impact of cost savings generated by our work plan, and lower costs resulting from the substantial completion of our restatement activities. We expect that the increase will be partially offset by increased investment costs in certain parts of the business and accruals for expected employee bonuses for 2005 which were not incurred in 2004. The expected increase in Management EBT is also expected to be partially offset by increased special charges in 2005 compared to 2004 associated with our work plan and an expected absence of gain on sale of businesses and assets and income tax recoveries that were included in our 2004 results.

For the first quarter of 2005, we expect modest growth in revenues compared to the first quarter of 2004, gross margins to be in the range of 40 to 44 percent of revenue, operating expenses to increase slightly compared to the first quarter of 2004 and an ending cash balance of approximately $3,500.

How we measure performance

Our 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. In 2004, each reportable segment was managed separately with each segment manager reporting directly or indirectly to the CEO. The CEO relies on the information derived directly from our management reporting system. Commencing in the second quarter of 2004, in conjunction with the appointment of William A. Owens as our president and chief executive officer, the primary financial measure used by the CEO in assessing performance and allocating resources to the segments was Management EBT. This primary financial measure replaced contribution margin, the previously disclosed primary financial measure used for earlier periods. See “Segment information — General description” in note 5 of the accompanying consolidated financial statements.

Each reportable segment is also allocated resources and assets based on whether projected customer demand would support additional investment. We make adjustments to resources and assets within a reportable segment in response to market conditions or where opportunities for improved efficiencies present themselves. Working capital for each segment is primarily managed by our regional finance organization which manages accounts receivable performance and by our global operations organization which manages inventory and accounts payable. Our other significant assets including cash and cash equivalents, deferred income taxes, goodwill and a significant portion of plant and equipment that relate to real estate and information systems infrastructure are managed at a corporate level and are not allocated to or managed by our segments.

Our financial targets focus on cash, costs and revenue. We expect to achieve targeted improvements in cash flow from operations by driving improved earnings performance and working capital management. We measure working capital performance through the use of working capital metrics (see “Liquidity and capital resources — cash flows”). In particular, we are focused on improvements in accounts receivable performance and levels of inventory.

We have also set targets for cost reductions that include reducing our operating expenditures, which is our combined SG&A and R&D spending, as a percentage of revenue. We are also focused on maximizing cost effectiveness as we continue to experience pricing pressures for many of our products. We expect operating expenses as a percent of revenue to trend towards the low 30’s by the end of 2005 primarily driven by benefits from our previously announced restructuring work plan and reductions in restatement, accounting and reporting costs. We have implemented a variety of programs to drive lower costs including our work plan which targets a reduction of approximately 3,250 employees and cost savings of approximately $500 on an annual basis. Our model of outsourced manufacturing, including our agreement with Flextronics, is important to maximizing our long term cost effectiveness.

As a global supplier in the communications equipment market, one of the keys to our long term success is revenue growth. In addition to efficiently providing global sales and support and product development, it is important that we maintain or gain market share for us to be viewed by our customers as a long term, innovative networking solutions supplier. We are focusing on government, security and services to drive revenue growth as evidenced by our recent announcement of our planned acquisition of PEC Solutions, Inc., or PEC.

In addition to the above financial measures, we also monitor performance in the following areas: status with our key customers on a global basis; the achievement of expected milestones of our key R&D projects; and the achievement of our key strategic initiatives. In an effort to ensure we are creating value for our customers and maintaining strong relationships with those customers, we monitor our project implementation, customer service levels and the status of key contracts. We also conduct regular customer satisfaction and loyalty surveys to monitor customer relationships. With respect to our R&D projects, we measure content, quality and timeliness versus project plans. Our key strategic initiatives include our finance transformation project which will include, among other things, implementing a new information technology program (SAP) to provide an integrated global financial system; our supply chain evolution strategy with Flextronics; planned new joint ventures in Asia; and improvements in the effectiveness of our strategic alliances.

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Developments in 2004 and 2005

2004 consolidated results summary

Summary of consolidated statements of operations data:

Our revenues declined by approximately 4% in 2004 compared to 2003 and declined by approximately 7% in 2003 compared to 2002. In 2004 compared to 2003, revenues declined across all segments with the exception of Wireless Networks which increased 10%. In 2004, our consolidated revenues were $2,615 in the fourth quarter, $2,179 in the third quarter, $2,590 in the second quarter and $2,444 in the first quarter, with the fourth quarter generally being our strongest quarter of the year. Wireless Networks continues to be our largest segment, with revenues of $4,839 representing 49% of our 2004 consolidated revenues, compared to revenues of $4,389 representing 43% of our 2003 consolidated revenues.

Our gross margin decreased slightly to 42% in 2004 compared to 43% in 2003. The slight decrease was primarily due to pricing pressures on certain of our products due to increased competition, unfavorable product mix, an estimated project loss of approximately $160 recorded in 2004 related to a wireless network contract with BSNL in India that we entered into in August 2004 and lower sales volume. This was partially offset by continued improvements in our cost structure, lower inventory and warranty provisions and decreased expenses related to our employee bonus plans in 2004. For further information related to the BSNL contract, see “Other business developments — Bharat Sanchar Nigram Limited”.

SG&A expense increased by 3% as a percentage of revenues in 2004 compared to 2003 primarily due to increased costs related to our restatement activities, unfavorable foreign exchange rate fluctuation impacts associated with the strengthening of the Canadian dollar, euro and British pound against the U.S. dollar, increased employee related expenses and lower net trade and customer financing receivable recoveries in 2004.

R&D expense increased by approximately 1% as a percentage of revenues in 2004 compared to 2003 primarily due to unfavorable foreign exchange impacts, partially offset by the continued impact of our workforce reductions.

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Special charges decreased substantially in 2004 compared to 2003 because a substantial portion of activities associated with our restructuring work plan initiated in 2001 has been completed. These activities included workforce reductions, contract settlements and facility closures. This was partially offset by special charges associated with the implementation of our new strategic plan, including a new restructuring work plan initiated in 2004. For further information related to our 2004 work plan, see “Results of Operations — continuing operations — Consolidated operating expenses — Special charges”.

Gain on sale of businesses and assets was $98 in 2004 compared to $4 in 2003. The $98 gain was primarily due to a gain of approximately $30 related to the sale of our directory and operator services, or DOS, business to VoltDelta Resources LLC, or VoltDelta, and a gain of $78 related to the sale of certain assets in CALA.

Our discontinued operations contributed $49 of net earnings in 2004 compared to $184 of net earnings in 2003. The $49 of net earnings was primarily the result of a customer financing agreement that was restructured and a gain related to the reassessment of our remaining provisions for discontinued operations in 2004. For further information related to discontinued operations, see “Results of Operations — discontinued operations”.

We reported net earnings before cumulative effect of accounting changes of $107 in 2004 compared to net earnings before cumulative effect of accounting changes of $614 in 2003 primarily due to the factors mentioned above.

We record any material adjustments identified before the applicable financial statements are published and consider the materiality of any adjustments relating to prior periods both to the current period and to the prior periods. In the course of the preparation of our 2004 financial statements, and in part as a result of the application of our compensating procedures and processes, we have recorded adjustments related to prior periods which are included in our 2004 financial statements. These adjustments include, among other items, an Asia Optical revenue deferral of approximately $80 and a Brazil foreign exchange gain of approximately $32, both of which were recorded in the third quarter of 2004. We also recorded a revenue deferral of approximately $50 in the fourth quarter of 2004 related to an EMEA Wireless contract, which revenue was previously recognized primarily in 2002 and 2003. We determined that this revenue should have been deferred and recognized upon delivery of the undelivered elements such as services and/or hardware. The aggregate impact of the adjustments relating to prior periods to our 2004 results was not material to our financial statements or to any individual segment or geographic region, and resulted in a net reduction of approximately $60 to our net earnings (loss), primarily driven by a net reduction of approximately $60 in our 2004 gross profit of $4,100. These adjustments were immaterial to our 2003, 2002 and prior year results.

Nortel Audit Committee Independent Review; restatements; related matters

Comprehensive Review and First Restatement

In May 2003, we commenced certain balance sheet reviews at the direction of certain members of former management that led to the Comprehensive Review, which resulted in the First Restatement. See the “Controls and Procedures” section of this report.

In connection with the Comprehensive Review, Deloitte & Touche LLP, or Deloitte, our independent auditors, informed the Audit Committee on July 24, 2003 of a “reportable condition” that did not constitute a “material weakness” in our internal control over financial reporting (throughout this report with respect to dates and periods ended before December 31, 2004, “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, which are applicable for 2003; with respect to dates and periods ending on or after December 31, 2004, “material weakness” has the meaning set forth under Public Company Accounting Oversight Board Auditing Standard No. 2 throughout this report). Later, on November 18, 2003, as part of the communications by Deloitte to the Audit Committee with respect to Deloitte’s interim audit procedures for the year ended December 31, 2003, Deloitte informed the Audit Committee that it had identified certain reportable conditions, each of which constituted a material weakness in our internal control over financial reporting. These material weaknesses identified in the First Restatement were also later identified in connection with the Second Restatement together with certain additional material weaknesses in our internal control over financial reporting, as described in greater detail in the “Controls and Procedures” section of this report.

Independent Review

In late October 2003, the Audit Committee initiated, 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 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 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.

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Second Restatement

As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns identified by WCPHD regarding provisioning activity and to review provision releases, down to a low threshold. That examination, and other errors identified by management, led to the Second Restatement. On January 11, 2005, we filed our 2003 Annual Report on Form 10-K in which we restated our results for the years ended December 31, 2002 and 2001. For more information regarding the Second Restatement, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2003 Annual Reports, Item 9A of the 2003 Annual Reports and note 3 to the consolidated financial statements that accompany the 2003 Annual Reports.

Material weaknesses in internal control over financial reporting

As described above and in the “Controls and Procedures” section of this report, two material weaknesses in our internal control over financial reporting were identified at the time of the First Restatement. Over the course of the Second Restatement process, we and Deloitte 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. On January 10, 2005, Deloitte confirmed to the Audit Committee the material weaknesses listed below:

	•		lack of compliance with written Nortel 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 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, “Foreign Currency Translation”, or 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 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 in the 2003 Annual Reports, 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”.

The first five of these six material weaknesses continued to exist at December 31, 2004. We continue to identify, develop and implement remedial measures to address these material weaknesses in our internal control over financial reporting, as described in the “Controls and Procedures” section of this report.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, management has assessed our internal control over financial reporting as at December 31, 2004, using the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, in Internal Control-Integrated Framework. Based on that assessment, management determined that the first five of the six material weaknesses listed above continued to exist as at December 31, 2004. Because of these material weaknesses, management believes that, as at December 31, 2004, we did not maintain effective internal control over financial reporting based on the COSO criteria. Our independent auditors have issued an attestation report with respect to that assessment and conclusion.

Management also determined, based on that assessment, that the sixth material weakness, relating to an inappropriate ‘tone at the top’, was eliminated as at December 31, 2004 as a result of certain modifications to our internal control over financial reporting, remedial measures and other actions. See the “Controls and Procedures” section of this report.

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Revenue Independent Review

Over the course of the Second Restatement process, management identified certain accounting practices that it determined should be adjusted as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and undertook a process of revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit Committee is reviewing the facts and circumstances leading to the restatement of these revenues for specific transactions identified in the Second Restatement. The review has a particular emphasis on the underlying conduct that led to the initial recognition of these revenues. The Audit Committee is seeking 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, or the Revenue Independent Review.

Personnel actions

In connection with the Independent Review, we have, among other actions, terminated for cause:

	•		our former president and chief executive officer, former chief financial officer and former controller in April 2004 (the former chief financial officer and former controller having been placed on paid leaves of absence in March 2004); and
	•		seven additional senior finance employees with, or who had, significant responsibilities for our financial reporting as a whole or for their respective business units and geographic regions in August 2004.

Each of these former members of management had responsibility for their respective positions at the time of the Comprehensive Review and First Restatement. The Board of Directors determined that each of these individuals had significant responsibilities for our financial reporting as a whole, or for their respective business units and geographic regions, and that each was aware, or ought to have been aware, that our provisioning activity, described above, did not comply with U.S. GAAP.

We have demanded repayment by the individuals terminated for cause of payments made under our bonus plans in respect of 2003. We have commenced litigation against our former president and chief executive officer, former chief financial officer and former controller seeking the return of those payments made to them.

EDC Support Facility

The delayed filing of the Reports with the SEC, the trustees under our and NNC’s public debt indentures and Export Development Canada, or EDC, gave EDC the right to (i) terminate its commitments under the $750 EDC support facility, or the EDC Support Facility, relating to certain of our performance related obligations arising out of normal course business activities, and (ii) exercise certain rights against the collateral pledged under related security agreements or require us to cash collateralize all existing support.

Throughout 2004 and into 2005, we obtained waivers from EDC with respect to these matters to permit continued access to the EDC Support Facility in accordance with its terms while we and NNC worked to complete our filing obligations. The waivers also applied to certain related breaches under the EDC Support Facility relating to the delayed filings and the restatements and revisions to our and NNC’s prior financial results, or the Related Breaches. In connection with such waivers, EDC reclassified the previously committed $300 revolving small bond sub-facility of the EDC Support Facility as uncommitted support during the applicable waiver period. The $300 revolving small bond sub-facility will not become committed support until all delayed filings have been filed with the SEC, the trustees under our and NNC’s public debt indentures and EDC and we obtain a permanent waiver of the Related Breaches.

We and NNC expect that the filing of the 2005 First Quarter Reports will be delayed and expect to file the 2005 First Quarter Reports by the end of May 2005. On April 29, 2005, we obtained a new waiver from EDC of certain defaults and related breaches by us under the EDC Support Facility. The new waiver remains in effect until the earliest of certain events including the date on which we and NNC have filed the 2004 Annual Reports and the 2005 First Quarter Reports, or May 31, 2005. If we and NNC fail to file the 2005 First Quarter Reports by May 31, 2005, EDC will have the right (absent a further waiver) to terminate the EDC Support Facility, exercise certain rights against collateral or require us to cash collateralize all existing support. In addition, the Related Breaches will continue beyond the filing of the 2004 Annual Reports and the 2005 First Quarter Reports. Accordingly, beginning on the earlier of the date upon which we and NNC file the 2004 Annual Reports and the 2005 First Quarter Reports with the SEC and May 31, 2005, EDC will have the right to terminate or suspend the EDC Support Facility notwithstanding the filing of the 2004 Annual Reports and the 2005 First Quarter Reports. While we intend to seek a permanent waiver from EDC in connection with the Related Breaches, there can be no assurance that we will receive any waiver or as to the terms of any such waiver.

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As of April 15, 2005, there was approximately $223 of outstanding support utilized under the EDC Support Facility, approximately $155 of which was outstanding under the small bond sub-facility. See “Available support facility” and “Risk factors/forward looking statements”.

Credit facilities and security agreements

On April 28, 2004, we notified the lenders under our and Nortel Networks Inc., or NNI, $750 April 2000 five year credit facilities, or the Five Year Facilities, that we were 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 our inability to file our 2003 Annual Report on Form 10-K by April 29, 2004. Upon termination, the Five Year Facilities were undrawn.

As a result of the termination of the Five Year Facilities, certain foreign security agreements entered into by us and various of our subsidiaries, under which shares of certain of our subsidiaries incorporated outside of the U.S. and Canada were pledged in favor of the banks under the Five Year Facilities, EDC and the holders of our and NNC’s outstanding public debt securities, also terminated in accordance with their terms (see note 23 of the accompanying consolidated financial statements). In addition, guarantees by certain subsidiaries of ours incorporated outside of the U.S. and Canada terminated in accordance with their terms. Security agreements remain in place under which substantially all of our assets located in the U.S. and Canada and those of most of our U.S. and Canadian subsidiaries, including the shares of certain of our U.S. and Canadian subsidiaries, are pledged in favor of EDC and the holders of our and NNC’s outstanding public debt securities. In addition, the guarantees by certain of our wholly owned subsidiaries, including NNI, most of our Canadian subsidiaries, Nortel Networks (Asia) Limited, Nortel Networks (Ireland) Limited and Nortel Networks U.K. Limited, of our obligations under the EDC Support Facility and our and NNC’s outstanding public debt securities, remain in place. See “Liquidity and capital resources”.

Debt securities

With the filing of the 2004 Annual Reports with the SEC and the delivery of the 2004 Annual Reports to the trustees under our and NNC’s public debt indentures, we and NNC will be in compliance with our delivery obligations under the public debt indentures.

However, as a result of the expected delay in filing the 2005 First Quarter Reports, we and NNC may not be in compliance with our obligations to deliver the 2005 First Quarter Reports to the trustees under our and NNC’s public debt indentures if such reports are filed after May 25, 2005. Any non-compliance with the delivery obligations under the public debt indentures with respect to the 2005 First Quarter Reports will not result in an automatic event of default and acceleration of the outstanding long-term debt of NNC and us and such default and acceleration could not occur unless notice of such non-compliance from holders of 25% of the outstanding principal amount of any relevant series of debt securities is provided to us or NNC, as applicable, and we or NNC, as applicable, failed to deliver the 2005 First Quarter Reports 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 as a result of the delayed filing of the Reports, neither we nor NNC has received such a notice to the date of this report. If notice were given and acceleration of our and NNC’s debt securities were to occur, we may be unable to meet our payment obligations. If notice with respect to the delayed filing of the 2005 First Quarter Reports were given, we believe that it is probable that we and NNC would file and deliver the 2005 First Quarter Reports within 90 days of receipt of such a notice.

Shelf registration statement

Owing to the delayed filing of the Reports and the expected delay in filing the 2005 First Quarter 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 on May 13, 2002 for various types of securities. After we have become current and timely with our SEC filings for a period of twelve months, we will again become eligible for short form shelf registration with the SEC. See “Liquidity and capital resources” and “Risk factors/forward looking statements”.

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Credit ratings

On April 28, 2004, Standard and Poor’s, or S&P, downgraded its ratings on us, including our long-term corporate credit ratings from “B” to “B-” and our preferred shares rating from “CCC” to “CCC-”. At the same time, it revised its outlook to developing from negative. On April 28, 2004, Moody’s Investors Service, Inc., or Moody’s, changed its outlook to potential downgrade from uncertain. See “Liquidity and capital resources — Credit ratings” and “Risk factors/forward looking statements”.

Regulatory actions and pending litigation

We are under investigation by the SEC and the Ontario Securities Commission, or OSC, Enforcement Staff. In addition, Nortel has received a U.S. federal grand jury subpoena for the production of certain documents sought in connection with an ongoing criminal investigation being conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division. Further, the Integrated Market Enforcement Team of the Royal Canadian Mounted Police, or RCMP, has advised us that it would be commencing a criminal investigation into our financial accounting situation. We will continue to cooperate fully with all authorities in connection with these investigations and reviews. See “Legal proceedings” and “Risk factors/forward looking statements”.

In addition, numerous class action complaints have been filed against us and NNC, including class action complaints under the Employee Retirement Income Security Act, or ERISA. In addition, a derivative action complaint has been filed against NNC. These pending civil litigation actions and regulatory and criminal investigations are significant and if decided against us, could materially adversely affect our results of operations, financial condition and liquidity by requiring us to pay substantial judgments, settlements, fines or other penalties. See “Liquidity and capital resources”, “Legal proceedings” and “Risk factors/forward looking statements”.

On May 31, 2004, the OSC issued a final order prohibiting all trading by our directors, officers and certain current and former employees in the securities of Nortel Networks Corporation and Nortel Networks Limited. This order will remain in effect until two full business days following the receipt by the OSC of all filings required to be made by us and NNC pursuant to Ontario securities laws. Because such filing would require amendments to each of the quarterly periods of 2003 and for earlier periods including 2002 and 2001, which we do not believe to be feasible for the same reasons mentioned in the “Controls and Procedures” section of this report with respect to the restatement of 2000 selected financial data, we and NNC plan to apply to the OSC to have this order revoked once we and NNC have become current with our filing obligations for 2005 under Ontario securities law. The OSC may, in its discretion, revoke the order where in its opinion to do so would not be prejudicial to the public interest.

As a result of our delay in filing the Reports and the expected delay in filing the 2005 First Quarter Reports, we were and expect to be in breach of the continued listing requirements of the NYSE and TSX. We and NNC continue to co-operate with the NYSE and the TSX concerning our and NNC’s delay in filing our financial reports. As of 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 and other of our or NNC’s listed securities. The commencement of any suspension or delisting procedure by either exchange remains, at all times, at the discretion of such exchange, and would be publicly announced by the exchange. See “Risk factors/forward looking statements”.

Stock-based compensation plans

As a result of our March 10, 2004 announcement that we and NNC would need to delay the filing of our 2003 Annual Reports, we suspended as of March 10, 2004: the purchase of Nortel Networks Corporation common shares under the stock purchase plans for eligible employees in eligible countries that facilitate the acquisition of Nortel Networks Corporation common shares; the exercise of outstanding options granted under the Nortel Networks Corporation 2000 Stock Option Plan, or the 2000 Plan, or Nortel Networks Corporation 1986 Stock Option Plan as amended and restated, or the 1986 Plan, or the 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 stock fund or purchase of Nortel Networks Corporation common shares under our defined contribution and investments plans, until such time as, at the earliest, that we and NNC are in compliance with U.S. and Canadian regulatory securities filing requirements.

Due to the suspension of the stock purchase plans as referred to above, in lieu of the employer portion of stock purchase plan contributions, we made equivalent pre-tax payments to eligible employees during the year ended December 31, 2004 totaling $7, which were recorded as compensation expense.

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Evolution of our supply chain strategy

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 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 locations, 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 revenues) 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. In the first quarter of 2005, we completed the portion of the transaction related to the manufacturing activities in Montreal. We previously reported that the portion of the transaction related to the manufacturing activities in Calgary is expected to close in the second quarter of 2005 and that the balance of the transaction is expected to close on separate dates occurring during the first half of 2005. We and Flextronics are currently discussing the timing of the closing of the balance of the transaction in order to optimize the business transition between the companies. As a result of these discussions, it is now expected that the balance of the transaction, relating to the manufacturing operations in Chateaudun, Calgary and Monkstown, will close by the end of the first quarter of 2006. As a result, we and Flextronics intend to enter into an amendment agreement to extend the term of the original agreement and offer to reflect this updated schedule. 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. We previously announced that the estimated cash proceeds would be received substantially in 2005. We and Flextronics are currently discussing the timing of the cash payments based on the expected change to the original schedule. Such payments will be subject to a number of adjustments, including potential post-closing date asset valuations and potential post-closing indemnity payments. As of the first quarter of 2005, we have received proceeds of approximately $85. 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 allocation of proceeds related to this transaction will be subject to an assessment of fair values related to the separate components included therein. Direct transaction costs and other costs associated with transferring operations to Flextronics (including transition, potential severance, information technology implementation and real estate costs) are expected to be incurred. As at December 31, 2004, direct transaction costs of $10 have been deferred as other assets and will be recognized as a cost of the ultimate divestiture of the operations.

Other business developments

Directory and operator services business

On August 2, 2004, we completed the contribution of certain fixed assets, intangible assets including customer contracts, software and other licenses, and liabilities of our DOS business to VoltDelta, a wholly owned subsidiary of Volt Information Sciences, Inc., or VIS, in return for a 24 percent interest in VoltDelta which was valued at $57. 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. This non-monetary exchange has been recorded at fair value, and we recorded a gain of $30 within sale of businesses and assets during 2004. The purchased option was initially recorded at a fair value of $4 and is being assessed for impairment throughout the term until exercise or expiration occurs. The written option is being marked to market through other income (expense) - net each period until exercise or expiration occurs. As of December 31, 2004, the estimated fair value of the written option was $9, which has been recorded in accrued liabilities. We are providing certain transitional services to VoltDelta over a ten year period and the expected proceeds of $4 are being recognized on a straight-line basis over the service term into other income (expense) — net. We are accounting for our investment in VoltDelta under the equity method and our proportionate share of VoltDelta’s net earnings of $3 since August 2, 2004 has been included in equity in net earnings (loss) of associated companies during 2004.

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Bharat Sanchar Nigram Limited contract

In August 2004, we entered into a contract with BSNL to establish a wireless network in India which we expect to generate approximately $500 in revenues to be recognized substantially in 2005. We believe that this contract has strategic importance and we expect that it will position us to capitalize on India’s potentially significant future growth for our long term benefit. Our commitments to date for orders received as of December 31, 2004 under this contract have resulted in an estimated project loss of approximately $160, which has been recorded as a charge to cost of revenues and accrued within contractual liabilities in 2004. We expect to record an additional loss of approximately $35 in the first half of 2005 as a result of additional orders received in that period. The losses on this contract are primarily driven by the pricing pressures as a result of the competitive nature of India’s telecom market and also our start up costs to become a significant GSM vendor in this market. We believe that the revenue volumes driven by this contract will create cost reduction benefits for our overall GSM business.

In addition to the orders under the existing contract, BSNL may increase the amounts purchased under the contract up to an additional 50% of the existing contract level to allow for business expansion. We expect that there is the potential for further product losses, which will be determined by the product mix and magnitude of additional orders.

Joint Ventures

On January 20, 2005, we signed a Joint Venture Framework Agreement with China Putian Corporation to establish a joint venture for R&D, manufacture and sale of third generation (3G) mobile telecommunications equipment and products to customers in China. We expect to enter into a definitive joint venture agreement by June 30, 2005. We anticipate that we will own 49% of the joint venture and China Putian will own 51%.

On January 23, 2005, we signed a Memorandum of Understanding with LG Electronics to establish a joint venture for providing high quality, leading edge telecommunications equipment and networking solutions to Korea and other markets globally. The proposed joint venture is subject to execution of a definitive agreement. We expect to complete this transaction in the second half of 2005. We anticipate that we will own 50% plus one share of the joint venture.

Optical components operations

On December 2, 2004, we entered into a restructuring agreement with Bookham Technology plc, or Bookham, a sole supplier of key components of our Optical Networks business. See “Acquisitions, divestitures and closures” in note 9 of the accompanying consolidated financial statements. In February 2005, we agreed to waive for a period of time minimum cash balance requirements under certain Bookham notes and in March 2005, to adjust the prepayment provisions of these notes and to amend our supply agreement with Bookham to provide Bookham with financial flexibility to continue the supply of components for our Optical Networks products. See “Related party transactions” in note 19 of the accompanying consolidated financial statements.

Acquisitions

On April 26, 2005, we announced that Nortel Networks Inc., a wholly owned subsidiary of NNL had entered into an agreement with PEC, providing for the acquisition of all of the outstanding shares of PEC for $15.50 per share in cash, or approximately $448 million (net of cash acquired) in the aggregate, plus transaction costs and expenses. The acquisition is subject to certain conditions, including the successful completion of a tender offer and regulatory approvals. We currently expect to complete the acquisition during the second quarter of 2005.

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Results of operations — continuing operations

Consolidated revenues

The following chart summarizes our quarterly revenues for 2004 and 2003:

2004 vs. 2003

In 2004, there was increased spending in the industry compared to 2003 by both service provider and enterprise customers as certain service provider customers began to expand and upgrade their existing networks, including next generation wireless technologies and VoIP solutions. This increase in industry spending was strongest in the build-out of new technologies in both established and emerging markets and with the build-out of traditional technologies in emerging markets. Although there was increased spending in the industry by both service provider and enterprise customers we experienced a decline in revenue in 2004 compared to 2003. There was decreased spending on our overall traditional technologies as customers continued to transition to next generation technologies. This decreased spending on traditional technologies outpaced the increased spending on new technologies with many of our customers realigning capital spending with their current levels of earnings in order to maximize their return on invested capital. 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.

Our consolidated revenues decreased 4% in 2004 compared to 2003 primarily due to declines across all segments with the exception of Wireless Networks which increased 10%.

Wireless Networks revenues increased 10% in 2004 compared to 2003 primarily due to increased spending by our wireless service provider customers on our GSM and UMTS technologies as a result of new contracts with certain customers as they continue to transition to next generation technologies and other customers expanding their existing networks to meet increased subscriber demand or enhancing their networks to support more sophisticated communication services.

Enterprise Networks declined 9% in 2004 compared to 2003 primarily due to a substantial decline in revenues of our traditional circuit switching products and interactive voice response products. This substantial decline was primarily due to the recognition of revenues in 2003 deferred from prior periods that did not occur to the same extent in 2004 as described below under “Enterprise Networks revenues”. We also experienced declines in revenues associated with our legacy routing portfolio and associated declines in new service contracts and service contract renewals. In addition, we experienced a decline in revenue from certain of our data networking products primarily due to pricing pressures driven by increased competition.

Wireline Networks revenues declined 14% in 2004 compared to 2003 primarily due to a substantial decline in our traditional circuit switching revenues, which continued to decline at a faster rate than the growth in our next generation wireline technologies.

Optical Networks revenues declined 23% in 2004 compared to 2003 primarily due to a substantial decline in the optical long-haul portion of this segment due to reduced customer spending and ongoing pricing pressures. The revenues of the metro optical portion of this segment increased significantly and surpassed long-haul revenues in terms of volume in 2004. In addition, a substantial portion of the decline was due in part to a cumulative correction of revenues previously recognized primarily in 2001 and 2002 relating to the delivery of future contractual post-contract support, or PCS, and other services, as described below under “Optical Networks revenues”.

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2005

Although we experienced a decline in revenue in 2004 compared to 2003, based on current customer orders in emerging markets, particularly in Asia and CALA and increased deployments of VoIP and next generation wireless technologies, including UMTS, we believe that we are well positioned to grow our revenues in 2005. For example, throughout 2004 and into 2005, 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 and new network build-outs were started in emerging markets and as a result of new technologies.

For 2005, we expect overall revenue growth over 2004 primarily due to:

	•		continued growth in our voice over packet technologies and our third generation wireless technologies;
	•		expansion and enhancement of existing networks by our customers due to subscriber growth and competitive pressures;
	•		build-out of the BSNL contract in the Asia Pacific region. For further information related to the BSNL contract, see “Other business developments — Bharat Sanchar Nigram Limited”;
	•		anticipated growth in our Enterprise Networks business, particularly in our converged networks products;
	•		expected focus on new technologies that create opportunities to optimize existing networks while limiting capital expenditures and operating costs;
	•		expected continued growth in metro optical and carrier VoIP; and
	•		expected focus on new product areas, such as Wireless Local Area Networks, or WLAN, and carrier routing.

Revenue growth generated from spending by our customers in the above areas of our business is expected to be partially offset by revenue declines from:

	•		customers limiting their investment in mature technologies as they focus on maximizing return on invested capital;
	•		pricing pressures on sales of certain of our products as a result of increased competition, particularly from low cost suppliers;
	•		consolidation of service providers which may reduce overall spending on telecom equipment; and
	•		the impact of our financial restatement activities and the internal restructuring and realignment programs that were initiated in August 2004. For additional information, see “Business overview — Our business environment”. While customer support generally remains strong, we believe that these activities had an adverse impact on business performance in 2004 and will continue to have an adverse impact into 2005.

See “Risk factors/forward looking statements” for other factors that may affect our revenues.

Segment revenues

The following table summarizes our revenues for 2004, 2003 and 2002, by segment:

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Wireless Networks revenues

The following chart summarizes recent quarterly revenues for Wireless Networks:

2004 vs. 2003

Wireless Networks revenues increased 10% in 2004 compared to 2003 primarily due to increased spending by our service provider customers on our GSM and UMTS technologies. This was a result of new contracts with certain customers as they continued to transition to next generation technologies and other customers expanding their existing networks to meet increased subscriber demand or enhancing their networks to support more sophisticated communication services.

GSM revenues increased substantially in 2004 compared to 2003. The substantial increase was across all regions primarily as a result of new contracts with certain customers and other customers expanding their existing networks to meet increased subscriber demand or enhancing their networks to support more sophisticated communication services.

UMTS revenues increased substantially in 2004 compared to 2003 primarily due to increased subscriber demand, new contracts with certain service provider customers and other customers expanding their existing networks and the continued transition to this next generation technology.

CDMA revenues increased slightly in 2004 compared to 2003 due to an increase in the U.S. and substantial increases in EMEA and CALA. The increases in these regions were primarily due to new contracts with certain service provider customers and other customers upgrading and expanding their existing networks to meet increased subscriber demand. These increases in revenues were partially offset by substantial declines in Asia Pacific and Canada primarily due to the completion of certain customer network deployments during the first half of 2003.

TDMA revenues declined substantially in 2004 compared to 2003 primarily due to the continued transition by customers to newer wireless technologies. The substantial decline was primarily due to customers across all regions continuing to migrate from the mature TDMA technology to GSM and CDMA technologies. In 2004, TDMA revenues accounted for less than 2% of total Wireless Networks revenues compared to 6% of total Wireless Networks revenues in 2003.

2003 vs. 2002

Wireless Networks revenues increased 5% in 2003 compared to 2002 due to a 31% increase in the second half of 2003 partially offset by a 17% decrease in the first half of 2003 compared to the same periods in 2002. The 31% increase in the second half of 2003 was primarily due to increased spending by our 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 service providers on capital and cash flow management and increased competition for customers by 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

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due to a substantial increase in the U.S. and Canada as a result of our customers expanding their existing networks and upgrading their existing networks to higher data speeds. The substantial increase in the U.S. and Canada was partially offset by a substantial decrease in EMEA. This substantial decline was primarily due to the completion of key customer network deployments during the first half of 2003, which had been underway in 2002.

The decrease in CDMA revenues in the first half of 2003 compared to the same period in 2002 was primarily due to a substantial decline in Canada and a decline in the U.S. as customers continued to experience capital spending restrictions as a result of their continued focus on capital and cash flow management. In Asia Pacific, CDMA revenues increased substantially in the first half of 2003 compared to the same period in 2002 primarily due to new contracts with certain service provider customers and other customers expanding their existing networks to meet increased subscriber demand.

GSM revenues increased significantly in 2003 compared to 2002 due to a substantial increase in revenues in the second half of 2003 compared to the same period in 2002. This substantial increase was partially offset by a significant decrease in the first half of 2003 compared to the same period in 2002.

The substantial increase in GSM revenues in the second half of 2003 compared to the same period in 2002 was primarily due to a substantial increase in the U.S. and EMEA. The substantial increase in the U.S was primarily due to accelerated network expansions with certain service providers to meet increased subscriber demand. The substantial increase in EMEA was mainly due to new contracts with certain service provider customers and other customers expanding their existing networks.

The significant decrease in GSM revenues in the first half of 2003 compared to the same period in 2002 was primarily due to substantial declines in Canada and Asia Pacific and a significant decline in the U.S. The substantial decline in Asia Pacific was mainly due to a decline in the overall growth rate of GSM technology deployments by 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.

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.

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.

2005

We continue to expect a growing percentage of our Wireless Networks revenues to come from our UMTS technology driven by strong growth anticipated in EMEA and Asia Pacific and moderate growth anticipated in other global markets. For 2005, we expect overall revenue growth over 2004 primarily due to anticipated growth in our next generation wireless technologies, expansion and enhancement of existing networks by our customers due to subscriber growth and competitive pressures, build-out of the BSNL contract in the Asia Pacific region and focus on our new product areas, such as WLAN.

Spending by our customers in the above areas of our business is expected to be partially offset by pricing pressures on sales of certain of our products as a result of increased competition, particularly from low cost suppliers.

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.

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Enterprise Networks revenues

The following chart summarizes recent quarterly revenues for Enterprise Networks:

2004 vs. 2003

Enterprise Networks revenues decreased 9% in 2004 compared to 2003 due to a significant decrease in the circuit and packet voice portion of this segment and a slight decrease in the data networking and security portion of this segment.

Revenues from the circuit and packet voice portion of this segment decreased significantly primarily due to a substantial decrease in revenues associated with our traditional circuit switching and interactive voice response products primarily in the U.S. This substantial decrease in revenues was primarily a result of the release of certain software, including the general availability of Succession 3.0 in the fourth quarter of 2003. The general availability of this software triggered the recognition of associated revenues deferred from prior periods, resulting in a net increase in revenues of $150 in 2003 ($300 in the fourth quarter of 2003) that did not occur to the same extent in 2004. In addition, revenues from certain products associated with various software upgrade marketing programs initiated in 2004 did not meet the criteria for revenue recognition in 2004 and were deferred to future periods. This decrease was partially offset by an increase in revenues across all regions primarily associated with our converged Internet Protocol, or IP, telephony solutions as customers continued to migrate towards converged packet voice solutions from our traditional circuit switching products.

Revenues associated with the data networking and security portion of this segment decreased slightly primarily due to a decline in revenues associated with our legacy routing portfolio and associated declines in new service contracts and service contract renewals. We also experienced a decline in revenue from certain of our data networking products primarily due to pricing pressures driven by increased competition. In addition, in 2003, we recognized revenues of approximately $60 compared with revenues of approximately $30 in 2004 primarily in the U.S. associated with the delivery of certain data switch upgrades. These declines were partially offset by growth from improved market penetration of certain new products.

2003 vs. 2002

Enterprise Networks revenues increased 7% in 2003 compared to 2002 due to a substantial increase in the circuit and packet voice portion of this segment offset by a significant decrease in the data networking and security portion of this segment.

Revenues from the circuit and packet voice portion of this segment increased substantially in 2003 compared to 2002. We experienced a substantial increase in revenues associated with our traditional circuit switching and interactive voice response solutions primarily in the U.S. as a result of the release of certain software, including the general availability of Succession 3.0 in the fourth quarter of 2003. The general availability of this software triggered the recognition of associated revenues deferred from prior periods, resulting in a net increase in revenues of $150 in 2003 ($300 in the fourth quarter of 2003). In addition, there was a substantial increase in revenues associated with our IP telephony solutions as customers continued to migrate towards converged packet voice solutions.

Revenues associated with the data networking and security portion of this segment decreased significantly in 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 solutions primarily due to pricing pressures driven by increased competition. This was partially offset by a net increase due to the recognition of previously deferred revenues associated with the delivery of certain data switch upgrades of approximately $60 in 2003.

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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 sequential increases 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.

2005

In 2005, we expect that data, voice and multimedia communications will continue to converge, and enterprises will look for ways to maximize the effectiveness of their existing networks while reducing ongoing capital expenditures and operating costs. Also, we anticipate that demand will continue to decline for our traditional circuit switching solutions; 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 key 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:

2004 vs. 2003

Wireline Networks revenues decreased 14% in 2004 compared to 2003 primarily due to a substantial decline in our traditional circuit switching product revenues.

Revenues from the circuit and packet voice portion of this segment decreased significantly primarily due to a substantial decline in our traditional circuit switching product revenues. The substantial decline in our traditional circuit switching product revenues was primarily due to continued reductions in capital expenditures by our U.S, Canada and EMEA service provider customers and a reduction in spending on our mature products in all regions. The substantial decline in traditional circuit switching product revenues was partially offset by the substantial increase in revenues related to our packet voice solutions in all regions but primarily in the U.S and CALA as customers transitioned to these next-generation products from our traditional circuit switching products.

Revenues from the data networking and security portion of this segment decreased significantly in 2004 compared to 2003 primarily due to substantial declines in the U.S. and Canada, and a significant decline in EMEA. In these regions, we experienced a decline in demand for our mature products primarily due to the ongoing shift towards IP-based technology.

2003 vs. 2002

Wireline Networks revenues decreased 22% in 2003 compared to 2002 primarily due to a substantial reduction in capital spending by our service provider customers as a result of the continued industry adjustment.

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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 the U.S 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 across all regions. In addition, the decline was due in part to the completion of a major contract in CALA in the first quarter of 2002. 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.

2005

In 2005, our service provider customers continue to increase the deployment of packet-based technologies in their communications networks as they look for ways to optimize their existing networks and offer new revenue generating services while 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. 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:

2004 vs. 2003

Optical Networks revenues decreased 23% in 2004 compared to 2003 primarily due to a substantial decline in the long-haul portion of this segment partially offset by a significant increase in the metro optical portion of this segment.

Revenues in the long-haul portion of this segment declined substantially in the U.S., Asia Pacific and EMEA, declined significantly in Canada and declined slightly in CALA. This was due in part to reduced spending by customers as they continued to focus on maximizing return on invested capital by increasing the capacity utilization rates and efficiency of existing networks. Significant excess inventories and capacity continued to exist in this portion of the segment which also resulted in ongoing pricing pressures across all regions. In addition, a substantial portion of the decline was a result of a cumulative correction made in the third quarter of 2004 for revenues previously recognized primarily in 2001 and 2002. These previously recognized revenues related to past sales of equipment to certain customers in the Asia Pacific region which we subsequently determined should have been deferred and recognized with the delivery of future contractual PCS and other services over the term of the PCS. A corresponding correction was made in the third quarter of 2004 to the associated costs of revenues which should also have been deferred and recognized with the delivery of future contractual PCS and other services. The adjustment to correct for the previously recognized revenues resulted in a reduction in revenues of approximately $80 in the third quarter of 2004. These revenues and associated costs of revenues will be recognized in future periods during the remaining term of the PCS. As a result of the corresponding correction made to the associated costs of revenues, there was no significant impact on our gross margin in 2004.

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Revenues in the metro optical portion of this segment increased significantly primarily due to certain service provider customers primarily in the U.S. and EMEA upgrading and expanding their existing networks. In 2004, the revenues in the metro optical portion of this segment surpassed the revenues in the long-haul portion.

2003 vs. 2002

Optical Networks revenues decreased 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 decreased substantially in 2003 compared to 2002 primarily due to the continuing industry adjustment, excess capacity, tightened capital markets mainly during the first half of 2003 and continued capital spending restrictions in the U.S., Canada and EMEA as customers continued to focus on maximizing return on invested capital by increasing the capacity utilization rates and efficiency of existing networks. In Asia Pacific, optical long-haul revenues declined substantially in 2003 compared to 2002 primarily due to the completion of network build-outs for certain customers in 2002 that were not repeated in 2003. In addition, significant excess inventories continued to exist in this portion of the segment which resulted in ongoing pricing pressures across all regions.

In the fourth quarter of 2002, we sold certain optical components assets to Bookham. As a result, our results in 2003 in the long-haul portion of this segment do not reflect revenues generated from these assets. In 2002, revenues generated from the optical components assets sold to Bookham were approximately 3% of the total Optical Networks revenues of $1,815.

Revenues in the metro optical portion of this segment were relatively flat in 2003 compared to 2002. This was primarily due to a substantial decrease in EMEA partially offset by an increase in revenues in the U.S. and a substantial increase in Asia Pacific. The substantial decrease in EMEA was primarily the result of the continued industry adjustment, tightened capital markets mainly during the first half of 2003 and customer spending restrictions. The increase in revenues in the U.S. and the substantial increase in Asia Pacific were primarily due to new customer contracts during the first half of 2003 for expansions of existing networks to meet increased customer demand.

2005

In 2005, our major customers in the optical long-haul portion of Optical Networks remain focused on maximizing return on their invested capital by increasing the capacity utilization rates and efficiency of existing networks. We expect that any additional capital spending by those customers in the near term will be increasingly directed to opportunities that enhance customer performance, revenue generation and cost reduction.

We anticipate an increase in demand for Dense Wavelength Division Multiplexing solutions within the metro optical portion of this segment. This expected 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 increased demand 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.

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Geographic revenues

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

2004 vs. 2003

From a geographic perspective, the 4% decrease in revenues in 2004 compared to 2003 was primarily due to a:

	•		11% decline in revenues in the U.S. primarily due to a substantial decrease in Wireline Networks revenues as our customers continued to reduce capital expenditures on our traditional circuit switching products. The decrease in the U.S. is also due in part to a substantial decrease in Enterprise Networks revenues primarily due to the recognition of revenues in 2003 deferred from prior periods that did not occur to the same extent in 2004 as described under “Enterprise Networks revenues”. In addition, the long-haul portion of the Optical Networks segment decreased substantially due in part to reduced spending by customers as they continued to focus on maximizing return on invested capital by increasing the capacity utilization rates and efficiency of existing networks. Significant excess inventories and capacity continued to exist in this portion of the segment which also resulted in ongoing pricing pressures. These declines were partially offset by an increase in Wireless Networks revenues primarily due to new contracts with certain customers and other customers upgrading and expanding their existing networks to meet increased subscriber demand on our GSM and CDMA solutions;
	•		4% decline in revenues in Asia Pacific due in part to ongoing pricing pressures and reductions in capital spending for optical products. In addition, a substantial portion of the decline in Asia Pacific was a result of a cumulative correction of approximately $80 made in the third quarter of 2004 for revenues previously recognized primarily in 2001 and 2002 relating to the delivery of future contractual PCS and other services, as described under “Optical Networks revenues”. Further, CDMA revenues declined substantially primarily due to the completion of certain customer network deployments during the first half of 2003. These declines were partially offset by a substantial increase of GSM revenues due to increased subscriber demand; and
	•		3% decline in revenues in Canada primarily due to a significant decrease in Wireline Networks revenues as our customers continued to reduce capital expenditures on our traditional circuit switching products. Further, CDMA revenues declined substantially primarily due to the completion of certain customer network deployments during the first half of 2003; partially offset by
	•		9% increase in revenues in EMEA primarily due to GSM and UMTS network expansion related to increased subscriber demand partially offset by continued reductions in capital expenditures on our traditional circuit switching products by our wireline service provider customers; and
	•		17% increase in revenues in CALA primarily from new GSM and CDMA contracts with certain wireless service provider customers and other customers upgrading and expanding their existing networks to meet increased subscriber demand. In addition, the increase was due to an increase in our packet voice solutions as wireline service provider customers transitioned to these next-generation products from our traditional circuit switching products.

2003 vs. 2002

From a geographic perspective, the 7% decline in revenues in 2003 compared to 2002 was due to a:

•

7% decline in revenues in the U.S. primarily due to capital spending restrictions experienced by our wireline 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

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			in the fourth quarter of 2003 which triggered the recognition of associated Enterprise Networks revenues deferred from prior periods resulting in a net increase in revenues of $150 in 2003 ($300 in the fourth quarter of 2003). In addition, Enterprise Networks revenues increased due to the recognition of deferred revenues of approximately $60 associated with certain data switch upgrades in 2003. Further, Wireless Networks revenues increased as GSM and CDMA customers upgraded and expanded their existing networks in the second half of 2003;
	•		12% decline in revenues in Asia Pacific primarily due to a substantial decline in optical long-haul revenues 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 the optical long-haul market which resulted in ongoing pricing pressures. In addition, the decline was due to capital spending restrictions by our wireline service provider customers;
	•		5% decline in revenues in EMEA primarily due to a substantial decline in optical long-haul revenues as customers continued to focus on maximizing return on invested capital by increasing the capacity utilization rates and efficiency of existing networks. The decline was also due to capital spending restrictions by our wireline service provider and enterprise customers and tightened capital markets mainly during the first half of 2003. This decline 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 a substantial decline in optical long-haul revenues as customers continued to focus on maximizing return on invested capital by increasing the capacity utilization rates and efficiency of existing networks. The decline was also due to capital spending restrictions experienced by our wireless service provider customers and their focus on capital and cash flow management 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 Wireline Networks contract in the first quarter of 2002 and continued capital spending restrictions experienced by our wireline service provider customers, which was partially offset by increases in revenues related to new GSM contracts with certain wireless service provider customers.

Consolidated gross profit and gross margin

Gross profit decreased $239 and gross margin decreased 0.9 percentage points in 2004 compared to 2003 primarily due to:

	•		a decrease of approximately $540 primarily as a result of (i) pricing pressures on certain of our products due to increased competition for service provider and enterprise customers; (ii) unfavorable product mix associated with increased sales of our next generation products which typically have lower gross margins in the early stages of product evolution; and (iii) lower sales volumes of network expansion products and software upgrades that typically have higher margins;
	•		an estimated project loss of approximately $160 related to a contract with BSNL in India recognized in 2004. For further information related to the BSNL contract, see “Developments in 2004 and 2005 — Other business developments — Bharat Sanchar Nigram Limited”;
	•		a decrease of approximately $200 due to overall lower sales volumes; and
	•		a one-time reduction in accruals of $53 associated with a certain customer bankruptcy settlement in the third quarter of 2003 not repeated in 2004; partially offset by
	•		an estimated increase of approximately $400 due to continued improvements in our cost structure primarily as a result of lower material pricing;
	•		an increase of approximately $205 primarily due to (i) an absence of significant inventory provision costs that were incurred in prior years as a result of excess inventories due to a decline in revenues in the Optical Networks segment of our business; and (ii) lower warranty costs as a result of improved product quality; and
	•		an approximate $85 decrease in expenses related to our employee return to profitability, or RTP, and regular bonus plans which were not incurred in 2004.

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Gross profit increased $477 and gross margin increased 7.4 percentage points in 2003 compared to 2002 primarily due to:

	•		an estimated increase of approximately $760 due to continued improvements in our cost structure primarily as a result of lower material pricing and the continued impact of our workforce reductions;
	•		an increase of approximately $195 primarily due to (i) absence of significant inventory provision costs that were incurred in prior years as a result of excess inventories due to a decline in revenues in the Optical Networks segment of our business; partially offset by (ii) an increase in warranty costs associated with certain product defects identified in 2003; and
	•		a one-time reduction in accruals of $53 associated with a certain customer bankruptcy settlement in the third quarter of 2003; partially offset by
	•		reductions of $415 due to overall lower sales volumes;
	•		an approximate $85 increase in expenses related to our employee RTP and regular bonus plans incurred in 2003 which were not incurred in 2002; and
	•		a decrease of approximately $72 primarily as a result of (i) pricing pressures on certain of our products due to increased competition for service provider and enterprise customers; and (ii) unfavorable product mix associated with increased sales of our next generation products which typically have lower gross margins in the early stages of product evolution; partially offset by higher sales volumes of network expansion products and software upgrades that typically have higher margins.

While we cannot predict the extent to which changes in product mix and pricing pressures will continue to impact our gross margin, we continue to see the effects of improvements in our product costs primarily due to favorable supplier 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% of revenue for the full year 2005. See “Risk factors/forward looking statements” for factors that may affect our gross margins. See “Segment Management EBT” for a discussion of our gross margins by segment.

Consolidated operating expenses

Selling, general and administrative expense

SG&A expense increased $193 and increased from 18.9% to 21.6% as a percentage of revenues in 2004 compared to 2003 primarily due to:

	•		costs related to our restatement activities of approximately $115 in 2004;
	•		significant unfavorable foreign exchange impacts associated with the strengthening of the Canadian dollar, euro and British pound against the U.S. dollar;
	•		an increase in expense related to our stock-based compensation plans, including restricted stock unit and stock option programs; and
	•		net trade and customer financing receivable recoveries totaling $127 in 2004 compared to a recovery of $179 in 2003. Recoveries were higher in 2003 as a result of favorable settlements related to the sale or restructuring of various receivables and net recoveries on other trade and customer financing receivables due to subsequent collections for amounts exceeding our original estimates of net recovery; partially offset by
	•		a decrease of approximately $120 related to our RTP and regular bonus plans in 2004 compared to 2003.

SG&A expense declined $601 and decreased from 23.0% to 18.9% as a percentage of revenues in 2003 compared to 2002 primarily due to:

•

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

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	•		a net decrease of $471 (recovery of $179 in 2003 and expense of $292 in 2002) related to increased net trade and customer financing receivable recoveries; partially offset by
	•		an increase of approximately $120 related to our RTP and regular bonus plans in 2003 compared to 2002;
	•		an increase due to significant foreign exchange impacts associated with the strengthening of the Canadian dollar, euro and British pound against the U.S. dollar; 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.

See “Segment Management EBT” for a discussion of our SG&A expense by segment.

Research and development expense

R&D expense remained flat in 2004 compared to 2003 and decreased $119 in 2003 compared to 2002 primarily due to unfavorable foreign exchange impacts associated with the strengthening of the Canadian dollar, euro and British pound against the U.S. dollar partially offset primarily by the continued impact of our workforce reductions.

Our continued strategic investments in R&D are aligned with technology leadership in anticipated growth areas. In 2004, 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 increased by 0.6 percentage points to 19.9% in 2004 compared to 19.3% in 2003, both of which were up from 19.0% in 2002.

We expect to continue to manage R&D expense according to the requirements of our business, allocating resources and investment where customer demand dictates, and reducing resources and investment where opportunities for improved efficiencies present themselves. Our R&D efforts are currently focused on secure and reliable converged networks including:

	•		packetization of voice and multimedia IP telephony solutions services;
	•		services edge capability to realize simplification of customer network operations and broadband access technologies, including wireless and wireline; and
	•		enhanced network security to ensure the level of reliability and performance that has traditionally existed in carrier networks.

We expect that our R&D expense as a percentage of revenue in 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 “Segment Management EBT” for a discussion of our R&D expense by segment.

We expect operating expenses (both SG&A expense and R&D expense) as a percent of revenue to trend towards the low 30’s by the end of 2005 primarily driven by benefits from our previously announced restructuring work plan and reduction in restatement, accounting and reporting costs. See “Business overview — Our strategic plan and outlook”.

Special charges

We implemented our work plan to streamline our operations and activities around our core markets and leadership strategies during 2001, or the 2001 Restructuring Plan, 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.

In addition, we initiated activities in 2003 to exit certain leased facilities and leases for assets no longer used across all segments.

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, including a voluntary retirement program, of approximately 3,250 employees, real estate optimization and other cost containment actions such as

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reductions in information services costs, outsourced services and other discretionary spending across all segments but primarily in Wireline Networks and Optical Networks, or the 2004 Restructuring Plan. Approximately 64% of employee actions related to the focused workforce reduction were completed by the end of 2004, including approximately 55% who were notified of termination or acceptance of voluntary retirement, with the remainder comprised of voluntary attrition of employees who were not replaced. The remainder of employee actions is expected to be completed by June 30, 2005. This workforce reduction is in addition to the workforce reduction that will result from our agreement with Flextronics. For more information, see “Developments in 2004 and 2005 — Evolution of our supply chain strategy”. We expect the real estate actions to be completed by the end of 2005.

We estimate charges to earnings associated with the 2004 Restructuring 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. We incurred aggregate charges of $160 in 2004 with the remainder expected to be incurred in 2005.

The associated cash costs of the 2004 Restructuring 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 relate to the real estate actions and are expected to be incurred in 2006 through to 2022 for ongoing lease costs related to impacted real estate facilities. In addition to the above, we also expect to incur capital cash costs of approximately $50 in 2005 for facility improvements related to the real estate actions.

We anticipate cost savings from the implementation of the 2004 Restructuring Plan of approximately $500 in 2005 primarily due to reductions to cost of revenues, SG&A, and R&D of approximately 20%, 40% and 40%, respectively, across all segments but primarily in Wireline Networks and Optical Networks. The majority of the cost reductions are expected to be substantially realized in the results of operations in the second half of 2005 and will be partially offset by the costs associated with new hires added throughout 2005. We expect that this work plan will primarily be funded with cash from operations.

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During the years ended December 31, 2004, 2003 and 2002, we continued to implement these restructuring work plans. Special charges recorded from January 1, 2002 to December 31, 2004 were as follows: