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F-16
3
.
R
estatement
First Restatemen
t
In May 2003, Nortel Networks commenced certain balance sheet reviews at the direction of certain members of former management that
led to a comprehensive review and analysis of its assets and liabilities (the “Comprehensive Review”), which resulted in the restatement
(effected in December 2003) of its consolidated financial statements for the years ended December 31, 2002, 2001 and 2000 and for the
quarters ended March 31, 2003 and June 30, 2003 (the “First Restatemen
t
”).
The Comprehensive Review purported to (i) identify balance sheet accounts that, as of June 30, 2003, were not supportable and required
adjustment; (ii) determine whether such adjustments related to the third quarter of 2003 or prior periods and (iii) document certain
account balances in accordance with Nortel Networks accounting policies and procedures. The Comprehensive Review as supplemented
by additional procedures carried out between July 2003 and November 2003 to quantify the effects of potential adjustments in the
relevant periods and review the appropriateness of releases of certain contractual liability and other related provisions (also called
accruals, reserves or accrued liabilities) in the six fiscal quarters ending with the fiscal quarter ended June 30, 2003 formed the basis for
the adjustments made to the financial statements in the First Restatement.
On December 23, 2003, Nortel Networks filed with the SEC an amended Annual Report on Form 10-K/A for the year ended
December 31, 2002 (the “2002 Form 10-K/A”) and amended Quarterly Reports on Form 10-Q/A for the first and second quarters of 2003
(the “2003 Form 10-Q/As”) reflecting the First Restatement. As disclosed in those reports, the net effect of the First Restatement
adjustments was a reduction in accumulated deficit of $497, $178 and $31 as of December 31, 2002, 2001 and 2000, respectively.
Second Restatemen
t
In late October 2003, the Audit Committee of Nortel Networks and NNL’s Boards of Directors (the “Audit Committee”) initiated an
independent review of the facts and circumstances leading to the First Restatement (the “Independent Review”) and engaged the law firm
now known as Wilmer Cutler Pickering Hale & Dorr LLP (“WCPHD”) to advise it in connection with the Independent Review. The
Audit Committee sought to gain a full understanding of the events that caused significant excess liabilities to be maintained on the
balance sheet that needed to be restated, and to recommend that the Board adopt, and direct management to implement, necessary
remedial measures to address personnel, controls, compliance and discipline. The Independent Review focused initially on events relating
to the establishment and release of contractual liability and other related provisions in the second half of 2002 and the first half of 2003,
including the involvement of senior corporate leadership. As the Independent Review evolved, its focus broadened to include specific
provisioning activities in each of the business units and geographic regions. In light of concerns raised in the initial phase of the
Independent Review, the Audit Committee expanded the review to include provisioning activities in the third and fourth quarters of 2003.
As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns
identified by WCPHD regarding provisioning activity and to review provision releases in each of the four quarters of 2003, down to a
low threshold. That examination, and other errors identified by management, led to the restatement of Nortel Networks consolidated
financial statements for the years ended December 31, 2002 and 2001 and the quarters ended March 31, 2003 and 2002, June 30, 2003
and 2002 and September 30, 2003 and 2002 (the “Second Restatement”).
Over the course of the Second Restatement process, management also identified certain accounting practices that it determined should be
adjusted as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and
undertook a process of revenue reviews. In light of the resulting adjustments to revenues previously reported, the Audit Committee has
determined to review the facts and circumstances leading to the restatement of these revenues for specific transactions identified in the
Second Restatement. This review will have a particular emphasis on the underlying conduct that led to the initial recognition of these
revenues. Other accounting practices that management examined and adjusted as part of the Second Restatement included, among other
things, the following:
• Nortel Networks foreign exchange accounting as part of management’s plan to address an identified material weakness related
to foreign currency translation;
• intercompany balances that did not eliminate upon consolidation and related provisions;
• the accounting treatment of the February 2001 acquisition of the 980 NPLC business from JDS Uniphase Corporation (“JDS”)
and the related OEM Purchase and Sale Agreement;
• special charges relating to goodwill, inventory impairment, contract settlement costs and other charges; and
• the accounting treatment of certain elements of discontinued operations.
Due to, among other factors, significant turnover in Nortel Networks finance personnel, changes in accounting systems, documentation
weaknesses, and identified material weaknesses in internal control over financial reporting, the Second Restatement involved hundreds of
Nortel Networks finance personnel and a number of outside consultants and advisors. The process required the review and verification of
a substantial number of documents and