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control over financial reporting (throughout this report, unless otherwise indicated, “reportable condition” and “material weakness” have the
meanings as formerly set forth under standards established by the American Institute of Certified Public Accountants, or AICPA). Later, on
November 18, 2003, as part of the communications by D&T to the Audit Committee with respect to D&T’s interim audit procedures for the
year ended December 31, 2003, D&T informed the Audit Committee that it had identified certain reportable conditions, each of which
constituted a material weakness in our internal control over financial reporting. These material weaknesses identified in the First Restatement
were also later identified in connection with the Second Restatement together with certain additional material weaknesses in our internal
control over financial reporting, as described in greater detail in the “Controls and Procedures” section of this report.
In late October 2003, the Audit Committee initiated the Independent Review and engaged WCPHD to advise it in connection with the
Independent Review in order to gain a full understanding of the events that caused significant excess liabilities to be maintained on the balance
sheet that needed to be restated, and to recommend that our Board of Directors adopt, and direct management to implement, necessary remedial
measures to address personnel, controls, compliance and discipline. The Independent Review focused initially on events relating to the
establishment and release of contractual liability and other related provisions (also called accruals reserves, or accrued liabilities) in the second
half of 2002 and the first half of 2003, including the involvement of senior corporate leadership. As the Independent Review evolved, its focus
broadened to include specific provisioning activities in each of the business units and geographic regions. In light of concerns raised in the
initial phase of the Independent Review, the Audit Committee expanded the review to include provisioning activities in the third and fourth
quarters of 2003.
As discussed more fully in the “Controls and Procedures” section of this report, the Independent Review concluded that
“[i]n summary, former
corporate management (now terminated for cause) and former finance management (now terminated for cause) in the Company’s finance
organization endorsed, and employees carried out, accounting practices relating to the recording and release of provisions that were not in
compliance with [U.S. GAAP] in at least four quarters, including the third and fourth quarters of 2002 and the first and second quarters of
2003. In three of those four quarters — when Nortel was at, or close to break even — these practices were undertaken to meet internally
imposed... targets. While the dollar value of most of the individual provisions was relatively small, the aggregate value of the provisions made
the difference between a profit and a reported loss, on a pro forma basis, in the fourth quarter of 2002 and the difference between a loss and a
reported profit, on a pro forma basis, in the first and second quarters of 2003.”
As the Independent Review progressed, the Audit Committee directed new corporate management to examine in depth the concerns identified
by WCPHD regarding provisioning activity and to review provision releases, down to a low threshold. That examination, and other errors
identified by management, led to the Second Restatement.
Over the course of the Second Restatement process, management identified certain accounting practices that it determined should be adjusted
as part of the Second Restatement. In particular, management identified certain errors related to revenue recognition and undertook a process of
revenue reviews, resulting in adjustments to previously reported revenues during the periods 1999 through 2003. Other accounting practices
that management examined and adjusted as part of the Second Restatement included, among other things the following:
The following tables present the impact of the Second Restatement adjustments on our previously reported consolidated statements of
operations data for the years ended December 31, 2002 and 2001. The Second Restatement adjustments related primarily to the following
items, each of which reflect a number of related adjustments that have been aggregated for disclosure purposes, and are described in the
paragraphs following the tables below. See “Restatement” in note 3 of the accompanying consolidated financial statements.
42
Inde
p
endent Review
Second Restatement
• intercompany balances that did not eliminate upon consolidation and related provisions;
• our foreign exchange accounting, as part of the plan to address our identified material weakness related to foreign currency
translation;
• the accounting treatment of the February 2001 acquisition of the 980 NPLC business from JDS Uniphase Corporation, or JDS, and
the related OEM Purchase and Sale Agreement;
• special charges relating to goodwill, inventory impairment, contract settlement costs and other charges; and
• the accounting treatment of certain elements of discontinued operations.
Years ended December 31, 2002 and 2001
• revenues and cost of revenues;
• foreign exchange;
• intercompany balances;
• special charges;
•other;
• reclassifications; and
• discontinued operations.